Real and Financial Assets
Every economy holds a stock of real and financial assets. Real assets can be tangible—such as land, natural resources, buildings, inventories, machinery, consumer durables and infrastructure—or intangible, like human capital, organizational systems and public institutions. Each real asset embodies saved resources: either the owner's own savings or funds provided by lenders who supply surplus savings. Much of the acquisition and expansion of real assets is financed through borrowing from these suppliers of savings.
Financial assets, sometimes called claims, securities or instruments, are created to mobilise and transfer savings into productive investment. They take many forms—equity instruments, debt instruments, bank deposits, units of collective investment schemes and insurance contracts—each defining a different claim on real assets or future income. In a modern market economy, efficient interaction between real and financial assets is essential: financial instruments channel savings to where they can be invested in real assets, and that process of mobilisation and allocation of funds underpins capital formation and economic growth.
Surplus and Deficit Economic Units
Every economy contains two broad types of economic units: surplus-spending units, which earn more income than they need for current expenditure and therefore supply funds to others; and deficit-spending units, which spend more than they earn and must obtain funds from the rest of the economy. This basic distinction explains the flow of savings and borrowings and underpins the role of financial markets, with surplus units acting as providers of funds (savers or lenders) and deficit units as users of funds (borrowers or spenders).
A surplus‑spending economic unit is one whose consumption plus planned investment is less than its income, leaving it with excess funds. These excess resources are held as cash balances or converted into financial assets such as deposits, bonds or equity. When a unit buys financial assets or makes loans it is, in effect, providing finance for productive investment elsewhere in the economy. Economists therefore describe such actions both as a demand for financial assets and as a supply of loanable funds.
In the Indian context, the household sector typically behaves as a net surplus‑spending unit, saving more than it consumes and channeling the surplus into financial instruments or loans. The roles of households and other sectors, and the flows between them, are analysed in greater detail under flow‑of‑funds frameworks used to trace how savings become investment across the economy.
Deficit-spending economic units are those whose consumption plus planned investment exceeds their income. Because they save negatively, they meet their financing needs either by borrowing or by running down their holdings of financial assets. Such borrowing creates a supply of financial securities and a demand for loanable funds. In India, the government and the corporate sector commonly operate as deficit-spending units.
Surplus-spending units—typically households—accumulate savings that must be transferred to deficit units if investment is to take place. This transfer requires a financial system that links surplus and deficit sectors. Funds can move directly through external financing, where borrowers issue securities straight to lenders, or indirectly through financial intermediation, where banks and other institutions stand between ultimate lenders and borrowers.
Financial intermediaries and financial markets are the two principal channels in this system. Intermediaries accept funds from savers and issue secondary instruments such as deposits, insurance contracts, or mutual fund units to those savers. They then use these funds to acquire primary securities issued by borrowers. Alternatively, ultimate borrowers can raise resources directly by issuing primary securities in financial markets. In both cases, savings flow from surplus units to deficit units, enabling capital formation.
The movement of funds from savers to investors through the financial system is the mechanism that supports capital formation and, ultimately, economic growth—measured as a sustained rise in real national output over time. Beyond simply linking savings and investment, the financial system accelerates the process by offering a range of services and instruments that encourage higher rates of saving and more efficient allocation of capital, thereby expanding the production of goods and services.
For clarity, the shorthand in the diagram uses Y for income, C for consumption and I for planned investment. A surplus occurs when Y > C + I; a deficit when Y < C + I. The diagram also indicates that surplus and deficit units can include households, government, corporates and the rest of the world.
Macroeconomic Frameworks for the Financial System
The financial system is the principal institutional and functional mechanism through which an economy mobilises savings, allocates capital, manages risk and channels resources into productive uses. The speed and extent to which broad national objectives—such as sustained growth, price stability, full employment and equitable development—are achieved therefore depend critically on the efficiency, depth and stability of this system. To understand the financial system’s role in the economy, economists use a range of macroeconomic frameworks and concepts; the main tools of analysis are as follows.
National income accounts apply the logic of bookkeeping to the economy as a whole, recording the flows of production, income and expenditure across society. The sector-of-origin presentation of these accounts breaks down the economy by broad sectors—such as agriculture, industry and services—showing each sector’s contribution to national income and the share of income that sector absorbs as consumption. By linking where income is generated to how it is used, these accounts make it possible to gauge the relative importance of different sectors and to analyse structural changes in the economy over time.
The process of saving and investment generates continuous movements of funds between different sectors of the economy. Many financial transactions—such as transfers of financial assets and claims between households, firms, banks and the government—do not appear in the national income accounts, so a separate record is needed to capture these flows. Flow of funds accounts record these inter‑sectoral financial transactions and reveal how economic activity is financed and how financial claims and liabilities are distributed across sectors.
When combined with the national income accounts, the flow of funds framework provides a comprehensive picture of fund transfers and the supply and demand conditions in the securities and credit markets. This integrated view makes it easier to trace the saving–investment process, identify sources and uses of finance, and understand the functioning and stability of the financial system.
The rate of saving and investment is a primary channel through which financial development influences economic growth. A well-functioning financial system both mobilizes additional savings and channels them into productive uses, thereby raising capital formation and supporting expansion. Tracking trends in savings and investment—across households, businesses and the public sector, and between public and private investment—helps assess how effectively the financial sector augments resources, allocates them across activities, and converts savings into productive investment that underpins growth.
