MacroScan - Investment in the Time of Economic Liberalisation

There was a short but influential period in recent years when Indian policy makers sought to persuade themselves and others that economic liberalisation and greater reliance on market mechanisms would imply that future economic growth would result from increased efficiency of investment rather than rises in the investment to GDP ratio. This line of reasoning used the argument that high ICORs (Incremental capital output ratios) which were observed in India essentially reflected high costs and inefficiency of resource use, which would be corrected by the liberalising regime. This in turn, it was argued, would mean that higher growth would result even from the same rate of investment, as ICORs would fall across sectors.

The actual pattern of growth over the 1990s has belied that assumption, especially as growth rates have spluttered and decelerated in the past few years. There is now less talk in official policy circles about improved ICORs (especially since the data indicate anything but such improvement) and more declaration that the reforms have succeeded in bringing about an increase in the aggregate rate of investment in the economy.

But is such an assertion justified ? In what follows, we examine the aggregate trends in investment over the past two decades, followed by a more disaggregated look at particular sectoral investment patterns since 1993-94. Such an exercise reveals that the ten years of liberalising reform thus far have not marked any break from previous trends in terms of increasing investment rates : rather, if anything, the longer run tendency of savings and investment rates appears to have slowed down over this period. Further, in the 1990s certain sectors and forms of capital formation have actually experienced declines.

Consider first the patterns in investment, savings and GDP growth over the past two decades. Chart 1 provides estimates of gross domestic capital formation and gross domestic savings as percentages of GDP, along with the rate of growth of GDP at 1993-94 prices from 1980-81 onwards. The first point to note is that GDP growth itself does not show any marked increase in the decade of the 1990s compared to the 1980s, and in fact after the peak rates of more than 7 per cent achieved during the middle of the decade have subsequently been lower.
Chart 1 >>

As Chart 1 shows, both savings and investment rates have increased over time. This increase in both is part of a trend of much longer duration, whereby savings and investment rates have tended to increase with economic development and as the economy expands, in an Engels curve type pattern whereby increased aggregate incomes also allow for a larger share for savings. Thus we find that savings rates have increased from an average of 9 per cent in the early 1950s, to 12 per cent in the early 1960s, to 15 per cent in the early 1970s, to 18 per cent in the early 1980s.

The increase in the subsequent period can be seen as part of this broad tendency. However, here it is interesting to note that while the year-on-year rate of increase of the investment rate between 1981-82 and 1990-91 was 20.5 per cent, between 1991-92 and 1999-2000 it was lower at 18.7 per cent. The rate of Gross Domestic Capital Formation increased from 20.3 per cent to touch a peak of 26.8 per cent in 1995-96, and has since declined and stagnated at around 23 per cent. Similarly, while the rate of savings increased by 16.4 per cent between 1981-82 and 1990-91 and reached a peak level of 25.1 per cent in 1995-96, over the period 1991-92 to 1999-2000 it actually fell marginally.

This is significant because the acceleration in rate of growth during the latter half of the 1980s occurred essentially because the investment rate which stood at around 20 per cent at the beginning of the 1980s rose to around 25 per cent by the end of that decade. As compared to this we find that during the 1990s, barring three years around the middle of the decade of the 1990s, the investment rate ruled at or well below its end-1980s level. Clearly, there is a link between the investment rate and growth, as is to be expected, and the current slowdown is the result of slack investment demand in the economy. Not surprisingly, the capital goods sector is the worst affected in the current recession.

Chart 2 allows a more disaggregated look at the behaviour of the savings rate. The important compositional change that is evident here is the gradual decline in public sector savings as a share of GDP. In fact the public sector over the 1990s moved from being a contributor to savings to being a net dissaver. This decline was not counterbalanced by increased private corporate savings; rather, it is the increased share of household savings which has prevented the savings rate from declining even further. The share of household savings in Gross Domestic Savings increased from 73 per cent in 1980-81, to 83 per cent in 1990-91, to as much as 89 per cent in 1999-2000. Private corporate savings reached a peak of 4.9 per cent of GDO in 1996-96 and subsequently declined to 3.7 per cent by the end of the decade.
Chart 2 >>