PLIs alone can’t spur investment

There could be some impatience on the part of the government over the rather indifferent response of the corporate sector when it comes to investment. Schemes such as PLI have been floated by the government to encourage industry to invest more in capital that will result in higher output which, in turn, will be rewarded with a cash-back of 4-6 per cent. Yet, the capital formation rate has moved rather sluggishly to 29.2 per cent, which is well below levels of 36.1 per cent seen in FY12.

There are two issues here. The first is the structure of capital formation in the economy in terms of which sector or institution provides the impetus. The second is consumption, which needs to increase to induce industry to invest more as capacity utilisation rates improve.

CSO data on gross capital formation presents an interesting picture on the entities involved in build-up of investment for the country. In FY21, which is the latest year for which this information is available, the biggest contributor was the household sector with a share of 39 per cent. Of this, 25.4 per cent was in houses, and 13.4 per cent was accounted for by plant and machinery. Therefore, it is necessary for individuals to buy more homes to drive investments.

The second part is the contribution of SMEs and this is the Achilles Heel. The plant and machinery emanating from the household sector is the investment made by SMEs. This segment has been buffeted quite sharply by the lockdowns and is in the process of recovering. Several micro and small units have also closed down, thus making the pushback stronger.

While the emergency credit line which guarantees loans taken by them help, the funds have been used for working capital, and hence survival, rather than growth. The government can consider a plan to provide a similar guarantee for pure investment purposes, which can be done through SIDBI.

The second largest player in capital formation is private non-financial corporate sector which has a share of around a third. Here, the main challenge is that companies will invest provided there is demand. The third important entity is the government with a share of around 16 per cent. These three segments account for almost 88 per cent of the country’s total capital formation.

Most of the government investment is in construction that gets reflected in roads and urban development. The challenge here is that while the Centre manages to meet its budgetary commitments, the States do not because they are grappling with fiscal constraints that often lead to cut back on capex spending to ensure fiscal deficit targets are not breached. The other significant entity is the PSU (non-financial) with a share of around 10 per cent. With several of them either in the throes of regulation (oil) or under financial strain (Discoms) or just being unviable and waiting to be disinvested, the drive for further investment is limited.

The other interesting aspect to capital formation in the economy is looking at it from the point of view of economic sectors that contribute to investment. The dominant sector here is real estate, with a share of 26.5 per cent, followed by manufacturing with 14.3 per cent. Hence, if one looks at the focus of the government on, say, the PLI, it impacts just one segment of the economy.

The ‘Transport, communications, storage’ segment has a share of 9.5 per cent of which, communications has 5.5 per cent. Investments here will be driven by the regulatory environment as telecom is one sector that has been embroiled in several controversies since the start of the last decade. The government sector has a share of 12.3 per cent (public administration, etc.) and agriculture 9.2 per cent. Electricity, gas, water, etc., has a share of 7.5 per cent.

Twofold problem

Some questions need to be posed. Are we doing enough on agriculture to push up investment here? Are we clear about how the telecom sector should grow, as with MNCs being involved, lack of clarity can be a deterrent (the Vodafone case)? Have we ironed out the problem on the power side (Discom issue)? What kind of push is being given to the real estate sector?

Therefore investment needs to go beyond the PLI which pertains to manufacturing to address challenges in terms of demand. When demand is stagnant there is less inducement to invest as there is a cost of capital as well as cost of holding inventory involved.

The problem today is twofold. The first is that jobs have not been created commensurate with economic growth, which was an issue even before the pandemic. This is why growth in income has been slower and has come in the way of incremental demand. The second issue is inflation. High inflation in some of the key consumption segments has militated against demand.

The overall consumption basket is skewed in the following manner. Food products account for a third of the basket followed by housing and transport which have a share of around 14.5 per cent each. Then come health, clothing and education with shares close to 5 per cent each. The CPI inflation has been persistently high in all these segments barring housing. As consumers maintain their consumption of these products or services, which are considered essential, there is less left for discretionary consumption thus leading to the demand-supply gap with the latter being higher. Such a scenario plays out also in non-consumption goods because at the end of the day all goods produced are linked to consumption. For steel demand to increase there needs to be either more cars being produced or houses constructed or factories coming up.

Therefore, the situation is quite complex and for investment to increase on a large scale, consumption too should be rising at a smart pace. This can be accomplished with more spending, through higher incomes being spent after being generated, which in turn leads to the issue of job creation. Also, we have to look at all sectors when providing incentives, and not just manufacturing. This can be a pointer for future policy decisions on investment.

The writer is Chief Economist, Bank of Baroda. Views are personal

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