Spur private investment for 8% growth, says Economic Survey

The Economic Survey 2019-20 has laid emphasis on private investment, which has lagged in the recent years, as the "key driver" of demand, capacity creation, labour productivity enhancement, introduction of new technology and generation of jobs.

The Survey, tabled by Finance Minister Nirmala Sitharaman in Parliament a day before the Budget on Thursday, says it was, therefore "critical" to put in place an ecosystem for private investment through optimal tax policy, calibrated expansion of the financial system, framework for risk-return trade-off and other such policy measures.

"Continuing the creation of an ecosystem for private investment, especially in the new economy, is therefore critical to enable the virtuous cycle of investment, demand, exports, growth and jobs," states the blueprint for long-term economic vision.

In its second term, Prime Minister Narendra Modi-led government is looking to grow the economy to $5 trillion by fiscal 2025. For this, India would need a sustained real GDP growth rate of 8%.

The survey, prepared by Chief Economic Adviser Krishnamurthy Subramanian, believes such growth can only be sustained by a "virtuous cycle of savings, investment and exports catalysed and supported by a favourable demographic phase".

It said this was evident from similar global experiences, especially in China and East Asia, where high growth rates were sustained only by an economic model propelled a virtuous cycle of saving investments and exports.

For fostering innovative investments, the survey sees optimal tax policy as a critical aspect but admits that achieving optimality in this regard would not be "an easy task".

"Several studies have also suggested that capital gains tax can have significant economic consequences for individual investors in terms of its lock-in effects and associated deterring incentives to use capital gains into riskier investments (Meade, 1990). Design of optimal tax policy also aims to raise revenue efficiently and fairly, while encouraging the bonafide taxpayers and punishing the mala fide ones. However, achieving this optimality is not an easy task. Therefore, to foster investment, getting this balance right is extremely critical in the Indian context," said the survey.

And even as it backs the investment-led growth model, which necessitates rapid expansion of financial system "by a factor of magnitude", the survey cautioned against the risk of disturbing the savings-investment dynamics.

"This is no idle concern as illustrated by the Asian Crisis of 1997-98. Some Southeast Asian countries appeared to be recreating the East Asian miracle in the nineties, but were unable to sustain the virtuous cycle because of large scale misallocation of capital," warned the Economic Survey.

It cites the domestic experience of rapid credit expansion in 2006-2012 that had seen a decline in the quality of credit with its rapid expansion.

"In this context, recent efforts to clean up the banks and establish a bankruptcy process should be seen as a valuable investment that must be completed. If India had attempted to press the accelerator five years ago, it would have almost certainly been hit by a major financial crisis in a few years. Painful as it may have seemed, the banking sector clean-up and the IBC framework are important foundations that will now reap benefits when the investment-driven growth model is put into motion as the incentives get aligned towards better quality lending," it said.

In the follow-up to the cleaning up of the financial services system, the Survey expected the cost of capital to drop. It saw the high capital cost adversely impacting the investment prospects in the country.

Devendra Pant, chief economist and senior director, India Ratings and Research, said it will be a while before the private investment begins trickling into the system in a meaningful way.

He said the government had limited capacity to sustain an overall virtuous cycle of investment, savings and exports.

"We are seeing private consumption growth is slowing. What has happened is that over the years the savings rate has gradually come down. In FY18, the saving rate was 30.5%. It has come down because of the household sector, which is the main contributor to overall savings," said Pant.

He also said there was still a capacity overhang in the system. As per the latest Reserve Bank of India data, overall capacity utilisation was at around 75-76%.

Pant said the government should first "crowd in" private investment in the infrastructure sector and improve the household sector; "improvement in the household sector will lead to an improvement in demand. However, unless corporate balance-sheets improve it will an uphill task to kick-start meaningful private investment".

He also feels that if the time taken for IBC resolution is reduced then a lot of existing capacity, currently lying idle, can be utilised with new investors coming in. This, he said, will reduce stress on the banking sector.

He, however, said bringing capacity back on the block would be futile unless demand also picked up.