National Income Accounts in India
National income accounts are the primary system of macroeconomic flow statistics used to measure both the production of goods and services and the earnings that flow from that production. Both national income and national product are flow concepts measured over a specified period. National product refers to the total flow of goods and services produced by a country’s residents during that period, while national income denotes the flow of payments to factors of production—the total earnings available to purchase the net output of goods and services in the economy over the same period.
The information produced by national income accounts has many uses. Annual series classified by industry of origin reveal the structural composition of the economy, showing which industries contribute most to output. Classification by sector of origin reveals the types of incomes generated in each sector and the total value of goods and services produced there, which helps policymakers and analysts assess sectoral performance and design targeted interventions.
In India, the task of estimating national income has been entrusted to the Central Statistical Organisation (CSO), which compiles the data for publication by the Government of India. The base year for these estimates has been revised several times: from 1948–49 to 1960–61 (revised in August 1967), to 1970–71 (January 1978), to 1980–81 (February 1988), to 1993–94 (February 1999), to 1999–2000 (February 2006), to 2004–05 (January 2010) and to 2011–12 (January 2015). These periodic base-year updates ensure the national accounts remain representative of the economy’s changing structure.
Sectoral Composition and National Accounts
The Indian economy is conventionally divided into several industrial sectors. The primary sector comprises agriculture, forestry, fishing and mining; the secondary sector covers manufacturing (both registered and unregistered), construction and utilities such as electricity, gas and water; a combined transport–communication–trade group includes transport, storage, communication, trade, hotels and restaurants; the finance and real estate group covers banking, insurance, ownership of dwellings and business services; community and personal services include public administration, defence and other services; and the foreign or external sector records transactions with the rest of the world.
The combined gross output of all domestic sectors, excluding the external sector, has traditionally been called Gross Domestic Product (GDP) at factor cost or the real GDP. GDP measures the economy’s total output not by simply summing gross outputs but by aggregating value added at each stage of production. It can be estimated in two equivalent ways: from the production side—where output is grouped broadly into agriculture, industry and services—or from the expenditure side as the sum of private consumption, government consumption, investment and net exports.
The rebasing of the national accounts to 2011–12 expanded coverage of economic activities and improved the measurement of value addition across sectors. The revised series places greater emphasis on value-linked indicators, which better capture growth arising from higher value added per unit rather than mere increases in physical volume—a critical distinction as economies develop. In line with international practice, sectoral estimates are now presented as Gross Value Added (GVA) at basic prices, while the aggregate measured at market prices is referred to as GDP.
Net National Product (NNP) is GNP adjusted for depreciation and therefore represents the net production of goods and services during a year. NNP indicates the net increase in a country’s total production and is useful for assessing the long-run problem of maintaining and augmenting the stock of physical capital.
The pattern of India’s growth changed noticeably in the 1990s. The GDP growth rate rose to 6.9 per cent in that decade, higher than in the 1980s, driven by stronger performance in industry and services while agricultural growth lagged. This marked a structural shift: economic growth became less sensitive to agricultural performance and to the vagaries of the monsoon. Within industry the main impetus came from manufacturing, and within services the faster-growing segments were trade, hotels and restaurants, finance and insurance, real estate and business services—signalling an expansion of finance-related activities and financial intermediation.
India recorded exceptional growth of 9.6 per cent in 2006–07, second among emerging economies only to China. The rise reflected a rebound in agriculture, higher investment and manufacturing output, improvements in electricity generation, buoyant software exports and rapid expansion of newer services such as trade, hotels, transport and communication. Greater competition, falling interest rates, improved infrastructure and stronger exports helped trigger a manufacturing boom that, for a time, outpaced services.
Investment-led expansion in manufacturing and services, healthy foreign exchange reserves and rising exports sustained growth until 2007. Growth slowed in 2008 as industrial activity decelerated and the economy faced international oil and commodity price shocks, rising inflation and cost of funds, moderating capital inflows, rupee depreciation and the global financial crisis. After a sharp post-crisis recovery, GDP growth rose to 8.4 per cent in 2009–10 but slowed again to 6.5 per cent in 2011–12, a nine-year low.
With the 2011–12 base series, some macro aggregates improved in 2013–14 and strengthened further in 2014–15. Agriculture supported growth in 2013–14 and accounted for about 16.1 per cent and 15.4 per cent of GVA in 2014–15 and 2015–16 respectively; the decline in agricultural growth in this period reflected, among other factors, a delayed monsoon. The Index of Industrial Production (IIP) picked up in 2014–15 after two years of stagnation, while the services sector remained the principal driver—contributing roughly 72.4 per cent of GDP in 2014–15. Manufacturing expanded by about 2 per cent in 2015–16, helped by petroleum refining, automobiles, wearing apparel, chemicals, electrical machinery and wood products and furniture. Services GVA growth moderated to 8.2 per cent in 2015–16 (from 9.4 per cent in 2014–15), and services accounted for about 61.87 per cent of GVA that year. Raising overall GDP growth sustainably therefore requires strengthening performance across all three broad sectors—agriculture, industry and services.
National income accounts provide core macroeconomic aggregates—GDP, GNP, NNP, savings and investment—that help identify surplus and deficit sectors. However, these accounts do not fully reveal inter-sectoral fund flows, linkages and financial instruments. To understand the economy’s financial inter-relationships, national income data must be used alongside flow-of-funds accounts, which trace the movement of funds among sectors and institutional actors.
Flow of Funds Framework
Flow of Funds accounts offer a systematic way to trace how savings are channelled into investment across an economy. Rather than treating savings and investment in isolation, these accounts map the paths of funds—showing which institutional sectors supply finance, which absorb it, and through which financial instruments these transactions occur. In doing so they reveal the pattern of financing economic activity and the financial interrelationships among sectors.
