economic development

The Impact of Inflation on India's Economic Development
Author(s): D. R. Khatkhate
Source: Economic Development and Cultural Change, Vol. 7, No. 3, Part 1 (Apr., 1959), pp. 363376
Published by: The University of Chicago Press
Stable URL: http://www.jstor.org/stable/1151642
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THE IMPACT OF INFLATION

ON INDIA'S ECONOMIC DEVELOPMENT

D. R. Khatkhate
The Reserve Bank of India

economy has to bear an impact of inflation during its
Any underdeveloped
when the process of growth happens to be at
economic development,
especially
a rapid pace.
In fact, the risk of inflation is, up to a point, inherent in the very
The level of investment
required to break through the vicious circle of
process.
low income-low
savings has to be on a large scale, and it is not always possible
to meet that investment
expenditure from taxation and current savings of the comA certain amount of credit creation to finance the investment
acmunity alone.
and the resulting frictions and pressures
tivity thus becomes nearly inevitable,
get reflected on the general and sectoral price levels,
though the degree of their
as for example,
in investment
and consumption
impact varies in different sectors,
goods sectors and within the latter with respect to some particular commodities.
to realize that the impact of inflationary
However, it is imperative
preseven in a situation where the extent of investment
sure is rather ineluctable,
exThe rate of capipenditure has been limited to the currently available savings.
if it is to become self-cumulative
and outstrip the rate of population
tal formation,
This means that switchover of current output
growth, has to be on a large scale.
to investment has to be substantial,
leaving a smaller porportion for current conThe process of growth also requires that the resources
have to be
sumption.
For these reasons,
forced into new investment
the price rise in the iniactivity.
both in regard to resource inputs as well as
tial stages of economic development,
consumption goods, is difficult to avoid, even though the economy attains equilibrium rate of growth with current savings matching additional investment outlay.
A case for inflationary method of financing investment has been made to
rest also on one more ground.
It has been argued that the disguisedly
unemployed
countries like India represent
people on land in the overpopulated
underdeveloped
a saving potential which can be actualized in investment if they can be put on new
The lack of finance then does not become a bottleneck,
inasmuch as the
jobs.
on more or less the
economy can utilize this unemployed labor in new investment
same level of consumption of food by having recourse to credit-creation.
This,
is only a theoretical
however,
concept so far and requires inductive verification.
one gets of the economic development in some of the
From whatever impression
it appears that consumption of food by the newly emcountries,
underdeveloped
As a result, any
ployed workers tends to rise consequent on their employment.
credit expansion brought about as a counterpart to the saving potential only helps
weak classes.
to depress the consumption level of the economically
more meaningful,
in the context of an underdevelBut what is operationally
is the nature of the impact of inflation.
oped economy,
Though inflationary presand developed
sures in their broad framework are similar in both underdeveloped
And since
the difference arises in regard to their modus operandi.
economies,
affected by inflation are different,
the crucial variables
that
policy measures
-363-

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364

THE IMPACT OF INFLATION

are also qualitatively
different.
The planning experiments
suggest themselves
that are being made in India over the last seven years in this connection are more
the
They throw into bold relief the nature of the impact of inflation,
illuminating.
between the variations in
sensitive
spots in the economy, and a close relationship
of food; they also show
the rate of investment and the changes in the availability
that recourse to inflationary methods does not always result in inflation, which
means that the approach to the problem of planning in countries like India has to be
in real terms and that financial planning has to be conceived in relation to certain
important factors which ultimately govern and regulate the process of economic
development.
The main purpose of this article is to discuss how Indian economic development proceeded and how inflation has affected it both under the First and Second
Five Year Plans, to point out its implications
for planning, and to indicate the naIn order that the acture of future difficulties
which India is likely to encounter.
it is prefaced
count of Indian planning and inflation should be more meaningful,
to which the economic developments
with an analytical framework with reference
in India are described.

