Is private investment expected to rise?

Sub: IR

Sec: Places in news

Context:

Finance Minister Nirmala Sitharaman expressed optimism about the potential recovery of private investments in India.
She highlighted the government’s actions, such as tax stimulus through income tax breaks and the Reserve Bank of India’s (RBI) interest rate cuts, as efforts to stimulate consumer spending and private investments.

Importance of Private Investment:

Private investment is crucial for economic growth as it helps in building physical, human, and other forms of capital, which ultimately increase the production of goods and services in an economy.
Private investment is generally seen as more efficient than public investment, as it is driven by the profit motive and market discipline, which ensure that resources are allocated based on consumer needs.
In contrast, public investments are not subject to the same market-driven pressures and can sometimes result in inefficiencies. Despite this, public investment has played a significant role in India’s high growth numbers in recent years.

Determinants of Private Investment:

Private investment is often thought to be driven by savings deposited in banks. However, in reality, it is influenced by the ability of banks to create loans.
Banks can electronically create loans, even without the need for savings to back them, thus creating a strong positive relationship between bank credit growth and private investment.
During periods of high bank credit growth, private investment tends to rise. Between 2005 and 2014, India experienced high economic growth with an average bank credit growth of 22%. However, from 2014 to 2021, the economy slowed down, and bank credit growth dropped to around 9%.

Concerns Regarding Private Investment:

Private investment has been on a downward trend for more than a decade, and it further weakened in the December 2024-2025 quarter, with a 4% drop.
In contrast, public investments, including those by the Centre and State governments, have increased significantly, 8% and 34.6%, respectively.
The drop in private investment is primarily attributed to a slowdown in economic reforms, which has discouraged investors from undertaking capital-intensive projects.

Why has private investment been sluggish?

One of the main reasons for sluggish private investment is insufficient consumer demand. Economists argue that unless consumers have more disposable income, businesses will be unwilling to invest in new projects.
The slowdown in private investment is also attributed to policy uncertainty and unfavourable government policies.
To address this, the government has introduced measures like income tax breaks, making incomes up to ₹12 lakh tax-free, to increase consumer spending.
This policy is seen as a way to boost demand and, in turn, encourage private investment.
However, historical trends suggest that there may be an inverse relationship between private investment and consumer spending.

Trends in Private Investment and Consumption:

Private final consumption expenditure stood at a high of 90% of GDP in 1950-51, from where it dropped gradually over the decades to hit a low of 7% of GDP in 2010-11.
At the same time, private investment as a percentage of GDP rose from around 10% in 1950s to around 27% in 2007-08.
After private investment peaked in 2011-12, private consumption spending started to rise, even though private investment has since declined.
This suggests that money not invested tends to be spent on consumption, and vice-versa.