For analysts and policymakers the Flow of Funds (FoF) accounts are indispensable. They clarify the role of finance in generating income, savings and expenditure, and illuminate how real economic activity affects financial markets. Comparing FoF data over time or across sectors highlights changes in the degree and pattern of financial intermediation, identifies the channels through which savings reach investment, and provides a measure of how intensively financial instruments are being used relative to aggregates such as GNP, NNP or capital formation. Because historical FoF series reveal emerging trends in sectoral behaviour and instrument choice, they are widely used in financial planning and forecasting as well as in assessing the structure and depth of financial development.
FoF accounts are organised along two dimensions—by institutional sectors and by financial instruments—so that flows can be examined both sector-wise and instrument-wise. The Reserve Bank of India prepares these accounts in alignment with the national accounts framework and the Central Statistics Office’s Sequence of Accounts. The economy is typically divided into five institutional sectors: (i) financial corporations, which include the central bank and other depository corporations (commercial and cooperative banks, deposit‑taking NBFCs and housing finance companies) as well as other financial corporations (all‑India financial institutions, non‑deposit‑taking NBFCs and HFCs, insurance corporations, provident and pension funds, and mutual funds); (ii) non‑financial corporations, covering both public and private non‑financial companies and certain public enterprises and utilities; (iii) general government, comprising central and state governments; (iv) households; and (v) the rest of the world.
Sectors participate in financial activity by issuing claims (borrowing) or accepting claims (lending). A sector whose borrowings exceed its lending is a deficit sector; conversely, a sector whose lending exceeds borrowing is a surplus sector. Financial instruments are classified into ten broad categories—currency and deposits; debt securities; loans and borrowings; equity; investment fund shares; insurance, pension and provident funds; monetary gold; trade and other accounts receivable/payable; and other liabilities/assets not elsewhere classified. Instrument‑wise analysis of flows thus reveals aggregate preferences of sectors for particular types of instruments.
Financial claims recorded in FoF accounts are also distinguished as primary issues—securities and other claims issued directly by ultimate borrowers—and secondary issues—claims issued by financial intermediaries in order to acquire and hold primary securities. The total flow of finance in an economy is the sum of these primary and secondary issues.
Methodologically, the FoF framework is implemented as a matrix built from the balance sheets of sectors at the beginning and end of a period. Net increases in assets are treated as uses of funds; net increases in liabilities are treated as sources. The standard presentation focuses on inter‑sectoral flows between two points in time and reports net flows across sectors rather than intra‑sectoral movements.
India’s published FoF series (available up to 2014–15 in the RBI publications) show several important trends. The overall financial resource balance—measured as net acquisition of financial assets less net increase in liabilities, expressed as a ratio to Net National Income at current market prices—narrowed in 2014–15. This improvement reflected a fall in net borrowings by non‑financial corporations (helped by lower input costs after the decline in commodity prices) and continued fiscal consolidation at the central government level. At the same time, net lending by financial corporations declined, largely because bank credit slowed amid asset‑quality concerns and subdued investment demand. Deposits remained the largest source of funds for banks and were mobilised mainly from households, which continued as the biggest supplier of finance to the economy.
The external sector (Rest of the World) has been significant in India’s FoF since the early 1990s. There were sizeable capital inflows—both direct and portfolio—during 2003–04 to 2007–08, and again in 2014–15 and 2015–16, supported by easing of foreign direct investment norms and changes that allowed portfolio investors to invest coupons from government securities outside a residual maturity limit introduced in July 2014 (a rule later extended to corporate bonds). For private non‑financial corporations, the Rest of the World, insurance companies and non‑banking financial companies were important sources of finance.
By instrument, currency and deposits remained the preferred financial vehicles. The share of loans and borrowings fell steadily between 2011 and 2014–15 as bank and financial institution credit to the private corporate sector weakened. Nevertheless, deposits together with loans and borrowings accounted for more than 60 per cent of total liabilities issued during 2011–12 to 2014–15. Meanwhile, the shares of equity and investment fund shares and of insurance, pension and provident funds rose to about 17 per cent and 6.1 per cent respectively in 2014–15.
Finally, separating total issues into primary issues (direct flows from surplus to deficit sectors) and secondary issues (flows mediated by financial intermediaries) shows broad expansion in both channels. According to Table 2.4 of the RBI series, total issues rose markedly from 246,384 billion in 2011–12 to 458,255 billion in 2014–15, with steady increases in both primary and secondary issues over that period.
Flow-of-Funds Financial Ratios
The role of the Indian financial system in capital accumulation and formation is best gauged through a set of finance‑deepening ratios. Financial development is studied by tracking changes in these ratios, originally developed by Goldsmith (1969). Broadly, they capture the size and composition of financial assets relative to national income, the shifting balance between bank and non‑bank intermediaries, and the degree to which the financial sector mobilizes savings and channels them into productive investment. Observing movements in these measures helps assess how effectively the financial system supports capital formation and economic growth.
The Finance Ratio (FR) measures financial deepening by showing how large the financial sector is relative to the real economy. It is used as an indicator of the rate at which financial development is proceeding in comparison with economic growth.
FR is calculated as the ratio of total financial claims (the total issues) to national income. The numerator — total financial claims — comprises both primary claims (direct liabilities of financial intermediaries, such as bank deposits and loans) and secondary claims (marketable financial instruments like bonds and equities). The denominator is the net national product at factor cost (net national income). A rising FR implies that financial assets and intermediation are growing faster than the underlying economy, signalling greater financial deepening.
