Indian Private Investment Function… Has the basics changed?!

Indian Private Investment Function… Has the basics changed?!

Over the years we economists started believing that Indian Private Investment function has changed. It no longer abides with the economic textbooks taught to an economic student. We are here to check that out.

ABSTRACT: Indian Private Investment Function

Indian Government is privatizing public companies with the hope that the economy will do better. Keeping this in mind we started analyzing what are the factors or variables that affect the private investment function of the Indian economy. This paper focuses on analyzing the private investment function over the period of 1980-2019. The period chosen, was simply due to the easy availability of data.

The key findings of this paper are, private investment depends on public investment. In other words, public investment crowds in private investment. We found a significant relation between private investment and interest rates. The most astonishing result which we could establish through this paper was the positive relation between private investment and gross fiscal deficit. This paper also presents a strong significant result between private investment and gross domestic product gap. 

INTRODUCTION: Private Investment

Investment is defined as the accumulation of goods which are purchased with the view of future consumption. People invest today to reap benefits in future. Investment can be divided into public and private investment. In this term paper, we are mostly concerned about private investment.

However, it is a known fact that private investment is dependent on public investment. Over the years, we see that public investment is complementary to private investment. There are many debates about public investment crowding in or out of private investment. This term paper was helpful in throwing some light in that direction.

Economists have been arguing that as years are passing interest rate no longer predominantly affect the private investment of the Indian economy. We were successful to establish a significant result between the two variables. They gave us a negative result, stating that out old school thought that rise in interest rates lead to a fall in investment isn’t faulted.

Private investment has been steadily rising over the years, even during the economic crisis period for the Indian economy. The investment did see a slight deviation from the steady growth path during the period 2001-2005. This may be due to the implementation of the private public partnership of the 10th plan year. The Indian Government realised the need to set up a stable growth rate in the tenth plan year, targeting an annual growth rate of 8%. This shifted the motive of the Indian Government from the role of a direct investor. And this might be the result of the small crowding out effect on the private investment.

There are other important factors that affect the functioning of the private investment in the Indian economy which has been discussed in this term paper. However, it is not manually possible to investigate and analyse all the variables that affect or can potentially affect the functioning of Indian private investment.

Private Investment

LITERATURE REVIEW: Indian Private Investment

The key determinants of private investment are the size of public sector capital stock, real effective exchange rate and credit availability. Stimulations show that if the Indian Government increases the public sector investment by 5% of GDP, then the private investment increases by at least 2% of the GDP.

It is observed that the effect of public investment leading to crowding out od private investment in the Indian economy has deteriorated. This is true post liberalization. In fact, results show that market friendly policies and incumbents along with liberal foreign direct investment policies lead to a better public and private investment structures.

With respect to the structural changes that happened in the Indian economy during the period 1980-90, literature provides empirical evidence that there exists a long-term relation between private, public and output. The relation is positive over the years. However, significant results could not be established between investment and interest rates. Public investment ‘crowded out’ private investment in India during the period 1950-80. In contrast, public investment is seen to crowd in private investment during the period 1980-2012. This can be due to the reforms in the policies.

Literature has conflicting theories regarding the effect of public investment on private investment. In India, the results are even more astonishing. Economic theory suggests that government investment financed through borrowing reduces the loanable amount available to the private sector. And hence, has a crowding out effect. Economists have conflicting opinion regarding Indian government investment. Some say that it shall add to the growth momentum of the country, while others strongly oppose this. They believe that, government investment will hinder and prohibit the country’s growth.

Empirical evidence for India suggests that the RBI monetary policies to tackle inflation has not been very strong i.e. they weren’t very aggressive. As per fisher’s theory suggest that ‘one for on response for interest rates with respect to inflation should leave real interest rate constant. This theory does not hold true for the Indian economy. Economists have the opinion that this is due to the fact that the marginal return on investment has declined. This leads to a dampened effect on the real interest rates.

METHODOLOGY: Investment Function

Figuring out the variables of this paper was a bit tricky and time taking. However, after days of struggle, we were able to break down the variables of the paper. This term paper is not an exact replica or extension of the working paper, ‘Reviving private investment in India: Determinants and Policy Levers’. We used the variables used in the paper but the calculations done to achieve the variables are slightly different than the structure of the referred working paper.

Software used for processing and analysing the data were:


2) Microsoft EXCEL

Excel was mostly used for compiling and sorting out the data but the regression and econometric tests were performed in STATA. The results are attached in the Appendix of this term paper.


