Gist of Economic Survey [Chapter 3]: Investment and Saving Slowdowns and Recoveries: Cross-Country Insights for India

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1 Gist f Ecnmic Survey [Chapter 3]: Investment and Saving Slwdwns and Recveries: Crss-Cuntry Insights fr India INTRODUCTION Since 2010, there is ne questin: hw sn will the Indian ecnmy revert t 8-10 percent grwth? Perhaps it is just arund the crner, given all the structural refrms the gvernment has implemented in recent years. Underlying this expectatin is the firm belief that dmestic saving and investment will sn start t accelerate. But this cannt be taken fr granted. Neither saving nr investment is unduly depressed. Investment (grss fixed capital frmatin) rate and grss dmestic saving rate are actually abve the levels that prevailed thrughut the 1990s. In fact, it was the bm f the 2000s that was exceptinal, as India s climb t abut 10% real GDP grwth was accmpanied by an unprecedented 9% pint pick-up in dmestic saving and investment rates. The subsequent slide in investment and saving (as a percent f GDP) has merely brught these rates back twards nrmal levels. Specifically: The rati f grss fixed capital frmatin t GDP climbed frm 26.5% in 2003, reached a peak f 35.6% in 2007, and then slid back t 26.4 percent in The rati f dmestic saving t GDP has registered a similar evlutin, rising frm 29.2 percent in 2003 t a peak f 38.3 percent in 2007, and then falling back t 29 percent in The cumulative fall ver 2007 and 2016 has been milder fr investment than saving, but investment has fallen t a lwer level. Sharp swings in investment and savings: Such sharp swings in investment and saving rates have never ccurred in India s histry nt during the balance-f-payments crises f 1991 nr during the Asian Financial Crisis f the late 1990s. While it is true that the past 15 years have been a special perid fr the entire glbal ecnmy, n ther cuntry seems have gne thrugh such a large investment bm and bust during this perid. The nly cuntry that displays a similar pattern t India ver the same time perid is Brazil and even in this case the parallel is far frm exact. Sectrs respnsible fr the saving/investment decline in India: Essentially, private investment and husehld/gvernment saving are respnsible. Private investment accunts fr 5 percentage pints ut f the 6.3 percentage pint verall investment decline ver and The fall in saving, by abut 8 percentage pints ver the same perid, has been driven almst equally by a fall in husehld and public saving. SELFSTUDYHISTORY@GMAIL.COM, MOB. NO:

2 The fall in husehld saving has in turn been driven by a fall in physical saving, partly ffset by an increase in the hlding f financial assets. Within the latter, there has been a shift frm currency and bank depsits twards market instruments, viz. shares and debentures. S, what can be expected ging frward, fr India s investment in particular and fr the cuntry s prspects f reverting t sustained high grwth rates? This chapter attempts t answer this questin, taking its cue frm saving and investment slwdwn episdes witnessed ver the past 40 years in ther, including similar, cuntries. IDENTIFYING INVESTMENT AND SAVING SLOWDOWNS Investment and saving slwdwns are defined using a specific set f cnditins: First, Shrtfall is defined as the difference between: the average f investment (saving) in the slwdwn year and subsequent tw years; and the average f the previus five years. Slwdwn year is defined as ne where the shrtfall in that year exceeds a certain threshld. If there are tw r mre cnsecutive slwdwn years, this cunts as a slwdwn episde. Secnd: The average investment rate fr the 5 years prir t the slwdwn year is at least 15 percent f GDP. Threshld: The threshlds cnsidered are f 2, 3 and 4 percentage pints. The lwer the threshld, the greater the risk f capturing episdes f temprary vlatility rather than mre enduring slwdwns. But because India s current investment (saving) slwdwn has been s gradual it is best captured in the 2 percent threshld. Mrever, in mst cases, the results fr the 3 and 4 percent threshlds als hld fr the 2 percent case. Frequency f investment slwdwns and saving slwdwns: Study reveals that investment episdes are mre frequent than saving episdes. Cmmn episdes (where bth investment and saving slw) are relatively unusual. This pattern, hwever, has reversed after 2008, with saving episdes catching-up with investment episdes. Presumably, the relatively lwer number f investment episdes in the latest perid reflects cncerted effrts in emerging ecnmies t revive investment after the Glbal Financial Crisis via stimulus and ther plicies. Duratin and magnitude f investment slwdwns and saving slwdwns: Investment and saving slwdwns tend t be similar in duratin. Duratin is a simple cunt f the number f years that the shrtfall in investment/saving exceeds the varius threshlds. Fr example, if the shrtfall persists fr 5 years, but exceeds 2 percent nly fr 2 years, then the duratin is SELFSTUDYHISTORY@GMAIL.COM, MOB. NO:

