The integration of innovative AI across education, skills, and health sectors offers India a powerful pathway to supercharge human capital.....

 Human capital, encompassing the knowledge, skills, experience, and health of a population, is a critical driver of economic development. India, with its large youth population, stands at a pivotal moment to leverage AI as a transformative tool for enhancing this capital. The integration of AI into core sectors like education, skill development, and health is not merely a technological upgrade but a strategic necessity to bridge existing gaps, improve efficiency, and prepare its workforce for the demands of a tech-based global economy. The Indian government's "AI for All" strategy and the IndiaAI Mission underscore this commitment, aiming to use AI for inclusive growth and to add an estimated $2 trillion to the Indian economy by 2035.

Innovative AI in Education

AI can revolutionize India's education system by moving beyond traditional, one-size-fits-all approaches to create a more effective, accessible, and personalized learning environment.

Personalized and Adaptive Learning: AI platforms can analyze individual learning patterns, strengths, and weaknesses to provide customized learning paths and materials. This ensures students receive content at their own pace, improving engagement and knowledge retention, and can significantly help students with special needs or those who are at risk of dropping out.

Smart Content Creation: Generative AI tools can assist educators in creating dynamic and interactive content, including quizzes, summaries, and lesson plans, reducing administrative burdens and allowing teachers to focus on student mentorship and engagement.

Bridging the Digital Divide: Online learning platforms and AI tutors can provide quality education access to students in remote and underserved rural areas with limited teacher availability, fostering digital inclusion.

Enhanced Assessment and Feedback: AI automates grading and provides real-time, actionable feedback to students and teachers, allowing for timely interventions and a data-driven approach to educational policy and improvements.

Innovative AI in Skills Development

AI is changing the nature of skills required in the workforce, necessitating a focus on lifelong learning and continuous upskilling.

Identifying Skill Gaps: Predictive analytics powered by AI can analyze current job market trends and an organization's existing skills inventory to identify future demand and skill shortages. This allows for proactive development of training programs.

Tailored Training Programs: AI can recommend personalized learning and development opportunities based on an individual's performance and career goals, accessible through platforms like the Skill India Digital Hub.

Hands-on and Experiential Learning: Integrating AI with augmented reality (AR) and virtual reality (VR) can create immersive simulations for practical, hands-on training, particularly in fields like manufacturing and healthcare, preparing the workforce for real-world scenarios.

Efficient Human Resource Management: AI streamlines HR functions from recruitment (automating resume screening, using chatbots for FAQs) to performance management and employee engagement, freeing up HR professionals for more strategic tasks like talent development and improving employee experience.

Innovative AI in Healthcare

A healthier population is a more productive one, and AI can dramatically improve healthcare delivery and outcomes in India, especially in remote regions.

Improved Diagnosis and Treatment: AI algorithms can analyze vast medical datasets and images (like X-rays or scans) to aid in early disease detection and diagnosis (e.g., in cancer and TB programs), supporting physicians in making more accurate and efficient treatment decisions.

Telemedicine and Remote Care: AI-powered telemedicine platforms can bridge the urban-rural healthcare gap by providing remote access to medical expertise, consultations, and monitoring, ensuring basic healthcare reaches underserved populations.

Personalized Medicine and Drug Discovery: AI accelerates the discovery of new drugs and enables personalized treatment plans by integrating genetic, environmental, and lifestyle factors, leading to better health outcomes and significant cost savings.

Administrative Efficiency and Preventive Care: AI automates routine administrative tasks like appointment scheduling and claims processing, reducing the burden on healthcare professionals and allowing more focus on patient care. Predictive analytics can identify high-risk patients and recommend preventive interventions, reducing hospitalizations and long-term costs.

