India's World-Beating Growth Hides Troubling Investment Trend

Investment had been trending down for about a decade going into the pandemic, despite efforts by the government to revive it

India has bounced back strongly from the pandemic and stands poised to claim the mantle of fastest-growing economy in 2021 and probably 2022 as well. The government's latest projections are for a 9.2 per cent expansion in the fiscal year that ends in March. Forecasts from the International Monetary Fund have growth dipping to 8.5 per cent the following year, but even at that slower pace, India is expected to outshine all major economies.

While the headline numbers are impressive, they conceal a troubling trend. Gross fixed capital formation, a measure that encompasses investment in physical assets from plants and equipment to bridges and roads, amounts to less than one-third of gross domestic product, according to World Bank data. In China, it's more than 40 per cent. Reserve Bank of India Governor Shaktikanta Das remarked in early December that private investment “is still lagging,” which could jeopardize the improvement in aggregate demand.

There's a broad consensus among economists that India needs to boost that number to ensure a sustainable recovery. The government is winding down its pandemic stimulus, motivated in part by the risk of having India's sovereign debt rating downgraded to junk. And while the central bank kept interest rates low even as inflation ticked higher in 2021, economists surveyed by Bloomberg are predicting 60 basis points of hikes in this calendar year.

Pent-up demand from households that were forced to retrench during two waves of Covid-19 infections will help underpin growth, but it will fade as the year wears on. “The two drivers that were there in the pre-Covid period—private consumption and government spending—will not be growing at the same pace,” says Nikhil Gupta, chief economist at Motilal Oswal Financial Services Ltd. “So the only possible driver is private investment, which has yet to show strong pickup.”