3 termed as 2 years. Using this definitin, bth investment and saving slwdwns typically last arund 4 years. Hwever, investment slwdwns are greater in magnitude. Magnitudes are the shrtfalls, cumulated ver the entire slwdwn episde. Sme ntable differences between investment and saving slwdwns: Investment is mre prne t extreme events: there are 4 cases where the cumulative investment slwdwn exceeded 50 percentage pints, whereas there are hardly any cases f saving slwdwns f this magnitude. On the ther hand, large saving slwdwn episdes measuring between 30 and 50 percentage pints tend t drag n fr a year mre n average than similarly-large investment slwdwns. Study f a cmplete crss-cuntry list f investment and saving slwdwns reveals that slwdwns are quite frequent, appearing even in success stries, such as China (1988), Singapre (1985, 1999), and Mauritius (1981, 1995, 2012). Slwdwns in Latin America: Mst slwdwns in Latin America and Africa ccurred during the 1980s, a perid that became knwn as the lst decade in thse cntinents. Fr example: The investment and saving slwdwn in Mexic fllwing the debt crisis f The weakness f the Brazilian ecnmy manifests as investment and saving slwdwns frm the early 1980s t the early 1990s. Slwdwn in Asian cuntries: Asian cuntries faced the largest number f slwdwn episdes (10) fllwing During that perid, there were large investment slwdwns in Malaysia, Thailand, Indnesia and Krea, which f curse is why this perid is knwn as the East Asian crisis thugh the phenmenn extended t cuntries as far away as Turkey and Argentina. Currently (after 2008), these ecnmies are in the era f saving slwdwns. The fractin f cuntries with investment slwdwns has als increased, thugh t a limited extent. Curiusly, this relatinship between the tw types f slwdwn turns ut t be unusual. Frm 1975 t 2007, the crrelatin between the number f cuntries experiencing an investment slwdwn and thse experiencing a saving slwdwn was negative but nw it seems t be breaking dwn and becming psitive in latest perid. Saving are perhaps less prne t cycles because f being influenced by lng term trends viz. demgraphics. Special case f India: India seems t be a special case. Until recently, India had nt experienced either type f slwdwn: nt during the lst decade, nt during the East Asian crisis, nt even after India s wn balancef payments crisis in SELFSTUDYHISTORY@GMAIL.COM, MOB. NO:

4 As a result, the current slwdwn in which bth investment and saving have slumped is the first in India s histry. Even then, the slwdwn is detected mst fully nly in the 2 percent threshld, largely because the slide has been gradual, unlike (fr example) the sharp adjustments that ccurred in East Asia after the 1997 crisis. Investment slwdwn: The investment slwdwn started in 2012 (when it surpassed the 2 percent threshld), subsequently intensified (surpassing the 3 percent and then the 4 percent threshlds in 2013 and 2014 respectively), and was apparently still cntinuing. With the slwdwn nw having lasted six years, recrded in the exceptinally severe cases. Yet because the investment decline has been s gradual, the magnitude f the shrtfall s far is relatively less severe it remains a mderate 21 percentage pints, well under the average magnitude. Saving slwdwn: The saving slwdwn started in 2010, and als seems t be still cntinuing. Thugh like its investment cunterpart, its magnitude was a belw-average 15 percentage pints. In ther wrds, India s current investment/saving slwdwn episde has been lengthy cmpared t ther cases and it may nt be ver yet. SAVING VERSUS INVESTMENT: GROWTH CONSEQUENCES The simultaneus slump in saving and investment gives rise t a questin: Shuld plicies that bst investment (viz. substantial infrastructure push, refrms t facilitate the ease f ding business r the Make in India prgram) be given greater pririty ver thse that bst saving? The issue is abut relative imprtance and urgency. Bth set f plicies are crucial in the lng run but which ne needs t be priritized at present? The standard slutin that is ften prescribed is that bth prblems need t be tackled simultaneusly. Investment is mre imprtant than saving fr grwth: Studies shw that: A simultaneus push may nt be necessary as successful ecnmic perfrmance is nt explained by saving transitin episdes. Cuntries experiencing psitive saving transitins d nt necessarily experience sustained grwth increases. Rather, cuntries that experience grwth transitins eventually see sustained higher rates f saving. Hence plicies shuld fcus n encuraging investment, rather than saving, t bst grwth. Relatinship between slwdwn and grwth decline: Given that a mre intense slwdwn shuld lead t a larger fall in real per-capita grwth, the relatinship between the tw variables is expected t be psitive. SELFSTUDYHISTORY@GMAIL.COM, MOB. NO:

