India is the third largest and the second fastest growing economy in the world. During the past few decades, Indian businesses have been establishing their presence in different parts of the globe. In just sixty years of Independence, the country has emerged as an important economic and business power. In this connection, this paper attempts to find out as to how the Indian economy and businesses are financing their activities. For this purpose, the saving and investment practices in the economy and the major sectors of business are analysed. First- hand details collected through field studies at selected industrial and business centres are used along with the macro- data to study the nature of financing at various levels. The results indicate that the growth of the economy and development of businesses have been driven by the domestic finance, funded mainly by own and local sources with support from the institutions.
Indian economy has been growing since Independence. For about three decades from the beginning of the 1950s, the rate of growth was 3.5 per cent. It started moving at a faster speed thereafter. The growth rate for the next quarter century averaged around 6 per cent per annum. The recent years show an impressive performance with the growth rates touching 9.4 percent in 2005-06, 9.6 percent in 2006-07 and 9 percent in 2007-08.

Maddison (1998) notes that the rate of growth of GDP (annual average compound growth rate) of India at 4.02 percent during 1952-78 was higher than the growth rate of the US at 3.46 percent. He also points out that during 1978-95, the annual average compound growth rate of India was much better than that of the Europe and the U.S.A. India’s growth rate during that period was also better than the world average, though China grew at a higher rate.

The industrial and business sectors started growing fast after Independence, displacing the expatriates who were in a commanding position earlier. The ‘license-permit raj’ created difficulties for the growth of domestic industry and business during the initial decades. But in spite of the difficulties, the growth continued and new groups of people started entering into businesses. Tripathi and Jumani (2007) capture the situation during those times: “ ……., the Indian business class registered substantial expansion after Independence. Not only did the number of persons opting for business as a profession increasingly go up, the new entrants into the profession came from a more varied background than was the case at the time of Independence.”

In the recent decades, Indian businesses are gaining world wide recognition. Many companies are emerging as world-class performers. Out of the 100 local companies identified by the Boston Consulting Group as the new global challengers from 12 rapidly developing economies, there were 21 Indian companies. (BCG Report, 2006) An increasing number of our companies have been going out during the recent years in different directions to establish, expand and diversify their businesses. India’s direct investment abroad had crossed $ 11 billions during 2006-07 (RBI, 2007). Many of the industrial and business clusters of India, run by the family based non-corporate sector, have emerged crucial to the global businesses.

While it is true that the growth story is yet to touch all the sections of the society, there is no doubt that on the whole, the Indian economy and businesses have been growing in spite of many difficulties and problems. What could be the reasons for such a good performance of the Indian economy and business in about sixty years? There are different factors that influenced this kind of performance. Among them, the one fundamental factor is the high savings base of the Indian society and the self financing nature of the Indian economy and businesses.


Savings and investments are the two crucial factors for the development of economy and businesses. Countries that generate more savings have advantages as they have the necessary funds for investments themselves. Even in 1950-51, the Gross Domestic Saving was 8.6 per cent of GDP. Of this, the household sector contributed 66 per cent, while the balance came from the corporate and the government sectors. Here we have to remember that in 1951, 45 per cent of the population was living in poverty, the literacy level was just 17 per cent and the life expectancy a little more than 32 years (Mohan, 2002). So even under difficult living conditions, Indians were saving a high percentage of out of their limited earnings. It only shows the natural tendency of Indians to save even in times of difficulties.

At the time of independence, agriculture was the main occupation in India. In 1951-1952, the institutional source of finance to agriculture was just 7.3 per cent, while the non-institutional credit was 92.7 per cent (Uma Kapila, 2003). It means a large majority of the people who were engaged in agriculture in those years were mobilising most of the funds required for agriculture out of their own efforts from different informal sources. The rate of saving has started increasing since the 1950s, and the official saving rate for the financial year 2006-2007 was 34.8 percent of GDP. The saving of the different sectors of the economy, namely the household, private corporate and government sectors, for the different decades beginning from the 1950s are given in Table 1 below.

“Table 1 about here”
We could see from Table 1 that the savings rate of the economy has doubled from the 1950s to the 1980s, from about 9 per cent to more than 18 per cent, to ultimately touch 34.8 per cent in 2006-2007. The contribution of household sector has always been high and in 2000-01 it contributed as much as 91 percent to the total savings of India. In this connection it is to be remembered that different types of family owned non-corporate enterprises involved in various economic activities are also included in the household sector.
The above saving rates of the households are without considering investments in gold and other indigenous avenues. Indians are the largest consumers of gold and buy one fifth to about one fourth of the global gold output annually. Vaidyanathan (2004) notes: “If we include gold alone in the savings, then the savings rate would be higher by another two percentage points.” There are many other indigenous methods of savings such as chit funds which are not taken into account for calculating the official saving rates. Hence in reality the total savings would be more than the official rates.

