India Perspectives: Will the investment cycle turn?

The quantity and quality of investments in India have declined significantly, HSBC says

March 11, 2014 10:31 IST | India Infoline News Service
Investments have taken a serious nose dive in the past couple of years after a strong run in the previous decade. This is a key reason for the significant slowdown in India’s GDP growth in recent years. While this trend is not unique to India, it has been more pronounced than in many of its peer economies. What has also been noteworthy is that the quality of investments has declined.

What explains this? The RBI has been blamed for keeping interests rates high, but at the same time high inflation has also been blamed. Some point to fiscal excess and the lack of structural reforms as key reasons. We have put these questions to the test by developing a quantitative model, which identifies some of the key drivers of investment.

While the model shows that high real interest rates weigh on investments, they are lower today than they were before the global financial crisis. They can, therefore, not carry the blame for the current weakness in investment. Moreover, the model shows that growth expectations are important determinants of investment. They have declined on the back of structural reform neglect, which has, therefore, hurt the investment cycle. Finally, the model shows that inflation and macroeconomic policy uncertainty has played a negative role in recent years.

In light of this, what is in store for investments? We expect that inflation will remain high, but less volatile. Moreover, monetary and fiscal policies will be better anchored and progress on structural reforms will help improve growth expectations. This is likely to translate into a gradual recovery in investments in coming years.

If, in an optimistic scenario, we move back to the “bliss” prevailing before the global financial crisis, investments would again be a key driver of growth. If we stay where we are, on the other hand, a recovery in GDP growth could prove elusive.

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