Structure:

1. Introduction- What is capital formation- 30 words
2. Benefits of Capital formation- 40 words
3. Trends of Capital formation- 80 words

Meaning of Capital Formation

• In an economy, adequate availability of capital formation is considered as one of the important factors for the overall growth and development of the country
• Inadequate availability or lack of capital formation in the economy may lead to underdevelopment of the economy
• Therefore, capital formation is considered as one of the important drivers of growth in the economy

Capital Formation is nothing but the transfer of savings from households and governments to the business sector, resulting in increased output and economic expansion.

Capital formation increases the real capital in the economy which in turn increases the productive capacity or potential of the society.

• The basic characteristic feature of capital is that it helps to enlarge the productive potential of the economy mainly by adding to the existing stock of capital goods such as machine, tools, plant and machinery, equipment, transport facilitates, land and building, furniture and fixtures etc
• There exists a close and positive relationship between the process of capital formation and economic growth of the economy.
• In theory, it has been emphasized that a high rate of capital formation is usually accompanied by a rapid growth in productivity and income.

In an economy, the process of physical capital formation can be expressed as a function of following factors or variables:

• An increase in the volume of real domestic savings so that the resources that would have been used for consumption are released for investment,
• The creation of adequate banking and financial institutions to mobilize savings of the economy and
• The emergence of an entrepreneurial class which can utilize the economy’s saving into productive channels of

Therefore, the growth of output of any economy depends on capital accumulation, and capital accumulation requires investment and an equivalent amount of saving to match it.

Trends of Capital Formation in India

• The central statistical organization (CSO) has been preparing estimates of saving and capital formation as part of National Accounts Statistics in India.
• While preparing the estimates of capital formation, the economy is divided into three sectors, viz

1. The household sector which comprises productive economic units either run on an individual basis or partnership or unincorporated business,
2. The private or the corporate sector which includes the joint stock companies
3. The public or the government sector which includes the capital assets of the government as also the assets of the enterprises run under state control

• If we sum up the net change in the value of the assets in a given period in these sectors, we arrive at a total of net domestic capital formation. To this if we add the net inflow of foreign capital we arrive at an estimate of the net national capital formation for the economy
• For this purpose, the estimate is compiled by the type of capital goods i.e., construction and machinery and equipment. This part of capital formation is called fixed capital formation
• Estimates of change of stock e., working capital are added to gross fixed capital to arrive at the total of gross capital formation.

Gross Fixed Capital Formation (GFCF) includes investments in fixed capital goods such as construction, machinery and equipment, plant and machinery etc. The aggregate Gross Domestic Capital Formation (GDCF) is estimated for the entire economy for each year by adding the GFCF and change in stocks. From the total of GDCF estimated, the independently estimates for the gross capital formation for the public sector and private sector are deducted to obtain the residual investment in the household sector.

Gross Domestic Capital Formation as a percentage of GDP

• Gross domestic capital formation (GDCF) of India as a percentage of GDP was 7 per cent of GDP in 1950-51, which increased to 20.3 per cent by 1980-81.
• Further, it increased to 3 per cent in 1990-91, and improved to 26.9 per cent in 1995- 96 and thereafter, it increased further to 33.8 per cent in 2005-06.

Table: Gross Domestic Capital Formation (GDCF) as a percentage of GDP in India (As a percentage of GDP at market prices)

Source: CSO, National Accounts Statistics, and Economic

Gross Domestic Capital Formation by Industry-Wise

• The economy is broadly classified into three sectors , Agricultural and Allied activities, Industrial sector and Services sector.

Table: Composition of Gross Domestic Capital Formation in India (As a percentage of total GDCF at 1999-00 prices)

Over the years, industries in services sector such as trade, hotels and restaurants, transport, storage and communication, finance, insurance, real estate and business services and community, social and personal services have also contributed a major proportion of total GDCF in As can be seen from the Table, the percentage share of manufacturing sector in total GDCF has increased to about 34.8 per cent by the end of 2004-05 from 19.2 per cent in 1950-51 where as the percentage share of agriculture, forestry and fishing in total GDCF has declined to 8 per cent in 2004-05 from 19.3 per cent in 1950-51.