India - Memorandum on recent economic developments

R EST R I CT E D F! F<_t 'tj J9'l > R e p o r t N 0: AS-66a INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT GMEMORANDUM ON RECENT ECONOMIC DEV ELOPMENTS IN INDIA April 7, 1958 Department of Operations South Asia and Middle East  CURRENCY EQUIVALENTS I Indian Rupee x U.S. $0.21 1 U.S. Dollar a Ra. 4.762 Rs. 1 billion a $2.1 million a L 750,000 I  CONTENTS Page No. FO0WOBD (ii) SUIEiIARY AND CONICLUSIS\ (iii) PART I. PRESENT STATE OF THE ECONO0AY Balance of Payments 1 Internal Finance 4 Production 10 PART II. PROSPECTS FOR THE CONiING YEAR Progress of Development 12 Public Finance 13 Demand and Supply 15 Balance of Payments 17 Key Problems for the Future 1s TABLES 1. Gold and Foreign Exchange Holdings 1 2. India's Balance of Payments 2 3. Revenue Budget of the Central 5 Government 4. Plan Outlay and Its Financing, 7 1956/57 and 1957/58 5. Credit Extension to Government 8 6. Causes of Changes in iioney Supply 9 7. Security Yields 10 8. Agricultural Production 10 9. Estimated Budget Receipts of Foreign 15 Aid, 1957/58 and 1958/59  (ii) FQRDiCRD The last economic report on India (No. AS-60a) was circulated in May 1957. Prior to that, the Bank Ilission which visited India in 1956 prepared a comprehensive report on India's economic prospects (No. AS-58a), to which refer- ence should be made for basic statistical information. The present report deals nvith econcmic developments during the past twelve months and surveys the prospects for the financial year beginning April 1, 1958, in the light of the Central Government's Budget introduced at the end of February. No attempt is made here to re-appraise the longer-term outlook. It is intended that this should be the subject of a further report to be prepared during the sumner on the basis of an on- the-spot study by members of the Bank staff.  (iii) SUMiA?RY AND CON4CLUSIONS 1. India has achieved a rapid acceleration in the -pace of economic development during the past two years. Public expenditures on develop- ment have increased from an average of around Rs. h billion (:,,840 million) a year during the First Five-Year Plan to Rs. 6.75 billion (`l.14 billion) in 1956/57 and an estimated Rs. 8.45 billion (',l1.8 billion) in 1957/58. In 1956/57 there was also a boom in private industrial investment, but this appears to have subsided during the past year. 2. The stepping up of development, combined vrith a sharp increase in defense expenditures, has resulted in a general excess of demand over domestic supplies, rhich has been reflected in a big increase in imports. Exports have shaown little or no advance. Part of the resulting deficit in the balance of payments has been covered by foreign aid, but India has also been forced to draw down her foreign exchange reserves by nearly $1 billion since the beginning of the Second Five-Year Plan. hore rigorous import licensing and larger receipts of foreign aid have greatly reduced the drain on reserves in recent months. The scope for further drawing on reserves is distinctly limited. 3. Deficit financing by the Government has exerted a strongly ex- pansionary influence on money supply, but this has been largely counter- acted by the reduction in foreign assets. Internal prices have conse- quently remained fairly stable during the past year. Agricultural production attained record levels in the crop year ending June 1957, but preliminary reports indicate that the current year's harvest has been less favorable. Industrial production has gone on expanding, but the rate of increase has slowTed dovm. 4. The problem before India is how to close the gap betwveen overseas payments and receipts (including foreign aid) without upsetting internal price stability or creating shortages of food or other essential commodi- ties and without too heavily mortgaging overseas earnings in future years. To achieve this, total demand mnust be progressively brought into line -with the resources currently available to meet it. 5. The Budget for 1958/59, which was introduced in February, contem- plates a slight net reduction in tax rates and a further increase of 15%- 20% in public development expenditures. In spite of this the estimate for deficit financing is considerably reduced. However, the assumptions made about domestic savings and foreign aid receipts appear distinctly optimis- tic, and government transactions will probably continue to exert a strongly expansionary influence on money supply during the coming year. The availability of foodgrains will be a critical factor both for the balance of payments and for internal prices. If demand can be satisfied from domestic production and from imports financed under aid programs (plus normal commercial imports), serious inflationary strains should be avoided.  (iv) 6. The balance of payments situation in 1958/59 will still be very difficult, even if India does not have to pay out of her oi^m resources for imports of foodgrains in excess of those to which she is committed under existing agreements with the United States and Burma. The issue of new import licenses has been cut in the last tyio 1 censing periods to vwell under half the levels prevailing in 1956, but large cormitments are still outstanding. Considerably larger receipts of foreign aid are already assured from the United States and other countries, but it looks as if a sizeable gap will remain to be covered by further draving on reserves and additional borrowing abroad. 