The Financial Inter-relation Ratio (FIR) measures the linkage between the financial system and the real economy by comparing financial claims to real capital formation. It expresses the proportion of financial issues relative to net capital formation and thus captures how the financial structure relates to the economy’s physical-asset structure. Formally, the ratio can be written as:
FIR = (Financial assets ÷ Total financial issues) ÷ (Physical assets ÷ Net domestic capital formation)
Viewed intuitively, FIR compares the share of finance in total financial issues with the share of physical investment in net domestic capital formation; a higher FIR indicates a relatively stronger role of finance compared with real-capital accumulation, while a lower FIR suggests the opposite.
The New Issue Ratio (NIR) is the proportion of primary claims issued by non‑financial institutions relative to total net domestic capital formation. Formally, NIR = Primary issues / Net domestic capital formation, where “primary issues” are new securities (for example, equity and debt) sold directly to savers, and “net domestic capital formation” equals net physical investment in the economy.
NIR therefore measures how much of investment by the producing sectors is financed directly by savers through primary securities rather than by other sources of funds. A higher NIR implies greater reliance on direct finance (new issues to savers) for funding investment, while a lower NIR indicates that investments are being met more from alternative sources such as retained earnings or indirect/intermediated finance.
Intermediation Ratio (IR) measures the role of financial intermediaries in channeling resources within an economy. It is defined as the ratio of secondary issues—financial claims issued by financial institutions—to primary issues—financial instruments issued by non-financial institutions. The IR therefore reflects the degree of institutionalisation of financing: a higher IR implies a larger share of funds being mobilised and allocated through financial intermediaries rather than directly through corporate or government securities.
Mathematically, IR = Total secondary issues / Total primary issues.
Table 2.4 presents the pattern of primary and secondary issues and the derived financial ratios for 2011–12 to 2014–15. Over this period primary and secondary market activity together (total issues) remained substantial, while the composition shifted somewhat between domestic and rest-of-world participation. The table’s ratios summarize how financial market activity relates to overall economic activity and to capital formation.
The Finance Ratio (FR), defined as total issues divided by national income, rose from 0.401 in 1990–91 to 0.53 in 2014–15. This increase signals a deepening of financial markets and greater institutionalization of investment finance. It also reflects a clearer separation between saving and investment—financial markets increasingly intermediate savings into productive uses rather than savings being directly tied to investment decisions.
The Financial Inter-relations Ratio (FIR), which compares total issues with net domestic capital formation, showed strong growth in the 1990s—ranging roughly from 1.75 to 2.87—implying that financial activity expanded faster than national income and that the financial system played an increasing role in capital formation. After a decline between 2004–05 and 2012–13, the FIR improved from 2013–14 onward (see Table 2.4), indicating renewed momentum in the financial sector’s contribution to investment.
The New Issue Ratio (NIR), the ratio of primary issues to net domestic capital formation, peaked at about 1.618 in 1991–92 following capital market reforms and liberalization. During 2011–12 to 2014–15 the NIR ranged between 0.97 and 1.20, showing a sustained level of fresh primary issuance—public issues—being used for capital formation.
The Intermediation Ratio (IR), measured as secondary issues divided by primary issues, reached an all‑time high of 0.89 in 1999–2000. In 2011–12 to 2014–15 it hovered between 0.67 and 0.74, reflecting the relatively greater role of financial intermediaries in secondary-market activity compared with primary issuance, and underscoring the importance of banks and other financial institutions in channeling funds to real economic activities.
Taken together, these ratios demonstrate the growing importance of financial intermediation in India: financial flows—both direct and indirect—have increased relative to economic activity, indicating a clear deepening and widening of the Indian financial system.
Saving and Investment Fundamentals
Saving and investment are fundamental to both economics and finance; they underpin key policy goals such as price stability, higher incomes and employment, and sustained economic growth. Understanding their relationship is essential to assessing how an economy accumulates resources and expands productive capacity.
Saving is the portion of income that is not spent on current consumption—income minus expenditure. Investment, by contrast, is the deliberate sacrifice of present consumption to create or acquire real assets that will produce future goods and services. This includes expenditures on plant and equipment, residential and other construction, and additions to inventories. In practice, investment is synonymous with capital formation: the net addition to fixed assets that determines a country’s capacity to grow over time.
In national accounts, investment is measured as Gross Fixed Capital Formation plus the physical change in stocks and work in progress. Gross Fixed Capital Formation includes depreciation (consumption of fixed capital), whereas net capital formation excludes depreciation and therefore measures the true increase in productive capital.
Both saving and investment are flow concepts: they describe additions to the stock of capital or wealth that occur over a period of time. By contrast, the stock concept—often called “savings” in the plural—refers to holdings of wealth at a point in time, usually in the form of financial claims. Thus, saving (flow) increases the stock of savings (wealth), while investment (flow) increases the stock of real capital.
Changes in the economy—variations in the money supply, creation of new capital projects, government deficits or surpluses, and the introduction of new financial claims—affect the supply of and demand for securities and other financial instruments. Because these forces are expressed through flows of saving and investment, analyzing those flows is central to understanding financial markets and the allocation of resources in the economy.
Savings, Investment and Capital Formation
The concepts of saving and investment are central to understanding several key issues in macroeconomics: why economies swing between prosperity and recession, how long‑term growth occurs, and how Gross Domestic Capital Formation is financed. Together they explain not only the level of aggregate demand at any time but also the availability of resources for productive activity and expansion.
Economic activity fluctuates when planned investment and available savings are out of step at a given level of income. If investment exceeds savings, demand rises and the economy tends toward expansion; if savings exceed investment, demand falls and a slowdown or recession can follow. Thus short‑run ups and downs in output often reflect changes in the balance between saving and investment.
