Financialisation and Slow Growth in Private Investment
Sanjay Roy
SINCE the global financial crisis, investment growth has not recovered to its pre-crisis level worldwide. India despite being a fast growing economy, the growth in gross fixed capital formation shows a declining trend in the past two decades. In the post-crisis period, the governments introduced various institutional reforms in the rubric of ‘ease of doing business’, also corporates could have greater access to finance and external borrowings and public investment was geared to crowd in private corporate investment. The fact however is that private corporate investment continues to remain subdued and although bank credit growth picked up since 2013-14 but investment growth continues to be less than the growth of credit provided by the commercial banks of India.
The moot point is India Inc.’s investment had not been the major driver of growth and the share of private gross fixed capital formation in GDP had declined over the years. One of the most noteworthy features of Indian corporates in the recent past is the decline in the ratio of mobilisation of external resources to the gross value added of non-agricultural sector. Investments generally either are funded by internal savings or largely by borrowings from banks. True indeed there is a rise in private corporate savings and decline in household savings in India, but rise in corporate savings which is held in the form of liquid assets may not lead to long term investment.
CHANGING CORPORATE FINANCE
The decline in the growth of corporate savings is often attributed to overleveraging during the pre-crisis period. Corporates usually mobilise resources either through long term debts from banks or through public subscriptions of equity. Debts are preferred due to tax advantages and because of easy flow of credits, corporates increased their borrowings. And in many sectors due to the slump that followed the global financial crisis, corporate balance sheets were populated by bad debts. Since they are not able to pay back their loans, the room left to access external loans actually declined. In fact, studies argue that during the pre-crisis period corporate investment was largely driven by the credit boom which acts as a drag on their current investment decisions.
Leveraging external funds and using it to new investments and earning higher profits is what corporates would generally like to do but if debts grow faster, beyond a threshold, it may act as a constraint to access external resources as repayments become increasingly difficult. Therefore, corporate debts which ballooned during the pre-crisis period not only increased the burden during the crisis but also made the corporates cautious in accessing external funds. It is interesting to note that of various sources of finance, it is bank credit to industry which suffers the biggest fall. In 2010-11, the ratio of bank credits to enterprises as percentage of non-agricultural gross value added was 7 per cent which suffers a secular decline in the past decade falling to 4 per cent in 2022-23. According to CMIE, credit to MSMEs was very small and actually there was hardly any credit flow to the MSMEs during the period 2015-16 to 2018-19. It only increased during the pandemic due to government’s emergency credit line guarantee scheme. But more importantly bank credit to large industries as a share of non-agricultural gross value added fell even sharply from 5.3 per cent in 2010-11 to 0.4 per cent in 2022-23.
On the other hand, external commercial borrowings and foreign investment flows have acquired increased importance in total financial resources raised by the industry. Reliance on such resources as well as on primary markets instead of commercial bank credits further increases financial vulnerability of the private corporate sector due to volatility of such flows as they largely depend on international markets. Even the SMEs had high exposure to foreign flows in the post-crisis period and most of them record negative net forex earnings. Greater dependence on foreign volatile capital increasingly makes investment decisions vulnerable to interest rate and exchange rate fluctuations. In other words, Indian corporate sector has undergone significant change in their portfolio of resources which further reduces their elbow room for long term investment as decisions are increasingly subject to external shocks.
FINANCIALISATION AND INVESTMENT
This change needs to be seen in the context of financialisation of the Indian economy. Not only the portfolio of the financial resources of the corporates have changed over the years, but also the role of banks is undergoing change. The importance of financial activities has increased in the economy. The share of financial and business services in the GDP has doubled since 1980s. As indicated above, the share of industry in total non-food credit of scheduled commercial banks declined over the years. Industries are relying more on non-banking financial sources particularly capital markets and external borrowings. The share of non-banking financial companies in total financial assets of the country has been increasing. On the other hand, banks are increasingly inclined to household financing and other non-interest incomes. In fact, the importance of non-interest incomes of banks has increased in the recent past. There is also a shift in the nature of investment by sectors. More investments are now flowing towards services.
But taking corporate sector together the significant fact to underline is the declining share of investment in corporate sector surpluses. The lukewarm response of the corporate sector in terms of new investments can be attributed to both short term factors as well as to larger structural issues. In the past decade there had been a rise in the number of stalled projects and business expectations had not been very exciting. It is not only because of the pandemic alone, but the cumulative effect of demonetisation, introduction of value added tax and related shocks, that have eroded incomes of the vast number of poor and working people. The low demand contributes to low expectation of profits for business. The structural change in the sources as well as in uses of finance also indicates a longer term structural problem. The share of investment in short term assets of corporate sector has increased in the past decades while relative share of expenditure on plant and machinery has declined. Corporates are more inclined to invest in financial assets as the rate of return in the financial sector has been higher than the non-financial sector. And as corporates are becoming more dependent on capital markets, maximising shareholders’ return assumes supreme importance overriding the objective of long term growth. If ensuring higher short term returns for shareholders is easier by investing in financial assets instead of productive capacities, corporate managers would obviously redistribute surplus towards financial activities. But increasing financial liabilities in the process further reduces the space to invest in fixed assets.
The rising inclination for financial assets of India’s corporate sector is also reflected by the fact of increasing share of liquid assets in corporate savings. Therefore, the decline in the share of industries in bank credit flows towards non-agricultural sector, is reflective of the larger structural change towards financialisation that the Indian economy is currently undergoing. It is marked by a shift towards short term gains instead of relying on building long term productive capacities. Such a change explains the relative weakening of the linkage between growth and physical investment reflected by the fact that India in the past decades experienced high growth in GDP but declining growth in private gross fixed capital formation.
