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Income, Savings, Wealth, Investment & Capital

Module: 1 - Table of Contents
Importance of Inflow of Foreign Capital

  1. Income, Savings, Wealth, Investment & Capital

  2. External Assistance & Inflow of Foreign Capital

  3. External Assistance & Inflow of Foreign Capital - Evolution of Govt. of India's Policy

  4. External Assistance & Inflow of Foreign Capital -Evolution of Govt.of India's Policy - The Devaluation of the Rupee and the Relaxations in Policies

  5. External Assistance & Inflow of Foreign Capital -Evolution of Govt. of India's Policy -Period 1991 and afterwards Advent of Market Oriented Economic Reforms

  6. External Assistance & Inflow of Foreign Capital -Evolution of Govt. of India's Policy -Period 1991 and afterwards Advent of Market Oriented Economic Reforms - Part: II

Other Modules under Foreign Investment

  1. Module: 2 - Foreign Direct Investment (FDI) (6 articles)

  2. Module: 3 - Global Depository Receipts (2 articles)

  3. Module: 4 - External Commercial Borrowings (4 articles)

  4. Module: 5 - Foreign Institutional Investor - Portfolio Investments (5 articles)

  5. Module: 6 - Investment Facilities to Non-Resident Indians (10 articles)

  6. Module: 7 - Non Resident Indians - Deposits ( 5 articles)

  7. Module: 8 - Facilities to NRI/FII - Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000 - (7 articles)

To the individual and the households financial stability and prosperity are represented by a steady inflow of recurring income. Part of the income so earned could be saved and retained as permenant wealth. Traditional sources of investment are acquisition of immovable property, gold, cattle etc. But the modern world has introduced several new types of investment-products to boost savings, like stock exchange securities, bank deposits and insurance policies, mutual fund investments etc. The features of a good investment are security, liquidity, value appreciation and generating a regular and assured income. A prudent investor diversifies his investments, to eliminate possible risks. The dictum is "do not keep all eggs in a single basket".

To a corporate entity however financial strength is represented by the capital it employs and the cash flow it generates. What is wealth to an individual is Capital to the Corporate body, and income to the individual is represented by turn-over (cash flow) and profits generated therefrom. From where does the corporate entity source its capital. It is gathered from the savings invested by individuals and households. Savings therefore underlie the nucleus for economic growth, development and prosperity. Savings are generated mostly by households and individuals, it is invested and turned into capital and capital is employed by the Corporate sector. It is function of the money market and capital/debt markets to transform savings of households as capital for productive enterprises operated by corporate entities.

From A research Paper on Savings

"The concept of saving plays an important role in economic analysis. Saving is defined as the difference between income and consumption. During pre-Independence period in India, people spent most of their income on consumption and only a small amount of income was left in the form of saving. As a result the saving rate was very low, specially in the rural sector. Since the attainment of Independence in 1947, the major objective of the government policy has been the promotion of saving and capital formation as they are the primary instruments of economic growth. Increase in the savings, use of increased saving for financing the increasing required investment, use of the increased investment for increasing savings, and use of the increased savings for a further financing the required investment constitute the strategy of economic growth. This process may continue till saving, investment ratio to income would get stabilized and there would be steady and self-sustained increases in national income and economic welfare. Several empirical studies have found that the rapid development of the western economies was the result of an increasing rate of investment. And the increase in the rate of investment was made possible by way of an almost proportionate rise in the rate of saving. Saving is therefore, the key factor in achieving a high rate of investment."1

What is capital? Savings generate investment. Investment in turn create capital. Capital can be used by the same person, who has accumulated and created it, or it can be hired/lent to others. Normally assets at your disposal are suited for a single-time use or application. If you have an apple in your hands, the minute you start biting it and enjoying it, the apple is no longer there. But wealth or capital represents assets that are put to repeated use. The residential flat you own and live in is a capital-asset that you have created for you and your family through your savings and investment. The house will be there for ever unless you sell it. After your demise your children could live in the same house.

Capital is a factor of production, along with the other factors namely Land, Labour, and Entrepreneurship (also called 'management'). It can generate value by co-acting with other factors of production and yield rent, wages, profit or interest. All these are lessons in primary economics that we studied long back in our schools and colleges.

But capital has a two dimensional countenance, i.e. one to the owner or creator of capital and the other to the hirer or user of capital. The owner is the person who generates Capital for investment. As far he is concerned capital is not a factor of production. He merely identifies it as his savings or wealth. Capital/wealth in this context represents deferred consumption, unspent current earnings kept by way of a provision or a source of sustenence for a rainy day. However to the hirer or user of capital, it is an indispensable factor of production. The characteristic of savings is to increment itself. We have studied the time value of money. A hundred rupees you save today is worth more than a Rs.100 next year. Thus a sizeable savings made by a person yields him if wisely invested, a steady additional income regularly in the future. This is called the cumulative growth of savings.

As in the case of the individual, a nation does not consume all the goods and other materials it produces in a year or over a span of time. After meeting the demands of consumption of its citizens, the country carries forward a net surplus out of the economic wealth it has created in the current time. This represents the savings of the country. India has the reputation of being a country generating a very high rate of domestic savings . Around 23% to 25% of our GDP is retained byway of savings every year. The bulk of the savings are by individuals and households. Thus there are several millions of individuals who save and accumulate capital to retain with themselves. Industrialists and businessmen particularly in the large and medium sector on the other hand need huge capital for their productive enterprises. By themselves they cannot save or accumulate all the capital needed by them. How the savings of millions of individuals and others flow to the meet the demands of the capital seekers is explained by studying the functions of the organised money market and capital market (equity & debt market). Let us now turn to discussing more about savings and investments relating to our country.

