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IV the Behavior of Private Investment IV The Behavior of Private Investment Kare n Parker s the results of the growth accounting exercise cline in investment. Despite the casing of credit con­ A in Section II indicate, capital accumulation has ditions in 1992/93-1993/94, gross capital formation been the main impetus to growth in India over the continued to decline as a result of weak domestic de­ past thirty years. Gross domestic capital formation mand and persistent uncertainty. nearly tripled as a share of GDP from 1950/51 to While severe, India's "investment pause" appears 1990/9 1 (Chart 4.1) . The increase in domestic capi­ to have been relatively brief. The upturn in produc­ tal formation can be attributed in part to public sec­ tion in the capital goods sector and the surge in capi­ tor investment, which rose from 3 percent of GDP tal goods imports point to a robust recovery of in­ in the mid-1950s to over 10 percent by the mid- vestment in 1994/95. Based on the econometric 1980s. However, about two thirds of gross capital results, private capital formation is projected to have formation has been undertaken by the private sector, recovered to 131/2 percent of GDP in 1994/95 and to and the latter's contribution is likely to increase rise further to almost 16 percent of GDP by 1995/96. over the next decade. To understand India's growth Underlying the investment recovery is an accelera­ record and prospects, it is therefore important to un­ tion of industrial growth, improved corporate prof­ derstand the factors that underlie private investment itability resulting from business and financial re­ behavior. structuring, and diminished uncertainty. This section analyzes the determinants of private investment in India, focusing in particular on its be­ havior since the reform program was launched in A Model of Private Investment 1991. The econometric results suggest that macro­ Behavior economic policies have played an important role­ both direct and indirect-in determining the behav­ This study uses a general-to-specific modeling ap­ ior of private investment over the past twenty years. proach to identify the principal determinants of pri­ Both the cost and availability of credit to the private vate capital formation in lndia.2 A large set of ex­ sector, as well as public sector investment, have had planatory variables was narrowed to seven through a significant impact on private capital formation. the successive elimination of statistically insignifi­ Private investment has also been influenced by the cant terms. All variables were expressed in scaled behavior of industrial production and by the pres­ form or as rates of change to avoid potentially spuri­ ence of price uncertainty. ous correlation among nonstationary series.3 Regres­ Private capital formation relative to GDP fell sions on annual data were estimated using ordinary sharply during 1991/92-1993/94 (Table 4.1) . Much least squares, and heteroskedasticity-consistent stan­ of the decline resulted from lower household invest­ dard errors were computed. ment in machinery and equipment; household and The choice of the set of potential explanatory vari­ corporate inventories also fell relative to GDP dur­ ables reflects recent developments in the literature ing this period. 1 In contrast, corporate fixed invest­ on investment (for a survey of recent empirical ment is estimated to have risen by 4 percentage work, see Rama (1993) and Greene and Villanueva points of GDP from 1990/9 1 to 1993/94. The model (1991 )). Neoclassical accelerator and "Tobin's Q" suggests that a tightening of financial conditions and models have been augmented to allow for the effects heightened uncertainty led to the initial sharp de- 2The methodology used is similar to that in Goldsbrough and I Household investment includes capital formation in the infor­ others (forthcoming). mal sector, that is, firms employing fewer than ten persons. How­ 'Augmented Dickey-Fuller tests did not support the hypothesis ever, large er rors and omissions in the national accounts statistics of a unit root in any series except public and private investment. make it difficult to interpret sectoral patterns of investment. Joshi However. these tests are known to have low power in small sam­ and Liule (1994) raise doubts about the split between corporate ples. An analysis of the sample autocorrelation functions for all of and household investment in India. the series revealed low or rapidly decaying values . • ©International Monetary Fund. Not for Redistribution I A Model of Private Investment Behavior Chart 4.1 Gross Domestic Capital Formation (In percent of GDP at current prices) Jo ------------------------------------------------ Public 25- I Private 1950/51 1955/56 1960/1 1965 /66 1970/7 1 1975/76 1980/8 1 1985/86 1990/9 1 Source: Go vernment of India, Central Statistical Organization. of credit rationing, external financing constraints, Table 4.2 presents the final estimation results, and uncertainty. The initial set of variables for India while Table 4.3 indicates the contribution of each of included the growth of real GOP and of industrial the explanatory variables. The real lending rate was production (lagged one and two periods to avoid si­ found to be a significant determinant of private in­ multaneity bias); the real weighted average lending vestment in India, with the expected sign. The real rate; the growth of real credit to the private sector growth of credit was also significant and had the from banks and term lending institutions; the share correct sign.4 Both the price and quantity of credit of public investment in GOP; the level of foreign ex­ have a bearing on investt:nent, which suggests that change reserves (in months of imports); external the Indian credit markets were segmented during debt service (in months of exports); and the variance the period under study; some borrowers may have of monthly inflation, the real exchange rate, and the index of industrial production (as proxies for uncer­ 4 Thcreal interest rate and the real growth of credit are highly tainty). A description of the initial set of variables is correlated, due to the influence of their common deflator, the given in the Appendix. wholesale price index. Ta ble 4.1. Private Capital Formation (In percent of GDP at constant prices) 1989/90 1990/91 1991/92 1992/93 1993/94 Private fixed investment 11.8 12.7 11.6 12.1 12.0 Corporate 3.5 4.1 6.0 6.4 8.1 Househol d 8.3 8.6 5.6 5.6 3.9 Changes in private stocks 1.6 2.5 1.2 1.6 -{),I Corporate 1.1 0.9 0.4 0.9 -0.4 Household 0.5 1.5 0.7 0.7 0.3 Errors and omissions 0.7 1.3 0.7 -1.2 0.8 Private capital formation 1 3.4 15.2 12.8 1 3.7 11.9 (Including errors and omissions) 14.1 16.5 13.5 12.5 11.0 Source: Data provided by the Indian authorities. • ©International Monetary Fund. Not for Redistribution IV BEHAVIOR OF PRIVATE INVESTMENT Ta ble 4.2. Private Investment Equation• UPE= -15.35 - 1.26 RWGT + 1.22 RCRE - 1.72UG -128.17VREER (-5.58) (-2.50) (2.1 5) (--4.46) (-2.74) - 823.47 VI NFL + 0.52 UPE(-1) + 2.00 IIPGR(-1) + 1.80 IIPGR(-2) (--4.21) (4.05) (2.45) (2.90) R-squared 0.79 Adjusted R-squared 0.65 Standard error of regression 0.1 I Durbin's h-statistic -1.82 Jarque-Bera 0.45 Arch 0.30 White 1.05 Source: IMF staff estimates. 1 Estimated using annual data and ordinary least squares. with heteroskedasticity-consistent standard errors. Estimation period: 1973/74-1993/94. T-statistics are given in parentheses. A description of the variables is gi ven in the Appendix. Ta ble 4.3. Investment Equation-Decomposition of Estimated Change (Dependent variable: Grossprivate investment/GOP. constant prices, in logs; OLS estimates, 197 317 4--/99 3194) - 1980/8 1-1986/87 1986/87-1 990/9 1 1990/9 1-1993/94 Estimated Share of Estimated Share of Estimated Share of I change in 1/GOP estimated change in 1/GDP estimated change in 1/GOP estimated Explanatory (In percent of change (In percent of change (In percent of change Variable GOP) explained by GOP) explained by GOP) explained by Real lending rate -1.6 43.6 1.1 26.2 �.2 10.0 Real growth of credit to the private sector 0.8 -22.5 -1.2 -30.0 �.4 1 7.4 Ratio of public investment to GOP (constant prices) --4.6 127.9 3.6 86.5 1.8 -76.3 Variance of monthly changes in REER 0.03 �.8 �.7 -16.5 0.5 -22.4 Variance of monthly changes in inflation 0.08 -2. 1 �. 2 -5.4 0.2 -10.0 Lagged dependent variable �.9 24.0 1.9 45.3 �.8 34.6 Lagged growth of industrial production (I period) 2.3 -64.3 �.2 --4.6 -1.7 68.8 Lagged growth of industrial production (2 periods) 0.2 -5.7 �.I -1.5 -1.9 77.9 To tal -3.6 100.0 4.1 100.0 -2.4 100.0 1980/8 1-1986/87 1986/87-1990/91 1990/9 1-1993/94 Memorandum items: Actual change in the dependent variable (in percent of GOP) -5.4 7.7 -5.4 Share of actual change in the dependent variable explained by regression equation 66.7 53.2 44.4 Share of actual change in the dependent variable due to change in residual 33.3 46.8 55.5 Source: IMF staff estimates.
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