Explained: Why India Inc is not investing in India?

India Inc.’s hesitance to invest in India’s economy is due to low consumer demand and several financial constraints.

Last Tuesday, finance minister Nirmala Sitharaman asked
India’s corporate honchos why they were not investing in the
Indian economy.

“I want to hear from India Inc,” she said, “what’s stopping
you when countries and industries abroad think this is the place to be.”

This is a valid question. In this piece, we will try and piece
together why India Inc, as corporate India is often clichély referred to, is
not investing in the Indian economy and what are the reasons behind the same.

The problem of low investment in the economy isn’t a recent
phenomenon related to the spread of the Covid pandemic. It has been around for
a while and is more than a decade old.

Let’s dig a little deeper. The overall investment in the
economy consists of household investment, private sector investment, and public
sector investment.

The household investment in the economy has been falling for a
while. In 2020-21, it stood at 10.3 percent of the GDP as against 15.9 percent
of the GDP in 2011-12.

Household investment to GDP is a good proxy for the small
informal businesses operating in the economy. And given that it has been
falling, what this tells us is that the informal businesses haven’t been doing
well and have been shutting down or shrinking.

Most recently, they have been impacted by the Covid pandemic
and a botched-up implementation of the goods and services tax. As Hindustan
Unilever Ltd, one of the largest fast moving consumer goods companies in the
country, said in its most
recent earnings call: “We continue to gain value and volume shares in
more than 75% of our business.” This is a reflection of an increasing
formalisation of the economy.

The private sector investment to GDP ratio peaked in 2007-08
at 21 percent of the GDP. This is also the year in which overall investment to
GDP ratio peaked. It has seen a largely downward trend since then.

In the period between 2003 and 2013, the Indian corporates
went on a borrowing binge accompanied by frenzied expansion. Private corporates
wanted to be ready to cash in on India being the next China.

In the process, they ended up borrowing more than they could
possibly repay and building excess capacity as well.

As per the Reserve Bank of India’s quarterly order books,
inventories and capacity utilisation survey, or OBICUS, the capacity utilisation
of manufacturing companies in the three-month period ending March 2022, which
is the latest data available, stood at 75.3 percent. A similar kind of capacity
utilisation has been seen regularly over the last decade, clearly pointing to
the fact that there is excess capacity in the economy.

In this scenario, it doesn’t make much sense for private
corporates to invest and expand. If the private sector can fulfil consumer
demand with its current capacity, why will it go about building new capacity?

Ultimately, any corporate firm reacts to the incentives at
play. Currently, there isn’t enough incentive for private corporates on the
whole to invest and expand.

In fact, this lack of creation of new capacity can also be
seen in the lending carried out by commercial banks to industry.

Bank lending to industry peaked in 2012-13 at 22.43 percent of
the GDP. it has largely fallen since then, standing at 13.32 percent in
2021-22. This was primarily due to excess enthusiasm in lending shown by banks
and excessive enthusiasm in borrowing shown by private corporates during the
period 2003-2013.

The implication of this was a massive rise in bad loans of
banks. Bad loans are largely loans that haven’t been repaid for 90 days or
more. They peaked at Rs 10.36 lakh crore as of March 2018, with corporates
being responsible for nearly three-fourths of the bad loans.

In the process, banks have on the whole been reluctant to lend
to many corporates and many corporates have been reluctant to borrow, or have
simply not been in a position to borrow. Of course, large corporates can borrow
from other sources as well. Nonetheless, the fall in bank lending to industry
does show a trend.

This leaves us with public sector investment in the economy,
which has varied largely between seven to nine percent of the GDP in the last
two and a half decades. In 2020-21, the latest data point available, it stood
at 7.2 percent of the GDP. What this means is that investment by the private
sector and households has fallen and is holding the economy back.

The question is, why is this the case?

In the case of households, as mentioned earlier, the
increasing formalisation of the economy is hurting small firms. In the case of
the private sector (read corporates), one reason is the excessive borrowing
binge that led to excess capacity creation. At the same time, the consumer
demand needs to catch up to the excess capacity that was created – and that
cycle is yet to completely play itself out.

Second, corporates invest when they are confident that their
investment will lead to future gains. That confidence has been missing for a
while. Take a look at the following chart which plots the new investment
projects announced by the Indian private sector over the years.

Also, as economist and former deputy chairman of the Planning
Commission, Montek Singh Ahluwalia, put it in a recent
column in the Mint: “Some
large houses have announced some large investments. This is good, but
announcements by a few large houses will not correct the underlying problem of
a much broader slowdown in private-sector investment.”

So, why is the private sector not investing? The answer
perhaps lies in the fact that the average Indian consumer has been feeling the
heat on the financial front for a while now.

Domestic two-wheeler sales in 2021-22 stood at around 13.5
million units, more or less similar to the 13.4 million units sold a decade ago
in 2011-12. What does this tell us?

First, a two-wheeler is typically the second- or third-most
expensive thing most individuals buy in their lifetime. And the fact that
two-wheeler sales in 2021-22 were almost the same as the sales a decade ago
tells us that the average individual isn’t really in a position to commit money
towards buying a two-wheeler. This reluctance largely stems from the lack of
confidence in the economic future.

A major reason for this is the lack of job creation. Data from
the Centre for Monitoring Indian Economy points out that the labour
participation rate in 2016-17 stood at 46.2 percent. By 2021-22, it had fallen
to 40.1 percent. This fall started before the Covid pandemic struck.

