Decline in Private Investment in India: Issues and Policy Recommendations

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Domestic private investment has declined by 1.4% in the third quarter (Q3) of FY 2024-25 as compared to the second quarter (Q2). This decline reflects fears of high input costs and slowing growth rate. However, state governments have promoted an increase in public investment.

Private Investment Trend in India

• Private investment in India increased significantly after economic reforms in the late 1980s and early 1990s.
  • Public investment was high before liberalization. However, private investment took over the growth in gross fixed capital formation (GFCF) after economic reforms.

• Before economic liberalisation, private investment was about 10% of GDP which increased to about 27% by the year 2007-08.
• After the global financial crisis of 2007-08, private investment started declining and reached the level of 19.6% of GDP in the year 2020-21.

Factors affecting investment decisions:

• Decrease in private consumption: Decrease in confidence of business or business groups to invest leads to a decrease in private consumption expenditure.
  • Without an increase in consumption, business establishments avoid investing in new projects as they are uncertain about future demand.
• Weak quarterly results: Poor financial performance in previous quarters discourages future investment.
• Global uncertainties: Economic instability, geopolitical risks and global market volatility create apprehensions about new investment.
• Policy issues: Unfavourable government policies and policy uncertainty discourage private investment.
  • Reforms in the 1990s boosted investment, but the lack of reforms in the last two decades has been a major reason for the decline in private investment.
• Policy uncertainty: Private investors seek stability and clarity in government policies and uncertainty in these areas can impede long-term investment.

Effects of reduced private investment

• Decrease in private gross fixed capital formation (GFCF)
• Slow economic recovery: Low rate of private investment hinders overall economic recovery and limits growth.
• Reduced job creation: Reduced investment, especially in infrastructure and new projects, leads to lower job creation, leading to increased unemployment and underemployment.
• Limited capacity expansion: Lack of private investment may result in companies being unable to expand their production capacity.
• Lack of innovation: Lack of investment in new ventures and research leads to stagnation in technological advancement, process improvement and new product development.
• Effect of taxation: Governments often impose high taxes to finance public investment, which can reduce disposable income. This can reduce economic activity.

• Supply chain disruptions: Without private investment in infrastructure and logistics, supply chains can be inefficient as well as vulnerable to disruptions.
• Public investment versus private investment: Reliance on public investment expenditure to stimulate growth puts additional pressure on government finances. It also reduces the incentive for private investors to invest their funds.
• Increased inflationary pressures: Without the growth that can be achieved through private investment, economies may face inflationary pressures due to supply constraints and rising costs.

Policy recommendations

• Accelerating economic reforms: Simplifying regulations, improving ease of doing business and increasing transparency is necessary to create a more investor-friendly environment.
• Tax reform: The tax system should be simplified. Tax incentives can be provided to encourage private investment, especially in the infrastructure and innovation sectors.
• Infrastructure reforms: Investments in key infrastructure sectors (e.g. roads, ports, energy) are necessary to create favourable conditions for private sector growth.
• Emphasis on policy stability: Consistent and predictable policies must be ensured to reduce uncertainty and restore investor confidence.
• Boosting private consumption: Focusing on increasing disposable income through targeted fiscal measures to boost demand is a pragmatic step. This can encourage businesses to invest.
• Public-Private Partnership (PPP): A collaboration between the government and the private sector to jointly invest in high priority sectors.
• Financial access: Improving access to affordable financing for businesses, particularly SMEs, is essential to reduce the cost of capital for investment.
• Fostering innovation and technology: Incentives for research and development and supporting startups can foster an environment of innovation.
• Labour market flexibility: Labour reforms should be implemented effectively to allow businesses to adapt to market conditions and invest with confidence.
• Focus on long-term growth sectors: Growth sectors such as green energy, technology and manufacturing should be identified and supported to attract private investment.