Pushing capital expenditure will not be enough
Prime Minister Narendra Modi has reportedly asked the cabinet secretary to prepare a list of infrastructure projects that have been delayed because of court or green tribunal orders. This should help the government take appropriate steps to address the concerns raised by courts and bring such projects back on track. Delays in completing projects escalate costs and reduce the efficiency of capital employed. In a situation where the economy is recovering from a pandemic-induced contraction, it is important for the government to not only increase capital expenditure, but also invest efficiently. However, the latest data on government finances shows that capital expenditure is lagging. Despite robust revenue collection, capital expenditure till July end was at 23.2 per cent of the Budget Estimate (BE), compared to 27.1 per cent during the same period last year. The need for pushing capital expenditure cannot be overemphasised at this stage.
The first-quarter gross domestic product (GDP) data, released this week, showed that despite 20.1 per cent growth, year-on-year, output was considerably lower than the level of 2019-20. Thus, given the fiscal position, it would make sense for the government to invest more than the budgeted amount. Higher capital expenditure by the government will boost demand and encourage the private sector to invest. Sustained higher investment is critical for attaining higher sustainable growth. Higher economic growth in the first decade of the century, for instance, was supported by higher investment. But both investment and growth suffered after the financial crisis. Besides, the efficiency of investment also took a hit. Gross fixed capital formation (GFCF) at current prices increased to about 36 per cent of GDP in 2007-08 and output grew by about 8 per cent around that time. GFCF remained at relatively high levels for some time but declined subsequently. It dipped to about 29 per cent in 2019-20, while growth slowed to 4 per cent.
Although GFCF recovered sharply in the first quarter of the current fiscal year, compared to a decline last year, it would be better to wait and see how it works as the economy returns to normal. The trend in recent years, however, suggests that the economy has not been growing proportionate to the level of investment. Thus, the capital required to increase output or the incremental capital-output ratio (ICOR) has gone up. A working group set up by the erstwhile Planning Commission, which submitted its report in 2012, analysed the ICOR for previous plans and estimated the level of investment required to attain different levels of growth. For instance, to attain 8 per cent growth during the 12th plan, the required investment rate at market prices was estimated to be 30.5 per cent of GDP. Given that there has been a revision in the GDP series, difference in GFCF and the investment rate, and the fact that some of the assumptions in the relevant economic framework are unrealistic, growth over the last few years has still been considerably low.
It is likely that investment made by the government has not led to the desired increase in productivity. Further, costs may have increased because of multiple factors, and capacity utilisation in general remains low. Thus, the prime minister has done well to initiate a review of delayed projects. But a lot more needs to be done to improve the overall efficiency of capital in the system. Strengthening the Insolvency and Bankruptcy Code and reforming the banking system would be a good start in this context.