Investment has slightly different meanings in economics and finance, but a combined definition can be as “Investment is the process of putting money in assets for increasing production or financial gains“. Yes, investment is all about putting money in assets. And, the investment models tell about how to put the money in assets.
In finance, term investment is putting money into an asset to get dividends, capital appreciation, and/or interest earnings. And in economics, term investment is the accumulation of newly produced physical entities, such as machinery, factories, goods inventories, and houses. For a first-hand understanding of investment, consider it as putting money in bank deposits, shares of companies, real estate, gold, business, or industry. For a country to grow, it should produce more goods and services, and hence investments in a business, agriculture, or industry or supporting infrastructure are highly appreciated. If the government has sufficient funds to invest in these areas, then it seems well and fine, but a nation like India with a Fiscal Deficit of 5.1% of GDP cannot ask the Government to take care of all investment needs. The investment should come from private players too and that’s a win-win situation for all.
Investment can be brought in the form of debt like a loan from domestic, ECB (External commercial borrowing), or in the form of equity, e.g. a partnership (joint ventures 50:50 sharing), shares (FDI/ FPI). A nation should produce more goods and services to grow and generate employment opportunities to all, and hence investments in agriculture, business, or industry or supporting infrastructure are highly appreciated.
Again, depending on where investment comes, there are two other investment models.
> Domestic Investment Model – It can be from Public, Private or PPP.
> Foreign Investment Model – It can be 100% FDI or Foreign-Domestic Mix.
And, depending on where the investment goes, there are various investment models. A few includes:
> Sector Specific Investment Models (In SEZ or MIZ etc).
> Cluster Investment Model (Eg: Food Processing Industries)
So for more income, we need more investment. Which are the modes by which Investments can be attracted? Money for investing in productive assets can be from Public Sources (Government), Private Sources (Corporate), or Combined Sources (Public-Private Partnership or PPP).
Models Used in the Planning Process
> Harrod – Domar Growth Model
> Mahalanobis Strategy of Economic Growth
> Planning Model Adopted in India
Infrastructure Investment Models
> Public-Private Partnership (PPP) in Infrastructure
> EPC MODEL
> Swiss Challenge Model
> Hybrid Annuity Model
Models of Foreign Investment
> Foreign Direct Investment
> Foreign Institutional Investors
Thus on the basis of who invests in assets for increasing production, there are three major investment models.
Public Investment Model:
For a government to invest, it needs revenue, but the present tax revenues of India are not sufficient enough to meet the budgetary expenditure of India. So India cannot move ahead in the path of growth without private individuals; even for the government to have a share in the investment, they need tax revenue from the private investors.
> As the world is facing the prospect of an extended period of weak economic growth, by enhancing public-sector investment large pools of savings can be channelized into productivity.
> Properly targeted public investment can do much to boost economic performance, generating aggregate demand quickly, fueling productivity growth by improving human capital, encouraging technological innovation, and spurring private-sector investment by increasing returns.
> Though public investment cannot fix a large demand shortfall overnight, it can accelerate the recovery and establish more sustainable growth patterns.
Private Investment Model:
The private investment can come from India or abroad. If it’s from abroad – they can be FDI or FPI. As India’s Current Account Deficit is widening due to increased Oil Import, in this age of globalization, we cannot say NO to FDI or FPI. Why private investment in India: For a country to grow and increase its income, the production has to be increased. More goods and services have to be produced. Infrastructure to support production – transport, energy, and communication – should also be developed. But how can a nation with near 30% of the population below the poverty line, invest in production or infrastructure? Therefore India needs private investment.
> Private investment can be sourced from domestic or international markets.
> From abroad private investment comes in the form of FDI or FPI.
> Private investment can generate more efficiency by creating more competition, the realization of economies of scale, and greater flexibility than is available to the public sector.
Public-Private Partnership Model(PPP):
PPP means combining the best benefit from both public and private investments. Public-private partnerships involve collaboration between a government agency and a private-sector company that can be used to finance, build, and operate projects, such as public transportation networks, parks, and convention centers. Financing a project through a public-private partnership can allow a project to be completed sooner or make it a possibility in the first place.
> In this type of partnership, investments are undertaken by the private sector entity, for a specified period of time.
> These partnerships work well when the private sector’s technology and innovation combine with public sector incentives to complete work on time and within budget.
> There is a well-defined allocation of risk between the private sector and the public entity.
> Private entities are chosen on the basis of open competitive bidding and receive performance-linked payments.
> PPP route can be an alternative in developing countries where governments face various constraints on borrowing money for important projects.
> It can also give the required expertise in planning or executing large projects.