Y = B0 + B1X1 + B2X2 + B3X3 + B4X4 + B5X5 + u

Kp = B0 + B1Kg + B2REER + B3yGDP + B4 r + B5GFD + u


1) Kp= Private Investment.

Kp = [GCF +(X-M)*capital output ratio]

We easily collected Goss Capital Formation (GCF), Export(X) and Import(M) of Indian Economy from over the years from 1980 to 2019. The data before 1980 were missing and lacking sufficient information for all variables.

However, Capital/output ratio calculation wasn’t mentioned in the paper. So, the basic formula we used since we learned economics was

Capital output ratio = Annual Investment/Annual Increase in GDP

The paper had used 4 as the ratio. But on calculating and then averaging, gave us 4.65 as the ratio.

2) Kg= Public Investment

Kg= Cg*capital/output ratio

Cg = Gross Final Public Consumption Expenditure.

Again, Compiling Cg was easy from the website. Also, using the same formula Capital output ratio = Annual Investment/Annual Increase in GDP. Here we got a slightly shocking result. It was very different from the result obtained in the working paper. The paper had a very absolute value of 5. However, we got the ratio to be as -0.3. The reason behind this can be that the paper worked with data up to 2013 with base as 2004-05. However, we worked with data up to 2019 and base 2011-12. Presenting a graphical representation of Kg shows that over the years, public investment with respect to investment-output ratio has performed terribly.

3) REER = Real Effective Exchange Rate of the Indian Rupee (36-Country Bilateral Weights) (Financial Year – Annual Average) (Base : 2011-12 = 100).

Now, RBI data base didn’t have the data over the years with the same base year. So, base shifting had to be done to current data and rebasing was done to the old data. Overall, the base year taken was 2011-2012. The reason behind base year selection depended on two factors:

i) Other RBI data had base year as 2011-2012

ii) The financial year 2011-2012 was very subtle. It did not see massive monetary fluctuations or business cycle shocks, neither did the year face an incredible policy change shock.

4) yGDP = Output GAP. This variable was creating insignificant results when we were not exactly sure how to calculate the variable. The working paper has used predicted values of GDP and then inferred the results. However, the paper does not state how the variable was predicted. [For detailed understanding read TABLE 2 , in the appendix]

We still managed to figure out a near approximation of the variable yGDP.

Ygt-1 = GDP growth rate for the time period t-1 over t-2.

Ygt-1 = {(Yt-1 -Yt-2) / Yt-2} * 100%

Yet = Predicted GDP value for the time period t

Yet = Ygt-1 + Yt-1

YGDP = Yet/ Yt where, Yt = actual GDP of the economy during the time period t.=

5) r = Real Interest rate

Collecting this data was easy enough. It was easily downloadable in the RBI data base.

6) GFD = Gross Fiscal Deficit. It was easily downloadable in the RBI data base. And no adjustments were done with this data because it was absolute amount in crores.

7) u = Error term. Here, the error term has a very important implication. Since there are many potential variables which should had been incorporated in the model to analyse the results of private investment and we were not able to do so. Therefore, we assume that the error term reflects such variables. We haven’t considered capital depreciation, as the paper had taken a simple straight-line depreciation method which isn’t true. Thus, the error term is representing all such assumptions taken in the model to simplify the model.

Test:- Simple linear regression model ( after testing for heteroskedasticity and auto correlation)

Table 1

The model was tested for ‘heteroskedasticity’. But it gave a negative result indicating that the variance of errors terms is constant.

We have a high positive correlation coefficient i.e. R2 = 0.99. This implies that the results are highly correlated and the results are good. But some time, good R2 is also achieved due to spurious regression. Hence, we perform the auto correlation test to test the if the error terms are correlated across the time period. Again, we received a near 2 result on the D-Watson test implying that the data is good and significant with zero auto correlation. Each variable has also been tested for unit root stationary, the results of which can be found in the appendix of this term paper.

In table 1 we can see the data is significant for Kg, r, yGDP, GFD. The results of this term paper were different from that of the working paper. According to the working paper private investment depends on public investment, REER and GDP gap. However, we landed with different results. We found that REER does not give us a significant result.

Private investment has a positive relation with public investment, GDP gap and Gross Fiscal Deficit. Also, we see a negative relation of private investment with the interest rates. Most results obtained are pretty obvious but one. We found that in our case, GFD has a positive result with private investment. This seemed spurious.

