Report to the President of the International Bank for Reconstruction and Development and the International Development Association on India's economic development effort (Vol. 10 of 14) : Financial policy

 PREFACE This Volume, No. X, and Volume IX d e a l with Financial Policy. X Volume X was prepared by Mr. Atle Elsaas and Volume I by Mr. Stanley Please. They a r e based on study i n India i n t h e period October 1964 t o March 1965. Writing of the reports was completed i n October 1965. Since t h a t date a few minor e d i t o r i a l changes have been made but there has been no substantive revision o r updating.  Page No. General Trend i n Government Finances 1 The F i n a n c i a l Relations Between t h e Center slid t h e S t a t e s 11 1 0 C-overm;ient Finances and Plan Zxpendi-Lwes IV. The O v e r a l l Budgetary P o s i t i o n of t h e Government and t h e Relation t o t h e Rest of t h e Econolny C e n t r a l Government finances 1958-53 t o 1945-66 VI. The Denand 'Zffects of t h e Budgetary Policy -a1. A Note on Taxation and t h e Balance of Payment s A g r i c u l t u r a l Cevelopnznt and F i s c a l Pollcy C onc luding Remarks A. Saxe O'oservations on Econo~uc Planning and F i s c a l Policy B. A Judgment of t h e Recent Budgetary Policy C. A g r i c u l t u r a l Developxent and F i s - c a l Policy D. A Note on Import S u b s t i t u t i o n and F i s c a l Poiicy Appendix I: The Inflow of FL 480 Counterpar-b Funds Appendix I The. Basis f o r t h e Calculation of t h e Demand Lff e c i s of t h e Budgetary Policy 1 Appendix 1 1r Supplementary Tables  I OEN ET I GEhTERAL TREiJD N G V R M N FINANCES . 1 . The current incomes of t h e Center and S t a t e s combined have increased from 8 percent of n a t i o n a l income in t h e beginning of the f i f t i e s t o about 15 percent i n 1964-65, The increase is p a r t l y due t o the general expansion of the economy, but t h e Government has a l s o made s u b s t a n t i a l e f f o r t s t o increase the l e v e l of taxation. Tab12 I shows t h e percentage increase in t a x incomes i n each of t h e Plan periods com- pared with t h e pre-Plan l e v e l . Table 1: THE INCREASE I N TAX FEVENUES THROUGH NX TAXATION Ed AND B D E AUTOlYATISM U GT CZNTER AND STATES- F i r s t Plan ( 1951-56) Second Plan ( 1956-61) TMrd Plan/a ( 1961-66) - % % 5 Increase i n t a x revenues by : Additional taxation 13.5 45.6 48. 5/a- Automatism 8.9 ?loo 43.5 Total increase over the Planning Periods 22,L -76.6 92 ,0/a- /a - Based on E n i s t r y of Finance estimate from a u t m 1964. e f f e c t s of sorne l a t e r t a x increases a r e not 3ncluded. The 2. The percentage increase is t h e increase over t h e Plan periods, from the l a s t year before t h e periods t o the l a s t year in t h e periods. The t a x revenues increased by 92 percent during the Third Plan. They were increased by close t o 50 percent through new taxation taking e f f e c t during t h e Third Plan, while an increase of s l i g h t l y more than LO percent - corresponding t o an annual increase of 7-5 p r c e n t - was due t o budgetary automatism. The d i s t r i b u t i o n between automatism and a d d i t i o n a l t a x a t i o n is n o t exact, f o r the two f i r s t Plan periods i t r e s t s upon t h e assumption t h a t t h e introduction of new taxation was evenly d i s t r i b u t e d within t h e Plan periods, t h e satre a p p l i e s t o t h e a d d i t i o n a l taxation introduced by the S t a t e s during t h e Third man. But broadly speaking it could be s a i d t h a t the t a x revenues were increased by 45-50 percent during each of the two l a s t Plan periods, while r i s i n g money incomes and turnovers have l e d t o a f u r t h e r increase of 30-40 percent, The r e l a t i v e l y high increase in t a x revenues during t h e Third Plan i s p a r t l y a r e s u l t of i n f l a t i o n a r y tendencies. 3- Taxes l e v i e d and collected by the Center have accounted f o r 78 percent of the a d d i t i o n a l t a x a t i o n introduced a f t e r 1950, while about 22 percent i s accounted f o r by taxes collected by t h e S t a t e s . This is also reflected i n the composition of the increase i n tax reven,ues as given in Table 2; Union excise duties have contributed t o a substantial part of the increzse in revenues; custom duties, corporate taxes and income taxes are a l s o collected by the Center. Table 2: mCEljTAGE DISTRIBUTION O THE liJCGAS3 C; F TAX R%VENUES O CZITEX A ; STilTES F 1D Composition of Increase Composition in Tax Revenue of 2evenues 1950/51- 1955j56- i960/61- 1955/56 1960;61 1964/65 196j/65& TOTAL - c' P li30. 0 -- -- 100.0 <* 10 - % 100.0 - d /o 100.0 .!- Direct Taxes Corporate Tax - 20.3 -2.0 7 24.8 12.7 -- 29.3 18.3 - 29.6 12.7 Income T a x -1.3 6.0 7 8 10.3 Land Revenue 19.3 3.7 2.2 5.1 Other 4.3 2.4 1.0 1.5 Indirect Taxes 3nion Excise Duties - - - 79.7 55.2 75.2 46.2 70.7 33.2 - 70.k 31.8 ~ u soriis t 6.7 0.6 15.7 13.9 Sales T2.x 15.5 14.0 12.6 12.4 Other 1.2 ib.4 9.2 12.3 - /a Budget estimates Source: iKnistry of Finance. 4. The general trend has been torrards an increase of i n d i r e c t taxation a s compared with d i r e c t taxation. Indirect taxes contributed 70-80 percent of t h e increase in t o t a l t a x revenue i n the period under consideration; the d i r e c t taxes 20-30 percent. A s t r i k i n g feature i s the very modest contribution from land revenue. 5. The r i s i n g t a x revenues have by and large been folloued 3y a corresponding increase i n current expenditures, and there has not been any s i g n i f i c a n t increase i n Government savints. The use of the current revenues of the Center and the S t a t e s i s indicated belorr: Civil Adininistration 40-5Cl percent Defense 29-25 I! Subsidies I n t e r e s t and other Transfer Payments 10-15 If Savings 19-15 11 Defense expenditures have been t r i p l e d during t h e f i v e years up t o 1965-66, while other current expenditures were close t o doubled. 6. Although Government s a v i n g s correspond t o 10-15 p e r c e n t of t h e c u r r e n t incomes of t h e Government t h e y have never exceefled 3 p e r c e n t o f n a t i o n a l income. On average f o r t h e 1950s t h e y corresponded t o a b o u t 1.2 per- c e n t o f t h e n a t i o n a l income.i/ L a t e l y they have i n c r e a s e d t o about 2.5 per- c e n t of n a t i o c a l income, o r about 25 p e r c e n t o f t o t a l s a v i n g s . But t h e con- t r i b u t i o n o f Government s a v i n g s t o t o t a l s a v i n g s has been low, p a r t i c u l a r ; ? i n view of t h e l a r g e s h a r e of i n v e s t m e n t s u n d e r t a k e n by t h e Government. During t h e F i r s t P l a n (1951-56) t h e p u b l i c s e c t o r investments;/ accounted f o r 46 per- c e n t of t o t a l i n v e s t m e n t s ; a r a t i o o f 60 p e r c e n t i s f o r e s e e n f o r t h e T h i r d P l a n , and 65 p e r c e n t h a s been i n d i c a t e d f o r t h e Fourth Plan. 7. The b u d g e t a r y p o l i c y i s s t r o n g l y i n f l u e n c e d by t h e i n v e s t m e n t ex- p e n d i t u r e s . Table 3 g i v e s t h e main i t e m s from t h e c o n s o l i d a t e d a c c o u n t s f o r , t h e C e n t e r and t h e S t a t e s . Hoc~ever i n v e s t m e n t s i n non-departmental S t a t e e n t e r p r i s e s a r e n o t i i ~ c l u d e di n t h e i n v e s t m e n t f i g u r e s . T a b l e 3 : GOVEiU81ENN TINCOI/IES AND GXPGqDITURES 1950/51 1960/61 -. Rs. b i l l i o n --- 1962/63 C u r r e n t income 8.01 16.38 19.98 C u r r e n t expendi t u r e - 6.59 - 14.09 19.12 Saving on c u r r e n t a c c o u n t 1.42 2.29 0.86 Plaintenance p r o v i s i o n of Government Enterprises - 0.49 - 0.91 - 1.20 Gross s a v i n g 1.90 3.20 2.06 /a Gross investment- F i n a n c i a 1 d e f i c i t on Government - account 0.87 4.63 9.99 Relative figures: Gross i n v e s t m e n t l a i n p e r c e n t o f c u r r e n t incomes S a v i n g i n p e r c e n t of i n v e s t m e n t i a 71.1 40.9 17.1 Financial d e f i c i t i n percent of c u r r e n t incomes Financial d e f i c i t i n percent of n a t i o n a l income 0.8 3.0 5.9 - /a E x c l u s i v e of i n v e s t m e n t i n non-departmental e n t e r p r i s e s of t h e S t a t e s . Source: C.S .O. E s t i n ~ a t e so f N a t i o n a l Income. - 1/ Reserve Bank of I n d i a B u l l e t i n , >larch 1965: " E s t i m a t e s o f Saving and I n v e s t m e n t i n t h e I n d i a n E ~ o n o ~ o y . 1950-51 t o 1962-63". - 2/ Governn~ent-f inanced p r i v a t e i n v e s t m e n t s a r e a 1 so i n c l u d e d . 8. The investnents (exclusive of investnents i n non-departmental Govern- ment e n t e r 9 r l s e s ) corresponded t o about one-third of t h e current incomes i n the ~ beginning of t h e I'ii.ti.es, and a t present t . :iiore %;-fin 6 3 percent. 3 Budgetary po71icy can theref t re not b e judged only by i-ts h p c t on t h e demand s i t u a t i o n ; oil t h e otner s i d e i s t h e i i ~ p a c tof investinents upon t h e productive capacity and t h e f u t u r e p o t e n - t i a l f o r econonlic growth. 9. The f i n a x i a l d e f i c i t was very modest i n t h e be2innir.g of t h e f i f t i e s , corresponding t o onl;z 0.8 percent 02 n a t i o n a l income. A s inv-es-lments expanded t h e over211 d e f i c i t increased. I n t h e l a s t year f o r wl?ich f i g u r e s a r e a v a i l - a b l e ( 1962-63 ) t h e d e f i c i t corresponded t o 50 percent of current Government incomes and about 6 percent of .the n a t i o n a l income. Only 17 percent of the Govem;lziit investments was covered by Covernient savings. 10. If p r i v a t e savin;s had been used wholly f o r p r i v a t e investnerits - - d i r e c t l y or v i a t h e c r e d i t system tha e x t e r n a l gap would, i n principle, be equivalent t o tihe f i n a n c i a l d e f i c i t on Government account. But i n most years t h e e x t e r n a l ;a:;., has been much s n a l l e r . There has been a tfsurplus't of p r i v a t e -- savings over p r i v a t e investlaents. Tllis surplus does not per s e I n d i c a t e an un- willingness of t h e p r i v a t e s e c t o r t o invest, but may a s well stec; from t h e eco- nomic p o l i c i e s pursued. Q u i t e a lar;.e p o r t i ~ n t h e p r i v a t e sa?engs channeled of t o the c r e d i t sjrstem (including 1ir"ct insurance and provident funds) has been transzerred t o the Gover~li'i~ent through s t a t u t o r y subscriptions i n Government bonds. And through t h e small savings schene, priva-te savings have been ckan- n rieled d i r e c t l y t o the Govern;::ent. Only a p a r t a t h e inflow of funds t o t h e credLt system has been returned t o tile p r i v a t e s e c t o r a s loans. The r e s u l t ha:; been a quite high n e t f i n a n c i a l saving by t h e p r i v a t e sector. Thus, the priva.';~ n e t Tinancia1 savings amounted t o 29-39 percent ol t h e t o t a l p r i v a t e s a v i r . 2 ~11.1 t h e beginning of ';he s i x t i e s , and t o !r0-50 percent a t p e s e n t . The f u t u r e p o l i c i e s indicated i n u n o f f i c i a l long-ten:> 1;ro;iections wculd r e q u i r e t h a t more than half a t h e p r i v a t e savings should .taI;e t h e form of n e t f i a a n c i a l savings. n 1 . 1 The channeling of p r i v a t e savings t o t h e Goverilinent i s a l a x i c a l con- sequence of a policy with very high Government investrilents without correspond- i n g Governiient savings. And t h e Government has t o undertake a large share of the investments, i t i s argued, p a r t l y because .the p r i v a t e sector could not be expected t o w-dertakz t h e kind of investments which a r e required f o r t h e develqment of the country. 12. Only a p a r t of t h e d e f i c i t on the Government I s savings-investment accoui~thas been covered by p r i v a t e f i n a n c i a l savings. The remainins p a r t - r q r e s e n t i n g t h e savings-investment gap f o r t h e ccuntry a s a whole - corresponds t o t h e d e f i c i t i n t h e e x t e r n a l balance. 13 Diagram I shows the development of Government investmentsL4 t h e extent t o which they have been covered by Government savings, p r i v a t e f i n a n c i a l sav- i n g s ( n e t ) and a d s f i c i t i n t h e balance of payments. The diagram a l s o shows how this def i c i ' t has been financed by g r a n t s frcin abroad and net borrowing abroad. l / b c l u s i v e of investments i n non-departmental S t a t e e n t e r p r i s e . These invest- ments were only p a r t l y financed by the savings of t h e enterprises, t h e r e s t i s financed by p r i v a t e f i n a n c i a l sa16ngs not included i n t h e ciagram.  INDIA: GOVERNMENT FINANCES, PRIVATE FINANCIAL SAVINGS AND BALANCE OF PAYMENTS (BILLIONS OF RUPEES) I I-- GOVERNMENT SAVINGS N E T FINANCIAL > SAVING O F PRIVATE SECTOR VERNMENT ACCOUNT GRANTS FROM ABROAD -PA- -- - N E T BORROWING ABROAD DEFICIT ON CURRENT ALANCE OF PAYMENTS 1352 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 FISCAL YEAR BEGINNING APRIL SOURCE: Estimates of National Income, G.S.O. February 1964 14. Up t o he middle of t h e f i f t i e s t h e e x t e r n a l d e f i c i t was r e l a t i v e l y nodes st. The f u r t h e r expansion of Gosrerment itlvestluents combined w i t h a r s d u c t i o n i n t h e p r i v a t e f i n a n c i a l s a v i n g s l e d t o a s t r o n g i n c r e a s e i n t h c e x t e r n a l d e f i c i ? i n 1956. S i n c e t h e n t h e annxal e x t e r n a l d e z i c i t h a s been of a n o r d e r o f magnitude of 3s. 3.5-4.5 b i l l i o n , o r $700-950 m i l l i o n . ' l h i l e t h e expansion of investlnents h a s been matched by i n c r e a s i n g s a v i n g s t h i s i s a n e x p o s t o b s e r v a t i o n which does n o t i n - d i c a t e t h a t t h e demand-supply b a l a n c e h a s remained unchanged. The l a r g e - l y p a r a l l e l i n c r e a s e i n investment and s a v i n g s h a s d u r i n g t h e l a s t t h r e e y e a r s t a k e n p l a c e s i m u l t a n e o u s l y w i t h r i s i n g p r i c e s and i n c r e a s L n g p r e s s u r e s i n t h e i n t e r n a l economy.  11. THE FTXANCIAL FLEXATIONS BEIt.mN THE CENTER AND T E STATES H 15 The Constitution of I ~ d i a prescribes which taxes may be levied by t h e Center and which t a x e s ii:ay be levied exc'iusiveljr by t h e Sta-Les. The provision i s a l s o made t h a t t h e revenue of c e r t a i n taxes and dlri;ies collected by t h e Center should be divided between Center and S t a t e s . The share t o be d i s t r i b u t e d t o t h e S t a t e s i s decided f o r a period of f i v e years upon recommendation by a s p e c i a l finance Commission. 16. I n general, land revenue and o:her t a x a t i o n of a g r i c u l t u r e a r e a l l o t t e d exclusively t o t h e S t a t e s , t h e income t a x and custon duties a r e a l l o t t e d exclusively t o t h e Centsr. Tie Center cannot levy taxes on a g r i c u l t u r a l income, o r c o l l e c t generzl s a l e s taxes. Hotlever, i t can levy excise d u t i e s - - s p e c i f i c or ad valorem t o such an extent t h a t t h e r e s u l t would be veFj similar t o t i e e a " f e X o f a general s a l e s t a x . 17. BJO-thirds af the inccme t a x (exclusive of corporation t a x ) i s a t present assigned t o t h e S t a t e s and d i s t r i b u t e d among them on t h e b a s i s of popula.tion ( 8 0 percent of the incorrie t o be d i s t r i b u t e d ) and t a x col-Lection ( 2 0 p e r c e n t ) . For t h e di-sisible excise d u t i e s t h e rnaln r u l e i s t h a t 20 percent should be d i s t r i b u t e d t o t h e S-bates and t h i s corresponds a t present t o about 1s percent of t h e t o t a l revenue fram cw.trall;. collected e x c i s e d u t i e s . B u t t h i s represents only a p a r t of t h c con- tributior! from t h e Center t o t h e S t a t e s . Including grants and net lending, a much larger share of t h e f i n a n c i a l resources of the Center i s channeled t o t h e S t a t e s , a s shown i n Table 4. Table 4 : TFLANSFDS FRO1";I-U CENTER TO ,ffE ST.4TSS - i955/50 1960/61 1 9 6 . c ~ ~ ( R s . millions) S t a t e s share of c;l.visible taxes Grants from Center t o S t a t e s Loans Gross t r a n s f e r t o S t a t e s Repayments from S t a t e s t o Center Net t r a n s f e r s frorn Center t o S t a t e s Net t r a n s f e r t o S t a t e s i n percent of taxes collected by Center ( $ ) 73 - 0 55.5 56.5 - /a Budget Source: Accounts andBudgets of t h e Center. I n terms of S t a t e finances we f i n d t h a t , a s indicated i n Table 5 , trans- f e r s from t h e Center, including t a x sharing, account f o r about 50 percent or" t h e i r f i n a n c i a l resources ( i n c o i e and borrov~ing). Table 5: F CUMENT A h ? CAPITAL IXC0i.E O STA'ES (Rs. mil'iion) - 1960/61 1964/55/a- Raised Transfers Raised Transfers by from Total by fron Total States Center States Center Taxes 5,078 1,166 6,244 7,116 2,540 9,656 Non-tax revenues 1,769 2,241 4,019 2,945 3,l-b1 6,086 Borrowing Total 9,328 - - - 6,77!4 - 16,102 -- 13,::~ 1-2,121 - - 25,230 Relative f i g u r e s 58 42 100 52 b8 100 - /a Budget Source: i.!inistry of Finance 18. It could be questioned whether t h e share of t h e S t a t e s i n the d i v i s i b l e t a x e s should b e considered a s a t r a n s f e r from t h e Center or not. B c l u d i n g t h e t a x sharing t h e contribution of t h e Center nevertheless accounts f o r about 38 percent of t h e t o t a l f i n a n c i a l resources f o r t h e States. 19 The t a x sharing i s , a s rnentloned, decided upon i n advance f o r periods of f i v e gears. The g r a n t s a r e p a r t l y general j r a n t s t o t h e economically weaker S t a t e s ( g r a n t s i n a i d ) , partl-1 s t a t u t o r y ;rants cover- i n s some types of expenditures, but the bull: of t h e g r a n t s and loans from t h e Center t o t h e S t a t e s a r e linked t o t h e Plzn e x p e ~ d i t u r e sor" the S t a t e s .  1. 11 GO~~-IENT LN FINATJCES AM) P A EXPENDITURES 20. Government expenditures a r e t r a d i t i o n a l l y c l a s s i f i e d a s ( a ) revenue expenditures and ( b ) c a p i t a l expenditures. The f i r s t i s broadly s p e a b n g expenditures f o r t h e operation of current a c t i v i t i e s , t h e l a t t e r a r e c a p i t a l outlays, loans, repayment of debt, e t c . 21. Another type of c l a s s i f i c a t i o n i s by (a! development expendi- t u r e s , ( b ) non-development expenditures. The development acpenditures include not only a d d i t i o n s t o f i x e d c a p i t a l equipraent, but a l s o expendi- t u r e s on s o c i a l s e r v i c e s and a g r i c u l t u r a l extension services. The purpose has been t o d i s t i n g u i s h between such expenditures which would represent a contribution t o economic developnlent i n contra st t o "non- development expenditurestt. But obviously this d i s t i l ~ c t i o ni s very d i f f i c u l t t o ~nake, and the c l a s s i f i c a t i o n i s t o some extent a r b i t r a r y . 22. A t h i r d c l a s s i f i c a t i o n i s between Plan and non-Plan e q e n d i t u r e s , and r e l a t e d t o the p r o j e c t s and schemes provided f o r i n the Five-Year Plans. Not only investment expenditures, but a l s o t h e cost of operating non-revenue-;yielding Plan p r o j e c t s being completed i n t h e Plan period ma)- be included. Thus, t h e c o s t of operating a new i r r i g a t i o n p r o j e c t completed i n t h e Plan period wou.ld be included a s Plan expenditure f o r t h e remainder 02 t h e Plan period. The argument f o r this procedure i s not coinp1etel;y c l e a r . It i s p a r t l y claimed t h a t it gives t h e S t a t e s a f i n a n c i a l i n c e n t i v e t o complete t h e i r p r o j e c t s arid g e t them i n t o opera- t i o n a s f a s t a s possible, a s t h e Center would then cover p a r t of t h e operational expenditures. 