18. To give an example, it is clear that if a decline in cash balances or an increase in short-term debt is
44
SECOND FIVE YEAR PLAN
matched by a corresponding withdrawal from foreign exchange reserves, there will not on balance, be any increase in domestic money supply. It is convenient, however, to treat a decline in cash balances or an increase in short-term debt as deficit financing and to allow separately for the money-withdrawing effect of any decline in foreign exchange reserves. Mention may also be made in this connection of a similar problem which arises in the case of sales of securities by the Central and State Governments from their cash balance investment accounts. These transactions were regarded in the first plan as deficit financing. The underlying assumption was that in the cir- cumstances of the time such sales would in effect have to be absorbed by the Reserve Bank. This has not happened in fact. As mentioned earlier, the long-term securities held by the Reserve Bank have declined. In effect therefore, the sales of old securities have not resulted in an increase in money supply. Thus, whereas on one assumption sale of securities from reserves is tantamount to deficit financing, it will, in another situation, have the same effect as borrowing from the public. Whether one includes the sale of securities from reserves in deficit financing or not, it is clear that in judging the effect of deficit financing on money supply it will be necessary to bear in mind other related data such as the change in the holdings of securities by the central bank. Further, the significance of a given increase in money supply has itself to be assessed with reference to a number of other circumstances.
19. Coming to an assessment of the likely reactions of the proposed deficit financing in the plan, it may be noted that against the deficit financing of Rs. 1200 crores, we must set off the drawing down of sterling balances by Rs. 200 crores. The remaining deficit of Rs. 1000 crores represents the net addition to currency in response to the government's budgetary operations. This may be expected to result in a secondary expansion of credit by banks. The ability of banks to create such credit is limited by the fact that the people in India have a distinct preference for holding currency rather than bank money, so that an initial accretion to the cash held by banks permits a relatively small increase in bank credit. If we assume that the ratio between currency in circulation and deposit money remains unaltered, money supply would show something like a 66 per cent increase over the plan period. National income over this period is expected to increase by 2S per cent and we may assume that an increase of the same order in money supply would in any case be safe. Some allowance must also be made for the increased monetisation of the economy and for the increased demand for cash as levels of living improve and the convenience of holding cash comes within the reach of a larger proportion of the people. Even so,the expansion of money supply of the order mentioned cannot but be regarded as the outside limit.
20. Deficit financing will augment the ability of banks to extend credit to the private sector. Such expansion will be needed and will have beneficial results upto a point. Care will, however, have to be taken to prevent excessive credit expansion which may react adversely on prices and to ensure that credit does not flow into speculation to the detriment of productive activity. The Reserve Bank has wide powers of supervision and control over commercial banks. It can vary its own accommodation to the banks and can issue directives to them under certain circumstances. Quantitative as well as qualitative controls on credit, including variations from time to time in the relationship to be maintained between the liabilities of banks and their reserves, should, we suggest, be regarded as an important accompaniment to the scheme of deficit financing we have recommended. Central banking policy along these lines can and has to play a vital role in steering the economy on an even course.
21. We have had occasion in an earlier chapter to mention some of the safeguards that can be adopted against the adverse consequences of deficit financing, and they need no more than a brief mention here. A major safeguard is building up of sufficiently large stocks of foodgrains in order to counteract inflationary pressures that may emerge from time to time, and this has been referred to in chapter II as an important constituent of economic policy. No amount of prudence in financial management can by itself eliminate completely the risk of inflation in an economy attempting to develop rapidly. The best defence against inflation is, is in a sense, to keep clear of it but a policy of "playing safe" is not always conducive to development. A measure of risk has to be undertaken, and the most effective insurance against this risk is command over reserve stocks of food grains-and a few other essential commodities which can be used to augment the supplies in the market as and when necessary. Prices of food and cloth occupy a strategic position in the Indian economy, and a sharp rise in these prices has to be prevented by the use of all available devices. So long as these prices can be maintained at reasonable levels, the cost of living of the large bulk of the population can be kept under control. Increases in prices of other commodities would be a matter of comparative unimportance, although any excessive rise in prices anywhere in the system does carry the danger of a drawing away of resources into low-priority uses. Corrective action can, however, take care of such a situation. A further defence against inflation is discriminating but prompt use of the instrument of taxation to prevent excessive increases in consumption in certain lines and to mop up the excess profits or windfall gains that deficit financing tends to generate. Finally, physical controls, including rationing and allocations, can be used to prevent consumption from increasing beyond
45
FINANCE AND FOREIGN EXCHANGE
a particular level and for economising scarce materials or scarce productive resources. But experience of the past suggests that physical controls, especially on essential and staple consumer goods, are not a device that can be relied upon to function effectively or equitably for any great length of time. This makes it all the more necessary to utilise to the full all the other available safeguards and correctives, for a curtailment of the plan itself can, in the nature of things, be thought of only in a situation of extreme difficulty.
