On Private Investment – Crowd-in must not start crowding investors out

Source: This post on Private Investment has been created based on the article “Crowd-in must not start crowding investors out” published in “Live Mint” on 27^th December 2023.

UPSC Syllabus Topic: GS Paper 3 Indian Economy – Indian Economy and issues relating to mobilization of resources, growth.

News: The article discusses the optimistic indicators in Indian economy which signal a future increase in private investment in the economy.

In June 2023, India’s credit-to-GDP gap has turned positive for the first time in a decade, according to Bank for International Settlements. This has led to optimism regarding the economy’s trajectory ahead.

What is Credit-to-GDP Gap?

The Credit-to-GDP gap compares the current level of credit (the amount of money lent by financial institutions) to the GDP.
This gap helps identify periods when the pace of credit expansion is unusually high relative to the growth of the economy. A high credit-to-GDP gap may indicate a credit boom, potentially signaling increased risk of financial instability or a future economic downturn. Conversely, a negative or low credit-to-GDP gap might suggest limited credit availability, which could constrain economic growth.

While the credit-to-GDP gap is a contentious figure to assess the state of an economy, it is often used along with other data as an early warning indicator of a banking crisis.

What are some other positive indicators in the economy?

1. Healthy State of Banks: Banks are broadly in better shape than a decade ago, with bad loans as a chunk of bank assets having fallen to low single-digit rates. Lending norms have been tightened and the risk of debts going bad appears to pose no systemic threat at this point.
2. Credit Growth: The rate of credit growth has reached mid-teen levels.
3. Increased Capacity Utilization in Manufacturing: It has crossed 75% (the percentage of potential output levels that is being achieved), which suggests business borrowings are increasing as expansion plans are dusted off for action.
   4. Consumer Spending: The post-pandemic recovery in consumer demand has been uneven, but markets for many products and services have logged record sales and even the laggards have begun to look up.
4. Increasing capex by the Government: India’s post-covid economic growth has been boosted by heavy capital expenditure by the Centre.
5. Crowd-in effect of Government Capex: A major thrust behind government’s capex push was to crowd-in private investment, which is crucial for gross capital formation. To this extent, the author has found that government capex has finally begun to crowd-in private investment (increased government spending leading to increased private investment).

What requires to be done?

The increase in government capex has resulted in an enlarged fiscal deficit. With crowding in of private investment, it’s time for a sharp fiscal pullback, sharper than outlined by India’s official glide path to 4.5% of GDP by 2025-26.

The economy has emerged from its COVID crater and grown faster than expected, but a big fiscal deficit for too long risks crowding out private players.

Question for practice:

Various economic indicators signal that private investment is about to pick up in India. Explain.