India's Capital Expenditure Growth Plan Requires Household Sector Emphasis

Economic Report: Capex Spending and its Limitations

Overview

The Indian government's focus on capital expenditure (capex) has been a key driver of growth in recent years, with a narrative that the government has been forced to make up for lackluster private investment. While this has increased GDP, the value addition from infrastructure projects has been limited, primarily due to the low quality of jobs created.

First-Order Effects of Capex Spending

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Government spending on roads, railways, and communications, which accounted for 9-10% of annual capital formation, added only 4-5% to Gross Value Added (GVA). The second-order effects, such as new industries and jobs created from improved infrastructure, are harder to quantify but are more important for sustainable growth.

Fiscal Strategy and RBI's Assessment

The Reserve Bank of India (RBI) sees the Union Budget as a careful balance between growth augmentation and fiscal consolidation. However, the RBI's assessment glosses over disconcerting aspects, including slowing growth in income tax collections and indirect taxes, which fell below Budget estimates for 2025-26.

The Overlooked Household Sector

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The household sector, accounting for 42% of all capital investment in 2023-24, is the largest investor in the economy. However, the sector is predominantly the informal economy, contributing over 40% of total GVA and over 80% of all employment. The problem is the small size of investments and their concentration in sectors that do not create many high-income jobs.

Concerns Over Quality of Investment

The investment pattern shows a third of investments in trade, transport services, and miscellaneous personal services, nearly a fifth in agriculture, and 15-16% in residential housing. The value addition from the ownership of dwellings is largely hypothetical, reckoned as the imputed rental value of owner-occupied housing.

Need for Structural Reform

The investment problem requires not only relieving the government of its capital spending burden or getting the private corporate sector to invest but also bringing the sizeable household sector into the formal economy. Recent measures to simplify labor laws, expand social security, and strengthen skill development are steps in the right direction.