RESOURCES OF STATE GOVERNMENTS 22. So far we have considered the resources position of the Central and State Governments in the aggregate as against the total plan of Rs. 4800 crores. We may now analyse separately the resources position of State Governments. Appendix I at the end of this chapter sets forth the relevant data, and the following table presents in summary form the contribution Part A and Part B States are expected to make towards the financing of their plans:
Financial Resources of Part A and Part B States
(Rupees crores)
1956-61
Part A Part B
States States Total
I. Size of the Plan 1567.2 535.4 2102.6
II. Resources on Revenue Account 312.3 24.4 336.7
(i) Balance from revenues at
existing rates of taxation 115.3 -17.5 97.8
(ii) Additional taxation 172.0 44.0 216.0
(iii) Share of additional taxation
at the Centre 49.1 8.1 57.2
Deduct-Interest charges on new
loans from the public 24.1 10.2 34.3
III. Resources on Capital Account 377.3 108.8 486.1
(i) New loans from the public
(gross) 210.0 90.0 300.0
(ii) Share of small savings 158.5 21.5 180.0
(iii) Other receipts (net)* 8.8 (-)2.7 6.1
Total Resources on Revenue and
Capital Accounts 689.6 133.2 822.8
Gap in Resources 877.6 402.2 1279.8
*These represent accumulations in provident funds, recoveries of loans and advances, appropriations from current revenues for reduction or avoidance of debt and miscellaneous capital receipts minus committed disbursements on capital account including repayments of loans, payments of compensation to zamindars and jagirdars, etc.
It will be seen that the balance which these States can make available from their resources at existing rates of taxation is below Rs. 100 crores. Their share of additional taxation against the total of Rs. 225 crores for all States works out at Rs. 216 crores. The States are likely to get about Rs. 57 crores as their share from the additional taxation to be raised at the Centre. Making allowance for interest charges in respect of new loans to be raised from the public, the revenue resources of Part A and Part B States aggregate to Rs. 337 crores. The target for new loans to be raised by State Governments in the second plan period has been placed at Rs. 300 crores. This is a gross figure, the repayments against which amount to about Rs. 35 crores; the net borrowing of some Rs. 265 crores by the States may be compared with the total borrowing programme of Rs. 700 crores for the Centre and States together. The State Governments are expected to receive as their share of small savings about Rs. 180 crores. Allowing for other net receipts on capital account, the total of States resources on capital account works out at Rs. 486 crores. Altogether Parts A and B States are thus expected to find about Rs. 823 crores as against their total plan of over Rs. 2100 crores.
23. The plans of Part C States together with those for Andaman and Nicobar islands, N.E.F.A. and Pondicherry are estimated to involve an expenditure of Rs. 125crores. The resources of Part C States for meeting these expenditures are negligible and in fact the Centre has to finance gaps on revenue account in respect of several of them. Measures for additional taxation amounting to Rs. 9 crores over the five year period have been suggested for Part C States; their estimated receipts by way of loans from the Centre against their collections of small savings are around Rs. 20 crores. The overall position is that the Centre has to finance the entire plans of these States as also of the other areas mentioned above.