Capital formation—the accumulation of physical assets used in production—is closely linked to economic growth. Growth can come from spreading existing capital over a larger workforce and output (capital widening) or from increasing the amount of capital used per worker and per unit of output (capital deepening). Both processes raise productive capacity, but they have different implications for productivity and long‑run development.
Financing this capital formation requires mobilizing financial resources. The volume and effectiveness of investment depend on how strongly savings are encouraged, collected, and channelled into productive uses. The financial system—banks, markets and related institutions—performs this intermediary role. As a larger share of savings flows through formal financial institutions, the economy’s financial depth increases, improving the ability to support sustained investment and growth.
Savings–Investment Dynamics in India
The Central Statistical Organisation (CSO) defines saving as the excess of current income over current expenditure—essentially the balancing item on the income-and-outlay accounts of producing enterprises, households, government administration and other final consumers. To estimate domestic saving, the economy is divided into three broad institutional sectors: household, private corporate and public.
The household sector is heterogeneous: it includes individuals, unincorporated businesses (sole proprietorships and partnerships), farm units and a range of non‑profit institutions. Household saving is simply that part of household income not spent on current consumption. It is measured as the sum of financial saving and saving in the form of physical assets. Financial saving comprises currency holdings, net bank deposits, investments in shares and debentures, net claims on government (such as central and state government securities and small savings), and increases in insurance and provident fund claims. Physical saving covers construction, machinery and equipment and inventories held by households and unincorporated enterprises; valuables such as gold are treated separately.
The private corporate sector includes non‑government, non‑financial companies, private financial institutions and cooperative institutions. Its saving is the excess of revenues over expenditures. The public sector consists of government administration and public enterprises—departmental and non‑departmental—with public saving defined as current receipts minus current expenditure.
In macroeconomic terms, investment refers to domestic capital formation. At the aggregate level, investment equals the savings available to the economy and is determined by domestic saving and net capital inflows from abroad. Investment is broadly classified into public investment (government spending on infrastructure, health and education) and private investment (firms’ and households’ spending on plant, machinery and buildings).
Longer‑term trends in saving and investment show several distinct phases. The rate of Gross Domestic Saving (GDS) rose from about 16.6 per cent of GDP in the 1970s to roughly 23.9 per cent in the 1990s, reaching 25.1 per cent in 1995–96 and an all‑time high of 37.7 per cent in 2007–08. Since the global financial stresses of 2008–09 the average saving rate has declined. For 2014–15 the rate of gross saving to gross national disposable income stood at 32.3 per cent (the same as 2013–14), and gross saving to GDP was 33.0 per cent.
Households are the dominant source of savings in India, contributing over three‑quarters of total saving. Financial saving began to acquire greater importance after the bank nationalisation of 1969, reflecting deeper financial intermediation. The GDS rate dipped in the early 1980s as household expenditure on consumer goods rose, but during the 1990s household financial saving became the single largest contributor to aggregate saving. Over the last few decades the share of household financial saving has persistently outstripped saving in physical assets—an indication of widening and deepening of financial markets and shifts in household portfolios.
Recent movements in household net financial saving illustrate this pattern. Net financial saving of the household sector rose to 7.7 per cent of gross national disposable income (GNDI) in 2015–16 from 7.5 per cent in 2014–15 and 7.4 per cent in 2013–14. This improvement reflected faster growth in household financial assets than in their financial liabilities. The asset side was supported by a revival in small‑savings instruments, greater investment in equities and mutual funds, higher flows into tax‑free public sector bonds, and increased currency holdings, even as bank deposit growth moderated. On the liability side, household borrowing from banks and housing finance companies also rose.
Two policy and market developments help explain shifts in household portfolios. The removal of wealth tax on various financial assets in the Union Budget 1992–93, together with growing financial intermediation, encouraged households towards formal financial instruments such as bank deposits and contractual savings. However, since about 2000–01, declining interest rates and subdued capital markets spurred increased household investment in physical assets—particularly housing and gold—so the rising preference for physical assets in recent years is primarily concentrated in real estate and valuables.
The government has historically channelled a rising proportion of household savings back into public uses—through insurance and provident fund collections, statutory requirements such as the Statutory Liquidity Ratio (SLR) for banks, and deficit financing via the Reserve Bank. This pre‑emption of household savings affects the composition and availability of resources for private investment.
Sectoral saving patterns have also shifted. The private corporate saving rate rose over the second half of the twentieth century—from about 1 per cent in the 1950s to 1.7 per cent in the 1980s and 3.8 per cent in the 1990s—and exceeded the public sector saving rate in the 1990s. Liberalisation and successive pro‑private measures in the 1990s boosted private corporate investment; subsequent reductions in corporate tax rates and lower debt servicing costs helped raise the private corporate saving rate from 3.4 per cent in 2001–02 to 8.8 per cent in 2007–08 and to 12.3 per cent in 2014–15.
By contrast, public sector saving fell sharply in the 1990s. In the late 1990s and the early 2000s public saving turned negative—reaching –2.5 per cent of GDP in 2001–02—largely because of increased dissaving by government administration. This negative public saving constrained domestic resource mobilisation and reduced aggregate savings. Public saving recovered to 2.2 per cent of GDP in 2004–05 and peaked at around 4.5 per cent in 2007–08, helped mainly by improved performance in non‑departmental public enterprises, but it has eased since 2008–09 partly because of fiscal stimulus and a weakening contribution from public enterprises.