23 The share of current expenditures i12 t o t a l Plan e q e n d i t u r e s has declined from 20.b percent i n t h e first Plan t o 16.3 percent i n t h e preliminary o u t l i n e f o r t h e Fourth Plan. Table 6: INVESDlENTS AND CURRErJT EXPENDIWRES I N THE "rN LKPENDI TURES O T E PUBLIC SECTOR F H (Rs . nLllion) First Second Third Fourth PIan Plan Plan& ?la& Plan Expenditure 19,6G0 - - 46,720 75,000 156,200 Current Expenditure 4,000 9,410 12,000 26,250 Investment Outlay 15,600 37,310 63,000 129,950 Current E q e n d i t u r e i n Percent of Plan Ex- penditure 20 .& 20.2 17.k 16.3 - /a Original Estimate. Total expenditure i s no>J estimated a t RS. 82,000 million. -/b Piemorandurn on t h e Fourth Five-Year Plan. 24. About 20 2ercent of t h e Plan expenditures a r e considered a s c u r r e n t expendituras in t h e Government Budget (Third plan), while 80 percent i s c a p i t a l expenditures. This corresponds broadly t o t h e proportion of c u r r e n t expenditures and investments i n t o t a l Plan outlay of t h e Government. 25 The Center i s financin; a s g b s t a n t i a l p a r t of t h e Plan expenditures of t h e S t a t e s . Table 7 gives t h e d i s t r i b u t i o n of, on t h e one hand, t h e f i n a l Plan expenditures of Center and S t a t e s , and,on t h e other hand, t h e c o n t r i b u t i o n of Center and S t a t e s t o t h e financing of these expenditures. The d i f f e r e n c e is due t o t h e financing by t h e Center of Plan expenditures of t h e S t a t e s . Table 7 : PUaLIC PLAEi EXF'DDITURES, DISTRIBUTIO!d O FITYiL EXPE:DITTiRE F Aim FITUNCING BEE:EEN CETJTEX AND STATES First Second Third Plan Plan Plan 2; rl P 4 /a Plan Expenditures : Center States Plan Expenditures financed by: Center States Central Assistance f o r S t a t e Plans: I n p e r c e n t of p l a n e x p e n d i t u r e of States 41 51 62 I n p c r c ~ n tE i n a n c i a l p l a n of - - . ---.. . c x p e n d i t.l ~ r e sof C z n t e r C- P 24 29 39 26. The r e l a t i v e share of t h e Plan expenditures of t h e Center has declined somer-?hatt o about 50 percent of t o t a l public Plan expenditures, 7lhile t h e share of t h e S t a t e s has been i n c r e a s i n ~ . On t h e o t h e r hand, t h e Center has had t o provide f o r an i n c r e a s i n = p a r t of t o t a l Plan expenditures. I n t h e Third Plan t h e Center was expected t o c o n t r i b u t e 80 percent of t h e f i n a n c i a l resources required f o r t h e public s e c t o r Plan outlays, and t h e S t a t e s 20 percent. About 62 percent of t h e f l a n expenditures of t h e S t a t e s would be financed by t h e Center. This i s exclusive of t a x s h a r i n g and o t h e r t r a n s f e r s ~ghicha r e not linked t o Plan expenditures.  IV. 'IHK OVEP?LL BWGETARY POSITION OF T E ~OVZc~LYIGNT J ~ E IU l H E RELATION T THE ,=ST OF 1ME ECO~TOE O 27. A comprehensive survey o f t h e f i n a n c i a l s i t u a t j o n of t h e C e n t e r and S t a t e s combined i s given i n T a b l e s 8 and 9. The s a v i n g s ;.nd J n v e s t - ments o f a 1 1 Government en c e r p r i s e s - l a l s o t h e n o n - d e p a r t ~ n e r i t ~c n t e r - prises - a r e included. 25. The s u r p l u s on c u r r e n t a c c o u n t i s t h e s u r p l u s o f c u r r e n t revenues over c u r r e n t expenditures.;/ This s u r p l u s together with t h e r e t a i n e d s u r p l u s o f Government e n t e r p r i s e s c o n s t i t u t e t h e t o t a l Govern- ment s a v i n g s a v a i l a b l e f o r f i n a n c i n g P l a n investlnents. The s a v i n g s covered o n l y 8 p e r c e n t of t h e i n v e s t m e n t s i n t h e Second P l a n compared v i t h an e s t i m a t e d 20 - 25 p e r c e n t i n t h e o t h e r P l a n p e r i o d s . Domestic borrowing, o t h e r t h a n from t h e S e s e r v e Bank, f i n a n c e d 30 - 50 p e r c e n t of t h e investments, 15 - 30 p e r c e n t was m e t by n e t borrowing from t h e Reserve Bank ( i n c l u d i n g Reserve Bank purchase o f Government bond-s), and 10 - 35 p e r c e n t was f i n a n c e d by f o r e i g n a s s i s t a n c e . Table 8: OVEPdLL BUDGETA:lY POSf TION OF CD!'ER AND STATES (Ks. m i l l i o n ) First Second Third Fourth Plan Plan ~lanLa plan& S u r p l u s on c u r r e n t a c c o u n t 2,370 1,220 1 19,000 S u r p l u s of p u b l i c u n d e r t a k i n g s Government savings!" Government P l a n I n v e s t m e i ~ t s Expenditure s u r p l u s 12,080 34,420 46,900 74,450 Financed by : Domestic borrowing o t h e r t h a n from t h e Xeserve Bank 7,558 12,490 19,400 34,450 Met drawings on Reserve Bank 2,632 11,4LcO 5,500 15,000Ld Foreign a s s i s t a n c e 1,890 10,490 22,000 25,000 - /a Original plan estimates. - /b T e n t a t i v e e s t i n a t e from i n t e r n a l document o f w r k i n g group on r e s o u r c e s . - /C S a v i n g s d i s p o s a b l e f o r p l a n i n v e s t m e n t s . There may be some S t a t e s a v i n g s and i n v e s t m e n t s " o u t s i d e " t h e p l a n . - /d Includi-ng s h o r t f a l l of r e s o u r c e s i n t h e o r d e r of R s . 7000 m i l l i o n . - 1/ There a r e non-Plan i n v e s t m e n t s i n c l u d e d i n c u r r e n t e x p e n d i t u r e s ; a c c o r d i n g l y t h e i n v e s t m e n t s and s a v i n g s i n t h e t a b l e a r e t o o low.  Table 9 : H F T E FINAIJCING O PUBLIC PLAN INVESTl!ENTS First Second Third Fourth Plan Plan Plan Plan Public Plan Investment Financed bv: ~overnmehtSavings 22.6 7.8 26.6 26.3 Domestic Borrowing 48.5 33.4 :.-! .8 34.0 Net Dra1,Jings on Reserve Bank 16.8 30.6 8.7 14.9k Foreibn Assistance 12.1 . 28 2 3k 7 !. .) 24.5 /a Including estimated s h o r t f a l l of resources of 7 percent. 29. I n general, this survey confirms what has been mentioned before: t h a t Government investments have by f a r exceeded Goverrnent savifigs, t h a t t h e d e f i c i t p a r t l y has been covered by private savings channeled t o the Government by Government borrowing, but t h a t a s u b s t a n t i a l p a r t of t h e d e f i c i t has been covered by foreign assistance. 30. f O t h e dornestic borroving, from other, than t h e Reserve Bad:, the Center raised about two-thirds and the S t a t e s one-third. . The n e t borrowing b S t a t e s (from others than the c e n t e r ) has not tended j t o increase very much; it amounted t o 5.4 b i l l i o n i n the Third Plan cornpared with 3.3 b i l l i o n in t h e F i r s t Plan. The t o t a l increase in t h e indebtebess of t h e S t a t e s during t h e ten years up t o 1900-61, amounted t o R s . 27 b i l l i o n and of this R s . 20 b i l l i o n were in the form of loans from t h e Center and R s . 7 b i l l i o n other loans. 31 The net drai~ingon t h e Reserve Bank i s mainly drawing by the Center; t h e S t a t e s have t o some extent access t o borrowing a t the Reserve Banhbut this i s mainly short-term advances t o meet seasonal needs. 32. The national accounts in India a r e incomplete and, a l t h o u b some separate s t u d i e s of money flows have been made, they do not give an integrated survey of f i n a n c i a l transactions between t h e Goverment, Central Bank, and t h e private sector, e t c . But by com i n i n g surveys of 19 Plan f i n a n c i a l s t a t i s t i c s and a s p e c i a l savings study, w obtained an e overall p i c t u r e of i n t e r n a l f i n a n c i a l flows a s given i n Table 10. The purpose of t h i s t a b l e i s t o show how t h e f i n a n c i a l transactions of the Government, r e f l e c t e d i n t h e f i n a n c i a l transactions of t h e r e s t of t h e economy. ISinus f i g u r e s denote an i n f l o v of f i n a n c i a l resources, rahile positive fi,gxres represent lending or increase i n f i n a n c i a l assets. l/Estimates of saving on investment i n t h e Indian Economy: 1950-51 t o - 1962-63. Reserve Banlc of India Bulletin, ?larch 1965.  Table 10: FINANCIAL nO1JS DWdLG THE SECGIEI PLAN (5s. c l i l l i o n ) Goverr,- Reserve House- Erit e r - Total ;dent Bank holds prises 1. Net domestic finan- c i a 1 investsient -23,330 6,742 18,091 -903 o f O which: ( a ) P r i v a t e holdings of currency - ( -5,31k) ( b ) Government borrow- i n g from Reserve Ban!; -11,440 11,440 - - 0 ( c ) Other domestic lending ( + ) and borrowing ( - ) -12,490 616 13,090 -1,216 0 2. Bet borrowing abroad -10,493& -6.74I 2/b , -.- - - 8 - -21,71& 3. Total n e t change i n n e t f i n a n c i a l posi- t i o n j1+2) -34,k2d 0 18,091 -5,381 -21,710 /a Borrowing and % r a n t s Reduction of f o r e i g n exchange ho1clir.g~of Reserve Bank - E e f i c i t i n t h c balance of p a p e n t s 33 Tha f i r s t l i n e s h o t ~ st h e n c t change i n t h e f i n a n c i a l p o s i t i o n of each s e c t o r towards a l l other domestic s e c t o r s . Line 2 shows t h e n e t borrowing abroad {inclucLng o f f i c i a l g r a n t s ) ; f o r t n e Reserve Bank t h e f i g u r e r e f t r s t o t h e change i n i t s f o r e i g n exchange holdings ( n e t f oreien a s s e t s ) . Line 3 shows t h e change i n t h e n e t f i n a n c i a l p ~ s i t i o n each of t h e s e c t o r s of and t h e country a s a whole. 'The f i g u r e s correspond t o i;he savings- investment gap of each of t h e s e c t o r s . The Government and t h e e n t e r p r i s e s e c t o r have a d e f i c i t while t h e household s e c t o r has a s u b s t a n t i a l surplus. The t o t a l f o r t h e country a s a whole corresponds t o t h e d e f i c i t i n t h e balance of payments . 34 9 Tine f i r s t column gives t h e financing of t h e d e f i c i t on t h e Govern- ment savings investment account, and t h e f i g u r e s a r e t h e same a s i n Tsble 8. About one-third of t h e d e f i c i t i s financed by drawing on t h e Reserre Bank, one-third by other dorrlestic borrowing and one-third by f o r e i g n a s s i s t a n c e . 35 . The secand column shows t h e t r a n s a c t i o n s 03 t h e iZeserve B n : a! whic!l could be srnrizarized a s follows:  Rs. million Net Lending t o t h e Government 1 ,L40 1 616 Net Lending t o t h e P r i v a t e Sector (including banks) - Net out -pawent by Reserve Bank and Governinent 12,056 Corresponding t o : ( a ) Increase in p r i v a t e holdings of Domestic Currency 5,314 ( b ) Reduction of b c h a n g e Holdings of Reserve Bank 6,7L2 36 About h a l f of t h e outflow of l i q u i d i t y from t h e Reserve Bank xas absorbed i n increased holdinss of currency, while t h e r e s t Is matched by f a l l i n g exchange reserves. 37 The household s e c t o r includes a g r i c u l t u r e and non-corporate business. The n e t f i n a n c i a l savings of t h e household s e c t o r amounted t o 45 percent of a l l household savings. The composition of t h e n e t f i n a n c i a l savings of households i s g i ~ r e nbelow. Rs . Xelative - millions -- FF,gures ?i P Total Financial Savings of Hou.senolds 18,091 - 100.0 Increase i n Holdings of Currency 5,001 -27.5 Put a t d i s p o s a l f o r others, net, 72.5 Insurance and R o v i d e n t Funds -m Banks Enterprises Government 38 The f i g u r e s a r e n e t i n t h e sense t h a t t h e borrowing from banks, insurance, e t c . , has been deducted from t h e increase i n t h e gross claims of households on t h e s e s e c t o r s . A t o t a l of 41 percent of household savings was in t h e form of n e t clairiis on insurance campanies arld provident f i n d s . Onljr abouk iis.l.3billFon eas n e t payments t o t h e Government, compared 1 5 t h a Government b o r r o u i n ~of Rs. 12.5 b i l l i o n . The remaining R s . 11.2 i n Government borros;ing has been borrowing froin t h e c r e d i t system and probably t o sorne e x t e n t from t h e e n t e r p r i s e s e c t o r . 39. The column f o r t h e e n t e r p r i s e s e c t o r i n Table 1 0 i s calculated a s a r e s i d u a l on t h e b a s i s of t h e information we have f o r t h e other s e c t o r s . The n e t domestic borrowin, of t h e e n t e r p r i s e s e c t o r i s too low, t o t h e e x t e n t t h a t t h e Public Plan Investments include public financing of p r i v a t e investliients; information on t h i s is not available. 40. The general p a t t e r n of Government financing and domestic f i n a n c i a l flow has been t h e same both before and a f t e r 1960-61. Household sauin~s have provided t h e bulk of t h e domestic i n v e s t i b l e funds, which have,to a l a r g e extent, been channeled t o t h e Government v i a t h e c r e d i t system concurrently with increasing f o r e i g n a s s i s t a n c e from abroad. Government borrowing, o t h e r than borrowing from t h e Zeserve Bank, was expected t o i n c r e a s e by 55 percent from t h e Second t o t h e Third flan, but t h i s t a r g e t was exceeded i n t h e f i r s t f o u r years of t h e Third Plan r ~ h i l e , a s visualized, t h e f o r e i g n a s s i s t a n c e has approximately doubled. 41. Government bond i s s u e s (excluding t h e p a r t taken over by t h e Reserve Bad<) have t o a l a r g e e x t e n t been zbsorbed by f i n a n c i a l i n s t i t u t i o n s ; and i n t h e f o u r y e a r s 1959-60 t o 1962-63 t h e r e was some decrease i n Government bonds held outside t h e i n s t i t u t i o n s . Table 1 shows t h e 1 o ~ m e r s h i pd i s t r i b u t i o n of Government bonds other than those held by t h e Government i t s e l f and t h e Reserve Bank. Table 1 : OI.Ji\iERSHIP O GOVElilG~liTBObDS (CDTTER AND STATE COISEJE3 ) 1 F ( A s a t t n e end of Piarch 1963) Rs. million Relative Figures TOTAL: Government S e c u r i t i e s other than those held by t h e Government and Reserve Bank Held by: Commercial and Cooperative Banks Insurance Provident Funds Finance Corporations, Trusts and Local Authorities Others Source: iieserve Balk of I n d i a k l l e t i n . h2. I n s t i t u t i o n s hold a s much a s 77 percent Governmefit bonds, x h i l e l1Othersttheld only 23 percent. This r a t i o was declining in t h e f o u r years up t o t h e end of Piarch 1963. But, t h e small savings scheme has provided f o r a s u b s t a n t i a l i n f l o ~ :of p r i v a t e savin,s d i r e c t l y t o t h e Government. The small savinks scheme o f f e r s favorable conditions and has a l s o many p r a c t i c a l advantages f o r t h e general public. The lack of i n t e r e s t i n ordinary bonds has t o be considered a g a i c s t t h i s baclground.  V. CENTRAL (XV'32PlXENT FIi%UICZS 1952-59 TD 1965-66 33, The p r e v i o i i s c h a p t e r s have d e a l t p r i m a r i l y w i ch the f i n a n c e s of t h e (;o.~ernzc~enl: s e c t o r a s a whole, and t o some extenr. with t h e f i n a n c i a l r e l a t i o n s h i p between t h e C c n t e r and t h e S ta'cs. The S t a t e s a r e , t o a l a r g e e x t e n t . dependent upon d i f f e r e n t t y p e s o f f i n a n c i a l a s s i s t a n c e fro:? t h e C e n t e r , a c c o u n t i n g f o r about 50 p e r c e n t o f t h e i r f i n a n c i a l r e s o u r c e s o r about t h e same a s t h e t o t a l P l a n e x p e n 6 i t u r e s of the S t a t e s . f i r e h e n n o r e , t h e S t a t e s can o n l y t o a v e r y l i ~ ~ i t e d e x t e n t r e s o r t t o d e f i c i t f i n a n c i n g by borrowirLg from t h e Reserve Bank. Broadly s p ~ d t i n g ,i t e o u i d t h e r e f o r e be s a i d t h a t :he C e n t e r , i n p r a c t i c e , i s s u p p l y i n g t h e S t a t e s with t h c a d d i t i o n a l f u n d s r e q u i r e d t o meet t h e i r f i n a n c i a l d e E i c i t . 44. 'Thile t h e S t a t e s a r e a d m i n i s t e r i n g a s u b s t a n t i a l p a r t of t h e Government ' s e x p e n d i t u r e s b o t h f o r econornic development and f o r o t h e r p u r p o s e s , t h e f i n a n c i a l problems a r e t o a l a r g e e x t e n t t r a n s m i ~ t e dt o t h e C e n t e r . O b v i o u s l y , such a s t r u c t u r e i n Government f i n a n c e s r a i s e s d i f f i c u l t problems, b o t h ~ L I t h e s c r e e n i n g o f S t a ~ e expendj t u r e s and w i t h r e s p e c t t o t h e a l l o c a t i o n of funds from t h e C e n t e r t o t h e d i f E e r e n t S t a t e s . These problems a r e n o t t o be d i s c u s s e 2 h e r e . The p o i n t TE would l i k e t o eiiiphesLze h e r e i s t h a t t h e f i n a n c i a l problems of t h e Government a s a whola a r e l a r g e l y r e f l e c t e d i n t h e f i n a n c e s o f t h e C e u t c r . An a n a l y s i s of t h e development o f t h e f i n a n c e s of t h e Ceilter c o v e r s t h e g e n e r a l f i n a n c i a l p r o S i e i s o f t h e Government s e c t o r a s a whole. 45. The purpose o f t h i s c h a p t e r i s t o g i v e a more de'ca:.led y e a r - t o - y e a r survey o f C e n t r a l Government f i n a n c e s from 1957-58 up t o t h e Eudget f o r 1965/66. The survey g i v c n i n t h i s c h a p t e r i s Laser? upon t h e economic c l a s s i f i c a t i o n of t h e a c c o u n t s and budgets of t h e C e n t e r . The aclvantage i s t h a t t h e c o n c e p t s a r e u o r e c l e a r i y d e f i n e d and more r e l e v a n t f o r f i s c a l a n a l y s i s t h a x t h e t r a d i t i o n a l a c c o u n t s and budgets. Hov~ever, t 7 . 