Declining investment (especially private investment), has been a key concern area in the last few years in India. A separate section in this year's Economic Survey explored this critical linkage of investment to growth and pronounced that "investment slowdowns are more detrimental to growth than saving slowdowns and so, policy priorities over the short-run must focus on reviving investment".
The Economic Survey also pointed to the criticality of private investment through its finding that three-fifths of the investment slowdown episodes were due to decreases in private (rather than public) investments. While the notion of investment being a more significant determinant of growth than saving itself can be challenged, one would have expected Budget 2018 to come up with significant announcements to rev up at least the 'critical' private investments to boost growth. However, the provisions in Budget 2018, raise questions regarding the government's ability to accelerate growth through exploiting the saving-investment link.
Saving-investment link to growth
The link between saving, investment and growth is captured in the Harrod-Domar growth equation which posits that the growth rate of an economy (g) is correlated to the domestic investment rate (i) positively, and to the Incremental Capital Output Ratio (ICOR) or k negatively.
Domestic investment itself comprises of private (including private corporate and household) investment, as also public investment. Such domestic investments need to be financed through domestic saving - either through private (corporate and household) saving or through public saving. In the eventuality of domestic saving falling short, external saving can be used to fund domestic investment. However, such reliance on external saving to fund the shortfall in the domestic saving-investment gap would accentuate the Current Account Deficit.
The Economic Survey's contention that accelerating growth requires primarily reviving investments, since the relationship of saving with growth "not only remains insignificant but turns mildly negative" appears fallacious. For, investments cannot happen in the absence of saving. Moreover, while public investment in productive physical or social infrastructure can boost private investment in the long-run, such investment in the short run is bound to crowd out private investment through raising the interest rates. The fact is that both saving and investment have been declining in India since 2007.
Saving-investment and Budget 2018
Budget 2018 has no direct tangible measures to affect Indian corporate investment. The MSME sector has received certain incentives by way of extension of the reduced rate of corporate tax of 25% to companies whose reported turnover in the financial year 2016-17 was up to Rs.250 crore. The government expects this move to benefit the '99% MSMEs filing their tax returns', which in turn will "leave them with higher investible surplus which in turn will create more jobs".
However, anecdotal evidence suggests that Indian SMEs would increasingly prefer to use capital-intensive technologies due to their positive impact on profitability, as also the problems associated with employing labour.
Secondly, the government intends to 'boost' investment through channelizing business surpluses into manufacturing rather than their investment into financial assets through introduction of a Long-Term Capital Gains Tax on long term capital gains from listed equities.
Third, a direct increase in public investment is sought through higher public investments in health, as also agriculture. Of particular importance is the announcement of the "world's largest government funded health care programme" titled the National Health Protection Scheme to cover over 10 crore poor and vulnerable families (approximately 50 crore beneficiaries) providing coverage upto 5 lakh rupees per family per year for secondary and tertiary care hospitalization. While the details on how this ambitious healthcare scheme will be rolled out, or even work is still nebulous, the fact remains that a far less ambitious scheme of expanding the existent health insurance scheme, the Rashtriya Swasthya Bima Yojana, announced in an earlier budget by the same government has been less than successful. At the same time, a slew of measures seek to increase public investment in the agricultural sector. Such enhanced public investment, while on the one hand, indicates fiscal slippages, will impact corporate investment through crowding out.
On the other hand, the incentives to the agricultural sector, in particular, the higher Minimum Support Price (MSP) announced for Kharif crops is bound to increase retail food inflation, as also headline inflation measured by the Consumer Price Index-Combined, CPI-C. The CPI-C already hit a 17-month high in December 2017, well above the Reserve Bank of India's target of 4%. Further, food inflation in this basket was already at its highest since mid-2016. The inflationary impact of such incentives, as also some of the higher public investments on aggregate demand will be to reduce overall available saving, both private and public.
Budget 2018 seeks to reposition the government as one with the farmer and small enterprises. However, in such populism, the government has slipped in factoring in one of the key areas
to boost growth. The inadequate attention to the crucial link between savings and investment will cost the nation dear.
Tulsi Jayakumar is Professor of Economics, and Program Head, PGP-Family Managed Business at SPJIMR, Mumbai. (Views are personal)