Capital formation in a country can also take place with the help of foreign capital, i.e., foreign savings.Foreign capital can take the form of (a) direct private investment by foreigners. (b) loans or grants by foreign governments, (c) loans by international agencies like the World Bank.
In recent days foreign capital is playing a vital role in the economic development of less developed countries. After the agreement as well as the establishment of .TO odd Trade Organisation) on 1st January 1995, there is an enormous increase of foreign capital from developed countries to developing countries.
Foreign capital divided into two categories; viz. (A) Foreign Direct Investments, (FDI) and, (8) Foreign Institutional Investment (FIlS). (A) Foreign Direct Investment: (FOI) This is a very important reafforestation capital. The FDI means the foreigner’s are allowed investment either in collaboration with public and government (including both state and central) or directly starting of factories, mills, departmental stores, chain stores, infrastructure and so on. The FDI plays a vital role in the economic development of a country. Due to FDI the employment and economic growth of an economy increases. This further witl multiplier effects accelerate the economic growth and also commutative economic process take place. For developing countries this is a very good opportunity There is a direct relation between FDI and economic development.
Along with the First there is another kind of investment in India, that is the NRI deposits (Non- Resident Indian’s) or investments. If it is in government bonds, than it may not be a non-speculative. otherwise it may be of Fires type of investment.
Deficit Financing. Deficit financing, i.e., newly- created money, is another source of capital formation in a developing economy. Owing to very low standard of living of the people, the extent to which voluntary savings can be mobilised is very much limited. Also, taxation beyond limit is quite unpleasant and therefore politically inexpedient. Deficit financing is, therefore, the method on which the government can fall back to obtain funds. However, the danger inherent in this source of development finance is that it may lead to inflationary pressure in the economy. although a certain measure of deficit financing can be had without creating much pressures.
There is specially a good case for using deficit financing to utilize the existing and under employed labour in schemes which yield quick returns so that the inflationary potential of deficit financing may be neutralized by an increase in the supply of output in the short run.
Diminishing agricultural output. The objective is to mobilize these unproductive workers and employ them on various capital-creating projects; such as roads, canals, building of schools, health centers and buns for flood control in which they do not require much more capital to work with.