The integration of innovative AI across education, skills, and health sectors offers India a powerful pathway to supercharge human capital formation and achieve fast, long-run economic growth. By personalizing learning, creating a flexible and adaptive workforce, and providing inclusive and efficient healthcare, AI acts as a transformative ally for human development. The successful realization of this potential, as envisioned by initiatives like the IndiaAI Mission, hinges on strategic investments in digital infrastructure, ethical governance, and public-private collaboration to ensure equitable access and prepare every citizen to be a valuable human asset in the AI era. The future of work in India is not about humans versus machines, but about their synergistic coexistence to build a smarter, more prosperous, and inclusive nation. Innovative Artificial Intelligence (AI) can significantly accelerate human capital formation in India by providing personalized education, data-driven skill development, and enhanced healthcare access, which in turn drives sustained, long-run economic growth. By leveraging AI to augment human capabilities rather than replace them, India can foster a future-ready, productive workforce. 

Lagging human capital formation is a more significant concern than lagging physical capital formation in India today.....

 India possesses one of the world's largest youth populations, a demographic dividend that offers immense potential for economic transformation. However, persistent challenges in health, education quality, and skill development are hindering the full realization of this potential, leading to high rates of youth unemployment even among those with formal education. This deficiency in human capital is a greater worry than a lack of physical capital, as physical assets like roads and factories cannot be optimally utilized or sustained without a skilled and capable workforce.

The Primacy of Human Capital

Human capital (knowledge, skills, and health of a population) provides the essential base for effective physical capital formation:

Innovation and Productivity: A skilled workforce is capable of adopting new technologies, improving production processes, and fostering innovation, all of which enhance the efficiency and return on physical investments. In contrast, investment in physical capital without the human expertise to manage it often yields sub-optimal returns.

Sustainable Development: Physical infrastructure depreciates and requires continuous maintenance and upgrades. A healthy and educated population ensures the long-term sustainability and strategic planning necessary for national development.

Multiplier Effect on the Economy: Investments in human capital, such as education and health, yield high social and private returns over generations. This creates a positive feedback loop of improved well-being and economic participation, which is a powerful driver of long-term capital accumulation.

The Worry of Youth Unemployment

The current high rate of youth unemployment in India, despite the large young demographic, highlights the severity of the human capital deficit. This situation indicates a mismatch between the skills demanded by modern industries and those possessed by the emerging workforce. This not only represents a failure to utilize existing human capital but also leads to:

Economic Stagnation: Unemployed youth are a drain on the economy rather than productive contributors, leading to foregone economic output.

Social Unrest: Widespread youth unemployment can lead to social and political instability, creating an environment unconducive to any form of capital investment, physical or human.

Brain Drain: The most skilled individuals may seek opportunities abroad, leading to a loss of the very talent needed for domestic growth.

Physical capital formation is an important component of economic growth, but it is secondary to the foundational role of human capital. India's challenge with underutilized youth highlights the urgent need to prioritize investments in education, health, and skill development. Without a capable and healthy population to innovate, build, and manage its resources, the nation cannot achieve its full economic potential. Therefore, addressing the gaps in human capital is the more critical imperative for India's future prosperity. Lagging human capital formation is a more significant concern than lagging physical capital formation in India today because human capital is foundational to all other forms of development and long-term economic prosperity. While physical infrastructure is essential, a well-educated and healthy workforce drives innovation, efficiency, and sustainable growth, making it the critical base for capital formation.

Human capital formation acts as the essential bedrock upon which sustainable physical capital formation is built.....

 In the traditional view of economics, physical capital formation (investment in machinery, buildings, and infrastructure) was considered the primary driver of economic growth. However, modern economic thought and empirical evidence from India strongly suggest that human capital formation (investment in education, health, and skills) precedes and facilitates physical capital formation. Human capital enhances labor productivity, stimulates innovation, and enables the effective utilization of physical assets, thus creating the conditions necessary for sustainable physical investment and overall economic development. The availability of a skilled workforce attracts investment and determines how efficiently new physical capital can be employed.

How Human Capital Formation Precedes Capital Formation

The causal link is that an educated and healthy populace is better equipped to innovate and use complex physical capital, making investments in machinery and technology more productive and profitable.