7 0 t y p e s of ac! justments a r e made. They r e l a t e t o ( a ) Governtnent n e t d r a v i n g s on t h e d e s e r v e Ban!.: anG ( b ) t o t h e t r a n s a c t i o n s i n PIJ 480 c o u n t e r p a r t funds. (a) - ------- Gove rnalec t X e t Drawing on t h e Reserve Bank 46. The economic c l a s s i f i c a t i o n i s s t r i c t l y a c l a s s i f i c a t i o n of t h e Government a c c o 1 m 3 . The conce2i: o f " d e f i c i t f i n a n c i n g " i s , t h e r e f o r e , e x c l u s i v e of t h e purchase of Government bonds by t h e Reserve 3ank. And t h e Reserve Bank may t a k e o v e r s u b s t a n t i a l m o u n t s o f new i s s d e s f o r p o s s i b l e s a l e l a t e r o n ; i f n o t , they a r e h e l d by t h e Reserve Banir. !?e have t a k e n i n t o account t h e v a r l a t i o n s i n t h e 2 e s e r v e Eank's h o l d i n g s of Goveri~ment bonds. :Ihm t h e y i n c r e a s e t h i s i s corlsidered a s l e n d i n g t o t h e Government, i . e . , a s ? a r t of t h e Government n e t drawing on t h e Reserve Sank. T r a n s a c t i o n s i n U.S. Counterpart P ~ n d s 47. C o u n t e r p a r t f u n d s c o n s i s t of t h e amounts i n r u p e e s p a i d by t h e X I n d i a n Government t o t h e American a u t h o r i t i e s f o r F 480 imports. The b u l k of t h e s e f u n d s a r e immediately p a i d back t o t h e I n d i a n Government, p r e v i o a s l y by d e p o s i t i n g theti1 w i t h commercial banks f o r investment i n Government s e c u r i t i e s , presently by d i r e c t investments i n s p e c i a l Government s e c u r i t i e s established f o r t h e purpose. These funds, which a r e already i n some iiay or other channeled t o the Indian Government, can l a t e r be "usedff f o r s p e c i f i c purposes asreed upon by representatives f o r t h e tvro countries. This use of counterpart funds i s r e g i s t e r e d a s foreign a s s i s t a n c e i n the Government accounts, although it may have no connection with t h e a c t u a l i i i i o of ~foreign ~ a i d t h a t year. The discrepancy i s r e f l e c t e d i n t h e f i & - e s f o r domestic borrowing. Thus, t h e P 480 imports and t h e inf1or.r of counterpart funds may L be t h e same i n two years. But i n the one year the t h o l e amount may be r e f l e c t e d i n t h e domestic borrowing, i n t h e other year i n the foreign a s s i s t a n c e . A more d e t a i l e d explanation i s given i n Appendix I. 48. W have ?referred .i;o consider the inflow of nevr counterpart funds e - corresponding l a r g e l y t o t h e P, 480 imports i n t h a t year - a s foreign I assistance. W a l s o exclude from t h e domestic b o r r o d n g t h e transactions e based upon P 450 counterpart funds. L 49 The survey of recent development of Central Government finances covers t h e period from 1957-58 t o t h e Budget f o r 1965-46. Figures f o r a l l t h e years a r e not given i n t h e t a b l e s a s t h i s should not be necessary f o r i n d i c a t i n g t h e general tendency. SO. Table 1 2 shorn t h e current account of t h e Central Goverrment. Over t h i s period of e i g h t years the current revenues nearly t r e b l e d . The revenues from t a x a t i o n were approximately doubled throilgh additional taxation, i ~ h i l e r i s i n g incon~esand turnover ~ e s u l i e di n a s i m i l a r increase. Eut the c u r r e n t expenditures have by and l a r g e kept pace with t h e increasind revenues and Government savings have been lox. Xecently t h e r e have been some increases, but even t h e r e l a t i v e l y l a r g e f i g u r e f o r 1965-66 does not correspond t o more than 1 percent of the national income. Table 12 : CmTTRAL GOTJZ1'iltivEJT, CURIUNT ACCOUNT - (Rs. million) A. Current Incomes 7,342 9,500 1. Taxes on irlcome and wealth 1,538 1,998 2. I n d i r e c t taxes L,216 5,284 3. P r o f i t s 675 882 4. Other incomes 913 1,336 B. - Current Expenditures 1. Clivilian 2. Defense 2;796 2;733 C. Savings on Current Account 725 684 /a Revised budget estimate - 7'b Budget proposal Source: Economic C l a s s i f i c a t i o n of Central Governnnlent Budget 51 After t h e Chinese asgression t h e defense expenditures increased s u b s t a n t i a l l y and about halr' 02 t h e current expenditures of t h e Center a r e norr used f o r defense. T h i s corresponds t o about 4 percent of t h e gross National Product, The f i g u r e s a r e irdlucnced a l s o by r i s i n g ?rLces, and i t i s d i f f i c u l t t o a s s e s s ti13 expansion of f n e volume of Goverment a c t i v i t y . Including construction, t h e mploynent i n t h e Central Government increased by 35 percent i n t h e e i g h t y e a r s from 1956 t o 1964. 52 . Table 13 gives t h e c a p i t a l account of t h e Center includin, departlnental. e n t e r p r i s e s , i . e . raFlways, post and teiegraph and some other enterprisesl// but not the s t e e l m i l l s , f e r t i l i z e r p l a n t s and other more independent e n t e r p r i s e s . Ho~rever, t i e expenditares or" t h e Center f o r financing investments i n such e n t e r p r i s e s a r e included on the expenditure side. 53 The current f i n a n c i a l resources include t h e savings from -the current account of t h e Center, t h e savinos of departrnental e n t e r p r l s e s and t h e depreciation provision of these e n t e r p r i s e s , a s savinzs and investments a r e on a gross basis. Furthermore, t h e current f i n a n c i a l resources include t h e repaynents received by t h e Government cn loans outstanding. This amortixation income has becone an important source of financing igith t h e i n c r e a s i r , ~ volulme of new lending t o S t a t e s and non-de~artmental e n t e r p r i s e s . And by including t h i s item on t h e income s i d e r?e obt,ain a p i c t u r e of t h e t o t a l net- lcnc"liag on t h e expenditure side. of This new lending i s p a r t of t h e ~ o n t ~ i b u t i o n t h e Centcr t o t h e financing of new investments. - -,' tIncluding transport, e l. e c t r i c i t y arlci i r r i ; , a t i o n schemes operated by 1 h e Cen%ral Governmen-t  Table 13: CENTRAL G V R M N AND D P R N N A UfJDERTAKINGS O EN E T EA T E T L - CAPITAL ACCOUNT ( R s , million) A. Current f i n a n c i a l resources, 2,072 2,767 5,198 5,622 6,821 of which : 1 Savings . 1,457 1,685 3,075 2,581 3,1478 n (a) O current account of Center 735 684 1,386 1,120 1,783 (b) Retained prof i t s in enterprises 245 458 786 540 7 2 ( c) Depreciation provision 477 543 903 921 9 53 2. Amortization income k. 615 1,082 2,123 3,041 3 y 3143 B, Dc =t ,-- - and i n d i r e c t investments, 8,744 9,134 15,9b8 179253 18,782 of which : 1 Direct investments . 3,570 3,110 5,518 5,217 6, h59 2. Investment financing of: 5,174 6,02h 10,430 12,036 12,323 (a) States 2,971 3,622 6,740 7,930 8,lliO ( b) Non-departmental Gov- ernment enterprises 1,703 2,110 3,350 3,590 3,720 (c) Others 500 2 92 340 516 463 C, -- Expenditure surplus before Domestic borroving 6,672 6,367 10,750 11,631 -- 11,961 D, Domestic Borrowing other than - the from Reserve Bank 497 1,826 4,700 3 , U 3.,400& E . - Expenditure Surplus Overall -- 6,175 454 6,050 8,387 8 56d! financed by : i . Net drawing on t h e Reserve Bank 4,261 765 1,865 1,616 478-/d 2. Foreign Assistance 1,914 3,767 4 5 6,771 8,033 of which: ( a ) Inf lms of PL 480 counterpart funds 1,101 1,813 1,773 2,772 3,310 ( b) Other assistance 813 1,963 3,412 3,999 4,773 /a - Revised budget estimate - - Budget proposal Net of some minor c a p i t a l transfers not linked t o investnent.. -- 73 - Estimate by Mission. 54. n O the expenditure side we have grouped together the d i r e c t investments of the Government and t h e expenditure s for financing investments in other sectors. ?he l a t t e r i s called i n d i r e c t investment expenditures, and consists of purchases of shares, new lending and grants f o r c a p i t a l formation. Part of the lending i s not formally linked t o investments, and some of the lendilng i s t o Government f i n a n c i a l i n s t i t u t i o n s f o r t h e financing of private investments, But a s w i l l be seen from the table, the bulk of the i n d i r e c t investment exper-ditures are t r a n s f e r s of f i n a n c i a l resources t o the S t a t e s and non-departmental enterprises. And the t o t a l of the i n d i r e c t investment expenditures amounts t o approximately double t h a t of d i r e c t investments of the Center, The d i r e c t and i n d i r e c t inirestment expenditures of the Center are somewhat larger than t h e t o t a 1 Plan expenditures of the Center. (R s . million) Direct and Indirect Plan Expendi t w e s Investment Expenditures of Center of Center - /a - Revised budget estimate - Bud.get proposal 55. Although t h e coverage i s not the same, the d i r e c t a d indirect investment expenditures could, broadly speaking, be taken as an indicator of the Plan expenditures when judging the development of Governnent budgetary policy. 56. The investment expenditures ( d i r e c t and i n d i r e c t ) of the Center has by f a r exceeded t h e current f-hancial resources, and the d e f i c i t before domestic borrowing has been increasing from a b u t ,9s, 6.4 b i l l i o n i n 1960-61 t o about Rs. 12.0 b i l l i o n i n the 1964-65 and 1965-66 periods. This is an e-xpenditure surplus r e p e s e n t i n g the d e f i c i t on the savings-investment account when the i n d i r e c t investments are t r e a t e d as investments and when the n e t grants from abroad a r e treated not a s income, but i n the same way as b o r r o ~ i n gabroad. 57. Part of the expenditure surplus i s covered by domestic borrowing (other than from the Reserve ~ a n k ) . This borrowing is a " r e s t r i c t i v e financing1! as it rep-esents a channeling of f m d s from the c r e d i t system and the private sector t o the Government, The r e s t - which we have called. the overall expenditure surplus - i s financed by net drawings on the Reserve Bank and foreign assistLance ( n e t borrowing and grants). I n n e i t h e r case i s there any r e s t r i c t i v e e f f e c t from t h e niethods of financing on the purchasing potrer and spending capacity of the r e s t of the economy. But foreign assistance makes foretgn exchange available f o r imyorts and the subsequent sale of imported goods absorbs domestic purchasing power, In the case of drawings on t h e Reserve Bank, the excha~ges i t u ~ . t i o n ordinzr,lly doesvnot permit en'additional'demand f o r imports t o be met. 58 The o v e ~ a l lexpenditure s u r p l u s r e p r e s e n t s n e t out-palrl.ient I"rc;:~ t h e Government t o ';he cimestic economy and abroad. T h i s n e t out-payment i s sho:m belor: Tor a l l t h e years s i n c e 1957-58, t h e absolute mount and i n percenS of t h e n a t i o n a l income. S e t Out -payment from Percentage of t h e C e n t r a l Governnlent Kational Income - (Rs. m i l l i o n ) - Rough e s t i ~ a t e s /a 59. The ne-t o u t - p a p e n t i s by andystand=d l a r g e , and t h e r e has been an i n c r e a s i n g t r e n d since 1359-60, from R s . 3.L bilLion t o R s . 3.6 b i l l i o n . And i f t h i s had been a n e t out-payment t o t h e donestic economy - representing t h e n e t demand on domestic resources - t h e r e would have been a very s t r o n g expansionary e f f e c t . On t h e other hand, t h e s i t u a t i o n i s conqleteljr d i f f e r e n t i f t h e out-paymerlts rerilect not e n e t out-pzjmen'i, t o t h e donlestic economy, but payments abroad f o r imports oi" machinery and equipment f o r Government p r o j e c t s , imports f o r t h e cwrerrt a c t i v i t y of t h e Government and i n t e r e s t payments. The c u r r e n t actiYity i n t h e r e s t of t h e economy xould not be d i r e c t l y a f f e c t e d a t a l l by such t r a n s a c t i o n s . They have a d i r e c t jmpact on t h e balance of paymenix, ht no% v i a a general e q a n s l o n of domestic demand created by expenditure s w p l u s i n t h e domest5c t r a n s a c t i o n s of t h e Goverment. A:cordingly, the overall d e f i c i t on Goverment accounts may be deceiving when it comes t o judging t h e impact of budgetary policy on domestic demand. They may conceal u i d e l ; ~ d i f - .rerunt s i t m t i o n s with r e s p e c t t o payxents abroad and donestic transactions. 60. Indian s t a t i s t i c s do not p ~ ~ o v i d e f f i c i e n t information, but w su e have t r i e d t o assess t o what e x t e n t t h e n e t out-payment f r o n t h e Governn1en.t i s a paynent t o other domestic s e c t o r s , and t o what e x t e n t it r e f l e c t s Government papcents abroad. The d i z t i n c t i o n should i n p r i n c i p l e be bzsed upon 1:ho I s t h e f i n a l user of t h e b p o r t s , t h e Government o r t h e r a s t of t h e economy, and n o t who i s t h e a c t u a l importer. Thus, h e n t h e Goverment i s importing food it i s f o r f i n a l d e l i v e r i e s t o t h e p r i v a t e s e c t o r . The i s functioning a s ar! intermediary aGeccy, aiid we do not consider such i n p o r t s a s imports f o r Government use. Thus, t h e d i s t i n c t i o n between payments a t home and payments abroad i s based upon a t r a n s a c t i o n c r i t e r i o n exclusive of i n t e r n e d i a r y t r a n s a c t i o n s , i . e . according t o f i n a . 1 uses. Change i n Goverrient stocks of imported goods f o r p r i v a t e use should however be considered a s Goverment imports ( t l ~ e y r e included a i n Government investnent which i s a " f i n a l use1'. The n e t rof i t s of t h e 19 Government from exports by Government e n t e r p r i s e s should, be deducted ' e from Government expexlitures abroad. W have f o r obvious reasons not been able t o do t h a t , 61. iJe do n o t have t h e exact information which an a n a l y s l s a s outlined above would require. The b a s i s f o r judging t h e impact of budgetary develop- ments upon t h e domestic demand s i t u a t i o n i s i n s u f f i c i e n t . In i h e absence of the required information we have made some rough estimates. 14e have infor- mation on t h e c u r r e n t expenditures of t h e Governmrnt abroad, and t h e imports of c a p i t a l equipment f o r Government projects. lqe take t h i s t o represent t h e n e t out-payment f o r t h e import of goods and s e r v i c e s f o r f i n a l use by t h e Governrfient. Table 13, s e c t i o n E, gave t h e financing of t h e expenditure surplus by drawings on t h e Reserve Bank and f o r e i g n assistance; i n c o n t r a s t t o t h i s Table 14 shows i n t r a n s a c t i o n s with whcm t h e expenditure surplus has been incurred, t o what e x t e n t it i s an expenditure surplus i n t r a n s - a c t i o n s with t h e domestic economy, and t o what e x t e n t it is a n e t out-payne~t abroad f o r imports f o r f i n a l use by t h e Governnient, Table 14 : OEN ET CENTRAL G V R M N DOEJIESTIC A1113 EXTZRZJAL EXPEiJDITURE URN SURPLUS ON C R E T AHD INVESTPENT ACCOUNT (Rs , b i l l i o n ) Total Ekpenditure Surplus 45 -. - - 328 - 5c4 - - - 6.0 - - 8 4 Domestic Transactions 2,6 2.0 3. 5 2.2 4. 3 External Transactions 1.9 1.8 1.9 3.8 b.1 62. The break-down of t h e t o t a l expenditure surplus on domestic and e x t e r n a l t r a n s a c t i o n s i s not exact, and i s based upon budget f i g u r e s and incomplete s t a t i s t i c s f o r t h e l a s t two years f o r which f i g u r e s a r e given. Indian Government o f f i c i a l s believe t h a t complete d a t a would i n d i c a t e t h a t t h e domestic d e f i c i t was somewhat smaller and t h e n e t out-payments abroad p l a r g e r in t h e s e ~ F T O a r s than i s here estimated. The budget, i n t h i s event, would require more foreign exchange but have a l e s s expausionary e f f e c t than indicated above. The s t a t i s t i c s on which a r e v i s i o n of t h e estimates presented here could be based have been discontinued;z/ accordingly no -/ 1 Depends upon t h e n a t i o n a l accounting system with which one wants t o i n t e g r a t e such an analysis. - 2/ This a p p l i e s t o t h e "Analyses of Receipts and Disbursements Abroad" i n t h e explanatory memorandum of t h e budget, and t h e publication of break- downs of "Imports on Government Accountft (which include imports f o r p r i v a t e use). Our estimates a r e based upon budget f i g u r e s f o r 196&/65 and 1965/66, and s t a t i s t i c s of government i n p o r t s covering only a p a r t of t h i s period. r e v i s i o n has been made. It i s nevertheless c l e a r t h a t the expansionary e f f e c t of t h e bndget on domestic demand is m c h smaller than t h e o v e r a l l d e f i c i t might i n d i c a t e ; t h i s o v e r a l l d e f i c i t r e f l e c t s s u b s t a n t i a l n e t out- payments abroad f o r imports t o t h e public s e c t o r and i r h r e s t payments on t h e e x t e r n a l debt. The n e t out-payment t o the domestic economy has accounted f o r only about half of the t o t a l d e f i c i t , possibly somewhat l e s s . The rest i s a n e t out-payment abroad with no demand e f f e c t on domestic resources. The payments abroad have exceeded t h e inflow of foreign a f y s - tance a v a i l a b l e t o t h e Covernment f o r t h e financing of such payments.- The discrepancy was covered by a n e t t r a n s f e r of p r i v a t e f o r e i g n exchange earnings t o t h e public s e c t o r and a reduction of t h e o f f i c i a l exchange reserves, The public s e c t o r was i n t h i s sense a n e t user of foreign ex- change; i.e. a n e t user in con"dastto a s i t u a t i o n where the ~overnment provides f o r e i g n exchange f o r the r e s t of the economy by using l e s s than t h e inflow of a s s i s t a n c e within the public sector. B71t, it could not be taken f o r granted t h a t a reduction of, f o r example, import demanding investments i n the public s e c t o r would increasz t h e supply of f o r e i g n exchange a v a i l a b l e t o t h e p r i v a t e s e c t o r . The reason i s t h a t q u i t e a l a r g e p a r t of t h e forelgn assistance (excluding PL-480) has been t i e d t o s p e c i f i c p u b l i c s e c t o r p r o j e c t s and t h e i r import requirements. A r e d u c t i o l of such investments and t h e imports they require migilt a l s o mean a reduc- t i o n of t h e f o r e i g n a s s i s t a n c e available t o India. The expansionary e f f e c t of the budget on t h e domestic economy i s - because of t h e l a r g e payments abroad - much smaller than the t o t a l d e f i c i t might indicate. And, t h e n e t out-payment t o t h e domestic economy i n r e l a t i o n t o e,g. G.I'J,P. might not appear large. However, t h e secondary demand e f f e c t s of such an out- payment have t o be taken i n t o account. A discussion of this i s presented i n the next chapter. - 1/ i.e. f o r e i g n assistance exclusive of PI,-b80.  VI. THE DEMAND EFFECTS O TIE BUDGZTARY POLICY F 63 I n t h e five :rears 19GC-6i co 1965-66 .tile s e t out- payment from t h e Government t o t h e r e s t of t h e domestic economy miounted t o 1.2-2.3 percent of t h e n a t i o n a l income. This derrland r e p r e s e n t s i n i t i a l l y a demand on domestic resources only s i n c e t h e irnport content i n t h e d e l i v e r i e s t o t,he Goverrment has a l r e a d y been deducted. Furthermore, it appears reasonable t o consider t h e out-payments a s an out-payment t o ~ t h non-agricultural s e c t o r ; e . ~ .a s a payinent t o domestic f a c t o r s of production engaged ir, Goverrment financed investment a c t i v i t y . The f u r t h e r e f f e c t s \could depend upon horr t h e incomes a r e used by 'ike Income- earner f o r consuillption, savings and investment, and of t h e com2osition of t h e pri-rate demand r d t h r e s p e c t t o domestic products and imports. The d i s t r i b u t i o n of i n c ~ e a s i n gconsumption expenbitures between a g r i c u l t u r a l products and o t h e r products i s derive&/ from National Sample Survey d a t a on t h e composition of housekold expenditures a t d i f f e r e n t income l e v e l s . About 70 ~ e r c e n tof ari i n c r e a s e i n t h e consmptLon expenditures of r u r a l households would be f o r p r o d ~ c t sfrom . a g r i c u l t u r e , i ~ , c l u d i n ga g r i c u l t u r e - based manufactures The impor> content rjould vary, depending upon crops and b.ports of food. For t h e purpose of discussing t h e impact of f i s c a l p o l i c y upon t h e econoniy r.re have i n t h e f i r s t i n s t a n c e asswned s e l f - s u f f i c i e n c y i n a g r i c u l t u r a l products; t h i s assumpt-ion w i l l l a t e r oil be modLfied. An iriport content of 3 percent i n t h e consumption of r u r a l households may appear low. However, i t corresponds t o 10 percent of t h e expenditures on non- a g r i c u l t u r a l products, and includes a l s o t h e import content i n domestic manufact-ues d e l i v e r e d t o r u r a l households. For t h e urban population t h e marginal expenditures on products from a p i c u l t u r e i s lower (60 p e r c e a t ) v h i l e t h e denand f o r o t h e r products i s higher. 