Economy
India’s elusive private investment boom: Why animal spirits remain shackled
Summary
Uncertainty and investment don’t go hand in hand. India’s GDP growth is becoming increasingly tricky to forecast, a new US regime is making investors uneasy, and inflation risks are ever-present.In his classic book, General Theory of Employment, Interest and Money, economist John Maynard Keynes suggested that investment decisions are driven more by “animal spirits" than cold calculations of risk and return. He described animal spirits as an “urge to action rather than inaction", in which entrepreneurial optimism drives risk capital.
Policymakers have tried to invoke these animal spirits in various ways: boosting infrastructure spending, cutting corporate tax rates, raising welfare payments, and recently by giving tax breaks to the middle class. But a boom in private investment remains elusive. The reason? Uncertainties at critical points in the investment process make it difficult to make decisions with confidence.
1. Demand downgrade
Growth has slowed after a strong post-pandemic rebound, with India's economy expected to grow at 6-7% in 2025-26. Note the leftward shift in the probability distribution of estimates in chart 1, which shows that professional forecasters surveyed by the Reserve Bank of India (RBI) have downgraded growth estimates in the past six months. The biggest downward revisions are to growth in industry and exports, while forecasts of services growth have not changed much.
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The real downer is that there's uncertainty around even these scaled-back growth numbers. Chart 2 shows how forecasters’ responses have become more divergent—indicating greater uncertainty—across sectors. Growth forecasts for merchandise exports saw a much more broad-based drop, with more forecasters downgrading their figures. This was likely due to proposed US tariffs, risks to global trade, and geopolitical tensions.
Animal spirits are dampened when entrepreneurs are unsure of future demand or expect it to slow down. In fact, in December 2024, 52% of market experts surveyed by RBI thought it unlikely that the private capex cycle would be revived in the coming year. That may explain why manufacturing capacity remained stagnant around 74-74.2% in 2024-25.
2. Inflation dormant, not dead
Retail inflation was at a five-month low of 4.3% last month, vindicating the RBI’s decision to start the rate-cut cycle. Average inflation in 2024-25 so far has been 4.4%, well below the 6% ceiling, and only slightly higher than the RBI's 4% target. Reassuringly, a closer look at the consumer price index (CPI) basket shows 4%-plus inflation is limited to much fewer items now than before.
Yet, it would be wrong to conclude that inflation has been defeated: the most recent monetary policy warned that adverse climatic changes and exchange-rate volatility could pose risks to inflation. The former affects food prices, while the latter pushes up prices of imported goods.
An RBI study in October 2024 estimated that a 5% depreciation in the rupee's exchange rate (from the baseline of 83.5 to a dollar) would result in a 35-basis-point (bps) increase in inflation. Given that the rupee has already fallen by more than 4% in the current financial year, there is a real risk of depreciation passing through to input costs and eventually to prices.
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Fortunately the price of crude oil, a critical imported input, is low and stable. Yet, the latest RBI forward-looking surveys reveal that input cost pressures persist across manufacturing, infrastructure and services, and firms expect to increase prices to protect profit margins.
3. Uncertainty all around
An entrepreneur with plans to invest needs to be able to project future costs and demand with some level of confidence. If both are likely to change unpredictably, it's hard to estimate the return on investment. To some extent, this is the situation today: there is little incentive to invest as future outcomes are highly uncertain. Global economic conditions are in flux as US President Donald Trump upends alliances, alters existing trade relationships, and winds up established institutions. It is impossible to predict which country will be targeted next for what action.
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Not surprisingly, countries are safeguarding themselves in every possible way. For example, India has cut domestic tariffs preemptively, built up gold reserves, and offered to import more from the US. But the sheer unpredictability of US executive actions, as captured by the spike in the policy uncertainty index, is a deterrent to investment.
About 63% of experts surveyed by RBI in December 2024 expected a medium to high impact of global uncertainty on domestic macroeconomic stability. Such pessimism about economic conditions is not conducive to investment. Until private investors are confident that their investment decision will have positive outcomes, it will be impossible to unleash animal spirits.
The author is an independent writer in economics and finance.