Some of the Project Finance Schemes are as below:
> BOT (The private sector build-operate-transfer).
> BOOT (The private sector build-own-operate-transfer).
> BOO (The private sector build-own-operate).
> BLT (build-lease-transfer).
> DBFO (design-build-finance-operate).
> DBOT (design-build-operate-transfer).
> DCMF (design-construct–manage-finance).
Investment Models in Relation With India:
I hope it’s clear by now that capital formation is necessary for any country to grow. But the process is not easy. The savings rate in India is now near 30%. Per Capita Income of Indians is very low and hence the capital available for investing too is low. Investments should be studied from three angles – Households, Corporates, and Government. Investments expect a return – be it from the Government side or Private side. Though the return on investment in terms of profit or margin is the main motive behind investments, its effect on the welfare side and development should not be neglected.
Government Policies for PPP projects:
=> Viability Gap Funding
The scheme aims at supporting infrastructure projects that are economically justified but fall marginally short of financial viability. Support under this scheme is available only for infrastructure projects where private sector sponsors are selected through a process of competitive bidding. The total Viability Gap Funding under this scheme will not exceed 20 percent of the Total Project Cost; provided that the Government or statutory entity that owns the project may, if it so decides, provides additional grants out of its budget, up to a limit of a further 20 percent of the Total Project Cost. Bids are made in the form of government support required. Party bidding for the least government support wins the project.
=> India Infrastructure Finance Company Ltd.
This is a government company created in 2006 to provide long term finance to viable infrastructure projects through the Scheme for Financing Viable Infrastructure Projects through a Special Purpose Vehicle. The sectors eligible for financial assistance from IIFCL are transportation, energy, water, sanitation, communication, social and commercial infrastructure. IIFCL accords overriding priority to Public-Private Partnership (PPP) Projects.
=> Infrastructure Debt Fund
Infrastructure Debt Funds (IDFs) are investment vehicles to accelerate the flow of long term debt to the sector. IDFs aim at taking out a substantial share of the outstanding commercial bank loans. IDFs are set up by sponsoring entities either as Non-Banking Financing Companies or as Trusts/Mutual Funds. It prescribes a 70:30 Debt equity ratio for the fund.
=> 3P India
In the latest budget Finance minister announced the creation of an institution called 3P India with a corpus of Rs 500 crore, to provide support for mainstreaming of PPPs. The planned 3P India entity will examine issues related to regulation, financing structure, management of contracts and stressed Public-Private Partnership projects.
Problems with PPP Projects:
> PPP projects have been stuck in issues such as disputes in existing contracts, non-availability of capital and regulatory hurdles related to the acquisition of land.
> The Indian government has a poor record in regulating PPPs in practice.
> Metro projects become sites of crony capitalism and a means for accumulating land by private companies.
> Many PPP projects in the infrastructure sector are run by “politically connected firms” which have used political connections to win contracts.
> PPP firms use every opportunity for renegotiating contracts by citing reasons like lower revenue or rise in costs which becomes a norm in India.
> Frequent renegotiations also resulted in a drain of a larger share of public resources.
> These firms create a moral hazard by their opportunistic behavior.
Way Forward:
> PPPs are potentially viable to deliver infrastructure projects better and faster. Mega transit projects are significant for increasing mobility and for the changes in land-use patterns. Currently, PPPs are used as a tool to balance fiscal targets.
> A serious assessment of the efficacy and benefits of PPPs projects before adopting this model.
> 'Strategy for New India @75 ' a document by NITI Aayog, increased targeted investment rates to 36 percent by 2022-23 from 28 % (2017-2018).
> To boost both private and public investment, active measures are required. further, increase the rate of investment.
> Encouragement of private investment in infrastructure through a renewed PPP mechanism as suggested by the Kelkar Committee.
> A mature PPP framework is required to enable the government to accomplish, to a considerable extent, by promoting private sector investments and participation towards nation-building.
Project Finance Schemes and Finance Models: Understanding Models
A road can be constructed by adopted different models. Let’s analyze a few cases to understand the concept.
> Case 1: Government machinery and funds are directly used to construct a road. No intermediaries or third parties are involved.
Disadvantage: The government needs money to start the project.
> Case 2: A bid is placed for the road work contract. Usually, a contractor or company with the lowest bid gets the project. Government sanctions funds in part or full, depending upon the completion of stages.
> Case 3: Government spends no money from its pocket, but asks a company to construct the road. The government offers to collect toll fees from the road for a fixed period of 10 or 15 years until they recover their cost and a decent profit.
The benefit of this approach is that without spending any amount from the Government's pocket, the nation will get a road. Toll charges in addition to tax paid is a matter of concern, but it’s better than the case with no road or poor road with traffic congestion.
