To be fair, private investment in India has been solid compared to peer countries, at about 23% of gross domestic product (GDP). But investment in machinery and equipment, critical for expanding India’s productive capacity, has remained sluggish. Perhaps more importantly, India’s private sector capital stock sits at a mere one-third of the average emerging market, when adjusted for population size. Building it is crucial for India’s economic development.
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As our recent International Monetary Fund (IMF) country report argues, to achieve its vision of becoming Viksit Bharat, India needs to re-energize private investment through trade integration and structural reforms to unleash India’s vast entrepreneurial talent.
While the corporate sector is financially healthier than before and rising public investment has helped narrow India’s infrastructure deficit, the handover from public to private investment has not yet happened. In fact, firms remain cautious about committing to large-scale investments. But what’s keeping private investment in India from taking off? This million-dollar question has been debated extensively, with the answer involving, in part, that firms foresee insufficient demand, discouraging them from expanding, even as supply-side factors such as regulatory and financing hurdles remain impediments.
One indicator for investment appetite is capacity utilization. When firms operate closer to full capacity, they are more likely to invest. For India, there is no broad-based evidence of capacity constraints yet, with capacity utilization in manufacturing at almost 75%, in line with pre-pandemic levels. Nearly 86% of firms expect production capacity to be adequate to meet demand over the next six months, suggesting a soft investment appetite in the near term.
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That said, supply-side factors matter significantly. Our analysis shows that providing strong and predictable policies to foster a stable economic environment is important for catalysing investment. In fact, a one-standard-deviation increase in policy uncertainty is associated with an 11% drop in new investment projects per quarter and an 8% increase in abandoned projects.
Structural reforms are also key drivers of manufacturing investment. We can see this at the state level. States like Gujarat and Tamil Nadu, for example, which attract disproportionate amounts of manufacturing investment, are also among those that are active in business-climate reforms. Our state-level analysis shows that a 10-percentage-point increase in reform intensity leads to higher manufacturing investment of around 0.1% of gross state domestic production (GSDP).
Moreover, trade openness and the population’s educational attainment are predictors of stronger investment. All this suggests that healthy competition among states can be leveraged to drive better outcomes.
Trade restrictions remain a key impediment to domestic private investment in India and also undercut FDI. For companies to compete in export markets, they should be allowed to import without being subjected to large trade restrictions. Despite the tariff reductions announced in the Union budget, India still maintains significant trade barriers, which do not compare favourably with other emerging economies and are both complex and unpredictable, potentially stifling investment.
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This is a notable hurdle for smaller firms, which find it hard to navigate the country’s complex web of regulations. The recent imposition of quality control orders appears to be particularly burdensome, as evidenced by the collapse of India’s share in global exports of apparel made from man-made fibres. Lowering tariff and non-tariff barriers could increase inward FDI by 8% over the medium term, while greater trade openness would further integrate India into global value chains, making it a more attractive destination for multinational investment.
Bilateral Investment Treaties (BITs) may also help attract FDI by offering protection to foreign investors. Not all multinational corporations lay store by BITs, but survey results show that a significant number of executives find them relevant to their business prospects. Hence, there is a need for India to continue negotiating BITs with potential investment partners.
Beyond trade liberalization, business climate reforms are critical to unlock India’s immense investment potential. Our analysis highlights judicial and credit market reforms as key.
Moving 25% closer to the best-performing emerging markets in these areas could increase private investment by nearly 10% over the medium term—equivalent to additional investment of more than ₹26 trillion over three years. Enhancing judicial capacity to reduce case backlogs and improve contract enforcement would provide businesses with greater legal certainty. Also, strengthening the implementation of the Insolvency and Bankruptcy Code and reducing the public sector footprint in financial markets would improve the efficiency of capital allocation.
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India’s corporate sector is in a strong position to invest, and policy action can convert this into tangible capital formation. Fuelling private investment growth will require comprehensive efforts to enhance business confidence and increase trade openness. By providing stable policy frameworks, revitalizing foreign investment and strengthening the business climate, India can reinforce its position as a top global investment destination.
This agenda could unlock several trillion rupees in additional private investment, and thus help accelerate India’s journey towards becoming an advanced economy.
The authors are, respectively, director for the Asia and Pacific Department, and chief for India, at the International Monetary Fund.
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