India must reverse its decade-long slump in private investment before output growth loses steam

Investment no longer keeps pace with the economy’s needs. Our ability to build new factories, expand infrastructure and adopt new technologies is weakening. And this has consequences not just for future growth, but also for jobs, productivity and the country’s long-term development path.

A useful way to see what drives a country’s productive capacity comes from Xavier Sala-i-Martin’s framework. Capital grows when three things happen together: the economy saves more, its financial system converts household savings into financial savings and then into efficient lending, and the investments themselves are effective.

Think of national income as moving through a sequence of stacked stages. Income is first saved. These savings must then enter the financial system, which decides how much is actually channelled to borrowers. Borrowers, in turn, must convert this funding into real investment, such as factories, infrastructure or technology. Finally, this investment adds to productive capacity only if it is efficient and well-directed.

Capital stock grows only when income successfully passes through all these layers and the resulting productive investment is large enough to more than offset depreciation—the natural wearing out of machines, infrastructure and technology.

If even one layer is weak—low savings, poor financial intermediation, misallocated credit, stalled projects or inefficient investment—the final addition to capital is sharply reduced, regardless of how strong income growth may appear. In short, capital formation is only as strong as its weakest link.

This is precisely what is going on in today’s India. The first part of the link reflects the ‘quality’ of investments. In simple terms, it asks whether the money being spent actually creates productive assets.

If a factory produces at world standards, its efficiency is high. If a highway sharply reduces travel time, its efficiency is high. But if a bridge is built where few people travel or if a company raises funds but deploys them poorly, efficiency falls. India today faces increasing concerns on this front.

The recent IPO boom provides a stark example. In 2023-24 and 2024-25, India recorded more than ₹60,000 crore in fundraising from initial public offering (IPOs), the highest since the 2021 startup frenzy. Yet, several high-profile listings, from consumer tech to fintech, have been marked by weak post-listing performance, unclear profitability paths and swift price corrections.

Efficiency falls when capital flows into ventures unable to convert funds into lasting economic returns. Markets raise capital, but the economy does not necessarily gain productive assets.

The second part of the story is about how much households save and what portion of those savings actually flow into the financial system. Household savings have fallen from 23% of GDP in 2011 to around 18% today, largely on account of rising consumption and financial liabilities amid a growing shift towards gold and real estate.

Our gross domestic savings rate declined to 30.7% of GDP in 2023-24 from 32.2% in 2014-15. India imported nearly 800 tonnes of gold in 2024, up sharply from pandemic lows.

Gold is emotionally and culturally valued but economically stagnant: it sits locked in homes and vaults, instead of flowing into businesses or factories. When savings bypass banks, mutual funds and bond markets, they cannot be transformed into productive investment. The assembly line slows down.

Even when savings do reach the financial system, not all of them actually reach productive borrowers. Banks remain India’s predominant credit channel, providing more than 60% of all loans, but productive lending has been hampered by rising disbursals of personal loans and unsecured credit, with a continued preference for putting money into government securities.

In other words, the financial system is increasingly channelling funds to consumption and public borrowing, rather than long-term private capital creation. The financing of private investment remains weak despite high economic growth.

The next stage, turning investment funds into actual capital, is just as worrying. India’s gross fixed capital formation has fallen from 34% of GDP a little over a decade ago to about 30% today, versus China’s 41%. Private corporate investment, once touted as the engine of India’s growth story, remains stuck near 10% of GDP from a peak of 27% in 2007-08, with little movement even though profitability has improved.

Meanwhile, with state governments facing fiscal pressure, their capital expenditure has slowed down in the last two quarters. The Centre is the only entity maintaining strong capex growth, but it cannot bear the entire burden alone.

Finally, even though GDP has been growing near 6.5%, the combination of falling savings, muted private investment, lower efficiency and rising gold imports means the economy is running on a weaker engine. Growth is being driven less by new capacity and more by consumption and productivity gains. This cannot continue indefinitely.

India’s slowdown in capital formation matters because everything from future wages to the competitiveness of Indian firms is affected. Without sustained investment, businesses can’t modernize, adopt new technologies or scale production. This makes it tougher for them to generate high-quality jobs or compete with global players. It also limits India’s ability to take advantage of shifting supply chains, a once-in-a-generation opportunity.

The situation is not irreversible. India has strengths: a large domestic market, improving infrastructure, political stability and growing geopolitical relevance. But to sustain its growth momentum, policymakers will need to revive the full ‘assembly line’ of capital formation. That means rebuilding household financial savings, steering credit towards productive sectors, improving the quality of public investment and making sure that the IPO boom channels funds into businesses that actually expand the economy’s productive base.

India has long sought to escape the ‘middle- income trap.’ A strong and efficient investment engine is the surest way out. Reversing the capital formation slowdown is not only an economic imperative, it is the foundation upon which India’s long-term aspirations rest.

The author is professor, Madras School of Economics.