A country with a developing economy cannot depend exclusively on its domestic savings alone to fuel its economy's rapid growth. The domestic savings ofIndia is 25% of its GDP. But this can provide only a 2 to 3% growth of its economy on annual basis. The country has to maintain a 8 to 10% growth for a period of two decades to reach the level of advanced nations and to wipe out widespread poverty of its people. The gap is to be covered by inflow of foreign investment along with advanced technology.

Pattern of Savings in India in Recent Years

In India domestic savings originate from three principal sectors namely:

  1. household sector: The household sector comprises of individual, non-corporate business and private collectives like temples, educational institutions and charitable foundations. The saving can be held in the form of increases in (a) Liquid assets like currency bank deposits and gold (b) Financial assets like shares, securities and insurance policies and physical assets.

  2. the private corporate sector: The corporate sector includes joint stock companies in the private business sector, industrial credit and investment corporation etc., and cooperative institutions. Saving of the corporate sector is represented by the retained earning of this sector.

  3. Public sector: Government sector consists of the central and state government, the local authorities and various government and department undertakings, hence the saving of this sector relates to the budgetary surplus on current account of the central government, state government, local authorities, the current surplus of various government departments and retained projects of government undertakings.

The proportion of these three components of National saving throw more light on the structure of saving in India. The table given below provides the figure of sector wise saving in India in the year 1980-81 to 1998-99

Volume of Savings in India (at current price)
(Amount in Crores)
Sector 1980-81 %-age 1990-91 %-age 1998-99 %-age
Household saving 21848 75.9 109623 84.4 325456 82.7
Private saving 2284 8.0 14940 11.5 67573 17.2
Public saving 4654 16.2 5436 4.2 572 0.15
Total saving 28786 100.0 129999 100.0 393601 100.0

[Source: Economic Survey 1999-2000]

The above table reveals that household sector saving provides the bulk of national saving. The share of total household saving to total National saving is more than three quarters. It does further suggest that the public sector saving rate declined but the corporate saving rate improved. This declining trend of public sector saving rate is due to negative saving of government administration. a decline in public savings was attributed to poor performance of government non-statutory corporations, mounting government employment and wage bill and rising trend in government purchases of goods and services. The private corporate saving rate was very low during eighties. The dampened saving impulse was owing to the growth in consumerism. It also pointed out that the low private corporate saving was due to the typical behaviour of the India corporate sector relying more on borrowed funds as against owned funds. Private corporate saving has shown a steady increase over the last two decades. This was due to liberalized environment. In the liberalized environment with increased internal and foreign competition as well as foreign direct investment in various sectors, the profits of corporate sector have been high leading to increased saving.1

The statistics furnished in the Economic Survey for the year 2002-03 published with the Union Budget for the year 2003-04 gives the following picture with reference to savings, investment & capital formation.

In 2001-02, gross and net domestic savings at current prices, grew by 11.8 percent and 13.3 percent respectively, to increase their share in GDP at market prices. Gross (net) domestic savings, as a proportion of GDP (NNP) at market prices, improved to 24.0 (16.0) percent in 2001-02, from 23.4 (15.4) percent in 2000-01. The household sector was once again the best performer, with the increase in its gross savings exceeding the total increase in gross domestic savings. Households increased the share of financial savings in their total savings from 48.0 percent in 2000-01 to 49.8 percent in 2001-02. Private corporate savings increased roughly at half the rate of increase of household savings. The public sector not only continued to be a net dis-saver, but it increased its dissavings by nearly Rs 10,000 crore. The departmental enterprises became net dis-savers in 2001-02. The increased savings by non-departmental enterprises were more than neutralized by the increased net dissavings of government administration.

Gross domestic capital formation at constant prices grew at 3.0 percent in 2001-02, which was considerably lower than the growth of GDP. At current prices, gross capital formation constituted 23.7 percent of GDP in 2001-02, which was slightly lower than the share of 24.0 percent observed in 2000-01, and 25.2 percent observed in 1999-2000.

From the foregoing it will be clear that despite having a good savings rate, the Indian economy cannot sustain a higher rate growth and it needs much larger growth of Investments and capital formation.

As per the Development Goals and Strategy of the 10th Plan, which was recently finalised-

The strategy to achieve a high annual growth target of 8.00% combines accelerated capital accumulation to raise the average investment rate from 24.23% to 28.41% with an increase in capital-use efficiency to reduce the ratio of incremental capital to output from 4.00 to about 3.55. Private sector development, infrastructure development, and increased foreign investment and trade are key to increasing efficiency

Role of External Assistance

Net external capital flows are projected at 1.57% of GDP for the 10th Plan period, as against 0.91% in the 9th Plan, or about $22 billion in FY2006, the terminal year of the 10th Plan. However, the bulk will consist of FDI, portfolio investment, commercial borrowing, and nonresident deposits. Gross official development assistance is estimated to be around $5.1 billion in FY2006

The regular inflow of external capital investment is indispensable to sustain our economic growth at the planned level and this is well-recognised by the plan document itself. Next we will study our policy since independence towards external assistance and the reasons why our country is able to attract huge does of foreign investments.

1SAVINGS BEHAVIOUR IN INDIA: AN EMPIRICAL STUDY Md.Abdus Salam and Umma Kulsum (Authors are Faculty Member and Research Fellow Respectively in the Department of Economics, AMU, Aligarh)

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[ last updated on 30.09.2004 ]<>[ chkd-apvd-ef ]