64. Because of t h e c o s t 05 t r a n s p o r t a t i o n and t r a d e z / a g r i c u l t u r e and r e l a t e d a c t i v i t y do not o b t a i n an incame corresponding t o t h e expenditures of t h e conslmler. From input-output d a t a we fbd t h a t t h e i p r o d u c e r s l ~ r i c e s about 80 percent of f i n a l p r i c e f o r a g r i c u l t u r a l and agriculture-based products, and b:~ reducing t h e marginal expenditure sharcs correspondin,-ly/ ze obtaii: t h e income s h a r e of a ~ r i c u l t u r ei n an increase of consumers1 e q e ; . d i t u r e s . - - - - - - l / J e have derived t h e marginal r a t e s from t h e d a t a given by I . L.C. G o r e ~ 1 k i n Appendix 1 1 t o t h i s l ~ i i s s i o n ' sReport on Agriculture: llImplications of A l t e r n a t i v e Rates of A g r i c u l t u r a l Srotrth on t h e Indian S ~ o n o i n y ~ ~ , Table 1, confer our Appendix I T , Table 2. - 2/Accordin~ t o input-output d a t a t h e d e l i v e r i e s from o t h e r s e c t o r s t o a g r i c u l t u r e and agricuiture-based a c t i v i t y f o r c u r r e n t production a r e v e r j small and could i n this context be neglected. - 3hJe have used a margin of 15 percent f o r consumption by t h e r u r a i population and 25 percent f o r t h e urban population. The margin i n c l u d e s a l s o i n p u t s which a r e not i d e n t i f i e d i n t h e input-output t a b l e . Table 15: INCOl43 SHARES AI<D Iib!POllT SHAD' I L IN FINAL DWAI\~DPIARGIHAL RATE& ~ ~ Income Share of - - I - - 7r:ports To:ai - Agriculture Other S e c t o r s -- Consumption by A g r i c u l t u r a l Population 60.0 37.0 3.0 iOO.0 Consumption by iu'on- a g r i c u l t u r a l Population 45.0 50.0 5.0 100.0 Investments i n Agriculture - 90.0 10.0 100.0 Other P r i v a t e Investments - 75.0 25.0 100.0 --- - /a The sources and estimates f o r t h i s t a b l e a r e given i n Appendix 11. 65 A l l production of investnent goods i s undertaken by t h e non- a g r i c u l t u r a l s e c t o r s ; t h e import content i n t h e investments i s assumed t o be 1 0 percent and 25 percent f o r d e l i v e r i e s t o a k r i c u l t u r e and non-agri- c u l t u r e r e s p e c t i v e l y . This estimate i s supported by input-output s t u d i e s . 66. The a s s ~ n p t i o n son t h e use of' an incretise i n incones are: A z r i c u l t u r e and Other - Related A c t i v i t y Sectors __r_58-- T idiarginal Propensity t o Consume - 6 - Piarginal Savinks & t e F i n a l Use of Savj-22s: - 15 Inve s tme n L 5 Increase i n Iiolain.gs of Currency 10 According t o a s t u d j u of savings i n I n d i a the m a r g i i ~ a lpropensity t o save by i n d i v i d u a l s i s s l i g h t l y l e s s than 23 percenZ and t h e propensity f o r corporations t o r e t a i n p r o f i t s i s about 50 percent. Rut t h i s does not weigh h e a v i l y i n t h e t o t a l . 67. Our s t a r t i n g p o i n t i s t h e n e t out-payment from t h e Government a f t e r domestic borrowing. The income which t h i s represerlts f o r t h e r e s t of t h e economy i s thereTore n e t of t a x a t i o n and t h a t p a z t of t h e incomes and savings which have a c t u a l l y been charmeled t o the Government d i r e c t l y (small savings) o r i n d i r e c t l y v i a t h e c r e d i t system and -the bond market. - 1/ National Council f o r Applied Economic Research, "Savings i n India", Ne~rDelhi 1961. A c c o r d i n g l y , t h e s a v i n g s element i s l i m i t e d t o t h a t p a r t which i s used f o r p r i v a t e investu\ents;/ and an i n c r e a s e i n t h e c3Jrrency h o l d i n g s . Of t h e t o t a l o f t h i s s a v i n g a b o ~ i t2 3 p e r c e n t I . J ~ S i n t h e y e a r s 1957-55 t o 1962-63 i n t h e form o f i n c r e a s e d c u r r e n c y hoic'ing,s!/l, but n a r g l n a l l y t h e iricrease i n currency h o l d i n g s was mdch h l g n z r ; abour 59-63 p e r c e n t of t h e i n c r e a s e i n savin::s was i n t h i s form. .?e have asswaed t h a t a b o u t t w o - t h i r d s of t h e i z c r s a s e i n r ? i r a l s a v i n g s would be i n t h e form of c u r r e n c y h o l d i i i g s , and a b o u t 50 2 e r c e n t o f t h e urban s a v i n g s . 68. The e s t i m a t e s and a s s c m p t i o n s w e have made p e r m i t u s t o c a l c u l a t e t h e demand e f f e c t s of a n e t out-paynent from t h e Government t o t h e n o n - a g r i c u l - t u r a l s e c t o r . And t h i s i s an out-payment f o r t h e purchase o f domestic goods and s e r v i c e s a s t h e i m p o r t s f o r f i n a l u s e by t h e Government have a l r e a d y Seen ts deducted. The main r e s u l t s a r e given belobr. The t a b l e s h o ~ ~ h e e f f e c t of t h e out-payment from t h e Government o f R s . 1 b i l l i o n . Table 16 : C:;LcUumi) EFFECT' OF A NET OUT-PAD~E~TL~i?S . OF ? BILLION FROii ? H ; 'I LXlVERNtviENT ' 0 r NON -AGBI CULTU?Al, SSCTOR !Rs. b i l l i o n ) ~ ~ r i ct u l e r o t h e r S-e c t o r s u r T o t- a l -c r e a s e i n : In 1. lnco~nes- 2. Consuxption ( a ) Domestic p r o d u c t s based on a g r i c u l tureLd ( b ) O t h e r domes t i c p r 2 d u c t s (c) Imports 3. Savinzs 4. Znvestnents ( a ) D ~ m e s t i cp r o d u c t i o n ('01 Imports 5. Bet f i n a n c i a l s a v i n g s by t h e private sector - 0.28 0.38 - 6. !Jet out-payment by t h e Goverament 7. I n c r e a s e i n d e f i c i t i n balatice o f payments ( 6 - 5 ) equal t o i n c r e a s e i n imports (2c+4b) - /a For Governn~enti n v e s t n e n t , e x c l u s i v e of t h e f o r e i g n exchange compocent. - /b I n c l u d i n g a p i c u l t u r e - b a s e d manufacturing. - /C Producers' p r i c e s : e x c l u s i v e of margins f o r t r a d e and t r a n s p o r t ) . - /d Mar!<et p r i c e ( i n c l u d i n g margins f o r t r a d e and t r a n s p o r t and u n i d e n t i f i e d deliveries to agriculture). - 1/ D i r e c t l y o r v i a t h e c r e d i t system a s an i n t e r m e d i a r y . - 2/ Zeserve Bank of I n d i a B u l l e t i n , iglarch 1965: " E s t i m a t e s o f S a v i n g s and I n - v e s t a e n t s i n t h e I n d i a n Economy: 1950-51 t o 1962/63". The i n f l o w o f p r i v a t e s a v i n g s t o t h e Govern~nent i s based upon t h e Economic C l a s s i f i c a t i o n o f t h e Budget of t h e C e n t e r c o r r e c t e d f o r PL 480 t r a n s a c t i o n s . 69. The n e t out-payment from t h e Government of R s . 1 b i l l i o n r e p r e s e n t s i n i t i a l l y a correspondink i n c r e a s e S t h e incomes of t h e non- a l r i c u l t u r a l s e c t o r . T::enty percent or' t h i s incoce was saved (personal and --. corporate s a v i t h e )incomes,l f t h e r eh o r e , r e s u l t e d i n an f o r inves%ments. i\"lnety percent of n g s but h a of t e savings >rere used f additlorial demand, p a r t l y f o r a g r i c u l t u r a l products, p a r t l y f o r other domestic products and p a r t i y f o r imports. Arid i n c r e a s i n g incomes i n a g r i c u l t u r e r e s u l t e d i n a f u r t h e r expansion of t o t a l demand. A s a r e s u l t of the t r a n s a c t i o n s between them an incorne-demand c i r c l e i s c r e a t e d i n s i d e each of t h e t~lros e c t o r s . It i s t h e t o t a l of -these e f f e c t s which i s given i n Table 16. I n p r a c t i c e t'ne process !nay be brought t o a h a i t because bottlenec!ts and shortages a r e developing, r e s u l t i n g in !If orcedl' f i n a n c i a l savings, a d d i t i o n a l imports and a t a p e r h g o f f of t h e e f f e c t i v e doraestic demand. O r example sho:rs hori f a r .;he e f f e c t s r:oiiLd, in p r i n c i ~ l e ,go u under t h e asswnptions t h a t t h e a d d i t i o n a l demand Tor a g r i c u l t u r a l and akriculture-based products i s a c t u a i l y met by increased production. X l a r g e p a r t of a g r i c u l t u r e i s outside t h e nonetized sphere of t h e econoiny and rrould not p a r t i c i p a t e i n t h e process. This means t h a t t h e inpact be from t h e demand s i d e on t h e mone+,ized s e c t o r ~ j o ~ l d Inore s t r o n ~ l y e i tf than i f it :ras d i s t r i b u t e d over t h e t o t a l of a p i c u l t u r e . 70. A n a t i o n a l income m u l t i p l i e r of c l o s e t o 6.6 may sppear high. However, t h e outflow which r-ras t h e s t a r t i n g . point i s c e t a f t e r t h e a c t u a l "feedback': of t a x revenues has been deducted. factor i s t h e r e l a t i v e l y small aiinount of imports i n t h e f i n a l d e l i v e r i e s f o r p r i v a t e cons~mption. A i n c r e a s i n g demand would t o a l a r g e e x t e n t be a n demand f o r domestic resources. This may p a r t l y be due t o ir~lport r e s t r i c t i o n s . But whatever the reason, whether import r e g u l a t i o n s o r preTerences, t h e r e s u l t i s tha% a l o ~ r import content strengthens t h e expansionary e f f e c t s of a n e t out-payment from t h e Goverrment. Considering t h e s e two f a c t o r s , t h e c a l c u l a t e d efTect of a n e t out- payment ol" Rs. 1 b i l l i o n i s no+, s u r p l - i s i ~ l g l y a r g e . l 71. TaSle 16 shor~st h e c a i c u l a t e d e f f e c t of a n e t out-pxyaent from %he Govemient of R s . 1 b i l l i o n , but t h e n e t out-pajr,ents from t h e Go- . < e r n . ~ e ; ~have becn much l a r g e r , on average R s . 2.0 b i l l i o n per year i n i t h e f i v e y e a r s 1960-61 t o 196h-65. :~pplyi.ng t h e r e s u l t s of our c d c u l a t i o n on this annual average t:e f i n d t h a t t h e e f f ect.3 on t h e economy would be : (a) an expansion of t h e demand f o r a g r i c u l t u r a l products by 1 0 percent. (b) an increase i n t h e demand f o r other domestic production of consumer goods by 12 percent. (c) an i n c r e a s e i n p r i v a t e investment demand by 15 percent. (d) an increase i n t h e demand on domestic r e s o m c e s by 1 2 p e r c e i ~ t . (e) an i n c r e a s e i n t h e demand of imports f o r p r i v a t e use in r e l a t i o n t o t o t a l imports by 9 percent. 72. , These a r c t h e e f f e c t s i n r e l a t i o n t o t h e t h e o r e t i c a l level-1' of incomes and deixand ir, a s i t u a t i o n with no ne.t out-payment from t h s C-overnaent t o t h e dales-tic econorny. Tiler represent t h e annual average f o r a period of Tive yeai-s; i n sone ;rears t h e e;.qansio::ary i.qjazt has been much stron2e-r. But t h e example s h o t ~ st h e eff'ec-Ls under t h e assumption or" se'if-sufficiency i n a g r i c u l t u r a l p?oducts, wl-Lle t h i s llss not been t h e case during t h e gerlods under conslderatiorl. There have been s u b s t a n t i a l ir[,ports of food, and t h e lagging a g r i c u l t u r a l p r oauction has r e s u l t e d i n a riluch lower income l e v e l I n a g r i c u l t u r e thzn would have been t h e case if t h e farmers had been a b l e t o m e t t h e domestlc dzmand f o r a g r i c u l t u r a l coiimodities. Purchase of i;:,ported food by t h e urban population has r e s u l t z d i n an inflow of eoney t o t h e ~overrJrentZ/ I i s t e a d or' incomes f o r a g r i c u l t u r e . The income-c'enand c i r c l e which would be e f f e c t i v e with s e x - s u f f i c i e n c y i n a g r i c u l t u r a l co,modities has p a r t l ; been broken. ' . 9 t h self-sufficie:~c;r i n a g r i c u l t a r e t h e budgetar-y policy would have crzated an a d d i t i o n a l demand f o r a g r i c u l t u r a l c o m o d i t i e s ( a t producers1 p r i c e s ) of about R s . 8 b i l l i o n a s an annual average, and a corresponding increase I n t h e incoines of t h e farmers. But this il-icone d i d not m a t e r i a l i z e because a g r i c u l t u r e could not meet t h e le~nand, and shortagas and ilglationar-y pressures were t o a l a r g e extent avoided throagh PL 480 i r q o r t s . These irfiports a , l o u ~ t e d o R s . l c 6 b i l l i o n per t year and r:e iiia:? consider t h i s a s t h e gap t h a t a g r i c u l t u r e could not xeet a t t h e generally lamer l e v e l of incomes anc': denla11d t h a t t h e depressed situation i n agriculture led to. The t a b l e be1071 nhovs t h e ei'fezts of budgetary policy i n two a l t e r n a t i v e s ; when a g r i c u l t u r e Is a b l e t o m e t t h e increasing denand, and, when shortcoi?iings i n a g r i c u l t u r e a r e ne-L i~jr iirc3orts of food. The c a l c u l a t i o n r e f e r s a s before t o t h e atrerase f o r t h e y e a r s 1960-61 t o 196b.-65 and t h e average PL 480 i n i p o r t s / a r e taken t,o represent t h e a c t u a l gap i.n do::;estic production and danand f o r a g r i c u l t u r a l products, -/ 1 e '93;~f f e c t s a r e r e l a t e d t o %he n a t i o n a l income f l z u r e s froiil #'The Notes on Perspective Develop!;:ent I n d i a 1960-81 t o 1975-'76'', Planr,ing Commission. The average f o r 1960-61 and t h e 1965-66 e s t i ~ l i a t ehas been used, t h e t h e o r e t i c a l e f f e c t s have been deducted, and t h e e f f e c t s i n percent i s rieasured a g a i n s t t'ds lower Level. - 2/ T h i s i s discussed i n inore d e t a i l i n Appens-x I: of Counterpart F u d s . The Inflow and Use - 3/ I n the c a l c u l a t i o n we use i n f a c t t h e inflor.~of ?L 480 counterpart funds t o the Goverment and not t h e imports. The reason i s t h a t p a r t of t h e counterpart funds a r e used by t h s U.S.A. a u t h o r i t i e s i n India, and this has an expansionary e f f e c t , by using t h e net i n f l o u t o t h e Governlent instead of t h e iiilg0r-Ls ile c o r r e c t f o r t h i s .  Table 17: EFFECTS O B D E A Y POLICY UNDER ALTERNATIVE F U GT R ASSUMPTIONS WITH RESPXCT TO AGRICULTURE - O AERAGF: F R 1960-61 t o 196b-65 Alternative I Alternative I1 With Self- L With P 480 Imports sufficiency Suppl.einenting Lagging i n Agriculture Domestic Production Total Dellland on Domestic Resources 12.4 L -. Demad f o r Domestic Agricultural Products Demand f o r other Domestic Products For Private Consumption For Private and Government Investment Imports f o r Private Use /a - 11.0 - 23.2,'b /a Increase i n imports f o r private use in percent of t o t a l imports, -- Including PL 480 imports. 73 The f i s c a l policy has been expansionary, b u t t h e demand e f f e c t s have been greatly weakened by P 480 imports. IIIuch stronger demand L pressures would have developed i f the money paid by the urban population f o r imported food had been cash incoms f o r the farmers. 74- The budgetary policy has created an estknated a d d i t i o ~ ~ demandal on domestic resources of 4.5 ~ e r c e n t annually. But there has also been a c r e d i t expansicn through net lending from the Reserve Bank of India t o the commercial banks and the S t a t e Caoperative Banks. This net lending arnounted t o an annual average of Rs. 260 million compared with a n ~ out- t payment f r o m t h e Governmnt of Rs. 2.8 b i l l i o n . The r e s u l t of our analyses, therefore, is not g r e a t l y modified by the demand e f f e c t s of the c r e d i t expansion. According t o our calculation the combined demand e f f e c t s of f i s c a l and c r e d i t policy in India has been a s shor.;n belm.  Percentage Increase i n Demand. t o F-hcal and Credit Policy 2= - Denand on domestic resources 5.4 Agriculture Other domestic production For private consumption 6Q9 For Investment, Government and Private, /b 18,L Imports f o r private use& 809 - /a O the b a s i s of assumptions implied 5 Alternative I1 in Table 17 n a but inclusive of the impact of c r e d i t expansion, - /b . In percent of gross investments minus calculated iniports f o r i r x e s tment s - /c Exclusive of PL J480; i n percent of other imports fo? private use, The t o t a l additional demand on domestic resources - created by the expansionary f i s c a l and c r e d i t policy - arnounts t o 5.4 percent a s a n annual average f o r the period under consideration. This is the additiorlai demand created by the n e t out-payment of the Government and t h e Reserve Bank t o the private sector, including the demmd e f f e c t s of the induced income generation on t h e supply side. It should be observed t h a t the percentages given above are not r a t e s of growth of demaad, They represent the upward s h i f t i n demand a t t r i b u t a b l e t o f i s c a l and credit policy and as an average f o r the f i v e years under consideration, They iindicate the share in t o t a l observed demand t h a t - accord-hg t o our calculation - is the r e s u l t of an expansionary f i s cal and credit policy. I n other wcrds, it i s an additional demand compa~edwith a s i t u a t i o n with no net out- paymmt from the Goverment and the Reserve Bank. The n e t out-payrr~nt from the G o v e r m n t i s assumed t o be a net out-payment t o the non- a g r i c u l t u r a l sectors f o r Govexll~&n.tinvestments and investment financ-hg. Other f a c t o r s such as increasirlg export earnings have a l s o contributed t o an increase i n domestic demand; w have considersd the e f f e c t s ~ n l y e of f i s c a l and c r e d i t policy. 75 The impact of the expansionary policy on the demand f o r agri- c u l t u r a l products is low, only 2 percent, but t h i s is due t o the PL 480 imports. The expansionary effects, both on agriculture and other sectors, would have been much stronger i f the amounts paid by the consumers f o r imported food had been incomes f o r agriculture i n India. Considering t h a t there has been v i r t u a l l y no increase i n a g r i c u l t u r a l output, a 2.3 percent annual increase in the population, t h a t t h e narketable supply constitutes only p a r t of t c t a l production, and t h a t the demand supply s i t u a t i o n has varied f o r d i f f e r e n t products in d i f f e r e n t years, t h i s should not be inconsistent with the price increases which have actually occurred. 76. The a d d i t i o n a l demnd f o r domestic products of non-agricultural o r i g i n was 9.1 percent, and hrith a s t r o n g concentration on investment goods : 18.4 percent compared with 6,9 percent of consumer goods. Our -- c a l c u l a t i o n is i n monetary term and would per s e n o t indicate the e f f e c t s on t h e one hand on production, on the other hand on p r i c e clevelopme~ts. The analysis is l i m i t e d t o the demnd side, and the problems r e l a t e d t o an expansionary policy, economic growth and p r i c e s t a b i l i t y a r e contro- versial. There are d i f f e r e n t schools of thought. It has been a ~ g u e d t h a t economic growth could take place and s u s t a i n i t s e l f without any fcrce- f u l pressures from an a d d i t i o n a l demand created by economic policy, in- creasing exports, etc. The incomes generated through increasing produc- t i o n would provide t h e required demancl, and i t might be s u f f i c i e n t t o i n s u r e an increase i n money supply i n accordance with t h e needs of an ex- panding economy, and t o counterbalance tendencFes towards over-expansion o r recession through moderate and marginal measures. This argument r e s t s l a r g e l y upon t h e assumptions of a f r e e market economy under p e r f e c t competition. Today i t is a q u i t e widely held view t h a t an a d d i t i o n a l demand created by an expansionary policy o f t e n may be a p r e r e q u i s i t e f o r t h e achievement of a s a t i s f a c t o r y growth, e s p e c i a l l y i n an economy with i d l e resources and a t r a d i t i o n a l l y oriented supply side. Balance of payments d i f f i c u l t i e s may a r i s e , and one of t h e purposes of foreign a s s i s t a n c e is t o meet these problems. Some schools of thought would go f u r t h e r and advocate t h a t o v e r a l l demand should be somewhat ahead of the productive capacity i n order t o give the s u f f i c i e n t incentives f o r an expansion of production. The daager i s of course t h a t i n t t i a l l y modest p r i c e increases might r e l e a s e secondary cost-induced p r i c e i ~ c r e a s e s , r e s u l t i n g i n a weakening of t h e competitive position, and t h a t d i r e c t regulations may c r e a t e anomalies and d i f f i c u l t i e s on t h e production side, 77. The d i f f e r e n t l i n e s of argument a r e based upon d i f f e r e n t assumptions with respect t o t h e production side, how i t would respond in the absence of an a d d i t i o n a l demnd compared with a s i t u a t i o n where some pressures from the demand s i d e are present. The s i t u a t i o n may not be t h e same i n an advanced economy with a high degree of f l e x i b i l i t y and competition and i n a developing country; a more f o r c e f u l drive from t h e demand s i d e may be required i n order t o c r e a t e the climate f o r economic growth. 