Investment behaviour has mirrored these saving dynamics. Gross Domestic Capital Formation rose to 26.9 per cent of GDP in 1995–96 but declined to 24.0 per cent in 2000–01 as public sector savings deteriorated. Capital formation in the public sector fell during the 1990s, with a temporary rise to 6.9 per cent in 1999–2000 driven by buffer stock accumulation rather than fixed investment. The overall investment rate peaked again at 32.9 per cent of GDP in 2007–08, supported by both public and private corporate investment, but it has been on a declining trend since 2008–09. From 2011–12 a modest recovery in gross capital formation was aided by larger capital inflows from the rest of the world, while 2015–16 remained subdued but held prospects of a turnaround in capital expenditure.
Until around 2000–01 India’s gross capital formation rates were generally higher than gross domestic saving, producing a saving–investment gap often financed by fiscal deficits and, increasingly, by foreign capital. Domestic saving has traditionally financed over 90 per cent of investment in India; net external savings averaged less than one per cent of GDP since 1991–92. A notable exception occurred in 2001–02 when a saving–investment surplus of 0.6 per cent of GDP emerged—the first surplus since 1975–78—reflected in a current account surplus. From 2004–05 onwards the current account has generally been in deficit as investment outpaced saving.
This pattern—household dominance of savings, increasing financialisation followed by renewed interest in physical assets, a strengthening private corporate sector alongside fiscal pressures in the public sector, and the interaction between domestic saving and foreign capital—frames the modern Indian saving–investment story and explains many of the macroeconomic choices and constraints policymakers face.
Household Financial Savings and Borrowing
Household savings in India are held in a variety of forms: currency, bank and non-bank deposits, life insurance funds, provident and pension fund claims on the government, and investments in shares and debentures, including units of the Unit Trust of India. For sustained economic growth, it is desirable that a larger share of these savings be channelled into financial assets—deposits, securities and contractual savings—rather than being held as currency, which is more likely to be diverted into unproductive assets such as gold. This concern has prompted careful analysis of the composition of household savings.
The analysis shows that deposits—both with commercial banks and non-banking institutions—account for a large proportion of household financial savings. The rapid expansion of the commercial banking system over past decades was therefore an important factor behind higher savings mobilisation. Close behind deposits are contractual savings: provident funds, pension schemes and life insurance. These instruments are attractive to households because they lock in resources for the long term and are typically channelled into long-term investment. The rise in household savings in 1999–2000 and 2000–01, for example, was driven largely by an increase in long-term contractual savings. Given India’s substantial infrastructure financing needs, such long-term pooled resources are vital; they can fund infrastructure projects, help revive the capital market and provide a measure of social security.
Financial saving in the form of shares and debentures has varied over time. As a share of household financial assets it rose from about 0.8 per cent in 1970–71 to 1973–74 to 3.9 per cent in 1993–94 to 1998–99, becoming the third most popular financial asset (see Table 2.9). This shift reflected financial market reforms introduced in July 1991, which stimulated new equity issues and a rising Sensex, as well as broader improvements in market depth, size and liquidity. However, the share of household financial saving in equities fell to 0.1 per cent of financial assets in 2005–06 and further to −0.7 per cent in 2011–12, before rising again to 0.7 per cent of GNDI in 2015–16 (see Table 2.10). (Note that some figures are expressed as percentages of household financial assets, while others are reported relative to gross national disposable income.)
Small retail investors remain the backbone of India’s capital markets: their broad participation aids price discovery and can offset the influence of large players such as foreign institutional investors. Yet recurrent scams, high volatility, instances of fraudulent management and weak corporate governance have eroded individual investor confidence at times. Renewed participation since 2011–12 reflects more buoyant equity markets and stronger macroeconomic fundamentals.
Overall, household savings are increasingly held in financial instruments—deposits, insurance and marketable securities—rather than as currency. This trend signals a growing preference for financial intermediation and suggests that funds mobilised by intermediaries are being directed towards more productive investment.
Table 2.10 shows that the household sector in India relies primarily on banks for its borrowings. In 1999–2000 and 2000–01, bank loans to households rose by about 40 per cent over the level in 1998–99. Over the following decade bank borrowings moved from Rs. 2,43,354 crore in 2001–02 to Rs. 2,64,991 crore in 2011–12, a rise that was aided by lower interest rates and encouraged households to finance purchases of durables and real estate. After banks, the next important source of household finance is loans and advances from other financial institutions.
Overall, the household sector has been a net surplus sector: its savings have outstripped its financial liabilities, making it the single most important contributor to Gross Domestic Savings (GDS). While the private sector showed improvements in both saving and investment, the government exhibited negative saving. Large fiscal deficits made the public sector the biggest deficit sector, forcing the government to rely heavily on market borrowings to fill the financing gap.
A review of the trends in savings and investment suggests that financial development and improved intermediation have supported a higher national saving rate, by widening access to financial services and mobilising household savings more effectively.
Determinants of India's Savings Rate
India’s saving rate remains relatively low compared with many East Asian economies, indicating substantial scope for improvement. Increasing savings is important for long‑run investment and growth, and understanding the determinants of household and aggregate savings helps identify where policy and market action can have the greatest effect.
An empirical study by the Reserve Bank of India (2001) finds that two factors—real per capita income and financial deepening—have significant positive effects on the aggregate gross domestic savings (GDS) rate. The study uses an intermediation ratio (measured as secondary issues to primary issues) as an indicator of financial deepening. Holding other factors constant, a 1 per cent rise in real per capita income is associated with a 6.6 percentage‑point increase in the aggregate savings rate, while a 1 per cent rise in the intermediation ratio corresponds to a 3.4 percentage‑point increase.