7. Vi:nile the economic situation in India during the nexttvelve months v'll certainly not be easy, it should not be unmanageable. But the present trend of the economy poses a number of serious problems for the future, Nao that foreign exchange reserves no longer provide an ample margin of safety, larger domestic savings will have to be secured if the momentum of development is to be maintained. Alternatively, more severe restraints nill have to be imposed on government expendi- tures, and this may involve some slowring daon in the tempo of develop- ment. The food situation also demands urgent re-examination. Finally, increasing attention will have to be paid to the problem of maintaining and ultimnately expanding export earnings.  PART I - FRESENT STATE OF TIE ECONOMiAY Balance of Payments 1. Recent months have witnessed a striking improvement in India's external balance of payments, and the drain on foreign exchange reserves has been greatly reduced. More rigorous licensing of imports and increased receipts of foreign aid have both contributed to this result. In the first half of Miarch the reserves actually increased slightly, but this is an ex- ceDtionally favorable season for exports, and it should not be assumed that the results in the following months will be equally good. 2. The relevant figures are set out in Table 1. Since the beginning of 1958 the loss of reserves has averaged just under Rs. 14 million a week, compared with Rs. 42 million a week in the fourth quarter of 1957 and about Rs. 80 million a week in the third quarter. Total use of reserves and IliiF credits since April 1, 1957, (i.e. during the second year of the present Five-Year Plan) now amounts to about Rs. 2.79 billion (N586 million). Table 1. Gold and Foreign Exchange Holdings (Rs. billion) RBI Holdings of Gold Decline Drawings Total Use of and Foreign Exchange D-iring on Reserves and (end of period) Period I l.i F INiF Credits 1955/56 8.64 - - - 1956/57 6.45 2.19 0.61 2.80 April-June 1957 5.71 0.73 0.34 1.07 July-September 1957 4.70 1.01 - 1.01 Oct-December 1957 4.15 0.55 - 0.55 January-March 14, 1958 4.00 0.15 - 0.15 Total 1957/58 to date - 2.45 0.34 2.79 3. Commodity aid from the United States and gifts of wheat from Canada have provided invaluable support during a critical period when food supplies have been scarce. Increased disbursements of IBRD loans have also provided substantial relief. Total disbursements of Bank loans to India in the fourth quarter of 1957 were $53 million, compared with 422 million in the third quarter, $14 million in the second quarter and $12 million in the first quarter. Disbursements in the first quarter of 1958 were $47 million. On top of this, India has been helped by the agreement of some of her main suppliers to defer payments due on imports of capital equipment, particu- larly the equipment for the German steel plant.  - 2 - 4. At the present level of around Es. )4CO billion ("I.840 million) India's external reserves are sufficient to cover about one-third of last year's amport expenditure. The min:L`-um reserve required by law, to be held entirely in gold, is now Rs. 1.15 billion (N241 million). In practice, howrxever, the reserves have to be maintaired at well above this minimum to provide adequate wPforking balances, and account must also be taken of India's liabilities to the International Monetary Fund. 5. The balance of payments estimates for the first half of 1957/58 (i.e. Aprl-Seplenm;er 1957) show that rising imports continue to be the main factor responsible for the fall in external reserves. Details are given in Table 2. Table 2. India's Balance of Payments (Rs. billion) Current Account 1954/5 1955/6 1956/7 Apr-Sept. Apr-Sept. 1956 1957 Imports, c.i.f.a/ 6.84 7.51 10.76 4.77 6.22 Exports and re-exports, 5.97 6.21 6.37 2.88 2.67 f.o.b. - - - Trade balance -0.87 -1.10 -4. 39 -1.89 -3.55 Invisibles net $0.77 $0.85 /1.07 /0.45 $0.51 (exc. official grants) - _ - - Current balance -0.10 -0.25 -3.32 -1.44 -3.004 (exc. official grants) Official grants /0.16 $0.)42 /0.40 /0.18 /0.06 Current balance /0.06 /0.17 -2.92 -1.26 -2.98 (inc. official grants) Errors and Cmissions -0.12 -0.03 -0.05 /0.11 $0.16 Capital Account Official loans received $2 0.001 /0.04 $0.56 /0.08 /0.90 Transactions with I1F net (dravings $) -0.17 -0.07 /0.55 -0.06 /0.34 Other capital transactions net /oO25 /0.04 -0.33 -0.16 -0.17 Change in reserves -0.17 /0.15 -2.19 -1.29 -1.74 a/ Including debits in respect of imports of foodgrains and other comrodities under P.L. 480 for which corresponding credits are included under official loans (and also, to a very small extent, under official grants and net invisibles). b/ Including loans from IBRD and ICA, the Soviet steel credit and the bulk of transactions under P.L. 480.  