Enhanced Productivity of Physical Capital: Skilled workers can handle machines and technology more efficiently than unskilled workers, increasing the overall productivity of physical capital. In India, for example, the impressive growth of the software industry has been driven by a rich stock of scientific and technical manpower, enabling the country to leverage knowledge as a key economic resource.

Innovation and Technological Absorption: Education and training foster creativity and the ability to adapt to new technologies. An educated workforce provides the necessary foundation for research and development, which is essential for modern economic growth. The National Education Policy 2020 recognizes this, highlighting the need for a skilled workforce in areas like data science and AI to meet the demands of a changing global knowledge landscape.

Entrepreneurship and Modern Outlook: Human capital formation brings about a positive and modern outlook in society, encouraging entrepreneurship and a greater rate of participation in the workforce. This shift in mindset from traditional to modern approaches fosters a more dynamic economic environment where physical capital investment is more likely to yield high returns.

Effective Policy Formulation: Societies with higher levels of human capital are better able to make informed decisions regarding investments and resource allocation. Competent professionals (e.g., professors, engineers, doctors) are needed to produce more human capital and design effective development strategies, as recognized in India's Seventh Five Year Plan.

Recent Numbers and Data

Recent data highlights both the progress made and the challenges that underscore the importance of human capital investment in India:

Human Capital Index (HCI): India's score in the World Bank's HCI improved from 0.44 in 2018 to 0.49 in 2020, indicating progress in health and education outcomes. This improvement suggests that investments in human potential are yielding results, which in turn support the environment for future physical capital investment.

Education Expenditure: The government's expenditure on education as a percentage of GDP has historically been inadequate (hovering a little over 4%, compared to the recommended 6%). This gap presents a challenge for fully harnessing the demographic dividend and ensuring a sufficiently skilled workforce to manage advanced physical capital.

Health Indicators: Improvements in health indicators, such as the decline in the Infant Mortality Rate (to 33 per 1000 live births in 2016-17 from 146 in 1951) and increased life expectancy, signify a healthier, more productive workforce capable of sustaining economic activity over a longer period. Recent Economic Surveys (2024-25 highlights) also show government health expenditure increasing (to 48% of total health expenditure), which reduces the financial burden on households and enhances workforce health and productivity.

Skill Gaps and Employment: Despite an increasing workforce, India faces a significant skill gap. Unemployment rates among educated youth (e.g., around 19% for male graduates in rural areas as per 2011-12 data) have been a concern, emphasizing the need to align education and training with industry demands to ensure effective utilization of human capital, which then drives demand for new physical capital.

Human capital formation acts as the essential bedrock upon which sustainable physical capital formation is built. In India's context, the ongoing efforts to enhance education and health, as evidenced by improving HCI scores and health indicators, are critical drivers of the nation's capacity for innovation and efficient production. While physical capital is vital, it is the quality of human capital that ultimately determines how effectively these tangible assets are utilized. Therefore, continued and increased investment in people is not just a social imperative but an essential economic strategy for accelerating India's development and ensuring inclusive, long-term growth.

Lower income tax, GST and borrowing cost could increase real wages and savings supporting capital expediture.....

 India's private capital formation is showing signs of recovery, primarily driven by strong public sector investment and an improved banking sector, but the direct links between this recovery and specific policy measures like lower income tax, GST, and borrowing costs are complex and often indirect. The key variables at play include government capital expenditure, corporate balance sheet strength, improved bank asset quality, and expected reductions in borrowing costs, alongside consistent GDP growth. Private capital formation is a cornerstone of sustained economic growth, and its revival in India is crucial for long-term development. Following a period of balance sheet adjustments in the private sector, there are now encouraging signs of a recovery in private investment. This recovery is unfolding within an economic environment shaped by significant government initiatives, though the direct impact on real wages and savings through the specific mechanisms of lower income tax, GST reforms, and reduced borrowing costs presents a nuanced picture.

