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India’s unprecedented climb to historic high levels of investment and saving rates in the mid-2000s has been followed by a pronounced, albeit gradual, decline. This current episode of investment and saving slowdown is still ongoing. This chapter draws on cross-country experience to study the pattern of investment and saving slowdowns as well as recoveries in order to obtain policy lessons for India. One finding is that investment slowdowns have an impact on growth but not necessarily saving. Another is that recoveries from investment slowdowns, especially those associated with balance sheet difficulties--as in India--tend to be slow. Notably, mean reversion or some degree of automatic bounce-back is absent so that the deeper the slowdown, the slower and shallower the recovery. The policy conclusion is urgent prioritization of investment revival to arrest more lasting growth impacts, as the government has done with plans for resolution of bad debts and recapitalization of public sector banks. IDENTIFYING INVESTMENT AND SAVING SLOWDOWNS Investment and saving slowdowns are defined using a specific set of conditions (filters). 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. Then, a “slowdown year” is defined as one where the shortfall in that year exceeds a certain threshold. If there are two or more consecutive slowdown years, this counts as a “slowdown episode”. Second: the average investment rate for the 5 years prior to the slowdown year is at least 15 percent of GDP. The thresholds considered are of 2, 3 and 4 percentage points. As noted in Rodrik (2000), the lower the threshold, the greater the risk of capturing episodes of temporary volatility rather than more enduring slowdowns. But because India’s current investment (saving) slowdown has been so gradual it is best captured in the 2 percent threshold. Moreover, in most cases, the results for the 3 and 4 percent thresholds also hold for the 2 percent case. POLICY LESSONS FOR INDIA First, it is clear that investment slowdowns are more detrimental to growth than saving slowdowns, a conclusion that was earlier reached by Rodrik (2000). So, policy priorities over the short-run 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. But this leads to the third question: how will the investment slowdown reverse, so that India can regain 8-10 percent growth? There is both a bleak and a hopeful pointer from similar episodes in other countries. 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.
By: Abhishek Sharma ProfileResourcesReport error
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