Non- corporate sector

The non corporate sector plays the crucial and dominant role in the Indian economic and business systems. The share of this sector to the Indian economy is much higher than the combined share of the other two sectors, namely the corporate sector and the government sector. The share of the non-corporate segment in Net Domestic Product by economic activity was around 57 per cent during 2002-03 (CSO, Govt. of India, 2005). Its share is higher in critical areas such as trade, hotels and restaurants, construction and transport. The reach of the banking and financial institutions in the non-corporate segments is less. Most of their activities are funded through savings and funds mobilised from their own and local sources. It could be seen that wherever people find opportunities, they mobilise resources locally along with their savings and try to engage in some productive activity or other. As a result there are lots of economic activities in the form of unorganised enterprises and small and medium scale units.

Unorganised enterprises

The Economic Census 1998 had noted that there were 30.35 million enterprises in the unorganised sector. Of them, 24.39 million enterprises (80.4 per cent) were found to be self-financing. It clearly shows that a very high percentage of the promoters self -finance their ventures to engage in different types of entrepreneurial activities. Only less than five percent of the units were supported by the institutions and government schemes. Chadha (2003) notes that the Village and Small Industry sector is estimated to contribute about 50 percent of the value added in the manufacturing sector. Rural industries, covered officially under the Village and Small Industry sector, play an important role in providing employment and generating output. It was shown that own savings play the vital role in rural industries even for adopting technological improvements. Own savings contribute 87.25 per cent of finance for new designs, 78.57 per cent for new products, 69.23 per cent for new raw material and 51.56 per cent for improved machinery.

Small Scale Industries

Small-Scale Industries (SSIs) play a significant role in the Indian economy. The Third Census of the Small Scale Industries (Government of India, 2004) noted that there were more than 10.52 million units in the SSI sector. Of them, there were 50,606 exporting units. About 44 percent of the total units were in the services sector, 40 percent in manufacturing and allied activities, and the remaining 16 percent engaged in repairing and maintenance activities. About 95.8 per cent of the units in the SSI sector were found to be functioning as proprietary enterprises, while 1.9 per cent of them belonged to the partnership form. Most of these units generate funds on their own efforts through own and local sources without depending much on the financial and banking institutions. Out of the total enterprises in this sector, only 4.55 percent of them were having outstanding loans with institutional sources.


The Third Census of the Small Scale Industries had estimated that there were 2042 clusters, with a predominant share of small and medium businesses/industries. These clusters cover 521 different products and have a share of 32.68 per cent and 37.85 per cent in the total estimated number of registered and unregistered units respectively. India is known throughout the world for its quality products and services offered by different clusters such as Surat, Tirupur, Rajkot and Ludhiana. The businessmen from many of these clusters compete with companies from different countries and multi-national enterprises and emerge successfully, establishing the name of the country in the international markets. Many foreign companies, including the multi-national firms, openly acknowledge the higher quality of many of these business and industrial clusters.
Savings are usually in the range of a high order in many clusters. A detailed study by Chari (2003) in the textile industry of Tirupur in Tamil Nadu has shown that different categories of the exporters and domestic producers were saving more than 40 per cent of their earnings. He mentions the savings of one particular group of exporters, namely the Gounder ex-workers, who saved up to 85 percent. The above study shows that family sources and savings from prior earnings are the major sources of initial capital. It also notes that the sources of capital were the most diversified, spanning farm, family and non-farm work, and to a lesser extent chit funds, marriage dowries and land sales. Chari mentions: “A large and diverse market in private and informal credit exists to make the whole production a complex function. Non-bank sources of credit in Tiruppur include private finance companies, rotating credit unions called chit funds, moneylenders, and forms of mutual assistance between friends, family or kin.”