780 Economic policy i n India has r e s u l t e d i n a q u i t e strong addi- t i o n a l demand f o r non-agricultural consumer goods ( 0.9 percent) and although the f i g u r e s are n o t comparable - it i s i n t e r e s t i n g t o observe t h a t the annual grcwth of the production i n t h i s s e c t o r has, during the f i r s t f o u r years of t h e considered period, been of t h e same order of magnitude (some- what lower). But the calculated a d d i t i o n a l demand f o r investment goods antounted t o 18 percent, while t h e growth I t h i s f i e l d was 12-1b percent, n It i s d i f f i c u l t t o believe t h a t these growth r a t e s could have been achieved if t h e economic policy had not created some a d d i t i o n a l demand, It could however a l s o be argued t h a t a somewhat l e s s expansionary policy than was a c t u a l l y pursued might have r e s u l t e d in a stronger expansion of production. The reason i s t h a t shortages, pressures and r i s i n g p r i c e s have developed, and t h e a u t h o r i t i e s have t o an increasing degree had t o r e l y upon physical controls. P r i o r i t y has been given t o investments both in the a l l o c a t i o n of f o r e i g n exchange and in t h e domestic licensing. The s c a r c i t i e s have p a r t l y been t r a n s f e r r e d t o t h e suyplies needed f o r the current production, andhave in many cases r e s u l t e d in u n d e r u t i l i z a t i o n of e x i s t i n g capacity, a l s o in the investment producing industries. And in the e::panding sec- t o r s t h e r e is an interdependency on the production s i d e , Shor%ages and delays i n one f i e l d would often a f f e c t t h e developinent in other f i e l d s ; t h e r e a r e m11.ltiplier e f f e c t s a l s o in bottlenecks. l'he autllori t i e s ha\-e been faced iqith t h e increasingly d i f f i c u l t t a s k of allocat-ing f o r e l g n exchange be tween a multitude of competing purposes and projects, while the i n p a c t throngh complex i n t e r - i n d u s t r i a l r e l a t i o n s h i p s are f a r f r o n clea?. It could be argued that; a lower demand might remove some cf these obstacles on the production side, and thereby r e s u l t in a gain of produc- tion. En problem i s how f a r it would be necessary t o go, and which e f f e c t s w o n l d in the f i n a l outcome be t h e strongest : t2.e negative e f f e c t s of a gene^-31 redustion of demand and t h e p o s i t i v e e f f e c t s of a more e f f i c i e n t u t i l i z a t i o n of e x i s t i n g c a p c i t y in some f i e l d s o f production, 79. O u r analysis has been concerned ma~h'lywith the demmd side, and our calculations r e s t upon estimates and assumpticns which are n e c e s s a r i l y uncertain. They should be considered more a s i l l u s t r a t i v e examplss t h u l as r e l i a b l e estimates. Eut charges i n t h e basic assumptions do n o t appear t o modify the general p i c t u r e very greatly; t h i s i s discussed i n Appendix 1 . 1 80. The general economic s i t u a t i o n could not be explained only by the budgetary policy. The e f f i c i e n c y in p r o j e c t selection, im?iemeiltation a i c l operation is a s important f o r the supply s i d e a s the budgetary policy f o r the demand side, and t h e two should preferably meet. I n India they have not, and it could be discussed whether t h i s should be a t t r i b u t e d t o d e f i - ciencies on the development and organizaticn of the supply side, o r a t c o expansionary p o l i c y in general. Regardless of t h i s , the r e s u l t has been an increasing r e l i a n c e on physical controls. Controls cannot remo.ve im- balances; they can a t best minimize t h e i r negative e f f e c t s , but may a l s o lead t o disorganization and i n e f f i c i e n c y on the supply side. The inbalances could be a t t r i b u t e d t o the demand side, and t h e b ~ d g e ti s the main f a c t o r on t h e demand side. This r a i s e s t h e question whether budgetary policy has been too expansionary or not. W w i l l r e t u r n t o t h i s i n Chapter I X , cot- e cluding remarks.  VII, - A NOTE ON TAXATION AND THE BALANCE OF PAYMENTS 81. One implication of our analysis i s t h a t the l e v e l cf taxation has t o be increased quite s t r o n g l y in order t o achieve a signLficarit sav- ings of foreign exchange, Thus, the t a x - reven-~es . - had 50 be increased by ab0u.t Rs. 3.2 b i l l i o n i n order t o obtain a saving of foreign exchange of Rs. 1 biliio&; - t h e a d d i t i o n a l taxation would hare t o be of the o r d e r of 9s. 5 b i l l i o n because of t h e l o s s in t a x revenues through f a l l i i l g p r i v a t e incornes. Bie l e v e l of t a x a t i o n had t o be increased by 25 percent compared with what i t i s a t present. Overall domestic demand had t o be decreased by 12-14 percent in order t o achieve a savings of i m ~ o r t sof Rs. 1 b i l l i o n . The reason is t h a t the import content ~ZI the prtvate demand i s low, and general measures f o r the purpose of saving f c r e i g n exchange had, therefore, t o go q u i t e f a r , r e s u l t i n g in a strong reduction i n domestic demand. - - - - - - - - - -- - 1/ See Tables I1 a d I11 of Appendix 11.  VIII . AC-RICTJLTTSRAL DEVEL0R:ZlLTT AID FISCAL POLICY _I----- 82. This c h a p t e r d i s c u s s e s tvso problenis r e l a t i n g t o 1"Lscil p o l i c y and a g r i c u l t u r e . The first i s h o i ~ i s c a l p o l i c y may contrlbilte t o a f c o r r e c t i o n of an e x i s t i n g imbal.ance between a g r i c u l t u r a l production and t h e development of t h e rest of the ecor,omy. The second i s t h e implica,tions f o r f i s c a l p o l i c y or" a more r a p i d groxth of a g r i c i l l t u r e ~ 5 t h s u b s t i t u t i o n a of food imports by domestic production. 83. According t o o w a n a l y s i s , a c e t out-2aynent from t h e Govermle~lt t o t h e n o n - a g r i c u l t u r a l s e c t o r i s liltc-ly t o resul-L i i n a r e l a t i v e l y s t r o n g demand f o r agricultural prcducts both from t h e urban s e c t o r s and x i t h i n a g r i c u l t u r e i 5 s e l f . This rrouid be t h e case when t h e income e<i'ec+,s a r e dLstributed r e l a t i v e l y even r 6 t i l i n a g 9 . c u i t u r e and n o t absorbecl i n e x t r a - o r d i n a r i l y high p r o f i t s and nionetary savings by partied-ar g o u p s , a s may be t h e c a s e i n t h e s h o r t run. 8.4 According t o some i n t e r p r e t a t i o n s of ingut-output s t u d i e s t h e r e should be a r e l a t i v e l y s n a i l degree of dependency betxeeer, a g r i c u l t u r e (includi.lig agriculture-based a c t i v i t y ) and otlier s e c t o r s frox t h e production s i d e . It should be t e c h n i c a l l y p o s s i b l e t o expand $he non- a g r i c u l t u r a l production with no, o r only l i m i t e d use, of' a g r i c u l t u r e - based products a s i n p u t s i n tile prodilction of o t h e r goods. From t h i s t h e conclusion has been d r a m t h a t a r a p i d i n d u s t r i a l i z a t i o n could be undertaken r.rithout any conpara'u1.e expansion of a 5 r i c u l t i x e . But t h e c o n s i d e r a t i o n i s based only upon t h e r e l a t i o n s h i p s on t h e s ~ 2 p l y i d e , s x h i l e t h e r e may be a s t r o n g dependence from t h e danand s i d e . Fxparislon employment and inconmes rrould i n c r e a s e of n o n - a g r i c u l t u r a l p r o d - ~ ~ c t i o n , t h e urban population1s demand f o r food and f ribe~-s. It may i n p r i n c i p l e be p o s s i b l e t o expafid t h e n o n - e g r i c u l t u r a l production nore o r l e s s independently of t h e supply of a g r i c u l t u r a l cormoditLes, b ~ t f t h e i a g r i c u l t u r a l producLion i s lagging, shor'cages would develop o r - t h i s had t o be p r e m n t e d by f i s c a l measures. The purpose r.:ould be t o keep t h e groving d e m d w i t h i n t h e limits of a more slo~11yexpanding a g r i c u l t u r a l production. B u t t o keep back t h e demand f o r food and f i b e r s i n an e x p a d - i n g 1c.v-j-ncome economy i s a d i f f i c u l t -task; it micht mean t h a t t h e r e a l brage r a t e ( a f t e r t a x e s ) i n 'che expanding s e c t o r s sllould be reduced a s er;!plojment i s i n c r e a s l h ~ . , balanced growth bet:;een the .two s e c t o r s i s 2 obviously a more d e s i r a b l e s o l u t i o n . This problem i s discussed bjr D r . 2. Goreux i n Appendix 111 t o t h e A g r i c l ~ l t u r a lReport of t h i s Iiission: implications of A l t e r n a t i v e Rates of A g r i c u l t u r a l Groirth on t h e I n d i a n Economic De~elo~mC?nt. Goreux shor:s t h e conbination of g o ~ ? t h a k s f o r f1 r be a k r i c u l t u r a l conmodities and o t h e r commodities crlfich ~ o u l d r e q u i r e d i n o r d e r t o meet an expanding demand. Ye have shorn t h e demarid e f f e c t s of an expansion of t h e non-agricultural, s e c t o r c r e a t e d by t h e budgetary policy, and t h e r e s u l t s a r e t h e same.;/ -/ I. - Goreuxls c a l c u l a t i o n r e f e r s only t o comriiodities, trhile s e r v i c e s a r e i n - eluded i n t h e d a t a we have used. LWrthermo~le,t h e production by "other s e c t o r s f 1 i n our c a l c u l a t i o n i n c l u d e s a l s o t h e production f o r Government investment. Correcting f o r t h i s , t h e results should be i d e n t i c a l 13th r e s p e c t t o t h e p a t h of expansion r e q c i r e d f o r s a t i s f y k g consumersl demand. 85 l An imbalance created by lagging a ~ r i c u l t u r a product.ion nay r e s u l t i n an i.!liprovwr,ent of -i;he terr,ls of t r a d e of a g r i c u l t u r e , i .e., an i n c r e a s e i n t h e p r i c e s of a g r l c u l t - x a l products I n r e l a t i o n t o other p r i c e s . The r e s i l l t would be a slower groxth af tile r e a l incones i n the non-agricultural s e c t o r s and a stronger Incentive f o r increased ~ ~ r o d u c t i o n i n a g r i c u l t u r e ; t h e imbalance may t o some e x t e c t bc corrected. A change i n t h e income d i s t r i b u t i o n i n favor of a g ~ i c u l t u r emay g i v e i n c e n t i v e s ?or increased production, but only p a r t of t h e i ~ z r e a s e ouL3 be ~ ~ r l t a t e d w . The reason i s t h a t i n c r e a s i n g i ~ c c m e si n a g r i c u l t u r e would r e s u l t i n increased consumption within a g r i c u l t u r e , and only t o a limited exteilt t h e a a r k e t ed supply. Increased t a x a t i o n of a z r i c u l t u r e concurrently v i t h improved t e r a s of t r a d e f o r t h a t s e c t o r inay represent a solutioil t o t h i s dileiilina. A l a r g e r share of t h e crop would have t o 3 e marketed i n order t o provide cash f o r t h e t a x payments. It .should a l s o 5e r e c a l l e d t h a t a,ricul.tural t a x a t i o n i n I n d i a i s low, and t h a t higher taxa-Lion of t h e ini6dl.e and u p p r income groups i n a g r i c u l t u r e , a l s o froin t h i s p o i n t or" v i e t ~ , seems j u s t i f i e d . 84. The c r u c i a l assumption 3ehind %he point of vi..ew presented above i s t h a t only half of an i n c r e a s z i n t h e production of a g r i c u l t u r a l cor~nod- i t i e s would be exported t o t h e urban markets, while t h e other h a U Is consunled by -the a g r i c u l t u r a l population. T E s i s a g e n e r a l i z a t i o n based ugon t h e consumption p a t t e r n of households a t dzf e r e n t income l e v e l s . But m a y s p e c i f i c schemes may r e s u l t i n a much higher productlo11 f o r t h e market. The other s i d e 05 t h e general a s s u m ~ t l o ni s t h a t increasing i n - comes i r , e g r i c u l t u r e would not be l i k e l y t o r e s u l t i n substan5i21 monetary savings. Increased t a x a t i o n oZ a g r i c u l t u r e would be a s u b s t i t u t e f o r t h e l a t t e r and n e c e s s i t a t e l a r g e r s a l e s t o t h e market. 87. It could be arzued t h a t highe:. food p r i c e s and h i z h e r incornes i11 w a g r i c u l t u r e ~o!~lbined i t h increased t a x a t i o n of a g r i c u l t u r e i n t h e f i n a l a n a l y s i s i s veqr s i m i l a r to, e.g., a s a l e s t a x on a g r i c u l t u r a l products. I n s m e r e s p e c t s this i s c o r r e c t . The d i f f e r e n c e l i e s i n t h e ir;.~:chanlsm with r e s p e c t t o t h e mrlteted suppLy. A s a l e s t a x rlould be levied only on what i s actualllr marketed. Taxation of a g r i c u l t u r e Inacpendent1,y ei" t h i s su~ply would require s a l e s t o t h e r41arkct, a l s o b r those who otherwise would not bs i n c l i n e d t o do so, and increased s a l e s 5j other. This m: add up ay t o a s u b s t a n t i a l difference. 88. The second p r o b l a , ~ s how a successful development 0," a g r i c u l - i t u r a l production d ~ h atf f e c t t h s r e s t of t h e economy. 'ire have already demonstrated t h a t t h e present s l t u a t i a n with lagging a g r i c u l t u r a l production and imports of food has dampened t h e e f f e c t s of an e?ansiona=.y budgetary policy. I-art oi' t h e a d d i t i o n a l demand has Seen met by i i ~ p o r t e da g r i c u l - t u r a l products, and t h e expansion 91hich would t a k e ?lace when a g r i c u l t u r e i s a b l e t o meet t h e demand has not rliaterlalized. Bul; s e E - s u f f i c i e n c y i n a g r i c u l t u r a l products i s z t a r g e t f o r the, ecmomic policy i n I n d i a . This would ,wan i;nproved standards of l i v i n & and higher cash incarnes f o r t h e - 1/ The e x t e n t t o which inproved p r o d u c t i v i t y i r L a g r i c u l t u r e would i ~ l c r c a s e t h e r e a l incoines i n a g r i c u l t u r e depends a l s o upon t h e r e l a t i v e p r i c e s between a g r i c u l t u r a l producbs and other products. biith a d e t e r i o r a t i o n of t h e terms of t r a d e of a g r i c u l t u r e , p a r t of t h e gains taould be t r a n s - f e r r e d t o t h e urban population and i n c r e a s e t h e i r aernznd ( i n r e a l t e r n s ) , , r u r a l population, and consequently also a higher demand f o r goods and services. The difference between a l t e r n a t i v e I1 and I given in .Table 17 could with some reservations be taken as an indicator of the expansion of demand t h a t would accompany an i creasing self-sufficiency i n a g r i c u l t u r a l 17 products. The main reservation, is t h a t the food imports are a t present a t a much higher l e v e l than the average of Rs. 1.6 b i l l i o n f o r the period covered by our calculation, For 1965-66 the PL, 480 imports are i n f a c t estimated a t Rs. 3.3 billlon. O the other hand, the automatism i n the tax n system would be a brake on the expansion. Government revenues correspond.ilng t o 5 percent of an increase in a g r i c u l t u r a l incomes and 15 percent of the increase i n other incomes woilld reduce ihe expansion of t o t a l demand on domestic resources by 38 percent. The t r a n s i t i o n t o self-sufficiency would nevertheless have more strongly expansionary e f f e c t s than indicated in our previous example. Taking the demand e f f e c t s i n t o account the substitution of 3s. 1 b i l l i o n of imported food would - - according t o our example require an increase in the domestic production of food by close t o Rs. 3 b i l l i o n . The difference i s due t o the induced demand. The farmers are i n i t i a l l y earning R s , 1 b i l l i o n more, and t h i s increases the demand both f o r agri- c u l t u r a l products and other products, resulting ' f u r t h e r expansion of n i incomes and demand. The need f o r focd imports would be reduced by only one-third of the increased production i n agriculture, as two-thirds would be needed t o meet the induced demand. A t the same time there nould a l s o be an increase i n the demand f o r non-agricultural products., 2/ - 1/ lie have a l s o neglected on the one hand the possible need f o r higher current inputs i n agriculture, end on the other hmd the increase i n agriculture-based exports t o which a general improvement of the produc- t i v i t y i n agriculture may lead. - 2/ Cf . Table 18. Table 18: O i L C U L A E D EFFECTS OF F SUBSTLTTJ'IZON O RS. 1 BILLION I N F O II.IPORTS BY DCi-ZSTIC PROljUCTlOId CD (Rs. b i l l i o n ) -- -.--..-..----..--w, Agricul- Other Total - ture /a Sectxs -- 1. Factor incane 2.95 1.66 14.61 2. /b Taxes- 0.15; 0.25 0.40 3. Disposable income 2.80 1 A1 b.21 . C onsurnpt ion 2-39 1.1.3 3 -52 a ) Domestic products, based on a z r i c u l t c r e /C 1 .UL 1.5'1 2.55 b ) 3 t h e r dornestic products 0.88 c.56 1.kh c ) ?L 485 k l p c r t - -1.20 -1.GO d ? Other i v o r t s 9.07 0.06 C.12 5. savings u.hl 0.28 3.69 6 , ~nvestment 0.13 G.1~ 0.27 a) Co~iesticproducts 0.12 0.10 0.22 'oj Imports 0.01 0.C4 0.05 7. Net f i n a n c i a l savings by t h e private sector (3.23 C.lk 0 .k2 8. N e t f i n a n c i a l savings by t h e Government - 9. Decrease i n d e f i c i t i n t h e balance of' payments equal t o decrease i n imports& - - 3.82 /a Including a;:riculture-based nanurnacturing . - Assumption: 5 percent ~f an i n c r e a s e i n a g r i c u l t u r e incomes, and 15 ;,orcent or" an i n c r e a s e i n o t h e r incimes. /c ~t prbducersf p r i c e s . - Imports and f o ~ e i y nexchange: ~eciu.ctionof PL ! r 8 ~i q o ~ t s k c ) ( 1.00 I n c r e a s e i n other ii~iports 0.18 Net reduction of i:;ports 0.82 Loss of f o r e i z n e:achange 0.18 89. The s u b s t i t u t i o n of t h e present l e v e l of food -imports would r e q u i r e an i n c r e a s e i n t h e a g r i c u l t u r a l production by 1b-17 percent in order t o meet a l s o t h e induced demaad f o r a g r i c u l % u r a l products. And t h e r e would be no savings of f o r e i g n exchange. The P i & n ~ o r t shave i I ! not been paid i n f o r e i g n exchange, and t h e expansionary e f f e c t s would i n c r e a s e t h e demand f o r other imports, i n our example by 1 3 percent of t h e reduction i n K L80 imports. A 1 1 i n a l l , t h e r e would be an expansion of domestic demand and a d e t e r i o r a t i o n of t h e exchanze s i t u a t i o n . The t o t a l s i t u a t i o n rnay t h e r e f o r e be such t h a t measures o f f s e t t i n g some of t h e a d d i t i o n a l demand on a g r i c u l t u r e has $0 be found. Taxation of a g r i c u l t u r e l / i s one a i t e r n a t i v e , t a x a t i o n of o t h e r groups, another a l t e r n a t i v e . For i l l u s t r a t f o n , we asswile t h a t taxation has t o o f f s e t t h e whole of t h e llsecondaryu demand f o r agricultural products r e s u l t i n g from a s u b s t i t u t i o n of imports of such products. The implication f o r t a x a t i o n i s given below. The required addit,ional t a x a t i o n i s expressed a l s o a s a percentage of t h e main c a t e g o r i e s of t a x e s i n t h e Budget 196b-65; t h i s r e f e r s t o $he revenues o. S t a t e s andf Center combined u n l e s s o t h e r ~ ~ s tea t e d . - BJ t a x reduce oft h e grrei cau lincome and purchasingcontext ofa xhaet i o n t h a t 1/ would ation a l t u r e we mean i n t h i s power t t population i n agriculture. I n p r a c t i c e i t i s o f t e n d i f f i c u l t t o decide who i s c a r r y i n g t h e burden of an a d d i t i o n a l tax; an e x c i s e duty may r e s u l t i n reduced income f o r t h e producers, o r i t may be passed on t o t h e buyers through higher p r i c e s , t h i s brould d e p e ~ dupon t h e market conditions and t h e competitive p o s i t i o n . I n other cases (land taxes, income t a x e s ) it i s more c l e a r who i s carrying t h e burdea; t h e s e t a x e s a r e not l i k e l y t o be s h i f t e d over on other groups. O r u d i s t i n c t i o n i s i n p r i n c i p l e based upon which type o f r e a l income would be a f f e c t e d , and not upon how t h e taxes a r e l e v i e d o r Srom whom they a r e collected. Table 19 : WQUIr7,ZD ADDITIOLUZsTAXATION I N ORDER TO OFFSET W INDUCED D M N . E E AD FOB AGRICULTURAL PLZODTlCTS BY A SUBSTLTUTIOjll OF THE PRESENT IEIPOitTS iZeauired a d d i t i o n a l t a x a t i o n T a x a t i o n of Tax revenaes -- a.qricu1t u r e Other taxation bndget , 1964/65 Required a d d i t i o n a l t a u a t i o n , 2s. b i l l i o n 3.2 I n c r e a s e i n t a x revenues 2s. b i l l i o n 1.7 2.3 -- percent 2s. b i l l i o n Required a d d i t i o n a l t a x a t i o n i n percer.t o f : Land revenue an2 a g r i c u l t l ~ r a l irrcone t a x 240.0 Personal income t a x I n d i r e c t taxes - 22.4 17.00 T o t a l t a x revenue of Center 22.0 26. S 14-50 Total t a x revenues, Center and S t a t e s 13.3 90. Offoet of t h e a d d i t i o n a l demand on a g r i c u l t u r a l p r o d u c t s i n - duced by a s u b s t i t u t i o i l o f food i m p o r t s by domestic p r o d u c t i o n , vould re- quire a d d i t i o n a l t a x a t i o n c o r r e s p o n d i n g t o 13-16 p e r c e n t of t h e p r e s e n t t o t a l t a x revenues. I f t h e t a s k f a l l s upon t h e C e n t e r , i t s rcvenucs xust be r a i s e d by 22-27 p e r c e n t . Land t a x a t i o n i s low, l a n d revenues and the a g r i c u l t u r a l income t a x amount t o R s . 