DIFFERENT MODELS OF INVESTMENT AND PLANNING RELATED TO INDIA INCLUDES:
=> Harrod Domar Model :
Harrod and Domar analyzed the dynamic nature of investment and demand and showed how variations in the capital and in-demand were responsible for instability in economic growth.
Therefore, this model suggests that the economy’s growth rate depends on two factors:
> Level of savings; and
> Productivity of investment i.e. Capital to Output ratio.
>> Harrod and Domar arrived at the following relation:
Growth Rate = Investment * (1/Capital-Output Ratio)
>> Relevance of Harrod-Domar Model for Developing Countries:
Harrod-Domar model was formulated primarily to protect the developed countries from chronic unemployment and not for developing economies.
The model was primarily based on the populace which had a high propensity to save and COR remained stable over time. On the contrary, developing economies’ main problem is to increase the propensity to save. Also, COR is usually high and fluctuating in these countries. Also, this model assumes no government intervention, fixed prices, and no institutional changes. All these assumptions to make it inappropriate.
=> Solow Swan Model :
The neoclassical model was an extension to the 1946 Harrod–Domar model that included a new term: productivity growth.
=> Feldman–Mahalanobis model :
Prof. P.C Mahalanobis prepared a growth model in which he showed that to achieve a self-sustained growth quickly in the country, it would be essential to devote a major part of the development outlay to building basic heavy industry, e.g. steel and the engineering industry for making different types of machines, the multipurpose river valley projects for irrigation and power.
According to Prof. Mahalanobis, the rate of real capital formation in a country like India did not depend merely on savings in the form of money but it depended on the capacity for making capital goods. The reason is that the consumer goods industry cannot grow without sufficient capital goods.
Thus, according to Prof. Mahalanobis, if we did not make huge investments in the heavy basic and capital goods industry, the country will forever remain dependent on foreign countries for the imports of steel and capital goods like machinery for economic development and real capital formation.
Since it is not possible for India to earn sufficient foreign exchange for the purpose of increasing exports, capital goods cannot be imported insufficient owing to foreign exchange constraints. The result will be that the rate of economic growth and the rate of real capital formation in the country will be slow indeed.
=> Rao Manmohan Model :
The policy of Economic Liberalization and FDI initiated in 1991 by Narasimha Rao and Dr.Manmohan Singh.
> Lewis model of economic development by unlimited labor supply.
> Induced Investment Model.
> Leverage Investment Model.
> Saving led growth model. - Significance to India.
> Demand led growth model.
> Consumption led growth model.
FACTORS AFFECTING INVESTMENT
Investment is a function of Income and Rate of Interest [I=f(Y,r)]. Higher the income, the more will be the investment; the higher the rate of interest the lesser will be the investment.
More Income->More Savings->More Investment->More Income
No investment->No Growth->Poverty, Malnutrition, Unemployment, etc
> Savings Rate.
> Tax Rate in the country. (Net income available after-tax).
> Inflation.
> Rate of Interest in Banks.
> Possible Rate of Return on Capital.
> Availability of other factors of production – cheap land, labor, etc and supporting infrastructure – transport, energy, and communication.
> Market size and stability.
> Investment friendly environment in the country.
Planning model adopted in India:
The second five-year plan was based on the Nehru-Mahalanobis strategy of development, which guided the planning practice for more than three decades until the end of the Seventh Five Year Plan.
The draft outline of this plan was based on the Mahalanobis Model which was viewed as a variant of the Soviet Planning model. The basic elements of this strategy can be summed up as:
> Raising the rate of investment. It involved stepping up domestic and foreign savings also
> Rapid growth of the productive capacity of the economy by directing public investment toward the development of industries. Simultaneously, promotion of labor-intensive, small and cottage industries
> Import substitution for self-reliance
> An elaborate system of controls and industrial licensing
> Predominance of the public sector in capital goods industries
conclusion:
Investment in an economy can be done mainly either by the government or by private players. These private players may include foreign players or domestic players. PPP aims at utilizing the strengths of two. The government has a huge risk-taking capacity that the private sector lacks. But the private sector has an effective and innovative record, provided good governance is there. Under the concept of good governance which holds, minimum government and maximum governance, such innovative arrangements are instrumental. This way the public can be provided choices, which further results in competition between service providers and finally improving prices and qualities.
This however gives results to issues of accountability. When a private player is handling national/natural resources such as oil and coal, it becomes crucial to monitor them so that reasonable prices are ensured. For the same logic, the Delhi High court allowed CAG to verify books of private Discoms while observing some limits.
Shailendra
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