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Falling Investment Rate: Effects and solutions

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Falling Investment Rate: Effects and solutions

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General awareness on current topics is essential as not only you will be getting questions on GK in various MBA entrance exams but it will be useful for Essay writing test and WAT also. 
 
Today, you will read General Awareness Topic: “Falling Investment Rate: Effects and solutions”  
 
Gross capital formation (or gross domestic investment) consists of outlays of the fixed assets of the economy plus net changes in the level of inventories. Fixed assets include land improvements plant, machinery, and equipment purchases; and the construction of roads, railways, and the like including schools, offices, hospitals, private residential dwellings, and commercial and industrial buildings. Inventories are stocks of goods held by firms to meet temporary or unexpected fluctuations in production or sales. 
 
The investment rate is a major factor in determining the country’s economic growth and its overall health. When investment rate is divided by the incremental capital output ratio (ICOR), it gives the growth rate of the economy. 
 
The ICOR measures how much output (GDP) is produced with every unit of additional capital. This is a simple measure of productivity where falling ICOR indicates higher productivity. Investment rate also entails the sentiments prevailing in the economy. It also affects the income, employment, inflation etc.
 
Falling investment means lowering income resulting in cost cutting through retrenchment negatively impacting the employment scenario. Moreover, unlike developed world, in such a scenario, markets in developing country face inflation due to the phenomenon of stagflation.
GDP growth rate of India in second quarter of 2012-13 was 5.5 percent. A careful examination suggests that declining productivity and falling investment rate have been the main culprits, dragging down India’s potential growth from 2008-09 onwards.
 
The investment rate, which was 33 percent of GDP in 2007-08, fell to 29.5 percent in 2011-12. Though it is still higher as compared to many countries, it is cause of concern if the growth and development needs of India need to be addressed as high investment rate are required to increase the job creation and increase the productive capacity of the country. 
 
Falling public sector savings or rising fiscal deficit has surely been a reason behind the declining investment rate. However, the falling private corporate capital expenditure is also a reason to worry. According to RBI data on corporate investment, the aggregate investment intentions in private-sector projects (only projects larger than R100 million were considered) funded by banks and other financial institutions declined 46% between 2011 and 2012. 
 
The outlook for 2013 also remains challenging. If there are no deferments of capital expenditure (capex) plans, then existing projects’ capex will likely be Rs.2.07 trillion in 2013. Although capex on new projects has been declining for three years now, 2013 will be the first year when capex on existing projects is likely to fall. In this case, capex on new projects will have to be Rs.1.43 trillion in 2013 to match the overall 2012 capex spends of Rs.3.5 trillion. This will require a 91% increase in capital spending on new projects in 2013 compared with 2012, an impossible target to achieve. Therefore, overall corporate capex is likely to decline in 2013 too. 
 
Increasing ICOR of Indian economy is also a measure concern. Barring a few abnormal years, for most of our post-independence history, ICOR has hovered between 4 and 5. However, in fiscal year 2012, ICOR increased to around 5.9; and, with a falling investment rate, it is becoming difficult to achieve even 6 percent GDP growth. Rising ICOR is a clear indication that capital is not being used efficiently.
 
One of the reasons could be projects stuck at different levels of approval or because of lack of critical inputs. If ICOR remains low, it can compensate the falling investment rate, but if it is rising with a falling investment rate, it is a double whammy for the economy.
 
Recently announced measures like cut in diesel subsidies, FDI in retail are the measures in the right direction, however, measures must also be targeted at increasing the investment rate and productivity of the economy. 
 
Clearly, FDI in retail should be a productivity booster because of its potential to overhaul the supply chain. Similarly, the loss-restructuring plan for state electricity boards can improve the power situation (productivity improvement) and release funds from the financial system for more productive investment.
 
Steps taken to reduce the fiscal deficit should also increase the investment rate over time but the near-term impact might be limited. Other recent policy announcements might not have a direct impact on productivity and investment but they are trying to revive investor sentiment and attempt an asset-market-led economic recovery.
 
Other important reforms measures would be the setting up of the National Investment Board to fast-track project approvals, streamlining the land acquisition process by passing the relevant bill, and implementing the uniform GST. The productivity impact of these measures is going to push the potential growth higher, sending us back into a virtuous cycle. 
 
Apart from these measures, in case the private investment is not picking up, government may step up the public investment building up the countrywide infrastructure network consisting of the road, rail, ports, power, telecommunication etc. 
 
Mere manipulation of interest rates is not going to pick up the investment rate if investors don’t find the business climate conducive for fresh investments. India is itself is a vast market and therefore we don’t need to look towards west for its developmental needs. What is required is an overhauling of policy structure to boost the investment climate through holistic reforms measures and India will be able to achieve its growth target of twelfth five year plan.

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