An analysis of capital flows between the agricultural and non-agricultural sectors of India

(CATALOG NO. 11) This paper is prepared for staff use and is not for publication. The views expressed are those of the author and not necessarily those of the Bank. INTER1dATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Economics Department Working Paper No. 42 An Analysis of Capital Flows Between the Agricultcural and Non-agricultural Sectors of India June 6, 1969 This paper originated, as part of the work undertaken in the Fiscal Policies of Develop- ing Countries Division for a paper on "Capital Flows and Income Transfers Within and Between Nations to Sustain the Agricultural Revolution,," (Sec M69-290 dated June 2, 1969) whiich Mr. McNamara presented at the Bellagio Conference on Agricultural Development. The analysis is based on a methodology which was developed jointly with Mr. Per Eklund who applied it in a parallel study of capital flows in West Pakistan (Working Paper No. 41). I am indebted in particular to Mr. Wouter Tims for support and criticism in the preparation of this paper. An earlier draft version has received valuable suggestions from several colleagues in the Bank particularly Messrs. Ablasser, Myint, Kavalsky and WiJaide. Fiscal Policies of Developing Countries Division Prepared by: Emmerich M. Schebeck  ANi ANALYSIS OF CAPITAL FLOWS BET1WEE THE AGRICULTURAL AND NON-AGICUJLTURAL SECTORS OF INDIA I. Introduction 1. The purpose of the study is to determine the direction and magnitude of capital flows between the agricultural and norn-agricultural sectors of India within the context of rising agricultural income., supp- lemented by subsidies, which almost entirely escapes direct taxation. Not only is direct taxation of agriculture extremely low, it is even declining with the abolition of direct taxation in several states, thus contributing indirectly to a further rise in income in the agri- cultural sector. 2. Information on the flow of funds between the agricultural and non-agricultural sectors of India is limited. FAO in its Indica- tive World Plan for 1962 to 1975 has concluded that although "the savings rate in agriculture proves to be lower than postulated for the entire economy, the agricultural sector could finance the industrial sector to a significant extent."l/ 3. The study, which in Part II attempts to analyze these capital flows shows that a large and rapidly increasing outflow of capital from India's agricultural sector appears to be taking place just when agri- culture requires a large volume of investible funds for rapid expansion of food grain production. Details of conclusions and policy implications relating to this capital outflow are discussed in Part III of the study. 1/ FAO, "Main Conclusion and Policy Implications of the Indicative World Plan Regional Study for Asi12" Ninth FAO Regional Conference for Asia and the Far East, Bangkok, Thailand, November 1968, p. 50.  -2- II. Analysis Growth of Agriculture l>. Net output of agriculturel/ for the period 1960/61 to 1968/69 has been growing at an annual compound rate of 1.2 percent on a semi- logarithmic trend.Z/ During the first four years (1960/61-1963/64) of the Third Plan (196o/61-i96l/65) the growth of agricultural value added was 2.2 percent compounded annually on a trend basis. However, the severe drought of 1965/66, and the sharp decline of agricultural output depressed agricultural growth and resulted in an annual compound growth rate of 1.76 percent in the entire Third Plan period. Thus, the gap between projected production grovth of 3 percent for the Third Plan and actual achievements was substantially widened. Table 1: Growth of Agricultural Value Added in India l960_/6_1to6 1965/69_ (at constant 1964/65 factor prices) Trend rates of growth per annum2/ 1960/6l-196T765 1960/61-1965/66 1960/61-1968/69 - in percent - Major, minor crops and livestock 2.21 1.76 1.19 a/ Least squares estimate of "b" in the equation log Y = a + b.time. Souirce: Computed from Revised Estimates of National Product, Central Statistical Organization, GOI, 1969 unpublished, to be incor- porated in the 1969 White Paper. The new revision constitutes a considerable downward revision of previous estimates. 1/ Refers to value added of major, minor crops and livestock at constant 1964/65 factor prices. 2/ Because of the fundamental revision of the national product estimates by the Central Statistical Organization, which covers only the period 1960/61 to 1968/69, it was not possible to extend this analysis over previous years.  -3- 5. Agricultural output during the Third Plan fell far short of the projected growth because of severe weather conditions and neglect of agricu'lture in the Third Plan in its reluctance to allocate to agriculture the resources necessary to accelerate adequately the growth of agricultural production. Particularly deterrent to growth was the inadequate supply of inputs, the absence of detailed planning, and the dispersal of limited resources over large areas .1/ 6. Changes in agricultural policy and programs, reflected by increased public expenditure in agricultuare cluring 1965/66, and the adcption of new technologies associated wi.th a nearly doublinlg of fertilizer consumption in 1966/67, and h-igher prices paid to farmers created conditions favorable for a potential rapid growth of the agri- cultural sector. A second severe drought in 1966/67 caused some setback to growth but in 1967/68 the value added in agriiculture increased sharply. The Central Statistical Office estimates a real growth (of value added) in agriculture by about 3 percent in 1968/69. 7. The Fourth Plan, which after 3 years of delay is supposed to be implemented beginning 1969/70, aims at an annual compound rate of growth of 4.6 percent in gross value added at factor cost. Although a growth of this magnitude is a substantial acceleration compared with the trend 1/ The Third Plan Progress Report, 1963/65, p. 47. GOI Planning Commission.  value of 1.2 percent from 1960/61 to 1968/69, it is not an unrealistic proposition in light of the recent deve.Gpment and the rapid adoption of new techmology in the agricu-ltural sector. The main contributions to growth are expected to come from new irxrigation systems, increased appli- cation of fertilizer and adoption of high yielding crop varieties. A striking evidence of this development is the installation of 70,000 new tubewells during 1966 and 1967 which compares with only 80,000 during the Third Plan, thus adding about 1