Studies in different industrial and business centres show that family relationships play an important role in supplying funds in different places. A study among the Reddiar community businessmen in central Tamil Nadu showed that nearly one fifth of them were supported with initial funds by their married sisters. (Kanagasabapathi and Reddy, 2004) A study of diamond exporters in Ahmedabad and Surat revealed that almost all of them received support from their relatives towards initial funds and about 89 percent of them received more than 20 percent of such funds. (Patel and Kanagasabapathi, 2005) Community networks also play a notable role in different business centres in meeting the financial requirements. World Bank (2001) mentions the role of community net works in mobilising funds at cheaper costs through informal methods in Tirupur.
In many clusters the local finance plays a significant role as a source of funds. A study of Karur in Tamil Nadu, which is a major textile centre known for exports, showed that in 2001 the businessmen mobilised almost two thirds of their required funds from local financiers, even though there were many banks having branches with necessary funds for lending. ( Kanagasabapathi, 2002) Generally people in many of the places approach banks only as a last resort, as they try to arrange funds on their own. A study of the transport industry of Namakkal, the centre with the largest lorry transport traffic in India, showed that only ten percent of businessmen went to banks for initial funds, while for working capital the percentage was only three. (Kanagasabapathi and Arun Kumar, 2006)

It is important to note that the entrepreneurs in many centres usually invest a large part of their surpluses back into the business for expansion and diversification. Purchase of assets and savings are the other priorities. Generally the consumption expenditure is very less, at least till they reach a certain level. In the case of power loom textile exporters of Palladam in Tamil Nadu, it was observed that all the respondents were reinvesting their surpluses into the business, with 80 percent of them investing their entire surpluses, 13.3 percent investing 80 percent and the balance investing between 40 and 60 percent. The study showed that even for expansion and diversification, businessmen prefer to rely on own funds and surpluses. ( Kanagasabapathi and Menakha, 2005)

The overall growth of economy and business has been aided by the growth of different activities in the non-corporate sector. In fact the growth of the non- corporate sector in some of the service and industrial activities has been much faster than the over all rate of growth of the economy.

More local funds, less banking finance and no foreign investments

The dependence of the unorgainsed enterprises, small scale industries and clusters is more on local funds and less on banking institutions and formal sources, especially at the initial stages. An important point to be noted here is that the funds coming as investments to these enterprises are mostly savings and surplus from different activities including the informal and agricultural activities in the rural and semi-urban areas. There are no foreign investments in these businesses and clusters. All these businesses and clusters have grown only due to domestic investments, most of them generated locally by the entrepreneurs. The entrepreneurs of different clusters have proved that they can grow very fast with local capital to emerge as successful players at the international levels. The people of Tirupur for example, generate an export turnover of Rs.11000 crores without getting any foreign investments. The arguments of savings- investment gap and the need for foreign capital are not applicable to them, as the entire funds required are generated by them through their own efforts.

Corporate Sector

In the case of the corporate sector, Indian companies generally relied more on internal sources of funds than on external sources for many years. Mall (1997) had shown that “companies tended to rely more on retained earnings till 1983 rather than on fresh infusion of paid-up capital, which has increased considerably since then.” Bank credit to the private sector is low in India compared to other countries in the world. Reserve Bank of India (2007) notes that in 2005 credit to the private sector as percentage of GDP was 47 in India, while the same was 166 in the U.K and 260 in the U.S.
Efficient Use of Money by domestic companies

Indian companies seem to make better use of the money invested than their multinational counterparts. An analysis of sample companies by The Economic Times (2006) showed that the Indian companies in the FMCG category ‘seem to be almost thrice as efficient as global heavyweights when it comes to utilization of capital.’ It also revealed that for every rupee invested, Indian companies generate Rs.4 worth of sales, whereas the number is only Rs.1.5 for multinationals.

Along with savings, capital formation has remained as the core economic activity of Indians even in their difficult times. This could be understood from the data relating to the capital formation since the 1950s. Even in 1950-51, capital formation was 8.4 percent of GDP. Since then it has been consistently growing. The higher proportions of savings of the household sector have played a crucial role in capital formation. Capital formation by the household sector has remained more than 40 percent during the last three decades. Moreover, the household sector has been contributing significantly to the private corporate as well as the government sectors for their capital formation. The private corporate sector has shown consistently a higher share in capital formation compared to savings, indicating flow of funds from the household sector through the intermediation of banking institutions and capital markets. The government also takes a huge portion of the household savings to carry on its capital formation activities.

It could be seen that the rate of capital formation has been continuously growing since 1950s. Table 2 presents the details of capital formation since the 1950-51.
“Table 2 about here”

The table shows that the gross domestic capital formation has increased from 8.4 percent in 1950-51 to almost 36 percent in 2006-07. This translates into more than three times increase during a period of fifty six years.