These results imply considerable potential for raising India’s saving rate. That potential can be tapped by financial markets and intermediaries that deepen intermediation and offer savers higher and more attractive rates of return.
Growth, Savings and Policy Priorities
The post-reform decades recorded a clear rise in India’s growth momentum. In the 1990s the GDP growth averaged 5.7 per cent, and it accelerated further to 7.3 per cent between 2000–01 and 2007–08 — a distinctly high and noteworthy performance. Alongside growth, national savings strengthened: gross domestic savings (GDS) averaged 23.9 per cent of GDP in the 1990s, rose to 33.8 per cent in 2009–10 and eased slightly to 32.3 per cent in 2010–11 (Table 2.6). Household saving behaviour also shifted, with a growing preference for financial over physical assets.
Investment outcomes mirrored the savings trend. During the Tenth Plan the gross domestic capital formation averaged 29.8 per cent of GDP, and the private corporate sector responded enthusiastically to the policy changes of the reform era, contributing significantly to the investment surge.
These gains were achieved despite a series of domestic and international shocks — the South‑east Asian crisis, uncertain prospects in Japan and Europe, political instability, economic sanctions and suspension of fresh multilateral lending after India’s nuclear tests, downgrades by international rating agencies, and reduced flows from foreign institutional investors. The economy’s ability to withstand and recover from these shocks rested largely on resilient domestic savings (Table 2.11). As Ragnar Nurkse observed in 1953, “capital is made at home,” and domestic saving proved central again during the global turbulence.
Today India ranks among the world’s fastest‑growing economies, and the target of sustaining about 8 per cent GDP growth over the coming five years is considered achievable given the right conditions.
Policy priorities follow directly from these lessons. The public sector must aim to generate positive savings, while attracting foreign direct investment depends on strong macroeconomic fundamentals. Equally important is a well‑developed, sound financial system: it is a prerequisite for mobilizing larger domestic and foreign savings and for allocating those resources efficiently to sustain higher growth.
Financial Development and Economic Growth
An efficient financial system is both a catalyst and a conduit for economic growth. By mobilizing savings and directing them toward the most productive uses, the financial system raises the economy’s overall output. Markets, institutions and instruments together form the structure that channels resources into investment; when this structure is well developed, capital flows more quickly to projects with the highest expected returns for a given level of risk.
Beyond simply collecting savings, a mature financial system expands and accelerates savings by offering a wider range of instruments and services through intermediaries. Greater product choice and competition reduce the cost of intermediation and help steer funds to higher-return uses. At the same time, a sophisticated financial sector lowers the cost of innovation—making new technologies and business models cheaper to finance and therefore more likely to be adopted—so the economy can modernize and grow faster.
The financial system also performs several technical but essential functions: it prices and evaluates assets, increases liquidity by making assets easier to buy and sell, and produces and disseminates information that reduces uncertainty for investors and firms. These informational and liquidity functions improve resource allocation across the economy and support more efficient investment decisions.
Financial systems do not develop in isolation; they respond to changing demands for financial services. For example, the global rise in demand for risk‑management tools in the 1970s led to increased trading activity and the creation of new risk‑management products. Thus, economic growth and evolving financial needs can themselves stimulate further development of the financial system.
The depth of financial markets matters for stability and policy effectiveness. Deeper money and government securities markets enhance liquidity and provide the central bank with instruments to conduct monetary policy through market operations. A balanced financial system—where both markets and institutions play complementary roles—is more resilient; persistent imbalances between the two can contribute to instability, as seen during financial crises in parts of Southeast Asia.
Linkages between the domestic and international financial systems also shape economic outcomes. Integration expands capital flows, lowers portfolio risk through diversification, and can speed the transfer of financial innovations and best practices. Moreover, active domestic financial markets help discipline corporate management and promote better governance by subjecting firms to market scrutiny.
Overall, the relationship between finance and growth is bidirectional and mutually reinforcing. A sound, sophisticated financial system speeds up economic growth; higher growth, in turn, supports further financial development. This symbiotic connection has been the focus of substantial theoretical and empirical research because of its central importance for policy and development.
Empirical Evidence on Finance and Growth
Early empirical work on finance and growth established a broad historical pattern: as economies develop, internal or self-financed capital investment tends to give way first to bank-mediated debt and later to the emergence of equity markets as an additional source of external finance. Gurley and Shaw and Goldsmith documented this evolution, arguing that the structure of finance changes with development and with firms’ increasing need for outside funds.
Some scholars have argued that this financial evolution was not merely a consequence of industrial progress but a precondition for it. Hicks suggested that the English Industrial Revolution required more liquid financial markets; large, long-term projects could not have been financed effectively without institutions that pooled savings and spread risk. In this view, a “financial revolution” enabled the sustained capital investment that underpinned industrial transformation.
The modern theoretical debate was sharpened by McKinnon and Shaw, who identified government-imposed restrictions on banking—such as interest rate controls, high reserve requirements, and mandated credit allocation—as obstacles to financial development, a phenomenon often termed financial repression. They argued that such constraints reduce the efficiency of financial intermediation and thereby slow economic growth, providing the intellectual case for liberalization of financial markets in many developing countries. Subsequent work by Cho emphasized that liberalization is incomplete without well-functioning equity markets, which are essential for spreading risk; both banks and stock markets are needed for a fully developed financial system.