6. Total payments for imports in April-September 1957 were 3C% greater than in the corresponding period of 1956 and over 7C% above the average rate for the two years preceding the start of the Second Five-Year Plan. Export earnings m.eanwhile have declined a little as a result of a fall in both volume and prices of tea exports, the weak- ness of the market for jute manufactures and continued restrictions on exports of vegetable oils. Reduced earnings from these three commodities have, however, been partly offset by higher earnings from sugar, iron and manganese ores and light engineering products. There has been little change in exports of cotton manufactures. 7. A closer analysis of imports brings out the following points: (a) Comparing April-September 1957 with the pre-Plan period, over half the rise in total imports is attributable to machinery, vehicles, iron and steel and non-ferrous metals. These would be mainly goods required for investment purposes; they vwould also include materials and components used in the manu- facture of cars, bicycles, radio sets and other durable consumer goods. (b) The other big increase is in imports of foodgrains, which account for roughly one-fifth of the increase in total import expenditure since the immediate pre- Plan years. During 1957 as a whole India imported about 3.6 million tons of cereals, compared with 1.4 million tons in 1956 and 700,000 tons in 1955. The greater part of the increase between 1956 and 1957 was supplied under P.L. 480. Not all the additional supplies have been consumed. Government stocks of foodgrains have been built up by nearly one million tons during the past twelve months. (c) Imports of industrial materials (other than metals) and of finished consumer goods were considerably smaller in April-September 1957 than in the same period of 1956 as a result of the tightening up of import restrictions. Imports still exceeded the levels of the pre-Plan period in some cases (e.g. petroleum, electrical goods and apparatus); but imports of textile materials wTere considerably belowv pre-Plan levels. (d) There has been a large increase in imports of defense equipment.  -4- 8. Price increases have contributed something to the rise in import expenditure during the past two years, but overwrhelmingly the greater part of the rise is due to a larger volume of imports. In 1956 such increases as occurred in import prices were matched by roughly equivalent rises in export prices, but Indla's terms of trade may have worsened somewrihat during 1957 - first because of the rise in freight rates which followed the Suez crisis and subsequently because of the fall in tea prices. The rise in freight rates has, hovrever, since been sharply reversed, and tea prices have shown signs of recovery in recent months. Internal Finance 9. The excess of Central Government revenues over current expenditures in the year just ended is estimated at about Rs. 50 million, as against nearly Rs. 900 million in 1956/57 (Table 3). Tax revenues rose by over Rs. 1 billion between the two years, largely as a result of the additional taxation levied in last year's Budget. A substantial part of the increase was, however, handed over to the States, and the revenues of the Centre rose by only Rs. 0.72 billion. Against this the current expenditures of the Central Government rose by Rs. 1.56 billion, or by Rs. 1.37 billion if grants to the States are excluded. Over half this latter increase was on account of defense expenditure, vwhich rose by nearly 4h% between the two years; the rest wras attributable to a wide variety of items, including education, health, ccmmunity development, agricultural grants, subsidies to cottage industries, scientific research and maintenance of roads and public buildings.  -5- a/ Table 3. Revenue Budget of the Central Government7 (Rs. bi'lion) Receipts 1954/55 1955/56 1956/57 1957/58 (Prov.) Customrs 1.85 1.67 173 1.83 Excise duties 1.08 1.h5 1.90 2.65 Corporation tax 0.37 0.37 051 0.51 Income tax and estate duty 1.23 1.33 1.54 1.58 Wealth tax . . . . . . 0.09 Tax on railvmay fares . . . . . . 0.05 Total tax receipts 4h53 4.82 5.68 6.71 less Share transferred to State s/ 0.72 0.74 0.79 1.21 Tax receipts retained by Centre 3.81 4.08 4.89 5.50 Other revenue c/ 0.59 0.79 0.82 0.93 Total receipts 4.40 4.87 5.71 6.43 Expenditure Defense d/ 1.87 172 1.92 2.66 Civil administration 0.75 Cv94 1.22 1.54 Debt service e/ 0.4o 0.L3 0.39 0.37 Grants to States 0.30 0.36 0.28 0.47 Other current expenditure 0.74 1.02 1.01 1.34 Total expenditure 4h06 4.47 4.82 6.38 Revenue surplus 0.34 l0.4O 0.89 0.C5 a/ This table does not correspond with the official presentat-on of the Budget, which shows total revenue in 1957/58 as Rs. 7.25 billion and expenditure as Es. 7.20 billion. The differences are due to the exclusion of the transactions of the steel equalisation fund from both sides of the account and to the rearrangement of the figures relating to financial transfers between the Centre and the States. These changes do not affect the final balance between receipts and expenditure. b/ The increase in this item in 1957/58 reflects new arrangements for the division of the proceeds of Central excise duties and for the levying of additional excise duties in replacement of State sales taxes. c/ Consisting mainly of profits made by the Reserve Bank, the M1int and the Posts and Telegraphs Department, together with certain foreign grants. Includes also proceeds of stamp and other duties, sale proceeds of evacuee property and revenue from State forests. d/ In addition, expenditures on defense in the capital budget have amounted to Es. 0.08, 0.18, 0.20 and 0.25 billion respectively. i Net of recoveries of interest on loans advanced to State Governments and of dividends payable by the Indian RailwTays on their capital-at- charge.  - 6 - 10. The reduction in the revenue surplus during the past year was accompanied by a continued rise in the caDital outlays of the Central and State Governments. At the Centre the rmain increases were in ex- penditure on the railways, on the new steel plants and on trading in foodgrains (partly on account of stock-building, partly because of losses incurred in the re-sale of imported grains). The Indian Rail- ways are estimated to have spent Rs. 2.35 billion on development during 1957/58, compared with Rs. 1.80 billion in 1956/57; rather over half the additional funds required were provided by the Government and rather under half came from the railwayst own resources. Expenditure on the steel plants in 1957/58 was probably around Rs. 1.35 billion or four times as muchi as in the pre-rious year. Government stocks of foodgrains were built up by nearly a million tons during 1957/58. 11. The railmays and the steel plants between them account for the great bulk of the increase in development expenditures during the past year. Total outlays under the Plan in 1957/58, including the programs of the States, are provisionally estimated at around Rs. 8.45 billion, or Rs. 0.55 billion less than budgeted a year ago. In fact, judging by past experience, the shortfall will probably be rather larger. These outlays include some current as well as capital items. For the first year of the Plan the comparable figure was Rs. 6.75 billion, so that the total outlay during the first two years wvill likely amount to around Res. 15 billion. This is less than one-third of thie original five-year total (Rs. 48 billion) and probably not much m,ore than one- quarter of the amount now estimated to be needed to carry out the Plan in full (upwards of Rs. 55 billion). 12. The ways in which Plan outlays are thought to have been financed during the past two years are illustrated by the very tentative esti- mates given in Table 4. YNThen the Plan was published in 1956, it was envisaged that 25% of the proposed expenditures would be financed out of c-arrent revenues (after allowing for additional taxation), 15% out of public loans, 1% out of small savings and 8% from other domestically generated savings, including railway profits. It -was hoped that external assistance would provide 17% of the finance needed, and the remaining 25% was to be raised by means of deficit financing. In practice, although expenditure has been running much belowf the average annual rate envisaged in the Plan, the proportion financed out of genuine domestic savings has fallen vrell short of expectations. In- deed, the shortfall has been larger than Table 4 suggests, since part of the money raised through public loans has come from inside the banking system. This shortfall is not wholly attributable to the revenue side of the account; it is also in part the result of a sharp increase in defense expenditure, for Which no allowvance was made in the Plan.  - 7 - Table 4. Plan Outlay and Its Financing, 1956/57 and 1957/58 (Rs. billion) 1956A7 1957/58 Total Percentage Percentages of total envisaged in Plan I. Plan Outlay 6.75 8.45 15.20 100 100 II. Domestic Budgetary Resources 3.70 3.60 7.30 48 58 (a) Contribution from current b/ revenues (115) (1.30) (2.h5) 16 25- (b) RailwQays' contribution 0.27 052 079 5 3 (c) Loans from the public 1.40 0.77 2.17 14 15 (d) Small savings 0.61 o.60 1.21 8 10 (e) Unfunded debt 0.27 0.27 0554 4 ) (f) Other capital heads - 0.15 0.15 1 ) 5 III. External Assistance o.65 1.05 1.70 11 17 IV. Total Resources includin External Assistance (II F III) 4.35 4e65 9000 59 75 V. Budgetary Gap (I - IV) 2.40 3.80 6.20 41 25 a/ The figures in this table are very rough estimates intended only to illustrate the orders of magnitude involved. The estimates of the contributions from current revenues are particularly uncertain. Theoretically they represent the surpluses of the revenues of the Central and State Governments combined over their non-development expenditures. b/ Originally it vas envisaged that 17% of the Plan outlays would be met out of current revenue, after allowing for additional taxation. It was subsequently stated to be the Government's intention to cover a further 8% of the proposed outlay from additional taxation. 13. The la rge gap between government receipts and expenditure has been financed through the issue of Treasury Bills. To obtain a correct measure of inflationary financing by the Government it is necessary to take into account not only the increase in the Treasury Bill issue, but also changes in bank holdings of other government securities, in government balances with the Reserve Bank and in the Reserve Bank's loans and advances to Governments. The results are set out in Table 5. The total ariount of fresh credit extended to Government in the eleven months up to the end of February 1958 was equivalent to about one-fifth of the money supply.  -8- Table 5. Credit Extension to Government (Rs. billion) Total of