Savings, Investment and Capital Formation

GDP measures the total output of goods and services for final use occurring within the domestic territory of a given country, regardless of the allocation to domestic and foreign claims.  A part of this is consumed and what left after the consumption is “saving”. So, gross domestic saving is the Gross Domestic Product minus final consumption.

The saved money is either kept with the public or is invested back. When the money is invested back, we come to the figures known as Capital Formation. The Ratio of saving and investments is very important for the economic health of the country.

The Gross Domestic Saving has two parts. One is Public Sector, another is Private sector. The largest segment of Private sector is the Household sector. Another segment of the Private sector is the private corporate sector. The Household may keep the financial assets with them or the physical assets such as Gold and other valuables.

It’s worth note that in the last few years, the Gross Domestic Saving as a part of GDP has remained almost constant. But it does not mean that saving is not increasing. When GDP grows, the Savings too increase and so do the Investments.

Trends in Gross Savings

As per First Revised Estimates of National Income, Consumption Expenditure, Saving and Capital Formation, 2015-16, Gross Saving during 2015-16 is estimated as Rs. 44.05 lakh crore as against Rs. 40.98 lakh crore during 2014-15. Rate of Gross Saving to GNDI for the year 2015-16 is estimated as 31.6 per cent as against 32.3 per cent, estimated for 2014-15.

The highest contributor to Gross Saving is the household sector, with a share of 59.2 per cent in the year 2015-16. However, the share has declined from 62.0 per cent in 2014-15 to 59.2 per cent in 2015-16. This decline can be attributed to decline in household savings in physical assets, which has declined from Rs. 15.78 lakh crore in 2014-15 to Rs. 14.84 lakh crore in 2015-16. On the other hand, the share of Non-Financial Corporations has increased from 34.3 per cent in 2014-15 to 37.3 per cent in 2015-16. The share of Financial Corporations decreased from 8.3 per cent in 2014-15 to 6.5 per cent in 2015-16, while the dis-saving of General Government has decreased from 4.6 per cent of Gross Saving in 2014-15 to 3.1 per cent in 2015-16.

Gross Capital Formation

In simple words Gross Capital Formation is Investment. When people save, they tend to invest. The percentage of the investment made each year out of the total GDP is called Gross Capital Formation. So, Rate of Gross Capital Formation is arrived as follows:

Rate of Capital Formation = (Investments /GDP) X 100

Gross capital formation includes fixed capital formation, change in stock and valuables. The fixed capital formation or fixed investment reflects the addition to the productive capacity in the economy.  Its importance lies in the fact that this is that part of GDP which helps in the growth of the GDP itself. This is a must for achieving high rate of production, capital formation, changes in production techniques and changing in the outlook of the people themselves.

To achieve, the Optimum rate of economic growth, the suggested rate of capital formation is above 40%.

Trends in Capital Formation

In India, the GCF has been around 35% for last few years. As per latest available data, the Gross Capital Formation (GCF) at current prices is estimated as Rs. 45.45 lakh crore for the year 2015-16 as compared to Rs. 42.58 lakh crore during 2014-15. The rate of GCF to GDP declined from 34.2 per cent during 2014-15 to 33.2 per cent in the year 2015-16.  In terms of the share to the total GCF (at current prices), the highest contributor is Non-Financial Corporations, with the share rising steadily from 45.7 per cent in 2011-12 to 51.3 per cent in 2015-16. The share of household sector in GCF is also significant, but has declined from 43.4 per cent in 2011-12 to 34.7 per cent in 2015-16. The share of General Government in GCF has increased from 9.6 per cent in 2011-12 to 12.4 per cent in 2015-16.

This is a trend reversal because traditionally, the share of the household sector has been significantly larger than the private corporate sector. This apart, the Fixed investment rate has been declining since 2011-12 as shown in below graphics:

This trend needs to be reversed for medium to long term growth prospects. Being aware of the need to boost investment and growth, Government, in coordination with the Reserve Bank of India and other stakeholders, has taken a number of steps to improve the ease of doing business and to improve the balance sheet positions of banks and firms.