When we see the contribution of different sectors to capital formation, we find that the household sector has been contributing the maximum share. Apart from this, the savings of the household sector are used by the private and government sectors to meet their savings- investment imbalances. In this connection it is relevant to note that the savings by the private and government sectors have registered growth since 2003-04. It is important to note that on the whole there were more savings than investments in 2001-02, 2002-03 and 2003-04. As a result, the savings- investment gap as a percentage of GDP was just 0.2 percent during 2001-05.


Foreign investments are allowed in to India since the early 1990s and the rules regulating their entry were being relaxed over these years. As a result they are now allowed in different areas, with a few exceptions and with different limits. Table 3 provides the foreign direct investments (FDIs) and portfolio investments in India in rupee and dollar terms.
“Table 3 about here”

The above table shows that FDI and portfolio investments have increased many times since 1990-91.

Table 4 below provides figures relating to FDI as a percentage of GDP since 1992-93.

“Table 4 about here”

The above table shows that the foreign direct investments are very small for an economy of India’s size. In fact these investments have remained less than one per cent of the GDP on an average during the above period. But at the same time one has to remember that the foreign direct investments have reached significant levels in a few companies and segments.

Foreign Direct Investment – India and China comparison

It is often argued that foreign direct investment is the main reason for the faster growth of China than India. Let us see the facts.
“Table 5 about here”

Table 5 shows that the net foreign direct investment into India has remained on an average less than 10 percent of that of China since 2000. There is no doubt that the rate of growth of China is higher compared to India. But is an FDI driven growth sustainable and good for the economy in the long run? Huang and Khanna (2003) note that India has a better and a sustainable model than the FDI- dependent model of China.
To quote: “What's the fastest route to economic development? Welcome foreign direct investment (FDI), says China, and most policy experts agree. But a comparison with long-time laggard India suggests that FDI is not the only path to prosperity. Indeed, India's homegrown entrepreneurs may give it a long-term advantage over a China hamstrung by inefficient banks and capital markets….China and India are the world's next major powers. They also offer competing models of development. It has long been an article of faith that China is on the faster track, and the economic data bear this out.
However, the statistics tell only part of the story-the macroeconomic story. At the micro level, things look quite different. There, India displays every bit as much dynamism as China. Indeed, by relying primarily on organic growth, India is making fuller use of its resources and has chosen a path that may well deliver more sustainable progress than China's FDI-driven approach. "Can India surpass China?" is no longer a silly question, and, if it turns out that India has indeed made the wiser bet, the implications for China's future growth and for how policy experts think about economic development generally- could be enormous.”
Studies show that foreign investments do not help much in the growth of the economies in the long run. In fact many of the fast growing countries have higher self-financing ratios. Aizenman, Pinto and Radziwill (2003) note that "there is no evidence of any "growth bonus" associated with increasing the financing share of foreign savings. In fact, the evidence suggests the opposite: throughout the 1990s, countries with higher self-financing ratios grew significantly faster than countries with low self-financing ratios." It was observed that on an average, 90 per cent of the stock of capital in developing countries was self-financed.


Indian economy is basically a self financing and home grown one. The largest segment of the economy, namely the non-corporate sector, functions on its own without much support from the institutions for their financial needs. A sizable section of this segment, especially at the lower levels, pays higher rates of interest for funds and engages in different economic activities successfully, though the banking and institutional funds are not easily accessible to them. Much of the non-corporate sector investment is based on local funds generated by the promoters. Clusters mobilise most of the funds on their own, through own and close sources, and other local mechanisms. They go to banking and institutional sources mainly when their funds are not adequate to promote ventures, and in the later stages, when more funds are required for expansion and growth. In none of these places there are foreign direct investments. Generally the corporate sector tried to rely more on internal sources during the earlier periods. Even now bank credit as a percentage of GDP is lesser in India when compared to the developed economies.

So India is basically on the self financing track. In fact it has remained so since the 1950s. Indian economy and businesses have proved capable of generating funds on their own, even through the most difficult times. In contrast, savings and investments as a percentage of GDP have been declining in the case of the advanced economies. The growth of the Indian economy and development of businesses over all these years has been fundamentally driven by the domestic finance mobilised through savings and funds from close and local sources with support from the institutions.


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( Published in Pragati- Quarterly Research Journal, Vol.3, No.109, Bharatheeya Vichara Kendram Research Centre, Thiruvananthapuram, July- Sept.2009 )  

1 comment:

Kelly said...

Excellent thoughts Dr.Kanagasabapathi.You can start a new indian era...Thanks.