Investment and Saving Slowdowns and Recoveries: Cross-Country Insights for India
- Since 2010, discussions of India’s growth have centered on one simple question: how soon will the economy revert to 8-10 percent growth? The question is at times posed as if such a reversion is a fait accompli, a phenomenon just waiting to occur. Perhaps it is even just round the corner, given all the structural reforms the government has implemented in recent years.
- Underlying this expectation is the firm belief that domestic saving and investment will soon start to accelerate.
Some Facts about the Indian Economy
- Investment (gross fixed capital formation) rate and gross domestic saving rate are actually above the levels that prevailed throughout the 1990s. In fact, it was the boom of the 2000s that was exceptional, as India’s climb to about 10 percent real GDP growth was accompanied by an unprecedented 9 percentage point pick-up in domestic saving and investment rates. The subsequent slide in investment and saving (as a percent of GDP) has merely brought these rates back towards normal levels.
- The ratio of the gross fixed capital formation to GDP climbed from 26.5 percent in 2003, reached a peak of 35.6 percent in 2007, and then slid back to 26.4 percent in 2017.
- The ratio of domestic saving to GDP has registered a similar evolution, rising from 29.2 percent in 2003 to a peak of 38.3 percent in 2007, before falling back to 29 percent in 2016
Such sharp swings in investment and saving rates have never occurred in India’s history–not during the balance-of-payments crises of 1991 nor during the Asian Financial Crisis of the late 1990s.
IDENTIFYING INVESTMENT AND SAVING SLOWDOWNS
Investment and saving slowdowns are defined using a specific set of conditions
- 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.)
- Second: the average investment rate for the 5 years prior to the slowdown year is at least 15 percent of GDP
Table. Number of Slowdown Episodes (3 percent threshold)
Investment is more prone to extreme events: there are 4 cases where the cumulative investment slowdown exceeded 50 percentage points, whereas there are hardly any cases of saving slowdowns of this magnitude.
Table. Magnitude-wise Count and Duration of Slowdown Episodes (Percentage Points, Average of 2, 3, and 4 percent Thresholds)
History of Major Slowdowns
- While frequent, slowdowns have tended to cluster in particular time periods. Most slowdowns in Latin America and Africa occurred during the 1980s, a period that became known as the ‘lost decade’ in those continents.
- Meanwhile, 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 percentage of such countries at its peak
Figure 2. Percent of countries experiencing a slowdown (3 percent threshold)
Table 4. India Slowdown Years:
SAVING VERSUS INVESTMENT: GROWTH CONSEQUENCES
- The simultaneous slump in saving and investment gives rise to a question. Should policies that boost investment (viz. substantial infrastructure push, reforms to facilitate the ease of doing business or the ‘Make in India’ program) be given greater priority over those that boost saving?
- Both set of policies are crucial in the long run but which one needs to be prioritized at present?
- The standard solution that is often prescribed is that both problems need to be tackled simultaneously.
- Rodrik (2000) provides evidence that a simultaneous push may not be necessary—arguing that successful economic performance is not explained by saving transition episodes.
- Rodrik (2000) proposes that policies should focus on encouraging investment, rather than saving, to boost growth. Minsky also accorded primacy to the role of investment over saving (profits) in his analysis of macro-financial developments
- Cross-country regression results confirm the visual impression: the relationship is significantly positive for investment episodes, but insignificant for saving. A one percentage point fall in investment rate is expected to dent growth by 0.4-0.7 percentage points.
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 percent of GDP.
- Furthermore, it has a specific nature, in that it is a balance sheetrelated 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.
What happens after balance-sheet slowdowns?
- 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.
- India’s investment decline so far (8.5 percentage 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 percent of the decline 14 years after the peak, and about 40 percent of the decline 17 years after the peak. If India conforms to this pattern, the investment-GDP ratio would improve by 2.5 percentage points in the short run. Of course, this is the median: if India situates itself in the upper quartile, it can recover by more than 4 percentage points. But India is already 11 years past the peak, and its current performance puts it below the upper quartile.
CONCLUSION: POLICY LESSONS FOR INDIA
- First, it is clear that investment slowdowns are more detrimental to growth than saving slowdowns
- So, policy priorities over the shortrun must focus on reviving investment. Mobilizing saving, for example via attempts to unearth black money and encouraging the conversion of gold into financial saving or even courting foreign saving are, to paraphrase John Maynard Keynes, important but perhaps not as urgent as reviving investment.
- In any case, the share of financial saving is already rising in aggregate household saving—with a clear shift visible towards market instruments—a phenomenon that has been helped by demonetization.
- 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.
How will the investment slowdown reverse, so that India can regain 8-10 percent growth?
- India’s investment decline seems particularly difficult to reverse, partly because it stems from balance sheet stress and partly because it has been usually large.
- Cross -country evidence indicates a notable absence of automatic bounce-backs from investment slowdowns. The deeper the slowdown, the slower and shallower the recovery. At the same time, it remains true that some countries in similar circumstances have had fairly strong recoveries, suggesting that policy action can decisively improve the outlook.
- 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. The ‘animal spirits’ need to be conjured back.