1.3 b i l l i o n compared w i t h a n a t i ~ n a lincome i n a g r i c u l t a r e of about 'is. 80 b i l l i o n ; t h i s g i v e s a " t a x r a t e " of 1.7 p e r c e n t . This t a x a t i o n h a s t o be more t h a n i r i p l e d ( + 240 p e r c e n t ) i n o r d e r t o a c h i e v e t h e t a r g e i ; i f t h e o r d i n a r y income t a x were chosen i t h a s t o be a o r e t h a n doubled ( + 152 p e r c e n t ) . The n e t i n c r e a s e i n i a x revenues ( c f . l i n e nunlber 2 i n Table 19) has i n both a l t e r n a t i v e s t o be used f o r a s t r e n g t h e n i n g of t h e b a l a n c e of t h e b u d g e t , and n o t f o r a d d i t i o n a l e x p e n d i t u r e s . 91. Taxat.ion of a g r i c u l t u r e i s more e f f i c i e n t t h a n o t h e r t y p e s of taxatkon, i n t h e s e n s e t h a t a s a a l l e r amount of a d d i t i o n a l t a x a t i o n bnu?d be r e q u i r e d . I t should be observed h o ~ e v e rt h a t t h e a d d i t i o n a l t a x a t i o n i n both a l t e r n a t i v e s i s assumed t o be v e r y g e n e r a l i n t h e s e n s e t h a t i t a f f e c t s t h e demand i n t h e saine way a s rcould any o t h e r change i n t h e g e n e r a l income l e v e l ; t h e purpose was t o meet t h e t e n d e n c i e s towards a t o o h i g h demand c r e a t e d by an expansion of a g r i c u l t u r a l p r o d u c t i o n . The t a x a t i o n i s - i n our example - not selective with r e s p e c t t o a g r i c u l t u r a l goods. Thus, t h e farmers wouid f i n a n c e t h e t a x e s by r e d u c i n g t h e i r demand b o t h f o r a ~ r i c u l t u r a lgoods and o t h e r goods, which might be d e s i r a b l e a s t h e expansionary e f f e c t s would make themselves f e l t i n both f i e l d s . A s e l e c t i v e t a x a t i o n may r e s u l t i n a d d i t i o n a l production f o r t h e market, e x c l u s i v e l y f o r t h e purpose of r a i s i n g money f o r t a x e s ; however, i t i s a d i f f e r e n t problem w e have been d i s c u s s i n g above. 92 Our example emphasizes t h a t t h e t r a n s i t i o n t o self-sufficiency i n a g r i c u l t u r a l products may reqilire a substanf,iai i c c r e a s e i n taxation. This i s under t h e asslm,ption t h a t t h e t o t a l demand f o r a g r i c u l t u r a l products should not be increased a s a consecpence of t h e i r q o r t s u b s t i t u t i o n , and this may be an unnecessajcg' s t r i c t condition. Eoi:ever, i n t h e absence of new taxation, t h e l e v e i of a g r i c u l t u r a l production had t o be r a i s e d by about 15 percent and other f a c t o r s (grotrth of gopulatiog, P t h e general income l e v e l ) may require a f u r t h e r expansion, t h i s depends q o n t h e timing of the import s u b s t i t u t i o n . A stronger growth i n a g r i c u l t u r e may ease the s i t u a t i o n i n t h e market f o r agrlcult,ural commodities, and remove one c o n s t r a i n t on the & ? ~ ~of tdemand. Eut t h e ~ h demand e f f e c t s would a l s o make themselves f e l t f o r other commodities. Accordingly, increased t a x a t i o n may be required i n order t o balance t h e o v e r a l l s i t u a t i o n , while the p o t e n t i a l f o r a f a s t e r growth i n a g r i c u l t u r e rrould have t o be geared toward exports. The s p e c i f i c motivation f o r increased t a x a t i o n tiould be d i f f e r e n t , but t h e ~ e n e r a l purpose 5:ould be t h e same: t o balance ehe o v e r a l l s i t u a t i o n i n t h e domestic mar!:e+us and ease t h e pressures against t h e balance of ~ a p e r : t s . 93 . It may a t f i r s t s i g h t appear s l i g h t l y odd thaL a g r i c u l t u r a l production should require a more r e s t r i c t i v e f i s z a l policy. e i3ut t h e s i t u a t i o n w a r e d i s c u s s i n t i s one not only of i n c x a s i n , ? production i n a g r i c u l t u r e , but a l s o of decreasing imports based upon foreign a s s i s t a n c e (PL 480 i n ~ o r t s ) . 1Jith an increase i n a g r i c u l t u r a l production corresponding t o t h e decrease i n irtports of food t h e r e rfould be no increase i n o v e r a l l supplg. But the demand wculd bc higher because of t h e higher incomes of t h e farmers. Self-sufficiency i n a g r i c u l t i ~ r ewith inproving economic conditions f o r t h e farmers i s an important t a r g e t of economic policy I n India. Eut t o the extent t h a t t h i s production i s s u b s t i t u t i n g imports, t h e r e i s no increase i n t h e t o t a l supply and no savings of f o r e i g n exchange, and t h e f i s c a l policy has t o be prepared t o meet such a s i t u a t i o n . 94. These considerations a r e based upon t h e ass-mption t h a t t h e reduction of FL 480 a s s i s t a n c e would not be o f f s e t by an increase in other types of foreign assistance; i ' it were, it would i n f a c t mean l q u i t e a massive increase i n t h e other types of assistance, while t h e long-tern economic policy i n I c d i a aims a t a reduction of t h e inflow of resources from abroad. 35. of One i ~ p l i c a t i o n our analjjses i s t h a t -with a giver1 income - and demand s t r ~ ~ c t u r e t h e s u b s t i t u t i o n of a c e r t a i n q u a n t i t y of i i p o r t s by domestic production, can be achieved only by a l a r g e r increase I n production i n order t o meet a l s o t h e induced demand. This applies n o t only t o a g r i c u l t u r e , but t o import s u b s t i t u t i o n i n general; ire i5ll r e t u r n t o t h i s i n Chapter IX, Concluding Zenarks. 96. I n paragraphs 32-87 we argued t h a t l a n d t a x a t i o n would be r e l e v a n t as an i n c e n t i v e f o r i n c r e a s e d a g r i c u l t u r a l production and a n i n c r e a s e i n .the r n a ~ i t e t a b l esupply. The subsequent ~ a r a g r a p h sd i s c u s s e d t h e i m p l i c a t i o n s of' an expanding a ~ r i c u l t u r a l production s u b s t i t u t i n g t h e p r e s e n t Lnports of food. The conclusion iEs % h a t t h i s tbjould c r e a t e expansionary e f f e c t s i n t h e domes-Lic economy and r e s u l t i n a d e t e r i o r a t i o n i n t h e f o r e i g n exchange s i t u a t i o n , and t h a t t h i s mighi r e q u i r e a more r e s t r i c t i v e f i s c a l p o l i c y if s h o r t a g e s a r e t o Se prevented. lie t h e n i n d i c a t e d t h e o r d e r of magnitude of a d d i t i o n a l t a x a t i o n r e q u i r e d t o o f f s e t t h e a d d i t i o n a l demand on a g r i c u l t u r e ste.ming from inport zes s u b s t i t u t i o n , and t n e c i r c ~ ~ n ~ s t a n under which such a t a x a t i o n might be r e l e v a n t . Our d i s c u s s i o n h a s c e n t e r e d upon a g i c u l t 1 x e 3 but t h e p r i n c i p l e s have a broader applica5ion. The long-term t a r g e t s of economic growth and r e d u c t i o n of f o r e i g n a s s i s t a n c e would r e q u i r e a s u b s t a n t i a l i n c r e a s e i n t a x a t i o n . T h i s i s c l e a r l y -acknowled~edby t h e I n d i a n . a u t h o r i t i e s a s a g e n e r a l p o l i c y l i n e . ;.fe have d i s c u s s e d t h i s probl;irr! 1 6 t h r e s p e c t t o a g r i c u l t u r e , and f o r s e v e r a l reasons. The long-.term t a r g e t s of economic p o l i c y c l e a r l y aims a t s e l f - s u f f i c i e n c y I n a g r i c u l t u r a l products. A g r i c u l t u r e i s v i r t u a l i y exempt from taxa-Lion, while a successfu7, developineni of a g r i c u l t u r e ~ r o u l dr e q u i r e a s u b s t a n t i a l incl-ease i n t a x a t i o n ; t h e r e s t of t h e econor,ljr would other:l:i.se be confronted w i t h a demand .ilihich it r ~ o u l dn o t be a b l e t o neet. Considering t h a t t h e development of a s e l f - s u f f i c i e n t agr.icultw-e m a n s a s ~ b s t a n t i a i i n c r e a s e i n a g r i c u l t u r a l incomes, t h a t ~ g r i c u l t u r ei s t h e l a r g e s t s e c t o r in t h e econoniy and t h a t t h e t a x systern does n o t cover a g r i c u l t u r e i n a n adequate :Jay, t h e a r g m e n t s f o r a n inproved t a x s y s t e n f o r a g r i c u l t u r e appear very s t r o n g . The purpose uotlld be tr;ofold. F i r s t , a h i g h e r :Lad t a x a t i o n might be r e l e u a ~ t o r c r e a t i n g inceriti-es f o r production and an f i n c r e a s e i n t h e marketable supply. Second, t h e r e xould a l s o be need f o r a t a x system a b l e t o absorb some of t h e f u t u r e inci-ease i n a g r i c u l t u r a l i n c ~ m e s . But t r a d i t i o n a l land taxes a t f i x e d r a t e s a r e n o t e f f e c t i v e f o r m e t i n g growing incomes and demand; t h e r e f o r e a more f l e x i b l e systern ought t o be e s t a b l i s h e d . 97. A g r i c u l t u r e has t o meet r,ot only t h e demand from an i n c r e a s i n g population w l t h a n i n c r e a s i n g p e r c a p i t z income. It bas a l s o t o c a t c h up w i t h t h e baclclog i n supplg t o d a y r e f l e c t e d in FL b?O imports. It i s n o t l i k e l y t h a t s e l f - s u f i i c i e n c y i n a g r i c u l t u r e can be achieved v e r y soon. But consLdering t h e complexity of t h e problem, it i s a.lso probable t h a t t h e establishment of a n e f f e c t i v e and f l e x i b l e l a n d t a x a t i o n would be time-consumins. And i f t h e system i s n o t e s t a b l i s h e d i n advance, i n f l a t i o n a r y p r e s s u r e s and e~rtrernelyd i f f i c u l t f i s c a l problems may f o l l o w i n t h e wake of a s a t i s f a c t o r y a g r i c u l t u r a l growth, a gi-or,&i? t h a t sre a l l must hope ! : r i l l be achieved. O 'chis baclc;=round n t h e p r e p a r a t o r y work on an improved t a x system f o r a g r i c u l t u r e should be given h i g h p r i o r i t y .  - : LX - CONCLUDIIG FU.ARl:CS - Obssrvatlons Some -- on Zconoi::ic F l a n n i n g and F i s c a l P o l i c ; ~ 98 - b;i; F i s c a l . p c l i c y I n I n d i a i s cc~~fiplicatcd t h e f e d e r a l s t r u c t t l r e of t h e government w i t h 2 d i v i s i o n 02 aul;horil;,y beiween t h e Z n t e r and t h e S t a t e s which c r e a t e s problems of c o o r d i n a t i o n :.,;'rich a r e n o t easy t o liandle; o f t e n t h e Center can f u r t h e r a n a t i o n a l p o l i c y only through recoIrnei:dations, g u i d e - l i n e s and persuasioll ( l a n d t a x a t i o n ) . Seccr\d, the budget hzs a much wider f u n c t i o n t h a n merely covering t h e t r a d i t i o n a l f i e l d s 03 govermsent activity. The Suclget i s a l s o t h e main s o u r c e f o r investment f i n a n c i n g . The Goverm.en-t i s a t p r e s e n t f i n a n c i n g xore t h a n SO p e r c e n t cf t h e j.nves%- n e n t s i n t h e country, and tile Goverm,ent and the A d m i n i s t r a t i o n has t h e r e s p o r ! s i b i l i t y f o r t h e selection o? ~ ~ r i o r i t i e s p r o j e c t s , t 5 e i r and inple,:entation and o p e r a t i o n s i n a wide f i e l d of econon;ic a c t i v i t y . i l s u b s t a n t i a l p a r t of t h e t o t a l gov,?rment p l a n e x p e n d i t u ~ e sa r e c a r r i e d out by t h e S t a t e s (55-60 p e r c e n t ) , while about 8G p e r c e n t ( o f t h e t o t a l , n o t o n l ; ~ t a t e e q e i l d i t u r e s ) i s f i n a n c e d bbr %he C e n t e r . These e:pendl- S t u r e s a r e , t o a l a r z e e;;ten.t, r e f l e c t e d i n t n e S u d ~ e tof t h e Center: d t h e e >m~ l t u r e s f o r in~restn:ent and investiriei2i f i ~ a n c l n g amount a t present, t o c l o s e t o t h e sane amount a s t h e t o t a l c u r r e n t revenues of t h e Center ( zf . Tables 1 2 and 13) . The g u i d e l i n e s f o r .the i n v e s t n e n t pro!:ram are, t o a l a r g e e x t e i ~ t , l a i d down i n t h e lonz-terr;: plans. 99 Ccorlo~idc9 l a n n i . n ~i n I n d i a i s p r i m a r i l < y a lonz-term planillng f o r p e r i o d s QT 5 y e a r s ; p e r s p e c ~ i v e l a n s covering p e r i o d s of 15 t o 23 y e a r s p a r e a l s o prepared. Tha p l a n n i c z c o n c e n t r a t e s on t h e investments r e q u i r e d f o r t h e a c ' h i e v ~ m n t 02 ecozoniic drowt!l end ho:.! t h e f i n a n c e s can b e Sound. P r o 2 e c t i o n s and f o r e c a s t s a r e glade f o r savings, govern1::en-L revenues and t e x p e n d i t u r e s , and t h e a a a i t i o l ~ a l a x a . t i o n r e q u i r e d f o r a c h i e v i n g t h e s u f f i c i e n t t o t a l savings. The p l a n s give g u i d e l i n e s f o r f i s c a l p o X c y . They a r e e s s e n t i a l l y long-',ei-;.il p l a n s and t n e y a r e n o t sul;ple;?ented by a n n u a l p l a n s , f o r e c a s t s and programs f o r governnient a c t i o n . The ei;q~hasLs h i s on long-term development, b ~ t t e a c t u a l long-term development i s t h e sum of s1icsr.i-term dev.elopraen.ts slid t h e r e s u l t of t h e curlsen", d e c i s i o n s made by t h e Governaent end i t s a d m i n i s t r a t i v e a g e n c i e s . OSxi%msly, t l ~ c b u d s e t and i n t e r n a l p l a n s f o r a l l o c a t i o n of s c a r c e r e s o w c e s , l i c e n s i n g of intres-tnents, e t c . represen-t a n n u a l progra:ns f o r a z t i o n . But t;tiesc diPf e r e n t a d r i l i n i s t r a t i v e p r o g r a m a r e a p p a r e n t l y n o t brought tog.;e.L:ler f o r ana1;ysis w i t h i n t h e fra,:ewor:t of a short-term prograi,! talcin: i n t o accoui=t r a c e n t t r e n d s and t h e ;3rospects f o r t h e i f i ~ n e d i a t efu-Lure. A short-tcri.! plannin; of t h i s type t ~ o u l dn o t be a n a l t e r n a t i v e t o :long-ter:ii p l a n ~ i n g ; L t :-~ould z t h e r be an instruri?ent I n t h e implcmentaticn oi' t l i e r ob j c c t i v e s of t h e lonz-term p l a n s . S~?.ch s:fstern might g i v z an oi:por- 2 tunit:.r f o r EL 3101-e preclsel-;j defined s h o r a t - t e r n p o l i c y and ,'or a ?:ore q r s t z i x a t i c and b e t t e r organized r e v i s i o n oZ .the long-term p l a n s iil l i g h t of what t h e a c t u a l developlilents prslre t o be. It should i n t r o d u c e a s t r o n ~ e r2nd imre e x p l i c i t e1e:nent of f 1 e x i " o l l i t y i n t h e plannin,g and t h e i s ~ s t e i j ~ j o u l dprobably a l s o i n v i t e t o a s t r o n ~ e remphasis 011 t h e deveio9- ment or c u r r e n t and up-to-date s t a t i s t i c s and shor-t-term f o r e c a s t s which a l l polic.;r-xakin; has t o b u i l d upon. 100. Annual plans - based upon a coordinated adjustment of plans and programs f o r t h e separate f i e l d s - have not been established i n I n d i a and no s y s t e n has been established f o r analyzing t h e impact of f i s c a l polica on t h e econoiny a s a xhole i n t h e l i g h t of t h e reqci.re~xentsof t h e general econornic s i t u a t i o n . The cliscussion of f i s c a l policy i s l a r g e l y t, based upon t h e ordinary budget accounts and p ~ o ~ o s a l s h e i r d e f i c i t s and surpluses. But t h e budgetary balance i s f o r s e v e r a l reasons a v e n j unsatisfactory i n d i c a t o r of t h e demand e f f e c t s of t h e bud;et. The budget includes l a r g e transactions x i t h foreign countries, transactions which do not irLluence t h e domestic demand s i t u a t i o n . A balanced budge5 may conceal l a r g e o u t - ~ a ~ ~ ~ l t o t h e domestic economy and i x p o ~ t a n t en s changes from one year t o t h e other may not be revealed. The problem i s c l e a r l y recognized by t h e a u t i l o r i t i e s and improvements have been made, f i r s t and foremost, by an economic c l a s s i f i c a t i o n of t h e budget and t h e accounts of t h e Center. But t h e r e i s no up-to-date and adequate system of n a t i o n a l accounting acd f o r e c a s t i n g t o r e l a t e t h e recent Sudgetary developn.ents and t h e budget proposals t o . The fundamental basis f o r a more s a t i s f a c t o r y analysis i s not available. There i s a gap between, on t h e one hand, t h e e f f o r t s made i n developing a more so_nhisticated and e f f i c i e n t system f o r long-tern p l a n i n g and, on t h e other hand, t h e current planning, i n which t h e planning of f i s c a l policy should have a predominant place. 101. It could not be excluded t h a t t h e d i f f i c u l t i e s which ha.ve developed d u r i n ~ h e recent years a r e r e l a t e d , a t l e a s t t o some extent, t t o t h e i n s u f f i c i e n t analyses oi' t h e impact of f i s c a l policy on t h e denand s i t u a t i o n . The general bpression given by t h e formal budgets i s t h a t they a r e close t o balanced - f o r 1365/06 t h e r e is even a small surplus - and t h a t t h e budgetary policy i s by and l a r g e i n accordance wiLh conservative f i n a n c i a l p r i n c i p l e s . Our analyses would, on t h e contrary, i n d i c a t e a q u i t e strongly expansionary e f f e c t of t h e f i s c a l policy and e s p e c i a l l y so with respect t o some c r u c i a l s e c t o r s c f t h e econoniy. And t h e vzhole economic s i t u a t i o n i n d i c a t e s t h a t this i s c o r r e c t . Serioas shortages have developed, r e s u l t i n g i n delays i n t h e implementation of t h e i n v e s t m e ~ tprograms and under-utilization of capacity i n many i n d u s t r i e s . And t h e budgetary policy has been an important f a c t o r on t h e demand side. The inpression i s t h a t too l i t t l e a t t e n t i o n has been paid t o t h e planning of f i s c a l policy with respect t o i t s impact on demand. The a u t h o r i t i e s have, t o a l a r g e extent, r e l i e d upon p w s i c a l controls, and t h e budgetary policy lias a t t h e sane time contributed t o a demand s i t u a t i o n r e s u l t i n g i n increasing pressures on these controls, rendering t h e i r administration extremely d i f f i c u l t . The r e l i m c e on physical c o n t r o l s has ::eakened t h e position of budgetary policy. and it has not been subject t o t h e analyses t h a t i t s importance - everi i n an ecollomy with d i r e c t controls - should j u s t i f y . 