At the outset, two points need to be made. First, India’s incremental capital output ratio or ICOR, is rising on a consistent basis. ICOR measures the incremental capital investment required to generate an extra unit of output. In other words, it measures the capital efficiency of new capital investments. The number for India is currently in the 5-6 range, whereas for other countries in south-east Asia the number is generally in the 3-4 range.

Even for China, the number is 3.9. The worrisome aspect is that this number is rising, which means that capital efficiency is falling and therefore, as a country, we will have to employ more capital to generate the same level of growth. One of the reasons for this decline could be the increasingly dilapidated nature of India’s infrastructure that is just making it harder for businesses to operate efficiently. A second could be the high level of graft and mal-administration in our system. The second point pertains to Gross Capital Formation, or GCF. This is the total amount of capital that our economy generates every year and is a mix of household savings, savings by the private sector and savings by the public sector, including the government. Even if we assume an ICOR of 4.5, it implies that to grow at 8% a year, we need GCF to be approximately 36% every year. The number for India currently is about 25% — a shortfall of almost 10% of GDP every year. In other words, we lack capital formation by almost $70-80 billion every year. The interesting point is that while household savings are about 24% of GDP, private sector savings are only 3% of GDP. And the public sector, which should actually be most aggressively driving this capital formation, is actually showing a dis-saving of almost 2% a year. That means that the government as a whole is squandering the savings that ordinary Indians make every year.

Every year, we receive about $15 billion of external flows in the form of depository receipts, FDI, NRI deposits and external borrowings by the government and the private sector. But given the scale of the shortfall, these flows will simply not plug the requirements of the economy. Please observe that a bulk of the FII inflows, which go into the secondary market, do not contribute anything to plugging this gap. Over a 5-year period, the cumulative shortfall in capital formation would be almost $300-400 billion—staggering numbers.

Let’s look at the same numbers for industry. If the economy needs to grow by 8%, and agriculture contributes only 3% for its quarter share of the economy, then making certain assumptions for the services sector would imply that industry needs to grow at a rate closer to 10% every year for its quarter share contribution to the overall economy. Unfortunately, we have averaged a rate closer to 6% per annum for the last several years. Second, the gross capital formation in the industrial sector has been declining from levels of 60% of industrial output to about 45%. Assuming no change in productivity levels, industry would need to invest close to $70 billion every year for the next several years. Again, looking at the supply of funds, the industrial sector has raised close to $45 billion through a mix of both domestic and external funding, including FDI. The gap, therefore, is almost $25-30 billion every year.

Then there was the familiar saga of infighting among some of our corporate families. When the stakes are high and both parties feel that they have a rightful claim to some, or all, of the legacy of their parents, and these respective aspirations unfortunately are at variance with each other, then problems result. We will have to wait and see how these corporate/family issues do get resolved.

• The government is squandering the savings of ordinary Indians
• New funding can come from better capital utilisation by the government

The government will certainly need to exercise its mind on where these funds will come from. Any delay sets the economy back further. One could almost argue that given the magnitude of the shortfall, the time for an incrementalist approach to finding solutions is over. What we now require is a more transformational and risk-taking approach to generating new funding. And I am by no means arguing that this can only come from FDI, although that is clearly one of the preferred sources. It can, and should come, from greater savings by Indians, and probably most importantly, by better capital utilisation by the government sector, a reduction in revenue deficits of the various central and state governments and through increased profitability and, therefore, higher savings amongst public sector units.