In September, Finance Minister Nirmala Sitharaman was anguished that industry was holding back from investing in manufacturing despite a significant cut in corporate tax rates in 2019.
The slowdown in corporate investment did not happen because companies were making losses. In fact, private companies, boosted by considerable tax cuts, made windfall profits. A State Bank of India analysis shows that tax cuts contributed 19% to the top line of companies during the pandemic. But this did not result in increased investments.
Before the pandemic, instead of investing in themselves, companies chose to reward shareholders with higher dividends. During the pandemic, they did not use the profits for paying out dividends; they retained a big chunk of the profits. However, instead of investing in buildings, plants and machinery, they invested in equity shares and debt instruments. So, both before and after the outbreak, they shied away from capital investments.
The hesitancy to invest can be explained by a slowdown in the demand side of the economy. Consumer demand started to decline the year before the pandemic and worsened after the COVID-19 outbreak. This forced companies to use the increased profits to decrease their debts, pay dividends and invest in financial instruments instead of increasing productivity by making capital investments.
Chart 1 shows the new investment projects announced as a % of GDP (current prices). Since FY18, the share has remained below the 5% mark, compared to over 9% between FY05 and FY12.
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Chart 2 shows corporate tax and income tax collected in India as a % of GDP. After the cut in 2019, the share of corporate tax declined dramatically, while the share of income tax gradually increased. The shift in tax burden from the corporates to the people came at a time of job losses and reduced income levels. This pushed more people into poverty.
Chart 3 shows profit after tax earned by non-financial private companies in ₹ trillion. After the tax cut, the profits of these companies rose to ₹4-5 trillion in the last two financial years from ₹1-2 trillion in many of the previous periods.
Chart 4 shows dividends paid by non-financial private companies as a share of profits earned after tax. Payouts to shareholders surged in FY20, the year before the pandemic, but reduced in the following years.
Chart 5 shows profits retained by non-financial private companies as a share of profit earned after tax. Retained profits as a % of profit after tax surged to 63% in FY22 — the highest in a decade (limited companies were analysed in FY22, so data are provisional).
Chart 6 shows the debt-to-equity ratio of non-financial private companies. In FY21, the debt-to-equity ratio came down to 0.86 — the lowest in at least three decades. In FY22 (provisional data), it came down further to 0.71.
Chart 7 shows y-o-y change in the investments of non-financial private companies in fixed assets such as buildings, plants, machinery, transport and infrastructure. It also depicts the y-o-y change in investments in financial instruments such as equity, debt and mutual funds. While investment in fixed assets has declined in recent years, investment in financial instruments has surged.
Chart 8 shows y-o-y change in Private Final Consumption Expenditure — a proxy for demand in the economy. While consumption demand was slowing down even before the pandemic, it crashed after the outbreak. The latest spike is due to low base-effect.
Source: CMIE, Union budget, MOSPI