102. O r impression i s t h a t t h e r o l e of f i s c a l policy in t h e recent u developments has not been s u t ' f i c i e n t l j recognized and r:e believe t h a t this i s r e l a t e d t o an i n s u f z i c i e n t systen! f o r t h e a n a l y s i s of planning of f i s c a l policy - and short-term policy i n general. This i s a l s o one of t h e reasons aihy Ire believe t h a t India should e s t a b l i s h a system of short-term 'analysis and planning i n connection with t h e preparation of t h e annual budgets of t h e Center. This i s not an easy t a s k , e.g. because of t h e shortcomings on t h e s t a t i s t i c a l side. But t h i s i s a i s o a question of p r i o r i t i e s , and h hen f i r s t t h e needs and p r i o r i t i e s a r e recognized, it i s d i f f i c u l t t o s e e rz~hy, f o r instance, preliminary and up-to-date n a t i o n a l account e s t i x a t e s including money f1or.r~arid f lnancrial t r a n s - a c t i o n s should n o t be made; considering a l l tine s t a t i s t i c a l i d o r m a t i o n and e - q e r t i s e t h a t i s a v a i l a b l e i n India. 103. For t h e purpose of our ovm a n a l y s i s sje have p a r t l y f i l l e d i n t h e gaps i n t h e iilformation with rough estimates and s t a t i s t i c s of u n c e r t a i n q c a l i ' q ; we have a i s o adapted our methods t o t h e a v a i l a b l e i r Z o m a t i o n . The surveys and c a l c u l a t i o n s presented i n t h i s r e p o r t should be judged on this background and improvements could c e r t a i n l y be made. Further work r.rould be d e s i r a b l e rlith r e s p e c t t o t h e analyses of f i s c a l p o l i c y in India. 9. - A Judzment of t h e Recent Btxdgetary Policy lob. Our a n a l y s i s has been concerned f i r s t x i t h a general d e s c r i p t i o n of f i n a n c i a l developments and with disentangling d i f f e r e n t types of f i n a n c i a l s t a t i s t L c s . Second, ::e have t r i e d t o assess t h e impact of budgetair p o l i c y on t h e econonyj t h i s i s confined f i r s t and l ~ r e m o s t t o t h e demand s i d e . 105. The f i n d i n g s can be sumarisec! a s f o i l o t ~ s : ( a ) There has during t h e l a s t k--5 years been a n e t out- payment Srom t h e Center t o %lie r e s t of t h e econo;-riy i i n t h e order of R s . 2-4 b i l l i o n anually. Zlis compares with a n a t i o n a l income a t p r e s e ~ l ;of 3s. 180-230 b i l l i o n . (b) Under c e r t a i n assumptions with respect t o t h e s t r u c t u r e of t h e Indian economy (marginal savings r a t e s , composition of f i n a l demand), rj.e f i n d t h a t the expansionary e f f e c t s of t h e budgetary policy have probably been q u i t e strong. Budgetary p o l i c y ad c r e d i t policy have togetlier c r e a t e d an a d d i t i o n a l demand on domestic resources i n t h e order of 5-6 percent a s an annual average f o r t h e l a s t 5 years. Eut, on t h e non-.agricultural s e c t o r s , t h e pressure has been mncch stronger ( 9 percent) and e s p e c i a l l y on t h e s e c t o r s producing investment goods a9d d e l i v e r i e s f o r t h e production of such goods. 106. The budgetary p o l i c y has been expansionai2r, ,taxation hcs been r a i s e d , but t h i s has not been s u f f i c i e n t -Lo meet t h e i n c r e a s i n g expenditures f o r investments and invest,nent financing. The econo~rics i t u a t i o n has, on t h e negztlve s i d e , been characterized b r j s2lortazes a n d bottlenecl:~, delays i n tile i,a?le!nentation crf the invest- ~ and itlent prozrar~i, u a d e r u t i l i z a t i o n of e x i s t l n g c a p a c i t i e s , r i s i ~ e ; r i c e s increasin; pressures a g a i n s t the ph-pica1 c o n t r o l s and t h e balancz of' paynients. The p o s i t i v e s i d e i s a h i ~ h and i s c r e c s i n g invesinent l e v e l ; d tlie l a r z e nUber of p r o J e c t s being i , ~ l p l e ~ e n t eshould, rllien tlley a r c cnm- g l e t e d and corile i n t o operation, add t o t h e ec0nomi.c grot-~th. 107. The budget i n I n d i a could not be judged only b;r i t s ixpact on t h e delnarici ~ i t u a t i o n ; it i s ilot only an iiistrument f o r f:dei~and manage- lilent!' but a l s o t h e main source f o r aevelop~lentfinancing. There i s a pronounced dualisill i n t h e functions of the budget, it has t o be judged a;j;air,st : ( a ) t h e long-term developnent requirements, and (b) t h e impact upon t h e iliixediate demand-supply s i t u a t i o n . There aay be a c o n f l i c t between these two functions, t h e needs f o r invest,- tile ment s f o r promoting f u t u r e growth may o~rersl-iador~ requirexents of %he immediate demand s i t u a t i o n . Additions t o f u t u r e capacity m q r 5 e pref e r r d , although it a l s o r e s u l t s i n pressures and bottlenecks with adverse e f f e c t s on t h e present growth. The a r g w e n t could pro'babiy a l s o be ;na3e that-- i n a country vhere t h e production siac t o a large extent i s t r a d i t i o n a l l y oriented --some pressures frola the denand s i d e m g be j u s t i f i e d i n order t o promote a nore rapid t r a i l s i t i c n arid greaker rtlobilitj on tine sllpply s i d e . 1.08 . Shortages and bot.tlenecl:s have developed, but it i s questioi?aSle t o what extent b u d g e t a ~ j poiicy sufficientl;. s t r l s t t o reinove t h e b o t t l e - necks wou-!-d represent a s a t i s f a c t o r y soiutlon. A s t z x a t i o n has been r a i s e d s u b s t a n t i a l l y b o t h during t h e Second and t h e Third ?lan, this would i n p r a c t i c e be a question o? s l a ~ i n g down t h e e x ~ a n s i o nd t h e developcient ;:xpi.nditures. B a t IjiaW of t h e i ~ n p o r-deraland-ing d e t r e l ~ p ~ e i l t t e.xpenditwes are i ~ a r t l y financed by f o r e i g n c?ssistance linked t o the p r o j e c t and t h e i n p o r t s it requires. No, or very l i t t l e , sa%5ng of foreign exchange would be achieved by reducing such investments. And a cut of ins-estaents demanding no, o r E t t l e , f o r e i g n exchange xould require a r e l a t i v e l y strong reduction of investments donesf,ic dexand i n order t o obtain arqj s i g n i f i c a n t savi^?gs of f o r e i g n exchange through the i n d i r e c t effects. The reason i s t h a t t h e import content i s generally 1077. Ths i s a v i n ~ s n f o r e i g n exchange would be s o cost1;r i n terms of investments and dmiestic a c t i v i t y , t h a t t h i s would hardly be balanced bj7 t h e b e t t e r u t i l i - zation 03 capaci-t:y. i n import-denandin2 f i e l d s of p o d u c t i o n . ;,/iarginal investmeiits could probably be found i n any budget, but f o r t h e resson men- tioned above, t h e e f f ec-L -2 the excl.lan~es i t u a t i o n i s dubious. 109. ?le do not mean t o say t h a t budgetary policy could not o r should not have been more r e s t r i c t i v e ; on t h e c ~ n t r a q r ,r. some;rhet l e s s e x x m i o n a r y policy probably-wouJ.d .!zsr?been desirable; 3 u t a c c e p t i r ~the need f o r a high investnen-t l e v e l , and considering t h e q u i t e strorrgly r e s t r i c t i v e measures l required i l l the ~ e n e r a f i s c a l policy _i-n order -to obtain any s i g n i f i c a n t savings of foreign exchange, we do not believe t h a t general f i s c a l mea- sures sufl'iciently r e s t r i c t i v e t o raaove bottlenecks and shortagss would r e s u l t i n a s a t i s f a c t o r y economic development. General measures would not be t h e a p p r o p r i a t e incans f o r improving t h e s i t u a t i o n , more s e l e c t i v e be measures wo-~ld pref e ~ a b l e . 1-10. The question then i s what would have oeen the a3eai:at.e p o l i : ~ . This r a i s e s questicns o u t s i d e t h e budgetary p o l i c ~ ; but buCgetary p o l i c y cannot be judged i n i s o l a t i o n from other types of p o l i c i e s which have a l s o a d i r e c t bearing upon t h e c r u c i a l i s s u e s i n t h e econoniLc situaf,ion. Tne efficienc-r of planning, p r o j e c t s e l e c t i o n , i!nplerilentat,ion and operation a r e a s im2ortant f o r t h e supply s i d e a s t h e budgetary policy i s f o r the Is demand s i d e ; t h e s i t u s t l o l ~ a r e s u l t of Zactors operating or: botl: s i d e s . Ii; i s -the 2 o r e i ~ nexchan,e s i t u a t i o n ivi-ich has developed l:ito t h e rnost sesfere bottleneck and some OZ t h e f a c t o r s with a d i r e c t bearir,; on the f o r e i ~ n exchange s i t u a t i o n a r e : ( a ) t h e s i z e and tv-pe o f o r e i g n a s s i s t a n c e f ( b ) t h e d i r e c t c o n t r o l s and t h e i r aapplica-tion ( c ) the internal/external ?rice relations. Obviously a l a r g e r u n t i e d f o r e i g n a i d i n a d d i t i o n t o t h e proSect a i d would have Seen a b l e t o s o l v e many of t h e p r o b l e ~ , s reno-~ingb o t t l e - by necks and recl~.~ccirl~e p r e s s l x e s i n t h e econoi:l:J, i n s p i t e of t h e expan- th sionary impact 02 .the budget. 7 5 t h Toreign a s s i s t a n c e and t h e bndgetaqr p o l i c y being what they have been, d i r e c t r e s u l a t i o n s have been extensively used t o reduce thi: t o t a l imports, and +,hishas c r e s t e d anoillalies on t h e supply s i d e . S u t i n t h e absence of &irect regulations, t h e a c t u a l budget- a r y p o l i c y would have created a f o r e i g n exchange c r i s i s long azo. The t h i r d f a c t o r i s t h e i n t e r n a l / e x t e r n a l p r l c e r e l a t i o n s . Higher doinestic p r i c e s on inported goods i n r e l a t i o n t o doniastlc goods would lead t o sav- i n g s of f o r e i g n exchangz, bo'th v i a t h e demand s i d e and by inprovj-ne t h e competitive p o s i t i o n of domestic producers vis-a-vis i x p o r t s ; e x ~ ~ o r t s neght a l s o be stiriiulated. An adjustnent of t h e r e l a t i v e p r i c e s t o this e f f e c t would be a s e l e c t i v e measure conpared w?th t h e q u l t e sfroc2 reduction of the t o t a l clerlland t h a t would be required i n ordor -Lo c b t a i n an: signsicant savings of f o r e i g n escharige. It i s not p o s s i b l e t o sqv hovl strong t h e e f f e c . t s of a chazge i n r e l a t i v e p r i c e s would be; t h e y would, h o ~ e v z r ,work Tn t h e ri$it d i r s c t i o n . 11 1. The general conclusion i s t h a t , although b u d g e t a v policy has been exq~ansilonaryand perhaps t o o expansionary, t h e dicf i . c u l t l e s a r i s i n g i n tlie f i e l d of f o r e i g n exchange ccuid not have been removed i n a cissirable i?ay onl,. by a change i n budgetary policy. A sornet~hatmore r e s t r i c t i v e f l s c a l policy could c o n t r i b u t e t o a s o l u t i o n , a s would a l a r g e r f oreizn a s s i s t a n c e , a higner excharige r a t e and t h e relaxa.tion of d i r e c t c o n t r o l s which this inight p e r n i t . k h i ~ h e rexchange r a t e afid a r e l a x a t i o n of d i r e c t c o n t r o l s may be d e s i r a b l e or necessaiy elalients i n such a policy, but t h e volume of f o r e i g n a i d appears t o be t h e c r u c i a l f a c t o r a t t h e present sbage. C . - kgricul.tura1 Development and r ' i o c a. Poiicy l i12. I:e were l e d t o this discussion f i r s t because our denand a n a b s i s indicates t h a t an expansion (.f tile non-agricultural s e c t o r s woiild r e s u l t i n q u i t e a strong i n c r e a s e i n t h e demand f o r a g r l c - d b u r a l products, i n c h d i n g a g r i c u l t u r e - b a s e d manufactiure. With a long-term t a r g e t of s e l f - s u f f i c i e n c y i n a g r i c u l t u r a l products, this means t h a t t h e r e must b e a c e r t a i n balance between t h e g ~ o w t hof a g r i c u l t u r e and t h e r e s t of t h e economy. Secondly, we found t h a t t h e t r a n s i t i o n t o s e l f - s u f f i c i e n c y i n a g r i c u l t u r e would havs q u i t e a s t r o n g eirpznsionary e f f e c t and t h a t this might r e q u i r e a moTe r e s t r i c t i v e f i s c a l p o l i c y i f s h o r t a g e s a a d p r e s s u r e s i n t h e domestic eccnomy should be prevented. 'This a p p l i e s not only t o a g r i c u l t u r e , b u t t o import s u b s t i t u t i o n i n g e n e r a l . But a g r i c u l - t u r e i s v i r t u a l k y exe~nptfrom t a x a t i o n and our conclusion was -%kt e e a r l y th establisllrnent of a n iinproved t a x system f o r a g r i c u l t u r e should b e given M g h p r i o r i t y . Tile purpose would b e twofold. F i r s t , a higher l a n d t a x a t i o n might b e r e l e v a n t f o r c r e a t i n c s t r o n g e r i n c e n t i v e s f o r i n c r e a s e d p r o d ~ c t ~ i o n ar; i n c r e a s e of t h e i m r k e t a b l e supply. Second, t h e r e would and a l s o b e need f o r a t a x wstern a b l e t o absorb p a r t of t h e f u t u r e i n c r e a s a i n a g r i c u l t u r a l incomes. But t r a d i t i o n a l land t a x e s w i t h f i x e d r a t e s a r e n o t e f f e c t i v e i n meeting growing incomes and demand, and a more f l e x l b l e systerll ought t h e r e z o r e t o be esiab1is:iecl. D. on - A N ~ t e Import S u b s t i t u t i c n and Z i s c e l Pol.icjr 113. One i.inpiication of our a n a l y s i s i s tl-1a.t - w i t h a g i v e n income and deinand s t r u c t u r e - t h e s u b s t i t u t i o n of a c e r t a i n q u a n t i t y of i l l p o r t s by dornestic production can b e achieved only by a l a r g e r i n c r e a s e i n t o t a l production ( n o t necessari1,y of t h e sane goods) i n order t o meet a l s o t h e induced demand. Production and i m p o r t s a r e a l t e r n a t i v e s o u r c e s of supply, b u t one cannot i n c r e a s e production without i n c r e a s i n g t h e i n c o r ~ e s . Input- output a n a l y s e s , d i s c u s s i n g a l t e r n a t i v e s , d i s r e g a r d t h e demand e f f e c t s by assuming t h a t they can b e met b changes i n f i s c a l p o l i c y ; -the p o i n t of j view i s t h a t tlie f i s c a l p o l i c y can be s o designea a s t o f i t o r profilote a prog;-am t h a t i s pllysical1,y f e a s i b l e . 9 u t t h i s h a s a l s o t o be done and t h e i i n p l i c a t i o n s f o r f i s c a l p o l i c ; j may be q u i t e far-reaching. k program f o r import s u b s t i t i l t i o n may not f u l f i l l i t s e x p e c t a t i o n s i f t h e induced demand e 2 f e c t s a r e n e g l e c t e d i n the planKing and t h e a l l o c a t i o n of f o r e l g a exchange; t h e r e s u l t would b e s h o r t a g e s and p r e s s u r e s on t h e r e g u l a t i o n s ~ and t h balance of payments a s t h e demand would t u r n out t o b e h i g h e r t h a n expec Led. Because oT t h e s e demand e f f e c t s , one r ~ o u l dn o t s a v e f o r e i z n exchange corresponding t o t h e production s u b s t i t u t i n g i n p o r t s ; a t l z a s t , st this might r e q u i r e i n c r e a ~ ~ g l y r i c t iinport c o n t r o l s o r a change i n r e l a t i v e p r i c e s (do~::estic/external) . Another f a c t o r i s t h e i n d i r e c t needs f o r iii?ports which t h s i r , i ~ o r t - s u b s t i t u t i n gproduction xajr r z s u l t i n v i a i i l t e r s e c t o r de;llaiid and d e l i v e r i e s on t h e production s i d e . I n d i a h a s a massi~reprograr:? f o import s u b s t i t u t i o n , t h e p r e s s u r e s a g a i n s t t h e ~ balailca of payments have been i n c r e a s i n g and a p p a r e n t l y more s o thar, f o r e s e e n . ; a n v i ' a c t o r s have c o n t r i b u t e d t o t h i s ; i n s u f f i c i e n t , coordina- t i o n of t h e c u r r e n t f i s c a l p o l i c y t o t h e ph:rsical t a r g e t s could t:e one factor.  kPPB:ClIX - I TI33 INFIDL6 Aim USE CF PL b80 COilLJT=PART FU?DS - - TmLE OF COiiTENTS Page No. A. The Economic I m p l i c a t i o n s o f t h e T r a n s a c t i o n s i n FJ, 480 C o u n t e r p a r t Funds 1 B. The PL 420 Procedures 5 Table I : I n f l o w and U s e of PL 450 C o u n t e r p a r t Funds 9 Table 11: The I n f l o w of PL 480 Funds 2nd th.e O v e r a l l Budgetary P o s i t i o n o f t h e C e n t e r 10  - - TI% II\FIX;lJ AKD USE O PL 480 C O ~ J T E R P n 9 TFUTJE L F - A. The Economic Implications of t h e Transactions i n PL =-.--- --- -- - b00 Coulterpart Funds 1 . India has obtained a s u b s t a n t i a l amount i n a i d from t h e U.S.A. under t i e PL 480 program, mainly food. India dces not pay f o r t h i s i n d o l l a r s , but in rupees, t h e b S i of which i s put a t the disposal of the Indian Governrent. Disregarding the complexities of the f i n a n c i a l arrange- ments,the main point is t h a t food is granted f o India, and t h a t the s a l e of t h i s food i n India r e s u l t s in a s u b s t a n t i a l inflow of rupees t o t h e Indian Government. This inflow i s r e f l e c t e d i n the r j o v e m e n t a c c o u ~ t s and the balance of t h e budget and ~$11 subsequently be r e f e n d t o as counterpart funds. 2. Exlcuding the inflou of counterpart funds the for111albcdget has shotm a s u b s t a n t i a l d e f i c i t , a d e f i c i t which has increased by about Rs. 500 million per year during the l a s t three years, '!!en the inflow of counter- p a r t funds i s included m tke bwne side, the d e f i c i t i~ muc5 smaller; it has been d e c r e a s b g and the 1965-66 Budget sho'm a m a l l sur- plus f or the f F r s t time in, many years.l/ Accordingly, the i d l a r r and treatment of comterpart funds has strongly influenced the picture of budgetaw developments. 3a The purpose of t h e formal budget i s not t o seivc as a basis f o r economic analyses of f i s c a l policy, but Farliamentary control, adnibis- t r a t i v e accountability and bookkeeping and auditing purposes, In m q contexts the formal budget i s nevertheless the main b a s i s f o r the general discussions of f i s c a l policy. And t h e i n f i o x of counterpart funds t o the budget has been very high and is increasing. It is, therefore, not unim- portant how t h i s inflow t o the budget i s i n t e r p r e t e d from an economic point of view, b . I n India i t has been argued t h a t t,he inflot! of c o u n t e q a r t r'ur~ds ly has concealed an i n c r c a ~ ~ g expansionary f i s c a l policy, a policy which has contributed t o s h o r t a ~ e s and i n f l a t i o n a r y pressures. It has on t h e other hand been argued t h a t the payments t o the Go-rerrment from the private s e c t o r f o r the imported food has a, r e s t r i c t i v e e f f e c t on t h e monetsry conditions, a s has any other in-payment t o the Government. It is, there- fore, j u s t i f i e d , i t is argued, t o include the inf1or.r OZ counterpart funds a s an income i n the budget. 