Falling investments a cause for worry
There is an old proverb attributed to Confucius. It goes like this. If you want to plan for the next year, then plant some rice. If you want to plan for the next ten years, then plant a tree. But if you want to plan for a hundred years, then educate your children. Planning for tomorrow begins today, and longer the horizon, the more patient and more substantial should be your investment. The Chinese growth miracle of the past three decades was based on the availability of low cost labour, export-oriented growth and a welcoming approach towards foreign investors. But more than anything else, it was based on investing for the future. The investment to GDP ratio was consistently as high as 45 to 50 percent of GDP.
The latest data show that more than 11 trillion rupees worth of projects out of 100 trillion are stalled, and this ratio is the worst since 1995. The stalled projects syndrome continues to haunt us since 2010, but the ratio is deteriorating. Delays caused by government clearances continue to be a significant reason.
Of course it helped that most of the investment in infrastructure and large companies was done by the Chinese government. Highways, airports, high-speed railway connections –, all mushroomed rapidly. The Chinese were accused of “wasting capital” since there were no early signs of traffic or demand. The return on capital was pathetically low, it was alleged. Stories of ghost towns with empty tall buildings and highways to nowhere appeared in the Western press. But the fact is that the investment spending created a boom in industries like steel, cement, energy and metals, and also created large-scale employment. More importantly, that investment in infrastructure was going to serve the needs of future generations. So a long-term view guided the Chinese growth story, not myopia. Of course, the Chinese economy is struggling with excess capacity in many sectors, even as it tries to sell (or dump) in sluggish global markets.
The lesson for India is clear. At its stage of development, the ratio of investment spending to GDP must rise. It peaked at around 38 percent of GDP in 2009 but is down to 29 percent now. For the past three years, the growth rate of capital spending, captured by Gross Fixed Capital Formation (GFCF) has been steadily falling. For this fiscal year, it will be negative, possibly the first time in our history.
Large capital spending takes time to fructify. This is captured by the statistic called “projects under completion”, tracked by the Centre for Monitoring Indian Economy (CMIE) every quarter. The latest data show that more than 11 trillion rupees worth of projects out of 100 trillion are stalled, and this ratio is the worst since 1995. The stalled projects syndrome continues to haunt us since 2010, but the ratio is deteriorating. Delays caused by government clearances continue to be a significant reason.
But an additional reason is financial delinquency. This is reflected in what is called the “twin balance sheet” problem. On one hand the banks are burdened with stressed assets, which include bad loans and restructured loans (euphemism for forbearance). For quarter ending March this stressed asset ratio may climb to 16 percent of all banking assets. No wonder banks have little appetite to make large and new loans (despite the surge of cash due to demonetization). The credit flow to industry and projects is growing at single digits, if at all.
The twin balance sheet problem will be solved only when banks have adequate equity capital, their current loans start “performing” and when corporates develop the enthusiasm for large fresh investments.
The second of the twin balance sheet problem is on the private sector corporate side. The aftereffect of the lending boom during 2010 to 2013 is that corporates are under a huge debt burden. Even as the economy picks up, their first priority is debt servicing, not fresh loans. Besides, they still have idle and unused capacity. So fresh investment in new capacity is not on the top of the mind. This twin balance sheet problem will be solved only when banks have adequate equity capital, their current loans start “performing” and when corporates develop the enthusiasm for large fresh investments.
In a recent interaction, the Chief Economic Advisor remarked that the “twin balance sheet” problem should not be thought of as simply a banking problem. It is much bigger and hence needs a larger holistic solution.
There are early and encouraging signs. The Union Budget’s capital spending is higher by 11 per cent. There’s a record 3.9 trillion rupees earmarked for infrastructure including roads and railways. Of course must remember that more than 90 percent of capital spending in the economy comes from outside of the Union Budget. Secondly, even as the stalled projects ratio is worrisome, the new announcements are significantly up. The Purchase Managers’ Index (PMI), which captures business outlook, is slowly going up. Inbound foreign direct investment is coming in at a healthy pace. Exports are in positive territory after a long time.
All these are tentative signals, and one hopes that they pick up steam. It is rather a tough time for investment spending all over the world. Lack of good and large investment opportunities is possibly leading all the surplus liquidity to flow into stock markets. All three indices in the American stock market are at their all-time high.
Finally back to Confucius, and his emphasis on education. The nation’s capital stock is made up of both physical and human stock. The former is in the form of factories, and the latter is in the form of productive skilled labour. As a nation becomes an advanced economy, the proportion of human capital rises. Hence, as we worry about capital formation, we must remember that the greatest reward will come from investing in our human resources. Be it schooling, skilling or on the job training, that will not only help the worker and the economy, but also future generations. Children of well-educated parents tend to go much further. Here education needs to be understood in its broadest sense. Human capital is not just an instrumental view of human beings as a resource for the economy, but also as an integral part of a robust democracy and flourishing society. Thus investment, whether in physical or human capital, is one of big priorities of current times.
(Ajit Ranade is a senior economist based in Mumbai)