However, after a lot of literature surveys we could come to a defensive conclusion. ‘Fiscal deficit, private sector investment and crowding out in India’ authored ‘R.Meenakshi Abirami and Prasant Kumar Panda’ intelligence states two very important factor that leads to a positive relation between Gross Fiscal Deficit and Private Investment.

Firstly, if fiscal deficit is financed using external sources i.e. international loans, this does not crowd out private investment. Secondly, printing of new currency leads to an inflationary pressure on the economy which in turn boosts private investment rather than crowding out.

CONCLUSION: Private Investment Function

We can conclude from this term paper that private investment actually depends on public investment. They are complementary in nature. Public investment actually crowds in rather than crowding out of private investment.

Private investment is still a function of the real interest rates. Investments are elastic with respect to interest rate i.e. they have a significant negative relation. High interest rate pumps out private investment out of the Indian economy. Since, the loanable credits have higher interest rates, which means a higher liability on the investor. Therefore, we do face a trade off between inflation and growth.

The gross fiscal deficit and private investment seems to have a positive result. Literature has an answer to it. If fiscal deficits are financed using loans from external sources, the credit availability to the private sector is not hindered. Also, fiscal deficit arises due to public expenditure. Our study says that public investment and private investment are complementary. Therefore, such fiscal deficits also have a positive relation with the private investment.

On the other hand, when the government spends on infrastructure like roads, bridges, transportations, communications so on, this will definitely boost private investment and not curb it. Very conveniently, we could establish positive relation between fiscal deficit and private investment. Another important point to be noted is that, when the fiscal deficit is financed using printing of new currency, this creates an inflationary pressure. And it is not unknown that such inflationary pressures boost investment.

This term paper allowed me to explored my weakness and receive a slight command over them. Also, I now get a better view as how to tackle a research question before beginning the data hunt.


Overall, the term paper had many issues which were left unattended due to the shortage of time. Firstly, structural break analysis was planned but data collection and analysis took away more than anticipated time. Secondly, there were many other potential variables which desired our attention, but analysing so many variables in a single paper seems difficult. Also, capital depreciation has been ignored in this term paper which may or may not lead to other results.  
Disclaimer: This article is just a study. We are just presenting how to approach a data set and write a paper. However, the test conducted on the data aren’t the finest ones and differed results can be achieved if the data is treated better.


Chhibber, A., & Kalloor, A. (2016). Reviving Private Investment in India: Determinants and Policy Levers (No. 16/181).

Mitra, P. (2006). Has government investment crowded out private investment in India?. American Economic Review96(2), 337-341.

Abel, A. B. (1981). A dynamic model of investment and capacity utilization. The Quarterly Journal of Economics96(3), 379-403.

Bahal, G., Raissi, M., & Tulin, V. (2018). Crowding-out or crowding-in? Public and private investment in India. World Development109, 323-333.

Memos, M. S. (2013). Real Interest Rate impact on Investment and Growth–What the Empirical Evidence for India Suggests?.

Dash, P. (2016). The impact of public investment on private investment: Evidence from India. Vikalpa41(4), 288-307.


Table 2: Year, GDP (Yt) , incGDP (Yt-Yt-1) , GDP gwt[{(Yt -Yt-1) / Yt-1} * 100%] , absolute growth(Ygt) , Predicted GDP (Yet =Ygt + Yt) , YGDP (Yet/ Yt)

The appendix is the most knowledgeable part of this article. Please subscribe to our premium plan to read the article and receive access to the tables, data, and STATA results and commands. INR 25 per month. Recharge and receive access to unlimited knowledge.

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                               ———- Interpolated Dickey-Fuller ———

                  Test         1% Critical       5% Critical      10% Critical

               Statistic           Value             Value             Value


 Z(t)             -5.102            -3.675            -2.969            -2.617


MacKinnon approximate p-value for Z(t) = 0.0000


GFD Gross Fiscal Deficit

REER Real Effective Exchange Rate

yGDP GDP gap

Kp Private Investment

GCF Gross Capital Formation

Kg Public Investment

GFCE Gross Final Consumption Expenditure

r Commercial Bank (SBI) lending rate GDP deflator adjusted

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5 thoughts on “Indian Private Investment Function… Has the basics changed?!

  1. It seems like a research paper. So, we are still at par with the textbooks. The GFD & private investment is a new researched area u believe. Highly appreciable insights. Thank you.

  2. STATA … good to see some one using econometrics on articles too. OLS is the basics. Thank you for showing us the approach with basics.

  3. Highly in depth article with easy language. But we also want to learn some basic international economics Terms (Request)

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