Variables Pointing to a Recovery in India's Private Capital Formation

Several key variables indicate a recovery in private capital formation (Gross Fixed Capital Formation - GFCF in the private sector):

Sustained Public Capital Expenditure (Capex): The government's continued high public investment, which reached a record 8.0% of GDP in FY24, has been instrumental in creating a conducive environment and "crowding in" private investment. This focus on infrastructure (power, roads, etc.) provides demand for private sector goods and services, stimulating their investment.

Improved Corporate Balance Sheets: Indian companies have utilized record-high profits (e.g., in 2023-24) to strengthen their balance sheets, making them more capable of funding future expansion. Non-financial private-sector capital formation expanded vigorously in FY22 and FY23 in current prices.

Better Banking Sector Health: The asset quality of banks has improved significantly, with the Gross Non-Performing Assets (GNPA) ratio of Scheduled Commercial Banks (SCBs) declining to a 12-year low of 2.6% by September 2024. This has enhanced their capacity to lend to the private sector, and credit growth to the private sector is a critical variable for future investment, with growth above 10% of GDP needed for high economic growth.

Positive Investment Intentions: Forward-looking surveys show that private sector capex is projected to increase, with an estimated provisional capital expenditure per enterprise for acquiring new assets in 2024-25 at ₹172.2 crore, indicating plans for capacity expansion.

Impact on Real Wages and Savings

The impact of specific policy measures on real wages and savings concurrently with capital formation is less direct:

Real Wages: Real wage growth is expected to moderate slightly, projected to dip from 7% in FY25 to 6.5% in FY26. While corporate profits are high, ensuring moderate wage growth in formal sectors is crucial for sustaining domestic consumption and a healthy growth cycle. The link to the specified tax policies is indirect, but general economic growth is expected to lead to higher demand for labor and more jobs, which would eventually support wage growth.

Savings: India's saving rate has been a key source of investment funds, with the household sector accounting for over 50% of total savings. The relationship between real interest rates and household savings is complex, but ensuring price stability and low inflation is crucial for augmenting savings.

Role of Tax and Borrowing Cost Policies

Lower Income Tax: While not explicitly mentioned as the primary driver of current private capital formation recovery in recent reports, lower income taxes generally increase disposable income, which can boost household savings and consumption. Increased savings can then be channelled into investment.

GST: The implementation of GST (Goods and Services Tax) has simplified the tax structure, reduced the cascading effect of taxes, and improved logistics efficiency. This has created a single unified market and is expected to boost India's GDP by around 1.0% to 2.0% in the long term by enhancing competitiveness and attracting investment.

Borrowing Cost (Interest Rates): Lower borrowing costs directly reduce the cost of capital for businesses, encouraging private investment. In H1 2025, the Reserve Bank of India initiated a cautious rate cutting cycle, bringing the repo rate to 5.5% by June 2025, creating a more favorable environment for private credit expansion and capital expenditure, especially in infrastructure and real estate.

The recovery in India's private capital formation is a multifaceted phenomenon, primarily driven by a virtuous cycle of sustained government capital expenditure, deleveraged corporate balance sheets, and a healthier banking system. Policy measures like the structural benefits of GST and a declining interest rate curve are acting as key enablers by improving the business environment and reducing capital costs. While direct quantitative links between lower specific taxes and simultaneous increases in real wages and savings are hard to isolate precisely, these factors are contributing to overall economic growth, which in turn drives both capital formation and improved living standards in the long run. The transition to a self-sustaining private investment-led growth model, complemented by moderate real wage growth and stable savings rates, remains the key objective for Indian policymakers.

The current trend of increasing private corporate savings and decreasing household savings in India is a complex economic shift.....

