Economic Survey 2018 -Vol. 1, Ch.3: Investment & Saving Slowdowns & Recoveries: Insights (Download PDF)

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Investment (gross fixed capital formation) rate and gross domestic saving rate, at present are actually above the levels that prevailed throughout the 1990s. The investment decline has been so gradual, the magnitude of the shortfall so far is relatively less severe - it remains a moderate 21 % points, well under the average magnitude.

The boom of the 2000s was exceptional, when India climbed to about 10 % real GDP growth, which was accompanied by an unprecedented 9 % point pick-up in domestic saving and investment rates. The subsequent slide in investment and saving (as a % of GDP) has merely brought these rates back towards normal levels. Specifically:

  • The ratio of gross fixed capital formation to GDP climbed from 26.5 % in 2003, reached a peak of 35.6 % in 2007, and then slid back to 26.4 % in 2017.
  • The ratio of domestic saving to GDP has registered a similar evolution, rising from 29.2 % in 2003 to a peak of 38.3 % in 2007, before falling back to 29 % in 2016.
  • The cumulative fall over 2007 and 2016 has been milder for investment than saving, but investment has fallen to a lower level.
  • It is true that the past 15 years have been a special period for the entire global economy, no other country seems to have gone through such a large investment boom and bust during this period.
  • The fall in saving, by about 8 % points over the same period, has been driven almost equally by a fall in household and public saving. The fall in household saving has in turn been driven by a fall in physical saving, partly offset by an increase in the holding of financial assets.

Identifying Investment and Saving Slowdowns

  • 👌 Investment and saving slowdowns are defined using a specific set of conditions (filters) .
    1. First, a “shortfall” is defined as the difference between (a) the average of investment (saving) in the slowdown year and subsequent two years; and (b) the average of the previous five years. A “slowdown year” is defined as one where the shortfall in that year exceeds a certain threshold. If there are two or more consecutive slowdown years, this counts as a “slowdown episode” .
    2. The average investment rate for the 5 years prior to the slowdown year is at least 15 % of GDP.
  • Lower the threshold, greater the risk of capturing episodes of temporary volatility rather than more enduring slowdowns. But because India՚s current investment (saving) slowdown has been so gradual it is best captured in the 2 % threshold.
  • Investment episodes are more frequent than saving episodes, while common episodes (where both investment and saving slow) are relatively unusual. This pattern, however, has reversed after 2008, with saving episodes catching-up with investment episodes.
  • Investment and saving slowdowns tend to be similar in duration. However, investment slowdowns are greater in magnitude. Magnitudes are the shortfalls, cumulated over the entire slowdown episode.
  • Duration is a simple count of the number of years that the shortfall in investment/saving exceeds the various thresholds.
  • Investment is more prone to extreme events: there are 4 cases where the cumulative investment slowdown exceeded 50 % points, whereas there are hardly any cases of saving slowdowns of this magnitude. On the other hand, large saving slowdown episodes measuring between 30 and 50 % points tend to drag on for a year more on average than similarly-large investment slowdowns.

About Other Countries

  • Asian countries faced the largest number of slowdown episodes (10) following 1997. During that period, there were large investment slowdowns in Malaysia, Thailand, Indonesia and Korea, which of course is why this period is known as the East Asian crisis 📝 -though the phenomenon extended to countries as far away as Turkey and Argentina.
  • Currently (after 2008) , these economies are in the era of saving slowdowns, with the percent of such countries at its peak. The fraction of countries with investment slowdowns has also increased, though to a limited extent.

About India

  • The current slowdown - in which both investment and saving have slumped - is the first in India՚s history.
  • The slowdown is detected most fully only in the 2 % threshold, largely because the slide has been gradual.
  • The investment slowdown started in 2012 (when it surpassed the 2 % threshold) , subsequently intensified (surpassing the 3 % and then the 4 % thresholds in 2013 and 2014 respectively) , and was apparently still continuing as of the latest date, that for 2016.
  • If the current slowdown continued through 2017, as seems likely, it would have reached the six-year duration recorded in the exceptionally severe cases, called as slowdown episodes.
  • In other words, India՚s current investment/saving slowdown episode has been lengthy compared to other cases - and it may not be over yet.

Saving Versus Investment: Growth Consequences

  • Countries that experience growth transitions eventually see sustained higher rates of saving.
  • India՚s impact on growth has been relatively moderate than witnessed in comparable investment slowdowns in other countries.
  • The difference between investment and saving slowdowns can be isolated in another manner. There are a few episodes across economies in which both investment and saving have slowed simultaneously.
  • A further classification of the investment slowdowns can be attempted: those that are driven primarily by a fall in private investment and those that are not.
  • Data on the private investment component of aggregate gross fixed capital formation is available from the WDI database.

Recovery from ‘India-Type’ Investment Slowdowns

  • India՚s investment slowdown is unusual in that it is so far relatively moderate in magnitude, long in duration, and started from a relatively high peak rate of 36 % of GDP.
  • The slowdown has a specific nature, in that it is a balance sheet related slowdown. In other words, many companies have had to curtail their investments because their finances are stressed, as the investments they undertook during the boom have not generated enough revenues to allow them to service the debts that they have incurred.
  • Two types of international experience after slowdowns are considered: (i) balance sheet-related ones; and (ii) where investment fell by 8.5 % points peak-to-trough over 9 years.

What Happens After Balance-Sheet Slowdowns?

  • Since India is now 11 years past its investment peak, investment rates are measured as deviations from peak levels for years 11,14, and 17 after the peak dates.
  • The two take-aways from extent of investment recovery after slowdowns are
  1. Investment declines flowing from balance sheet problems are much more difficult to reverse. In these cases, investment remains highly depressed, even 17 years after the peak, whereas in case of non-balance-sheet slowdowns the shortfall is smaller and tends to reverse.
  2. India՚s investment decline so far (8.5 % points) has been unusually large when compared to other balance sheet cases.

What happens after similar investment falls?

  • A ‘full’ recovery is defined as attainment of an investment rate that completely reverses the fall, while no recovery implies the inability to reverse the fall at all or worse.
  • The median country reverses only about 25 % of the decline 14 years after the peak, and about 40 % of the decline 17 years after the peak. If India conforms to this pattern, the investment-GDP ratio would improve by 2.5 % points in the short run.
  • If India situates itself in the upper quartile, it can recover by more than 4 % points. But India is already 11 years past the peak, and its current performance puts it below the upper quartile.
  • Given the large fall in investment that India has registered, it has paid moderate costs in terms of growth. Between 2007 and 2016, rate of real per-capita GDP growth has fallen by about 2.3 % points-that is lower than the above 3 % decline in growth noticed.

📝 Conclusion: Policy Lessons for India

  1. It is clear that investment slowdowns are more detrimental to growth than saving slowdowns.
  2. Second, India՚s investment slowdown is not yet over although it has unfolded much more gradually than in other countries, keeping the cumulative magnitude of the loss - and the impact on growth - at moderate levels so far. Cross -country evidence indicates a notable absence of automatic bounce-backs from investment slowdowns. The deeper the slowdown, the slower and shallower the recovery.
  3. Taken together, the results suggest a clear and urgent policy agenda which the government has launched; first with the step-up in public investment since 2015 - 16; and now, given the constraints on public investment with policies to decisively resolve the TBS challenge.

These steps will have to be followed up, along with complementary measures: easing the costs of doing business further, and creating a clear, transparent, and stable tax and regulatory environment.

In addition, creating a conducive environment for small and medium industries to prosper and invest will help revive private investment. The focus of investment-incentivizing policies has to be on the big and small alike

- Published/Last Modified on: February 8, 2018


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