24. It will thus be seen that the resources of all the States taken together fall far short of their requirements-by as much as 60 per cent. of the
46
SECOND FIVE YEAR PLAN
total. In the circumstance, large transfers of resources from the Centre to the States are inevitable. It has to be remembered at the same time that the Centre's own resources are limited and if a plan of the dimension envisaged is to be implemented in full, it will be necessary for the State Governments to contribute their utmost by way of resources for the plan.
25. The target of Rs. 225 crores of additional taxation to be raised by State Governments has been determined on the basis of detailed discussions with them and an assessment of the likely yield of the various measures recommended by the Taxation Enquiry Commission. The measures in view include land revenue surcharges, increases in rates and extension of territorial coverage of agricultural income tax, more extensive adoption of property taxes and taxes on transfer of property by local bodies, a widening of the coverage and an increase in rates of sales tax, etc. So far as the Centre is concerned, some of the recommendations of the Taxation Enquiry Commission were implemented in 1955-56. The yield from these measures has been taken into account in estimating the resources available for the plan at existing rates of taxation. The Central Budget for 1956-57 contains proposals which are expected to yield an additional annual revenue of approximately Rs. 35 crores. A substantial step has thus been taken towards realising the target of Rs. 225 crores of taxation by the Centre over the five year period. That target, as we indicate later, needs to be raised. But, we should like in this context to reiterate the importance of early action on the part of States to obtain the additional tax resources of Rs. 225 crores which they are expected to find. Details have been worked out with State Governments for raising about Rs. 166 crores of this total of Rs. 225 crores, and with some of the States discussions are proceeding in regard to further measures. A rough break down of the tax measures to be adopted for raising Rs. 225 crores of additional taxation by states is as follows:
(Rs. crores)
Land revenue 37.0
Agricultural income tax 12.0
Betterment levy 16.0
Irrigation rates 11.0
Sales tax 112.0
Electricity duty 6.0
Motor vehicles tax
Stamp duties and court fees etc. 140
Others (mainly local property taxes) 17.0
TOTAL 225.0
It will be seen that what is envisaged is a little more effort along existing lines rather than any far-teaching innovations in the sphere of State taxation.
26. Reference has been made earlier to the specific need for augmenting public revenues so as to secure. on net a surplus which Could be utilised for-capital formation. The Least that is necessary is, obviously, that each public authority should balance its revenue account. There is scope for some transfer of items of expenditure from the revenue to the capital account; also the present practices in regard to is classification are not uniform in all the States. This aspect of the question is being looked into, Once an agreed classification A revenue and capital items has been worked out, revenue resources must be found by each taxing authority to meet its recurrent needs. The Finance Commission appointed at the end of every five years under the Constitution recommends such transfers of resources from the Centre to the States as it deems fit in view of all the circumstances. Given this award, large or continuing deficits in revenue budgets are clearly indefensible either on principle or on any practical grounds.
THE ROLE OF PUBLIC SAVINGS IN A DEVELOPING ECONOMY 27. An important. conclusion that emerges from the above. review of the financial resources of the Centre and States vis-a-vis the requirements of the plan is that an enlargement of the savings of public authorities is urgently necessary if the State is to Discharge effectively the new and growing responsibilities it is being called upon to shoulder. When the role of the State is to supply entrepreneurship and management over a wide field, this must carry with it the corresponding capacity to first the finances needed. A basic weakness of the present situation is that the Stale has very little resources of its own by way of surpluses it can utilise for investment, and it has, therefore, to depend upon whatever transfer of private savings it can bring about through its borrowing programmes or through deficit financing. Over the first plan period, the total volume of public servings raised by the Centre and States for financing their investment (as distinct from Development programmes) appears to have been around Rs. 250 crores. A large part of these public savings.became available in the first two years of the plan when export (rules yielded large amounts. In the second plan period. as shown, earlier, the contribution of current revenues to the financing of the plan is, in fact, somewhat less than is required to meet the current expenditure of Rs. 1000 crores. This, we shorted like to emphasize. is a limitation on the State's capacity to push through a big programme of investment.
28. Over a period a substantial increase in the tax resources of the Centre and States is necessary and feasible. As is well known, the proportion of tax revenues to national income in India is around 7.5 per cent which is much lower than the share of the public exchequer not only in countries like the U.K. and U.S.A. but also in certain relatively under-developed countries. The Taxation Enquiry Commission has drawn attention to the fact that this proportion has
47
FINANCE AND FOREIGN EXCHANGE
remained practically unchanged over several years, and that a widening and deepening of the tax structure is called for if the various demands of a welfare state are to be adequately met Considering the financial requirements of the second plan which are considerably larger than were assumed by the Taxation Enquiry Commission-and the dangers of deficit financing, or in the alternative, any cutback in plan expenditures-we recommend that the possibilities of stepping up of the target of additional tax resources substantially within this plan period be investigated fully and the goal set at covering by taxation or from state trading, suitable fiscal monopolies and profits of public enterprises, the gap of Rs. 400 crores which remains in the scheme of financing that has so far been envisaged. Considering the needs of the plan on the one hand and the degree of reliance that is being placed on borrowings and deficit financing, the conclusion is inescapable that the target for additional taxation has to be raised from Rs. 450 crores to around Rs. 850 crores. This will reduce the dangers of any serious inflationary situation developing and will rep- resent a step in the right direction from the more longrange point of view of strengthening the investment potential of the public sector.
29. The lines along which this further effort may be made will have to be examined carefully. In an earlier chapter, mention has been made of some of these, such as a tax on wealth, a gifts tax and a widening of the concept of income so as to include in it capital gains. Reference has also been made to the suggestion that the basis of personal taxtaion be shifted, at least for the higher income groups, from income to expenditure. The reform and strengthening of the tax system along these lines may open out possibilities not only of augmenting public revenues but of closing some of the loopholes in the present system which offer scope for tax evasion. Such evasion cannot always be stopped by a mere tightening of administration; it may require a modification of the very basis and procedures of assessment. It must be recognised, of course, that taxation has its limits, and this means in turn that it has to be supplemented by institutional arrangements which bring directly into the public exchequer the surpluses which accrue from the sale of goods and services to the public. It is through devices of this type, that is, through appropriate pricing policies in respect of the products of public enterprises and through state trading or fiscal monopolies in selected lines that some of the under-developed countries with levels of living not much higher than those in India are raising the resources required for their developmental effort. An essential corollary-if not a prerequisite-of a growing socialist pattern of society is a corresponding growth in what we have called public savings.
30. Finally, it must be mentioned that the carrying through of substantial investment programmes in the public sector implies the exercise of the greatest degree of economy in both plan and non-plan expenditures. Certain increases in non-plan items may be unavoidable, but the temptation to undertake developmental schemes outside the plan has to be strongly resisted. Here too, there may be unforeseen needs, but the necessary adjustments have to be made through annual plans within the framework of the five year plan. The concept of economy in this context is not the limited one of pruning expenditures; attempts at mere pruning, as experience has shown, rarely bear much fruit. What is required is meticulous care in the use of resources, especially of scarce resources like cement and steel, and the optimum utilisation of available manpower and materials in all projects so as to bring them into early fruition. It is in the light of these considerations that the National Development Council has recently constituted a high-powered Committee to watch over the progress of developmental projects so as to secure the maximum possible economy and efficiency in their implementation.
INVESTMENT IN THE PRIVATE SECTOR 31. In addition to the investment programme of Rs. 3800 crores in the public sector, the requirements by way of investment in the private sector are estimated at Rs. 2400 crores. The broad break-up of these requirements has been given. in Chapter III. The question arises whether the resources available to the private sector would be adequate to finance investment of this order, after making allowance for the resources claimed by the State. In one sense, the answer to this question is already implied in the assumption that aggregate savings on the scale required to finance the total investment in the economy would be forthcoming. The problem, as stated earlier, is to see that domestic savings rise from about 7 per cent. of national income at the beginning of the second plan period to some 10 per cent. by the end of the period. This rate of domestic savings would be ade- quate if external resources of the order of Rs. 1100 crores become available over the five year period. The stepping up of domestic savings as envisaged in the plan is by no means excessive. It implies, a marginal rate of saving of a little over 20 per cent. In a sense, therefore, the answer to the question posed in this paragraph is in the affirmative.
32. It is important however. to stress the point that this overall equality between projected investment and postulated savings is not a complete answer. Operationally, the problem is to ensure that the investments undertaken can be seen through without an excesssive strain on the economy through price rises and similar distortions, and the issue is essentially one of the adequacy of instruments or policies for getting the desire result. It is virtually impossible to know in advance whether the necessary savings would
48
SECOND FIVE YEAR PLAN
be forthcoming; nor is it easy to predict where any shortage of savings would impinge. It can be argued that since the investment programmes in the public sector depend to a large extent on borrowings from the private sector, the impact of any shortage in savings will probably fall mainly on the public rather than on the private sector. On the other hand, the public sector has certain advantages in the matter of getting access to scarce resources. It is also not true that the savings of the private sector emerge at precisely the points at which private investment is to take place. Very much, therfore, depends upon the relative efficiency of the two sectors in getting at the savings where they emerge. This fact highlights the need for suitable fiscal and other policies to ensure an overall sufficiency of savings and for safeguarding to the extent possible the priority programmes of investment in the private sector, should need arise, through special measures of assistance.
33. It is difficult to indicate for the private sector the sources of savings in any detail, as only a small proportion of the total savings utilised in that sector passes through institutional agencies. A large part of the investment in agriculture, trade, construction and small scale industries is financed by direct savings, that is, by the savings of the persons undertaking the investment or the savings of their friends and relatives. In this part of the private sector, any shortage of resources gets reflected directly in a failure to invest. Estimates of the sources of funds for investment in the organised sector of private industry can be made, though inevitably on certain broad assumptions. The scheme for financing such investment is shown in Chapter XIX. The State can assist in the fulfilment of the programmes in this sector partly by cutting out undesirable investment-through capital issues control over exports and imports and licensing of industries; partly through tax adjustments and concessions-and in part by way of selective financial assistance through the various corporations which have been set up for the purpose. The progress of investment in the-private sector has to be constantly watched even as that in the public sector and the necessary adjustments in policy have to be made from time to time. Broadly speaking, it would appear that considering the fairly high rates of investment already achieved in organised industries and the increasing strength of the capital market, it should not be difficult for them to raise the resources needed for fixed investment. As regards working capital, there should be even less difficulty in view of the deficit financing proposed in the plan. The problem in fact, as argued earlier, might well be to check an excessive expansion of bank credit and a diversion of resources to speculative purposes.
FOREIGN EXCHANGE RESOURCES FOR THE PLAN
34. We now turn to the problem of foreign exchange resources for the plan. It is to be expected that the second five year plan with the substantial stepping up of aggregate investment that it envisages and its stress on industrialisation will involve a heavy strain on foreign exchange resources. Estimates of foreign exchange earnings and requirements over a period of five years cannot be made with any great precision. There are many uncertainties in the situation. Several of India's important export commodities, such as tea, jute goods and manganese ore are subject to sharp fluctuations in demand, and a relatively small adverse turn in the monsoon is apt to necessitate substantial imports of foodgrains and raw materials. Again, the terms of trade change from time to time. Even a ten per cent. deterioration in these can make a difference of as much as Rs. 80 crores to the payments position in a single year. The annual phasing of import requirements presents special difficulties, for this depends not merely on the requirements of the development programme but also on the availability of machinery or key materials like steel from abroad. These uncertainties notwithstanding, it is essential to form a view of the likely trends in the balance of payments and to assess the adequacy of foreign exchange resources in the light of requirements.