 Savings are a crucial source of domestic capital for investment and economic growth in any economy. In India, the household sector has traditionally been the primary contributor to national savings, accounting for over 60% of the total. However, recent trends indicate a significant shift: private corporate savings are increasing, while household savings are declining, reaching a four-decade low of around 29.7% of GDP in 2022-23. This shift is primarily driven by rising household consumption, high inflation, increased financial liabilities (debt), and a transition towards market-linked investments. The parallel rise in corporate savings, fueled by improved profitability and tax incentives, reconfigures the national savings landscape with significant implications for income distribution and economic equality.

Effect on Income Distribution and Equality

The diverging trends in corporate and household savings generally exacerbate income and wealth inequality in India due to several mechanisms:

Wealth Concentration: Corporate savings, primarily in the form of retained earnings, accrue to the owners and shareholders of companies. Since the ownership of large corporations is generally concentrated among wealthier individuals and large institutional investors, the increase in corporate savings effectively channels a larger share of national income towards the already affluent sections of society.

Reduced Financial Resilience for Households: The decline in household savings, particularly among the lower- and middle-income groups, weakens their ability to withstand financial shocks such as job losses, medical emergencies, or retirement insecurity. This forces them to rely more on borrowing for essential needs and consumption, increasing debt burdens and vulnerability to debt traps, which further widens the economic gap with wealthier individuals who can save and invest effectively.

Shift in Investment Access: As households, especially in rural or underserved areas, reduce traditional savings (like bank deposits) and potentially move towards riskier financial assets (equities, mutual funds) without adequate financial literacy, they face higher risks. Wealthier urban households, with better access to financial information and services, are better positioned to benefit from returns on these market-linked investments, further increasing the divide between urban and rural, and rich and poor households.

Wage Stagnation and Income Growth Disparity: A situation where corporate profits (and thus savings) rise while household savings fall may indicate that a larger share of economic output is going to capital owners rather than workers (wages). Stagnant wages for organized sector workers, as mentioned in some reports, mean that most of the savings are accumulated by wealthier individuals, not those with lower or middle incomes.

Domestic Capital Formation and External Vulnerability: Reduced household savings mean a smaller pool of domestic capital available for overall investment, potentially increasing the economy's reliance on foreign capital (FDI and FPI). While foreign capital can drive growth, it can also lead to market volatility and external vulnerabilities, which disproportionately affect the economically weaker sections during a crisis.

The current trend of increasing private corporate savings and decreasing household savings in India is a complex economic shift that has profound implications for income distribution and equality. While rising corporate savings may signal a healthy environment for future private investment and economic expansion, the simultaneous erosion of household financial buffers deepens the financial insecurity of the average Indian family and exacerbates existing wealth disparities. This dynamic channels a greater portion of national wealth to capital owners while leaving low- and middle-income households vulnerable to debt and economic shocks. Addressing this growing imbalance requires proactive policy intervention to foster financial inclusion, promote micro-savings initiatives, ensure fair wage growth, and regulate lending practices to safeguard the financial resilience of all households and promote more inclusive economic development.

The current trend could pose risks to future capital formation and macroeconomic resilience...

 Saving is a cornerstone of economic development, serving as the essential fuel for capital formation (investment). Capital formation, in turn, drives productivity, job creation, and long-term economic growth. In India, gross domestic savings are typically composed of contributions from the household sector, the private corporate sector, and the public sector (government). A high savings rate generally leads to a high investment rate, reducing dependence on foreign capital and fostering self-sustained growth. Analyzing the trends during the UPA (2004-2014) and NDA (2014-2025) eras reveals distinct patterns in India's savings landscape and their impact on capital formation.

Savings and Capital Formation: 2004-2014 (UPA Government)

The period from 2004 to 2014, under the UPA government, was characterized by a buoyant trend in the aggregate savings rate, especially during the first five years (2004-2009).

Peak Savings Rate: India's gross domestic saving rate reached a historic peak of 37.7% of GDP in 2007-08. The aggregate savings rate consistently remained high, often exceeding 34% until 2011-12.

Component Contributions:

Household Savings: Remained relatively stable and were the most prominent component, averaging around 23-24% of GDP.