5 Indeed, the relatinship fr investment slwdwns is distinctly psitive; with many f the East Asian crisis episdes assciated with large grwth effects. But the relatinship fr saving slwdwns is unclear, with many f the large saving episdes (e.g. Peru 1984, Kenya 1994, Mauritius 2003) nt assciated with sharp declines in grwth. In India, the impact n grwth has been relatively mderate than witnessed in cmparable investment slwdwns in ther cuntries. Crss-cuntry cmparisn cnfirms that the relatinship is significantly psitive fr investment episdes, but insignificant fr saving. A ne percentage pint fall in investment rate is expected t dent grwth by percentage pints. There are a few episdes acrss ecnmies in which bth investment and saving have slwed simultaneusly. The relatinship f saving with grwth nt nly remains insignificant but turns mildly negative. Nt nly are investment episdes fllwed by slwer grwth (unlike saving episdes), this is als true f pure episdes f investment slwdwns, i.e. thse nt accmpanied by slwdwn in saving. Relatinship between private investment slwdwn and grwth: A further classificatin f the investment slwdwns can be: thse that are driven primarily by a fall in private investment and thse that are nt. Data n the private investment cmpnent f aggregate grss fixed capital frmatin is available frm the WDI database. The relatinship between the fall in investment and grwth decline hld in case f private investment slwdwn episdes als as it is psitive and significant. RECOVERY FROM INDIA-TYPE INVESTMENT SLOWDOWNS India s investment slwdwn is unusual: it is relatively mderate in magnitude, lng in duratin, and started frm a relatively high peak rate f 36 percent f GDP. It has a specific nature, in that it is a balance sheet related slwdwn. In ther wrds, many cmpanies have had t curtail their investments because their finances are stressed, as the investments they undertk during the bm have nt generated enugh revenues t allw them t service the debts that they have incurred. What d these characteristics prtend fr the extent f an eventual investment recvery? T answer this questin, tw types f internatinal experience after slwdwns are cnsidered: balance sheet-related nes; and where investment fell by 8.5 percentage pints peak-t trugh ver 9 years. What happens after balance-sheet slwdwns? What tends t happen t investment rates in the aftermath f balance sheet episdes? There are tw cnclusins frm studies: SELFSTUDYHISTORY@GMAIL.COM, MOB. NO:

6 Investment declines flwing frm balance sheet prblems are much mre difficult t reverse. In these cases, investment remains highly depressed fr lng time after the peak, whereas in case f nnbalance-sheet slwdwns the shrtfall is smaller and tends t reverse. India s investment decline s far (8.5 percentage pints) has been unusually large when cmpared t ther balance sheet cases. What happens after similar investment falls? The experience f cuntries with similar investment declines is examined. A full recvery is defined as attainment f an investment rate that cmpletely reverses the fall, while n recvery implies the inability t reverse the fall at all r wrse. The median cuntry reverses nly abut 25 percent f the decline 14 years after the peak, and abut 40 percent f the decline 17 years after the peak. If India cnfrms t this pattern, the investment-gdp rati wuld imprve by 2.5 percentage pints in the shrt run. If India situates itself in the upper quartile, it can recver by mre than 4 percentage pints. But India is already 11 years past the peak, and its current perfrmance puts it belw the upper quartile. Mderate csts in terms f grwth: Given the large fall in investment that India has registered, it has paid mderate csts in terms f grwth. Between 2007 and 2016, rate f real per-capita GDP grwth has fallen by abut 2.3% pints that is lwer than the abve 3% decline in grwth nticed in episdes in ther cuntries that have registered investment declines f similar magnitudes and frm rughly a similar peak (abut 36 percent). CONCLUSION: POLICY LESSONS FOR INDIA The ntin that grwth is cnstrained by saving has a lng and illustrius pedigree. But the evidence presented here pints in a different directin, albeit subtly. First, investment slwdwns are mre detrimental t grwth than saving slwdwns. S, plicy pririties ver the shrt run must fcus n reviving investment. Mbilizing saving, fr example via attempts t unearth black mney and encuraging the cnversin f gld int financial saving r even curting freign saving are imprtant but perhaps nt as urgent as reviving investment. In any case, the share f financial saving is already rising in aggregate husehld saving with a clear shift visible twards market instruments a phenmenn that has been helped by demnetizatin. Secnd, India s investment slwdwn is nt yet ver althugh it has unflded much mre gradually than in ther cuntries, keeping the cumulative magnitude f the lss and the impact n grwth at mderate levels s far. SELFSTUDYHISTORY@GMAIL.COM, MOB. NO:

7 Hw will the investment slwdwn reverse, s that India can regain 8-10 percent grwth? There is bth a bleak and a hpeful pinter frm similar episdes in ther cuntries. India s investment decline seems difficult t reverse, partly because it stems frm balance sheet stress and partly because it has been usually large. Crss -cuntry evidence indicates a ntable absence f autmatic buncebacks frm investment slwdwns. The deeper the slwdwn, the slwer and shallwer the recvery. At the same time, it remains true that sme cuntries in similar circumstances have had fairly strng recveries, suggesting that plicy actin can decisively imprve the utlk. Taken tgether, the results suggest a clear and urgent plicy agenda which the gvernment has launched: first with the step-up in public investment since ; and nw, given the cnstraints n public investment with plicies t decisively reslve the TBS challenge. These steps will have t be fllwed up, alng with cmplementary measures: easing the csts f ding business further, and creating a clear, transparent, and stable tax and regulatry envirnment. In additin, creating a cnducive envirnment fr small and medium industries t prsper and invest will help revive private investment. The fcus f investment-incentivizing plicies has t be n the big and small alike. The animal spirits need t be cnjured back. SELFSTUDYHISTORY@GMAIL.COM, MOB. NO: