Investment Cycle And Investment Growth In India: An Empirical Analysis


A 1% increase in the real interest rate (interest charged after allowing for inflation) leads to a decline of about 0.5% in the investment rate, a current study by the Reserve Bank of India (RBI) indicated, which recently released its working papers wherein the authors divulged their views and estimates regarding the investment cycle in the emerging Indian economy. It importantly stated that the investment rate is expected to rise to 33% in the coming years. Before further examination of the intriguing facts about India’s investment history, let’s understand the concept of an investment cycle.


Basically, an investment cycle is the holistic process of acquiring (investing in) assets, earning profits (returns) on that investment, and then disposing (selling) it off, after which the money is re-invested. This cycle continues and gets the economy going in a sustainable manner. To understand it in a better way, let’s take an example. Assume Mr. Gupta has a certain amount of savings, say Rs. 50,000, that he wants to invest. Soon enough, he comes across a road project in Bengaluru which he thinks is worth the investment, and invests it. Now the builder spends the money on cement and steel, hires workers, rents machinery, builds the road and starts collecting toll on the road. He returns Gupta the money with a handsome interest rate. Here, we notice that Gupta’s money has gone a full circle in the economy, benefitting cement and steel manufacturers, providing for the salary of some workers (who would spend it further), income for the machinery supplier (who would buy more machinery with it) and finally back to Gupta. This is briefly what an investment cycle signifies.

Now, let’s see how the cycle works in the context of India’s macro scale. The banks and large financial institutions are the ones to take in deposits from the households. They then lend it to industries that in turn expand, employ more people, buy more machinery, etc. They invest it in infrastructure projects such as railways, highways and power plants. The banks earn prodigious returns from such investments, and the households, their share of interest from the banks. Each one gains by this process and the cycle continues. The resultant economy produces and generates more economic output. The money is re-invested, witnessing GDP growth, and hence, the virtuous cycle of investment becomes self-sustained, thereby helping the economy grow.

Yes, that’s how important investing is, irrespective of the fact that all investments may not generate humungous returns, or even positive ones.

Now, an economy may experience expansions, peaks, recessions and troughs, as what is called a business cycle. It may be said that the business cycle compliments the investment cycle, in fact, can be used synonymously with it. An investment cycle covers a period that spans several business cycles. The measurement of an investment cycle is similar to the measurement of a business/economic cycle as investment activity like the business/economic cycle also works in two opposite directions, i.e., a period of relative growth and expansion, followed by a period of decline and contraction and so on.That is to say that the economy moving from one peak to another peak (after going through recessions in between) or from one trough to another trough (after going through expansions in between) over a period of time would form an investment cycle.


Investment activity plays a very important role in shaping the ongoing growth of an economy as well as boosting the country’s medium-term growth prospects. Past factual studies have found that investment activity is influenced by several domestic and global macro developments. In the post-Independence era, the real investment rate in India saw an upward trend to peak at 36.7% in 2007-08, before declining to 30.3 per cent by 2015-16.

This was a result of a combination of factors such as the adverse impact of the global financial crisis (2008), the twin balance sheet problem (high leveraging by the corporate sector and high non-performing assets of the banking sector) and subdued domestic capital market conditions.  A sluggish investment rate was one of the major factors which pulled down India’s GDP growth rate from a high of 9.3 per cent in 2007-08 to a low of 6.7 per cent in 2017-18. Though the investment rate has picked up since 2016-17, there is uncertainty about the sustainability of the recent upturn in investment activity and its role in stepping up India’s growth rate in the current and medium-term.

Real Interest rate (user cost of capital) and investment rate show a negative relationship (post 90s)

Coming to the interest rates issue, they accounted for only one quarter of the investment downturn, but lack of business confidence and economic policy uncertainty prevailing in the economy were the major factors in leading the slowdown in India’s investment activity. Another major factor was the reluctance in credit lending by the banks which decelerated from 21.3 per cent in March 2011 to 4.5 per cent in February 2017, mainly due to the downtrodden state of the economy, high NPAs (leading to risk aversion), capital adequacy requirements (minimum capital required to absorb in case of loss), highly leveraged corporate sector and an uncertain global environment.

The fall in investment activity has also been led by a sharp decline in the growth of capital goods production. Firms that have higher financial leverage and lower earnings relative to their interest expenses, invested less, as the study discovered. The Economic Survey (Government of India, 2018) found that one percentage point fall in investment rate dents economic growth by 0.4-0.7 percentage points.

In the case of capital-deficient developing countries, capital formation is the key driver of economic growth. Gross Fixed Capital Formation (GFCF) measures the value of acquisitions of new or existing fixed assets by the business sector, governments and households minus disposals of fixed assets. In short, it shows how much of the new value added in the economy is invested rather than consumed. Investment rate is also highly correlated with the non-agriculture GDP growth rate, particularly seen in recent years.


Growth rate of GFCF and the investment rate cycle are highly correlated

Now since we know that GFCF and investment rate portray a positive relationship, we must know that the private sector is the biggest contributor to gross capital formation and it has played a crucial role in driving India’s investment activity. However, the fiscal deficit in India appears to have crowded out private investment as is evident from the negative relationship between the GFD and the investment rate in the chart below.


In the post-liberalization period, four major downturns in the investment cycle were witnessed in the Indian economy. The first of those occurred in the early half of 1990s, when the economy was hit hard by the balance of payments (BOP) crisis, that was led by import compression and a deceleration in domestic activity. The next one occurred in the early 2000s due to an adverse impact of the bursting of the information technology (IT) bubble. The average real GDP growth from 2000 to 2003 decelerated to 4.5 per cent from 7.0 per cent in the second half of the 1990s. A sharp decline in the software exports due to the Y2K (Year 2000) problem also dampened the investment cycle during this phase. The third menace to the investment cycle was the 2008 global financial crisis, that knocked down the world economy, and caused a seizure of the international capital market and its aftermath. It led to a severe contraction in credit lending, forcing households and businesses to deleverage by paying down debt or defaulting. Tighter credit also greatly increased the frictions in the financial system, making it harder for companies to do business. The fourth and the last phase of downfall occurred in the period from 2011-12 to 2015-16, reflecting a combination of global and domestic factors. During this phase:

  • world GDP growth fell from 4.3% in 2011 to 3.2% in 2016,
  • average domestic inflation was around 8%,
  • real interest rate was high at around 5%,
  • the combined gross fiscal deficit (GFD) of the Centre and states was on an average of 7.1%,
  • the average current account deficit (CAD) was 2.6%, and
  • banks’ lending growth nosedived as they became risk averse on account of large non-performing assets.

These instances led to a dicey situation in the economy to the disapproval of one and all. It aggravated as the corporates targeted at deleveraging their positions rather than making fresh investments.

Turning points of investment cycle in India

The turnaround was seen from 2016-17 when the investment rate indicated a change in direction. This was also reflected by indicators such as industrial production which had picked up in the second half of 2017-18. Production of capital goods increased sharply, reflecting strengthening of capital formation. Capital raised through IPOs picked up from 2015-16 and rose sharply in 2107-18. Not only this, but the banking sector lending too saw an increase during the period.

Sectoral Credit Growth (yoy) :Credit flows to industry has turned positive since November 2017


  • Real GDP growth rate represents demand conditions, i.e., a higher GDP growth means higher income and employment, which then leads to higher consumption, even higher savings, and thereby increased investments contributing to the further growth of the economy.
  • The real interest rate is a substitute for cost of borrowing which is expected to be inversely related with investment activity. As the interest rate rises (maybe as a control for inflation or other factors), money in the hands of investors is seen to be insufficient for the purpose of carrying out the investment process. Thus at such a time, investment activity is miniscule.
  • Higher non-food credit is expected to have a positive sign, which explains the above point in a reverse way.
  • A higher level of the fiscal deficit crowds out private investment, as higher market borrowing by the government to finance the deficit could impact resource raising by the private sector because of a rise in the real interest rates.
  • The growth rate of world GDP, that has been hovering around the 3.5% mark for quite some time, is taken as a proxy for global demand, which is expected to be positively related to real investment.

While the average duration of expansion (from trough to peak) has been 1.6 years (seven quarters), the average duration of slowdown (from peak to trough) was 1.4 years (five quarters). From 1950-51 to 2017-18, the Indian economy saw broadly nine phases of contraction/expansion of two years and above. The largest decline in investment activity from 2011-12 to 2015-16 was led by a deceleration in both the trend and cyclical factors.


A consolidation in the trend of the investment activity has been seen from 2011-12 onwards. However, the cyclical component has shown upward movement from 2016-17, suggesting that recent improvement in investment activity is due to cyclical factors. The upturn in the current investment cycle, which began in 2016-17, is estimated to last up to 2022-23 when the investment rate is estimated to increase up to 33% from the current level of 31.4%. However, the challenge is to reverse the declining trend component of investment activity. This will require policy efforts on various fronts as:

  • Further improving ease of doing business in the country,
  • Accelerate the resolution of distressed assets,
  • Address the crucial NPAs problem of the banking sector, and
  • Speeding up implementation of the stalled projects, which is a major lacking in the country.

Fulfilling these measures over time will assist in riding the current phase of the investment cycle to its peak and boosting medium term prospects of investment activity. The sharp acceleration in real GDP growth in the first quarter of 2018-19, rise in bank credit growth and an optimistic stock market will augur well for sustaining the investment activity going forward. However, uncertainties on the global front and financial market volatility can be a cause of concern and need to be shielded against. After all this, it can be only be anticipated for that the comforting future estimates of the investment activity in India will live up to the expectations.