Private Corporate Savings: Showed a significant upsurge, nearly doubling from about 4.6% of GDP in 2004 to 9.4% in 2008, driven by a "Capex boom".

Public Sector Savings: Showed a remarkable turnaround, moving from negative to positive territory from 2003-04 onwards, contributing positively to the overall high rate.

Capital Formation: The high savings rate facilitated a corresponding increase in investment (gross capital formation), which also peaked at around 37-38% of GDP during this period. This high investment was primarily driven by the private sector, specifically the private corporate sector, which saw substantial increases in its share of capital formation.

Savings and Capital Formation: 2014-2025 (NDA Government)

The period from 2014 to 2025, under the current NDA government, has witnessed a noticeable decline and stagnation in the national savings rate compared to the peak years of the UPA era.

Declining Aggregate Savings: The gross domestic savings rate fell from a high of 34.6% in 2011-12 to approximately 30.7% in FY24 (and as low as 29.7% in FY23, a near four-decade low).

Component Shifts:

Household Savings: The most significant change has been the steep decline in household savings, particularly financial savings. Household financial savings as a percentage of GDP dropped from 11.5% in FY21 to 5.1% in FY23, while physical savings increased, suggesting a shift in portfolio allocation.

Rising Household Debt: Concurrently, household liabilities have risen significantly, reaching near 17-year highs (6.4% of GDP in FY24), partly due to increased borrowing for consumption, housing, and education.

Public Sector Capital Formation: While household savings dipped, the current government has focused on increasing public sector capital formation, with the public sector's gross fixed capital formation increasing substantially, from ₹6.4 lakh crore in 2011-12 to significant higher figures in recent years. Market borrowings surged to finance increased government expenditure, including capital formation.

High levels of domestic savings are crucial for sustainable, long-term, self-financed economic growth. The current government's performance on fostering a high national savings rate, a key source for capital formation, has attracted criticism. The primary criticism is the significant drop in the household savings rate, which traditionally forms the bedrock of India's savings pool. Critics argue that government policies and macroeconomic factors have eroded the ability and incentive for households to save. High inflation has eroded real incomes, reducing disposable income available for saving. Low real interest rates on traditional financial instruments like bank deposits have made them less attractive, pushing households towards physical assets or consumption. Some economists point to the "twin shocks" of demonetization and the initial implementation of the Goods and Services Tax (GST) as factors that particularly impacted the unregistered micro, small, and medium enterprises (part of the household sector), potentially hindering their savings capacity. The rising household liabilities are seen by some as a potential risk of a debt-driven consumption bubble, which is a less stable foundation for growth than savings-led investment. While the government has boosted public capital expenditure, the overall decline in the aggregate savings rate, largely driven by household behavior, remains a major concern for policymakers aspiring to achieve higher sustained growth rates without excessive dependence on external financing.

The volume of savings in an economy is a fundamental determinant of capital formation....

 The most significant variables for capital formation can be broadly categorized into three stages: the creation of savings, the mobilization of savings, and the investment of those savings. The volume of savings in an economy is a fundamental determinant of capital formation. A higher per capita and national income directly increases the ability of individuals and entities to save more. Beyond income, people must have the desire to defer present consumption for future security or investment opportunities. This is influenced by personal considerations, family needs, and a desire for progress. Favorable tax policies, such as tax benefits on saved income, encourage individuals and corporations to save and invest. High taxes on income and profit can have an adverse effect on savings. Attractive interest rates on savings can motivate people to save more. For businesses, retained earnings (profits not distributed as dividends) are a key source of self-financing for new capital projects. There is a strong need for bank deposits to compete with other investment assets. This competition is crucial for both the financial stability of banks and the broader economy, as investors actively shift their funds to alternatives offering higher perceived returns or better features like tax incentives.

Mobilization of Savings

Savings must be collected and transferred to those who can invest them in productive assets. A well-developed network of banks, insurance companies, mutual funds, and capital markets is crucial for channeling savings from individual savers to entrepreneurs and investors. Easy access to loans and credit facilities, particularly for potential investors, facilitates the acquisition of funds needed for investment.