Empirical studies have explored these claims in several ways. Some researchers find that the relationship between banks and securities markets shifts with the stage of development: when private sectors flourish and banking systems are well established, equity markets tend to grow and complement banks. Cross-country work by King and Levine found statistically significant links between measures of financial intermediary development and long-run growth. Atje and Jovanovic reported that stock market development alone could raise growth by about 2.5 percentage points per year in a typical developing country. Levine and Zervos showed that liberalizing controls on capital and dividends was associated with improved stock-market functioning, and Greenwood and Smith argued that larger stock markets lower the cost of mobilizing savings and channel investment into more productive techniques.
Additional empirical results stress complementarities and stability effects. Demirgüç-Kunt and Levine found that more open capital markets are associated with lower long-run stock-return volatility and that stock markets and financial intermediaries tend to develop together rather than as substitutes. Other studies, however, produce more nuanced findings: Demetriades and Hussein found limited support for the claim that finance is always the leading sector in development and in several cases evidence that economic growth itself systematically spurs financial development. On balance, much of the literature points to a two-way relationship: financial deepening can promote growth, and growth can, in turn, foster financial development.
A strand of research focusing on market liquidity reinforced the independent importance of stock markets for growth. Levine and Zervos used turnover and value-traded ratios as measures of liquidity and showed that liquidity services provided by stock markets are positively associated with subsequent economic growth, capital accumulation, and productivity. They also found that liberalization allowing foreign participation tends to improve market liquidity. Building on these ideas, Levine developed an endogenous growth framework in which the financial system affects the real economy by reducing information and transaction costs and by providing services—risk diversification, rapid information, corporate control, and savings mobilization—that raise capital accumulation and innovation.
Not all empirical findings are uniformly supportive. Mayer’s cross-country work suggested that internal finance still finances most corporate investment in several advanced economies and that stock markets play a limited role. Joseph Stiglitz critiqued simplistic liberalization prescriptions by highlighting market failures that financial liberalization can expose. Country-specific studies sometimes tell a different story: for India, Nagaraj found that expansion of capital markets between 1950 and 1991 shifted household financial savings from bank deposits toward shares and debentures but did not raise the overall savings rate or strengthen the link between capital markets and corporate investment or output growth; during the 1980s, corporate profitability fell even as the capital market expanded. Singh’s work on developing-country stock exchanges documented a twenty-fold increase in market capitalization in the 1982–92 decade but warned that rapid financial liberalization can increase system fragility and need not ensure higher long-term growth.
By the turn of the century, some researchers concluded that the simple dichotomy of bank- versus market-based finance was less useful for explaining growth than institutional fundamentals. Levine and coauthors argued that differences in legal and accounting institutions—creditor rights, contract enforcement, and accounting standards—better explain financial-intermediary development and, through it, economic performance than does the broad classification of financial structure.
Taken together, the empirical literature suggests a close, albeit imperfect, relationship between the effectiveness of an economy’s financial system and its rate of economic growth. Results are sensitive to methodology and context: many influential studies use cross‑section regressions that treat countries as comparable units, but causality patterns differ across countries and over time. This diversity of findings implies that careful, country-specific analysis is essential to understand how financial-sector reforms and financial development will affect a particular economy’s growth prospects.
Financial Flows and Intermediation
An economy’s financial flows are driven by two basic types of economic units: those that spend less than they earn and therefore generate surpluses, and those that spend more than their income and therefore run deficits. Surplus units—households, firms or governments that consume and plan investment below their income—supply funds to the rest of the economy. Deficit units—those whose consumption and planned investment exceed current income—demand funds. The institutions and instruments that channel savings from surplus to deficit units make up the financial system, which is the principal vehicle for economic transformation; the speed and effectiveness with which national objectives are achieved depend crucially on the efficiency of this system.
Macro-economic measurement relies primarily on national income accounts, which track production and the earnings derived from it. Flow of funds accounts complement these by tracing how savings and investments actually move across sectors and instruments. Organized along two dimensions—economic sectors and financial instruments—flow of funds statements show sector-wise and instrument-wise financial flows and thereby illuminate the structure of financial intermediation in the economy.
Several flow-of-funds indicators are commonly used to capture the changing role of finance: the Finance Ratio, the Financial Inter-relation Ratio, the New Issue Ratio, and the Intermediation Ratio. Taken together, these measures point to the rising importance of financial intermediation and to the expansion of financial flows relative to overall economic activity, in both direct and indirect finance.
Understanding saving and investment is central to explaining business cycles, long-run growth, and the financing of gross domestic capital formation. For practical measurement of domestic saving, the economy is conventionally divided into three institutional sectors: households, the private corporate sector, and the public sector. India’s Gross Domestic Savings rate stood at 34.8 per cent of GDP in 2006–07, with the household sector accounting for over three-quarters of total savings. Since 2000–01 the household sector has shown a greater preference for investment in physical assets, while the saving and investment rates of the private corporate sector have improved; a saving–investment surplus emerged for the first time in 2001–02.
At the same time, the composition of household savings has shifted away from currency toward financial assets such as bank deposits, insurance policies, and equity and debt instruments. This change reflects deeper financialisation of household portfolios and greater use of formal financial channels.
A well-functioning financial system facilitates economic activity and growth in multiple ways: it raises the level and velocity of savings, reduces the costs of intermediation and innovation, provides mechanisms for asset valuation, supports the central bank’s conduct of monetary policy, and enhances corporate governance through monitoring of firms. The increasing share of banking and financial services in real GDP underscores the growing importance of these intermediation activities in India’s economic development—the country recorded one of the world’s highest growth rates, 9.6 per cent in 2006–07, second only to China among emerging market economies—highlighting how closely financial deepening and economic expansion can be linked.