35. The difficulties that are inevitably involved in forecasting foreign exchange requirements and earnings over a period of five years are amply illustrated by the experience of the first plan. When that plan was formulated (i.e. in December, 1952) it was estimated that there might well be a deficit in the balance of payments of the order of Rs. 180-200 crores per year during the remainder of the plan period. In the event, however, the deficit on current account (exclusive of official donations) for the five year period as a whole has been of the order of only Rs. 50 crores the large deficit of Rs. 142 crores in 1951-52 and the small deficit of Rs. 9 crores in 1954-55 being partially offset by surpluses in the remaining years. One of the main reasons for this favourable outcome has been the lower volume of food imports on account of a large increase in domestic production. Imports of machinery have also been lower than was anticipated in the first plan report.
36. The following table sets forth the estimated balance of payments position for the second plan period.
49
Over the five years, the aggregate deficit on current account works out at about Rs. 1100 crores. The phasing of exports and imports given in the table above is necessarily very rough. But it will be seen that a large part of the deficit is expected to occur in the second and third years of the plan. The "hump" in the middle of the plan period is accounted for by the fact that imports of steel, machinery and equipment anticipated in the earlier years of the plan reach a peak about the time the plan is halfway through. The con- struction of the new steel plants and a large part of the expansion and re-equipment of the railways have to be completed before the last year of the plan. As these and other programmes get completed, the strain on the balance of payments will diminish.
37. The general picture that emerges is that while exports will rise moderately from an estimated level of Rs. 573 crores in 1956-57 to Rs. 615 crores in 1960-61, imports will rise substantially over the first four years, resulting in a negative trade balance of about Rs. 1375 crores over the plan period-or Rs. 275 crores a year on an average. After allowing for the surplus on invisibles, the deficit on current account works out to a total of Rs. 1120 crores or Rs. 224 crores a year
38. Before turning to the details of the expected level of exports, imports and invisible transactions, it is important to underline two assumptions on which the estimates given here are based: (a) that the terms of trade in the next five years will remain, on an average, the same as they have been in 1955-56 (first nine months), and (b) that inflationary pressures will be held firmly under control. The terms of trade index (with 1952-53=100) stood at about 100 in the first nine months of 1955-56 as against 133 in, 1951-52 when the Korean boom was at its height 101 in 1953-54 and 110 in 1954-55. These figures give a rough indication of the comparative significance of the particular terms of trade we have chosen as the basis of our calculations. The second assumption is one that underlies all our calculations of savings, investment and financial resources for the second plan, but it is relevant to emphasize this fact in the present context. The balance of payments is particularly sensitive to inflationary pressures. Rising domestic prices create new demands for imports and come in the way of exports. While commerical policy can mitigate these adverse repercussions for a time, there is no doubt that the corroding effect of a sharp or continued inflation within the economy cannot long be prevented from making itself felt in the country's balance of payments position. In the interest of domestic economic stability as well as of a healthy balance of payments position effective control of inflationary pressures is a prime necessity.
EXPORTS 39. The following table gives the expected earnings major exports over the second plan period as compared to those in 1954 and 1955:-
MERCHANDISE EXPORTS
(Rs. crores)
1954 1955 Last Annual Five
year of average, year
plan, second total,
1960-61 plan 1956-61
1 2 3 4 5
1. Tea 131 112 133 127 635
2. Jute yarn and manu-
factures 122 126 118 122 610
6-1/PC/ND/91.
50
SECOND FIVE YEAR PLAN
1 2 3 4 5
3. Cotton yam and manufactures 72 63 84 75 375
4. Oils (excluding mineral oils) 11 39 24 22 110
5. Tobacco 12 11 17 15 75
6. Hides, skins and leather (raw,
tanned & dressed) 29 27 28 28 140
7. Cotton raw & waste 19 35 22 22 110
8. Metallic ore and scrap iron and
steel 23 20 27 23 115
9. Coal and coke 6 4 3 5 25
10. Chemicals, drugs and medicines 5 4 5 5 25
11. Cutlery, hardware, vehicles,
electric goods and apparatus, and
machinery 3 4 4 4 20
12. Others 130 151 150 145 725
TOTAL 563 596 615 593 2965