The Indian market is riding high on expectations. Sensex rose significantly one week before the election results were announced and has remained high ever since. India has recently topped the Nielsen’s Consumer Confidence Index owing to consumers’ confidence in a stable and majority government. Investment confidence has also soared. Net investment by foreign investors in the month of July has surpassed Rs. 30,000 crores.
However, we should remember that the Indian government does not have a magic wand. The soaring capital flows are highly volatile. And it is not the sheer number of capital inflows that matters; what matters is the type of capital. FDI inflows are preferred to portfolio inflows as they lead to more capital formation in an economy. However, since FDI is investment to acquire a maximum of 10 percent of voting stock, it also includes investment by venture capital, private equity and hedge funds. The financial activities of such entities are regulated limitedly and hence such capital can hold adverse implications. It was the surge in such VC/PE/HF capital and volatile portfolio inflows that lead to the boom and debt lead growth in 2003-08. Currently, PE and VC investments have increased about 35% in the six months ending 30th June and may accentuate the economic cycle. Further, it is also desirable to direct a higher share of FDI into the telecom, manufacturing and IT industry which can bring long term technology spillovers.
Now, considering the domestic economy, the parameter for measuring investment- gross fixed capital formation includes manufacturing, construction and infrastructure investment. Infrastructure includes electricity, gas, water, transportation, storage and communication. The share of infrastructure in gross fixed capital investment should increase to ensure long term growth.
The bottom line is that more than celebrating the numerical increase in investments, it is important to scrutinize the components of investments. It is possible that the current investment surge is just cyclical. However, policy decisions by the new government like increasing the FDI limit in defense and railways infrastructure will contribute to long term capital formation and sustainable growth.