What does this mean? It means in 2016-17, for every 1,000
individuals aged 15 and above, on an average, 462 individuals were employed or
unemployed and looking for a job. By 2021-22, on an average, only 401 of 1,000
individuals were employed or unemployed and looking for a job. This is when the
overall population has also expanded.

Hence, many people simply dropped out of the labour force
because they were not able to find jobs over a period of time and stopped
actively looking for jobs. And without jobs, purchasing power is bound to take
a beating.

Second, if the sale of two-wheelers is similar to what it was
around a decade ago, why would any company invest in new capacity? Domestic
two-wheeler sales peaked in 2018-19 at 21.2 million units. Given that, there is
a lot of capacity currently lying idle in the two-wheeler industry.

Further, the domestic two-wheeler sales this year from April
to August stood at 6.6 million units – higher than the similar periods in
2020-21 and 2021-22, but lower than the years before that. Clearly, capacity is
not a problem with the two-wheeler industry right now. Hence, there is no
incentive to invest and expand.

Also, the fall in sales is not just because of the spread of
the Covid pandemic. Domestic two-wheeler sales started to fall even before the
pandemic had struck. This again points towards something that most people seem
to have forgotten, that the Indian economy had started to slow down even before
the pandemic began.

Analysts and economists who want to project how well the
Indian economy is doing tend to refer to booming car sales. There is no denying
that car sales have rebounded much faster than two-wheeler sales, but saying
that there is a boom in car sales is stretching the truth quite a bit.

In 2021-22, domestic car sales stood at around 3.1 million
units. This was more than the number of cars sold in 2019-20 and 2020-21, but
lower than the around 3.4 million units sold in 2018-19. So, the car industry
clearly has enough capacity. Also, the annual growth in car sales over the last
decade has stood at 1.6 percent on average.

Another point that needs to be made here is that there has
been a fall in the sale of entry-level cars. In 2018-19, domestic sales of mini
and compact cars (from 3,201 mm to 4,000 mm) stood at around two million units.
It has since fallen to 1.4 million units in 2021-22. What this clearly tells us
is that the financial strength of households, that could have possibly moved
from owning a two-wheeler to owning the most basic model of car, has come down
in the last few years. Also, the capacity to produce entry-level cars is not a
problem.

Further, the sale of the more expensive multi-utility vehicles
has gone up from around 0.9 million units in 2018-19 to around 1.5 million
units in 2021-22. This tells us that the rich have come out richer post the
pandemic. Of course, given the fact that the sale of multi-utility vehicles has
more than doubled in the last few years, it is hardly surprising that there is
a huge waiting period for these cars. This is a great example of how financial
inequality has gone up over the years.

After peaking in 2017-18 at around 91.09, the mobile tele-density
in the country has been falling. This means that every 10,000 individuals in
the population on an average owned 9,109 mobile phone connections. This fell to
83.07 in 2021-22. A substantial portion of this fall happened before the Covid
pandemic struck.

What this tells us is that many individuals have given up on
more than one mobile phone number that they used to have as their finances have
become stretched.

So, the average Indian consumer is financially stretched.
Another reason for this lies in the fact that previously, the growth in
household investment feeded into the growth in private investment. Household
investment went up when the informal sector did well. When this happened, the
consumption demand went up, leading to the private sector doing well and
investing more.

Of course, the well-to-do sections of the population continue
to do well and that is reflected in several economic parameters too. Private
corporates obviously understand this, and that reflects in their investment
decisions, irrespective of what they say in public when asked about economic
growth. Their real revealed preference is different.

The finance minister in her address had also said that
foreigners are betting big on India.

The net foreign direct investment (FDI) figure is obtained by
taking the FDI that foreigners bring into India in a given year and subtracting
their repatriations during that year. As we can see, the net FDI as a
proportion of the GDP has been flattish over the years after peaking at 3.5
percent of the GDP in 2008-09. In 2021-22, it stood at 1.8 percent of the GDP.

Nonetheless, in absolute terms, the net FDI number has gone up
in the last few years. It peaked at $56.2 billion in 2021-22 and it is perhaps
this that the finance minister was referring to in her address.

So, that leaves us with the final question: What are private
corporates doing with the profits they have made over the years, especially
given that they have earned bumper profits over the last two years thanks to
increasing formalisation, lower interest rates, smart cost cutting, and a cut
in the corporate income tax rate implemented in September 2019?

Economist Mahesh Vyas analysed 3,299 non-finance
companies, of which 2,509 companies are listed and the remaining unlisted.
These account for around 60 percent of sales of the 25,000 companies that the
Centre for Monitoring Indian Economy’s Prowess database follows. These
companies made a superlative net-profit of Rs 6.7 lakh crore in 2021-22, much
more than any of the previous years. This money did not go into the creation of
new capacities.

As Vyas writes: “Net fixed assets of non-finance companies
grew by only 2.3 per cent in 2020-21 and then by only 2.1 per cent in 2021-22.”
Even here, “investments into plant and machinery grew by only 0.97 per cent in
2020-21 and 0.21 per cent in 2021-22.”

So, companies clearly haven’t been investing much in expanding
capacities. Nonetheless, they were gung-ho about investing in shares and debt
instruments. As Vyas writes: “Investment into equity shares increased by 17.4
per cent. Investment into debt instruments increased by 28.5 per cent.”

What this means is that while companies remain confident in
the fact that sales will continue to recover from their Covid lows,
nonetheless, at the same time, they don’t see sales growing fast enough to put
their existing capacity to produce goods and services under pressure. Hence,
there is no need to invest. The private sector has very little incentive to
borrow and expand. And that’s the long and the short of it.

Written by Vivek Kaul. Kaul is an economic
commentator and the author of Bad Money.