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Private Investment in the Indian Economy

  • Context (TH): The slow increase in private investment is a significant problem for the Indian economy.
  • Private investment is measured by private gross fixed capital formation (% of GDP).
  • Private investment has consistently declined since 2011-12.
  • Impact: Low private investment can lead to slower economic growth because a larger fixed capital base is needed to boost economic output.
  • In 2019, the government reduced corporate taxes from 30% to 22% in hopes of stimulating private investment.

About GFCF

  • Gross Fixed Capital Formation (GFCF) measures the growth in fixed capital in an economy.
    • Fixed capital includes things like buildings and machinery that require investment to be created.
  • GFCF is important because fixed capital helps workers produce more goods and services, leading to economic growth and better living standards.
  • Developed economies like the U.S. have more fixed capital per person compared to developing economies like India.
  • Private GFCF gives an idea of how much the private sector is investing in the economy.
  • It also includes government investment in fixed capital.
  • Before economic reforms, private investment hovered around 10% of the GDP. Public investment, however, steadily rose over the decades, surpassing private investment as a percentage of GDP by the early 1980s.
  • After the Economic reforms, Private investment in India increased significantly, which boosted confidence in the private sector.
    • After liberalisation, private investment took the lead in fixed capital formation, while public investment declined.
    • Private investment continued to grow until the global financial crisis of 2007-08, reaching around 27% of GDP.
    • Since 2011-12, private investment has been declining, hitting a low of 19.6% of GDP in 2020-21.

Reasons for falling private investment

Low private consumption expenditure

  • Economists argue that businesses need strong consumer spending to have confidence in future demand for their products before investing in fixed capital.
  • To address this, economists suggest the government should increase people’s disposable income to boost consumption expenditure and stimulate private investment.

Analysis

  • However, historically, an increase in private consumption has not necessarily led to higher private investment in India.
  • In fact, a drop in consumption spending has sometimes boosted private investment. Since 2011-12, private consumption has risen while private investment has fallen.

Structural problems

  • Few Economists point to unfavourable government policies and policy uncertainty as major issues affecting private investment.
  • The increase in private investment in the 1990s and 2000s was linked to the economic reforms initiated in 1991.
  • Conversely, the decline in private investment correlated with a slowdown in the pace of reforms over the last two decades under both UPA and NDA governments.
  • Policy uncertainty can discourage private investment because investors prefer stability to undertake risky long-term projects.

Can Public Investment lead the way?

  • Some see the government’s push to increase government investment as negative because it may crowd out private investment. However, others believe that government investment offsets the lack of private investment.
  • Private investors are considered better allocators of capital than public officials, which helps prevent wasteful spending.
  • Taxes imposed to raise money for public spending can also weigh heavily on the economy.
  • “Crowding out” refers to a situation where government spending (which is part of fiscal policy) discourages (private) investment spending in the economy.
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