5 . This argumentation r z i s e s two differerit questions. i s a question of what should, f o r aualy'ciczl purposss, be included a s The f i r s t p a r t of f i s c a l policy. The second question Is whether a subst'antiaf inflow of courzterpart funds would not permit - or perhaps even require - a d e f i c i t and an expansionary e f f e c t froin t h e r e s t of the transactions af the Government. li C f . diagram I. 6. ve w i l l not go i n t o d e t a i l with r e s p e c t t o the f i r s t question. k p o i n t of view i s t h a t the economic character of t h e inflow of counter- p a r t funds i s fundamentally d i f f e r e n t from the t r a n s a c t i o n s and a c t i o n s undertaken by the Government f o r influencing demand through f i s c a l measures Thus, according t o the l965-66 Sudget, t h e r e would be an inflow of RS. 3.3 b i l l i o n i n counterpart funds. ',<ith a good a r v e s t i n t h e subsequent year, t h e r e would be no need f o r PL LBO imports,$ and t h e budgetary balsnce would d e t e r i o r a t e sharply. But t h i s would not be due t o a chailge i n t a m - t i o n , Government expenditures o r other elements of f i s c a l policy. It 5s - i n t h i s hypothetical example - t h e supply of food from domestic sources tkt has increased, rendering PL 480 imports superfluous. Imports have been s u b s t i t u t e d by domestic production and t h i s has an expansionary effect. And because of the p e c u l i a r i t i e s of t h e PL 480 arrangeinents t h i s becomes v i s i b l e i n a sudden d e t e r i o r a t i o n in the balance of the budget;. But t h i s should - i n our opinion - n o t be i n t e r p r e t e d a s a chaage i n f i s c a l policy. The c ~ u s a l f a c t o r sl i e i n a completely d i f f e r e n t sphere: an increase of the production i n a g r i c u l t u r e and a reducticn of t h e r e a l resources (PL 480 imports) supplied from abroad. ' 7. Would an increased a g r i c u l t u r a l production and reduced PL 480 e a s s i s t a n c e warrant a more r e s t r i c t i v e f i s c a l policy? W have discussed t h i s i n more d e t a i l i n Chapter V I I I i n t h e main report, Our conclusion i s t h a t it would. Reduced imports would be matched by an increased i n production and incomes i n agriculture. The marketable supply a d the cash incomes would be increased. The amount previously paid by %he urSm population t o the Government f o r PL L80 food would now be cash inccne l o r a g r i c u l t u r e , and t h i s cash income would f u r n i s h t h e b a s i s f o r an increased demand f o r goods and s e r v i c e s from o t h e r domestic s e c t o r s and from abroad. But the resources mzde available from abroad would not have increased, and the "newu demand f o r imports would have t o compete with other demands f o r scarce exchange resources. A s u b s t i t u t i o n of PL 480 imports by domestic production would increase the pressures on t h e balance of payments. the increased demmd f o r non-agricultural domestic products might create pressures i n t h e domestic economy. 8. The r e l a t i v e import content i n the a d d i t i o c a l demand generated by a d d i t i o n a l cash incomes i n a g r i c u l t u r e i s small, and it i s probably q u i t e modest a l s o when the induced demand e f f e c t s i n tne non-agricultural s e c t o r s are taken i n t o account. But if t h i s i s t h e case, the stronger would be the e f f e c t on the demand f o r domes5ic products. Both e x t e r n z l and i n t e r n a l considerations may require a more r e s t r i c t i v e f i s c a l policy. It may appear odd t h a t a good performance i n a g r i c u l t u r e should warrant a more r e s t r i c t i v e f i s c a l policy. It has, however, t o be observed t h a t t h e conclusion i s a consequence n o t only of an increase i n t h e agricul- t u r a l production and t h e cash incomes of the farmers, b u t a l s o of a reduction i n t h e resources made a v a i l a b l e from abroad. The previous inflow of PL 480 imports - r e f l e c t e d i n an inflow - 1 Fkcept perhaps f o r the building of buffer stocks. of PL 480 funds - permitted the Government t o pursue a l e s s r e s t r i c t i v e f i s c a l policy than would otherwise be required. T h i s i s close t o a platitude: with a larger inflow of resources from abroad a l e s s r e s t r i c t i v e policy i s permissible, or even required, than when these resources a r e not available. 9. The inflow of counterpart funds, f 9, we have concluded, not a controllable element of f i s c a l policy. It i s nevertheless a significant factor - a s is, f o r instance, t h e permissible d e f i c i t in the balance of payments -f o r the formulation of f i s c a l policy. The inflow r e f l e c t s an inflow of r e a l resources from abroad, an inflow w'hich has permitted the Government t o pursue a l e s s r e s t r i c t i v e policy than would otherwise be required. With a reduction i n this inflow and without an increase i n other types of foreign assistance, a more r e s t r i c t i v e policy would need t o be pursued. 10. One question i s whether this i s f u l l y appreciated. Another question i s how the inflow of PL 480 funds has influenced the f i s c a l policy of the Government. Thus the inflow of PL 480 funds has permitted the Government t o present budgets with modest d e f i c i t s , and the budget f o r 1965-66 shows a surplus f o r the f i r s t time i n many years, The f a c t t h a t this r e s u l t i s i n considerable measure due t o the need f o r and the a v a i l i - b i l i t y of large-scale food g i f t s r a t h e r than t o positive measures of policy may be obscured by the budget presentation. T h i s , however, i s a matter of presentation, not of economic principles. But obviously, when budgets show a balance it i s much e a s i e r f o r pressure groups t o demand lower taxes than when i t shows a substantial d e f i c i t ; it i s more d i f f i c u l t f o r the E a s t e r of Finance t o argue f o r an increase i n taxation or a s t r i c t e r screening of expenditures. 1.1 It has a l s o t o be observed t h a t the transactions i n counter- part funds a r e not often presented in a c l e a r and co~~prehensive form. Furthermore, there i s a l s o an earmarldng process i n the use of counter- part funds and r a t h e r complicated bookkeeping procedures, t o the e f f e c t t h a t t h e transactions i n PL 480 funds apparently a r e confusing even well- informed observers. Some of t h e fltechnical'' sides of the transactions a r e discussed i n the next chapter. 12. However, the general impression i s t h a t t h e transactions i n PL 480 funds, the procedures and t h e agrumentation surrounding these trans- actions, the sheer complexity of the procedures, plus the f a c t t h a t the formal budget i s strongly influenced i n a favorable direction, has influ- enced not only the picture of f i s c a l policy, but a l s o the policy pursued.  B. The PL 480 Procedures 13 Pubzic Law 480 (PI,480) i s t h e U.S. A g r i c t l t u r a l Trade ilevel- opment and Assistance Act. This Act, authorizes t h e President of t h e United S t a t e s t o e n t e r i n t o agreements with countries concerning t h e terms on which t h e a s s i s t a n c e i s received, including t h e use of t h e l o c a l currencies which t h e receiving country has t o pay t o the American a u t h o r i t i e s f o r t h e PL 480 imports, The f i r s t agreement with I n d i a was signed i n 1356, and e i g h t subsequent agreements have been signed, up t o September 1954. The c o ~ m o d i t i e simported by Inciia under these agreements a r e wheat, r i c e , maize, milo, cotton, tobacco, d a i r y products and o i l ; %:heat has Seen b r j f a r t h e most important item. 14- Under t h e present arrangement t h e Indian Government would - on r e c e i p t of fnformation on shipping of t h e imported cornmodi~ies pay t k e - cost, including p a r t of t h e f r e i g h t charges, - n rupees t o the .ri'ilerican 5 a u t h o r i t i e s i n India. Usually t h e Indian Government wodd da1 upon the r. -- Reserve Bank f o r t h i s purpose ( i s s u e ad hoc t r e a s u r y b i l l s ) , The main r u l e i s now t h a t about 13 percent of tine counterpart funds ~ o d be d r e t a i n e d by the American a u t h o r i t i e s i n India f o r t h e i r own use, 7 percent would be s e t aside f o r f i n a n c i a l support of p r i v a t e h d i l s t r y in India, cooperating with American f i r m s ( t h e Cooley Amendment), i:ilile t h e remaining 80 percent i s t o be used f o r c t h e r purposes agread upon by t h e two governments, It i s t h i s p a r t which subsequently i s r e f s r r e d t o a s counterpart funds. 15. p U t o 1360 the American a u t h o r i t i e s would cleposik the counterpart funds - which they have received from the Indian Govermeri - with commercial banks in Indfa (mainly t h e S t a t e Bank). The corrmercial banks were i n t u r n supposed t o i n v e s t a corresponding amount in Govern- ment s e c u r i t i e s , which they a?parently did. The s e c u r i t i e s could be bought d i r e c t l y from t h e Government or t h e Reserve Bark, but z l s o f r o m t h e market. Accordingly, t h e bond market might be affected, 3 u t t h e Indian a u t h o r l t f e s could i n p r i n c i p l e o f f s e t any e x t r a purchases by t h e commercial banks by additions; s a l e s t o t h e market. Disregardj-ng t h e possible influence v i a t h e bond market on t h e supply of c a p i t a l t o t h e p r i v a t e s e c t o r , t h e money went in a c i r c l e : from the Goverment t o t h e American a ~ t ~ h o r i t i e o t h e commercial banks and back t o the Goverrmnt, ts 16. Since 1360 t h e ppocedwes have Seen changed. The c o m t e r p a r t - funds resulLingfrom new PL L80 imports - were formally placed with t h e Reserve Back of India f c r investnent in s p e c i a l Government secilrit i e s e s t a b l i s h e d f o r t h e purpose, These transactions do not e n t e r t h e balance sheet of the Reserve Bank, and -xe r i i l l consider :hem a s a d i r e c t ifivestment b t h e Arrierican a u t h o r i t i e s i n s p e c i a l s e c u r i t i e s , Therefcre, accordirg t o y t h e present arrangerrent, t h e counterpart funds paid by t h e Indian "Jvernment t o t h e American a u t h o r i t i e s a r e immediately returned t o the Indian Govern- ment. The n e t p o s i t i o n of t h e Government with the Reserve Bank i s not affected. 17 Since 1960 the old counterpart funds deposited by t h e American a u t h o r i t i e s with t h e commercial banks have gradually been rJithdrawn f o r investment in s p e c i a l securities. The banks have presunably financed t h i s by a reduction of t h e i r subscriptions in new Government loans, i n some y e a r s by s a l e s of s e c u r i t i e s t o t h e Reserve Bank. 18. I n short, t h e counterpart funds paid by t h e Indian Government t o the American a u t h o r i t i e s have always been r e t u r r e d t o the Indian Goverrmnt, first v i a t h e com.ercialbanlcs, l a t e r on through d i r e c t investment ir~ p e c i a l s s e c u r i t i e s . But, as mentio3ed, by first cham-eling furids through t h e commercial banks and l a t e r on reversing t h e process, the c a p i t a l markel; may have been influenced, and banking and c a p i t a l market s t a t i s t i c s have been obscured. 19. The transactions w have s o f a r been considering a r e the payments e from t h e Indian Government t o t h e American a u t h o r i t i e s and back t o t h e Indian Government. Obviously, such transactions have no e f f e c t on t h e Indian economy, a p a r t from t h e disturbances which may have been created through the previous arrangement with t h e commerical banks. 20. The PL 480 funds invested \-nth t h e Indian Government a r e owned by t h e U. S. Government, they a r e not convertible and a r e assumed t o be used i n India f o r purposes which the two p a r t i e s agree upon. And sub- s t a n t i a l amounts have i n f a c t been used. But t h i s i s a i n a special meaning of t h e word. F i r s t , on t h e f i n a n c i a l s i d e i t means t h a t funds - r.~hicha r e already invested with the Indian Governmex~t or which would under any circumstances be invested 1 5 t h t h e Indian Government - are lent t o the Government o r given a s a grant t o t h e Governmeni. =sregarciing the continuous in- and outflorq of funds under t h e d i f f e r e n t arrangements, lor^ t h e use of counterpart funds means t h a t one debt ite&/ i n %he Government accounts i s i n c r sed acd another21 reduced; i n the case of graxhs t h e current revenuesj7 a r e increased. Obviously, i t i s not possible t o rnobifizz e i t h e r r e a l o r f i n a n c i a l resources by such procedures. But o f f i c i a l l j it i s maintained t h a t some e q e n d i t u r e s a r e b e h g financed. This might per- haps have some meaning from a n administrative point of view if the inflow of counterpart funds rims accumulated as a separate monetary reserve oT t h e t Gove,rnment ~ 5 t hh e Reserve Bank, and if t h e r e m r e some reason t o believe t h a t t h e money would be used f o r p r o j e c t s which ~ m u l dotherwise n o t be undertaken. But t h e inflow of counterpart funds has h i s t o r i c a l l y never r e s u l t e d i n any accumulation of Government reserves with t h e Reserve Bark, there has on t h e contrary been a continuous increase i n the indebtedness of t h e Government with the Reserve Bark. Secondly, Indian o f f i c i a l - s claim t h a t t h e projects t o which t h i s financing i s l l i n k e d would - perhaps with a fetr except,ions - be undertaken anyhow; i.e., t h e so-called "usen of - c a s e x t e r n a l debt. - Grants from abroad, 2/ S p e c i a l s e c u r i t i e s , considered as unfunded domestic debt, - 3/ counterpart funds have not l e a d t o any a d d i t i o n a l Government e x p e n ~ t u r e s , They consider t h e ;<lole thi.113 a:; a bookkeepbg procedws: t h e reduction of one debt i t e m , tine increase of another ar:d/or tile current incomes. For example, if PL 4eO funds a r e not "used1' t h e blvescment In s ? e c i a l be s e c u r i t i e s ~,rould larger, represecting a l a r g e r inflow t o t h e Govern- ment, which would then use t h e money f o r i t s expefiditure program, The . r e s u l t would be t h e same if a certa-in p r o j e c t i n t h i s p r o g r m i s ecr- marked f o r "?L 480 f inancingU 21 . PI, 489 funds. !le hava not' t r i e d t o describe two s i d e s of t h e 5ranssc-Lions in F i r s t t h e Indian Governnent t r a n s f e r s r i q e s s t o t h e American a u t h o r i t i e s , whsreupon Uiey a r e re-.transferred t o t h e Indian Government. Seccnd, t h e two governments agree upon t h e "use1' of these funds f o r s p e c i f i c exnenditures. A s these expenditures would probably be undertaken anylzcw, t h i s i s mainly a boo:d:eeping procedure. 22. Vith t h e r e s e r v a t i o n t h a t a ) the previous channelling of funds through t h e c o m e r c i a l banks and t h e subsequent r e v e r s a l of t'nis process has not i&luenced the c a p i t a l narket, and b) t h a t the f i c a r c i a l arrange- msnts have c o t encouraged an increase 5n t h e a c t u a l expenditures of t h e Government, t h e t r a p s a c t i o n s described above a r e of a bookiteepir,y r a t w e : they have no e f f e c t on t h e economic development of t h e country. This point of err has a l s o been expressed by t h e i j i n i s t e r of Fimnce in a s t a t e m e n t 3 t o t h e Parliamsnt ir. t h e debate on t h e F i n a c e D i l l , 1955-55 (?.lay, 1965). 23 Hcwever, the accumulation of rupee debt t o t h e American author- i t i e s hrrs created sonie concern i n In&-a, The l l f i r i l loans1' f o r s p e c i a l p r ~ j e c t sa r e t o be repaid eyer 40 years, afid carry b i t e r e s t . The repay- n;em?t and the i n t e r e s t payments ir- rupees a r e not any more PL 480 fluids t o be invested in s p e c i a l s e c u r i t i e s , and infornation on what zhe ' h e r l c a n a u t h o r i t i e s a r a doing with t h i s money tns not made available,Z About, / three-eighths of t h e covnterpart funds have s o f a r been ' ' - n i t t e n 03" as grants, rrhils five-eigh+,hs has taken t h e form of loans. Up t o nol-I t h e i n t e r e s t and the repa_vments have not amounted t o very much, But they : . r i l l i n the future. "In f a c t , a f t e r about 25 t o 30 years or s o the U.S. Embassy in India may have collected q u i t e a s i z e a b l e chunk of Indian currency and l i q u i d a t i o n of these rupee holdings through t r a n s f e r of r e a l resources from India t o t h e United S t a t e s may then pose a serious pro51en.u~/ Other commentators claim t h a t t h e problem does not a r i s e , because t h e PL be0 loans a r e not repayable i n f o r e i g n exchanze. The f i r s t groug is, h o ~ ~ e v e r , apparently of t h e opinion t h a t t h e P i L80 loans would have t o be LLquidated anyhcr.r. 24. In paragraph 22 vie concluded t h a t t h e transactions between t h e -4rr.erican a u t h o r i t i e s and t h e Indian Government could be considered mainly a s bookkeeping t r a n s a c t i o n s r%ithno e f f e c t s on t h e Indian ecor,cqr. They do not represent any t r a n s a c t i o n with t h e r e s t of the economy. Hotlever, t h i s - 1 s e a r e matched by these pay~tenks, and n e i t h e r has afiy economic e f f e c t s since they a r e of a bookkeeping nature.'! - 2/ According t o t h e newspa?er rupees out of these funds a r e now s o l d t o Anlerican t o u r i s t s a t t h e American Embassy and Co~lsulatesiyl India. - 3/ Pi. Z. Mozri, ItPL 480 Transactions1', t h e Economic Weelcly, biay 29, 1365. assumes t h a t the f i n a n c i a l arrangements have not influenced the a c t u a l e x p n d i t u r e program of the Indian Goverment, And i t may be asked if the existence of counterpart funds and the wlde1;r-heid view t h a t +,ha use of such funds i s not i n f l a t i o n a r y mlght not. have created preascros f o r ex- o penditures which would not otherwise be undertaken. N der^inif,e ansuar could be given t o t h i s question but the p o s s i b i l i t y could no+, be excluded, 2.5, For an outside observer the transactions and proced-mes between the American axbhorities a t f i r s t appear confusing and complicated, It i s , f o r example, d i f f i c u l t t o unders"und t h e purpose of chaneling funds through the c o m e r c i a l banks t o the Indian G,overrmen-Lo The main r e s u l t i s t h a t banking s t a t i s t i c s and c a p i t a l market s + , a t f s t i c s nave f o r years from - 1956-57 and 196L-65 - been obscured. Fcr the r a s t it has t o be remembered t h a t Public Law 480 requires t h a t the Anierican a u t h o r i t i e s should have some influence on the I1use1lof counterpart funds, and t h a t some earmarking procedures therefore have t o be used. Indian a f f i c i a l s claim t h a t these rupee-arrangements a r e not influencing the Plans and the expen'sli1;~reprcjgrax t o any extent. O t h e other hand,the American a u t h o r i t i e s a r e not inclined n t o consider s u b s t a n t i a l t r a n s f e r of counterpart funds earmarked f o r the financing of c e r t a i n sxpenditures a s msrely a bookkeepkg procedure. They a r e inclined Lo consider t h i s a s a contribulfon -50 the derelopnent of the country. 26. W have commectedin sane length upm t h e arrangements because e %he tralisactions in counterpart funds a r e notj very l a r g e - t h e i r ijresence - cannot be i g n o ~ e d and because discussions of Z i s c a l policy in India i n e v i t a b u grat.it,ates towards -Lhese trakisactions, They e a s i l y i n v i t e two d i f f e r e n t t:qes of i n t e r p r e t a t i o c s , and an i n t e r p r e t a t i o n has t c be mads.  !-: 0 C I T U ' c ' c .-. rC C .d O j .-4 C b U > . i a, 0 i 'c:: 'D 3 a: 3 W C rn 3 a, a 3 a: f i r 3 -% c +- g b- dcc 5 m ar >-'u 4 ! - ->, a+ a, a c ' l n .. t' L( 1 m 7 0 'a ': ar r n G> a 3 ' . >, m a aro o\ r c ": . c ,z , h ? d c o .4 c .- occa, C F W a m a h > .4 L 2 .A '0 G Table T I - : TI3Z I1tmX):J OF PL 480 F'UXIS &ID 2iIJ OTE?ALL BL?)BGTAC:Y POSITIOML~ O F TFE CZATES (Rs. aillion) I. G v e ~ a l ld e f i c i t ( s u r p l u s -1 a f t e r i n