A lower value of Incremental Capital Output Ratio (ICOR) is crucial for a developing economy like India. In this context, highlight the factors that limit efficient conversion of savings rate into investments in India. Also, suggest measures to improve it.
The Incremental capital output ratio is a measure which shows the amount of capital required to produce a given product.
High ICOR indicates an inefficient economic environment as a large amount of capital is being used to produce low value goods.
Constraints to efficient conversion of savings to investments:
- Low savings rate – Indians usually prefer investing in immovable assets/gold rather than savings in banks.
- Aversion to investments – Retail investment is affected by reluctance to invest in equity and preference for gold/immovable property.
- NPA crisis – proliferation of bad loans makes it difficult for banks to lend for businesses.
- Lacunae in corporate governance – recent instances of malafide disbursement of loans leads to reluctance in credit access.
- Regulatory hurdles in setting up of new businesses affects investments.
Measures to improve:
- Abatement of NPA crisis – through strategic waivers/writing offs, haircuts, bank consolidation, etc.
- Awareness and promotion of financial inclusion among savers.
- Efficient transmission of bank rate cuts by RBI.
- Overhaul of corporate governance structures – Kotak committee recommendations.
Efficient conversion of savings to investments and lowering of ICOR is sine-qua-non for rapid economic growth. Various regulatory and statutory measures should be introduced to ensure the same.
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