Investment of Savings

The actual use of mobilized savings for creating new capital goods is the final stage. The presence of daring entrepreneurs who are willing to take risks and identify profitable investment opportunities is vital. The availability of essential infrastructure (power, transportation, communication, etc.) and allied general facilities encourages private and public investment by lowering costs and expanding market potential.

Overall economic climate

A favorable overall economic climate, stable market conditions, and good potential for profit are strong motivators for investment. Innovation and the availability of advanced technology can stimulate capital formation by enabling more efficient production methods and encouraging investment in new equipment and R&D. A stable political environment and the security of life and property are fundamental for long-term investments. Investment in education, health, and on-the-job training creates skilled labor, which is essential for developing and utilizing physical capital effectively.

Gross domestic savings

India's gross domestic savings rate for the financial year 2023 was reported as 30.2%, a slight decrease from 31.2% in FY2022.This figure is considered high compared to the global average of 28.2%.

Household savings and debt

Household net financial savings dropped to a 43-year low of 5.3% of GDP in FY2023. This decline coincided with a surge in household financial liabilities, as households borrowed more for consumption and housing. The share of bank deposits within financial savings has been decreasing, while investments in mutual funds and equities have been rising, particularly in urban areas. There has been an increase in physical savings, such as real estate, relative to financial savings.

Funding for Banks

Deposits are a primary, stable, and low-cost source of funds for banks, which they use to finance loans and maintain liquidity. When deposits are not competitive, banks must turn to more expensive or less stable sources of funding, such as wholesale money markets or certificates of deposit (CDs), which increases their cost of capital, reduces profit margins, and poses liquidity risks.

Investor Behavior

Savers are rational and seek the best possible return on their money given their risk appetite. If investment options like mutual funds, equities, and other market-linked instruments offer significantly higher returns (especially in times of high inflation), investors will increasingly move their savings away from traditional bank deposits. This trend is already evident in some markets where mutual fund assets under management (AUM) are growing faster than bank deposits.

Systemic Risk

A significant gap between credit growth (bank lending) and deposit growth can create systemic risks in the banking system, an issue highlighted by regulatory bodies like the Reserve Bank of India (RBI). Banks need a robust deposit base to support lending and overall economic growth.

Monetary Policy and Innovation

Competition forces banks to be more efficient and innovative. They may offer more attractive interest rates, introduce new features like sweep-in facilities, or improve their digital services to attract and retain depositors. This competitive environment also aids in the effective transmission of monetary policy, as interest rate changes have a more direct impact on household saving decisions.

Risk vs. Return Trade-off

Bank deposits are traditionally considered very safe, often backed by deposit insurance, which guarantees returns and protects the principal from market volatility. Other assets carry higher risk but offer the potential for greater returns. For deposits to remain an attractive option for a portion of an investor's portfolio (especially for risk-averse individuals or for emergency funds), they must offer a return that is reasonably competitive, particularly against inflation.  

In essence, capital formation is a process driven by a healthy interplay between savings potential, an efficient financial system, and a conducive environment for productive investment in both physical and human capital. India's personal savings rate is debated, with some sources citing a high gross domestic savings rate of 30.2% for FY2023, while other reports indicate a significant decline in household net savings, which fell to a 43-year low of 5.3% of GDP in FY2023. This discrepancy is attributed to a surge in household debt to finance consumption and housing, a shift from traditional bank deposits, and a rise in physical savings like real estate over financial savings. Bank deposits must be competitive with other investment assets to ensure a stable funding base for the banking sector and to prevent a mass exodus of household savings to other financial intermediaries. Without sufficient competition (primarily through attractive interest rates and product features), banks face higher funding costs and liquidity challenges, while investors may miss out on suitable low-risk saving options that keep pace with inflation. Therefore, maintaining the competitiveness of bank deposits is a critical aspect of a well-functioning and stable financial system.