The Mechanics

of Inflation

For a rapid expansion of the economy, the rate of investment has to be
The given scale of investment outlay
larger than the rate of population growth.
can be sustained only if an adequate amount of consumer goods is forthcoming to
in its absence,
absorb the additional money incomes arising from new investment;
Thus, the principal limiting factor in ecoinflationary pressure would emerge.
of consumption goods as ex definitione the
nomic development is the availability
It folunderdeveloped
economy suffers from a very low per capita consumption.
lows, then, that if the economy can somehow procure a sufficient quantum of consumer goods, it would be in a position to maintain a greater level of investment
Of course, it is no doubt true that
and thus force the pace of capital formation.
by making a full use of saving potential as represented
by the diguised unemployed
in the economy,
can be stepped up, though in actual implethe rate of investment
mentation of planning, it is not always possible to ensure a release of consumption
of those workers who have now migrated to new investment;
nor is it easy to curb
For this
the tendency of those workers who have stayed behind to consume more.
reason, in a developing economy, a great deal of pressure is exerted on consumpWhile the shortage of consumer
tion goods and therefore prices tend to rise.
i. e.
nature, there is also another bottleneck,
goods is a bottleneck of a long-term
restricted
nature, as
supply of capital equipment which is mostly of a short-term
in the long run, if an adequacy of conit is conceivable
to increase its availability
In sum, therefore,
it can be easily seen that the
sumption goods is assured.
whenever
of inflationary pressures
developing economy bumps into difficulties
So far, the manner in which inflational
these two bottlenecks appear on the scene.
pressures
operate does not very much differ from that in more mature and rich
countries; the paths of inflation actually diverge when one comes to disaggregation
of the demand for consumption goods.
It would be pertinent to see the nature of consumption goods on which the
The item
demand arising from new money incomes is expected to be concentrated.
on which a large proportion of income will be expended is food. Since population
is, by and large, on a subnormal standard of living, newly employed people would

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ECONOMIC DEVELOPMENT

.AND CULTURAL

CHANGE

365

tend to enhance their consumption of that item when their money incomes rise.
Now, this increased
consumption of food tends to raise the prices of food and
rural incomes
though in fact the increased
thereby the incomes in the rural sector,
For one thing, the windfall rise in
are not generally spent on industrial products.
the money incomes of the peasantry initially tends to remove the incentive for more
For another, the agriculturists
less is produced.
and on the contrary,
production,
tend to consume a larger proportion of whatever output they produce, leaving a
smaller margin to be exchanged for industrial goods.
Thus, the benefit of exother than agrigoes to industries
panded demand for consumption goods scarcely
situation wherein sagging markets in industrial
culture, and we find a paradoxical
consumption goods coexist with buoyant markets for food.
of this is obvious for the process of inflation.
The implication
Normally,
when the demand
in many advanced countries,
situations experienced
in inflationary
for consumption goods expands, the profits of consumer goods industries
spurt up
inasmuch as a larger proportion of profit
and eventually create stable conditions,
ratio in a developOn the other hand, the profit-wages
earners' income is saved.
As
at any rate in the initial stages.
ing economy moves in a downward direction,
who benefit from a growing demand
we have seen above, the agricultural
classes,
for food, do not raise their profits because they tend to reduce their output. It
has its ricocheting
producing consumption goods other than
impact on the industries
of industrial wage
the cost of subsistence
food. Since the food prices increase,
to allow wage increases.
earners increases
pari passu, which forces the industries
ratio and therefore the rate of saving.
This brings about a fall in the profit-wages
The falling tendency in industrial profits is further fortified by sluggish demand
more than
conditions for industrial goods, because the demand for food increases
as
in proportion to the rise in money incomes of the community.
Furthermore,
in the initial stages of economic development,
capital outlay is incurred on projects
with a long gestation period; profits do not accrue till the projects are completed,
but at the same time, wages form a substantially
high proportion of total investment outlay.
ratio, because of all these reasons,
Thus, the falling profit-wages
and
that normally operates in advanced countries,
removes the natural stabilizer
are more acutely felt on the available food
in consequence
inflationary
pressures
supply.
conditions
here that the type of such inflationary
It has to be emphasized
in the economy; it
does not necessarily
emerge from a rising rate of investment
may as well result from a steep decline in food output without any change in the
A perceptible
fall in food makes, thus, even the existing level
rate of investment.
of investment
untenable.
Though a lack of an adequate quantity of food can be a serious limiting factor in the process of growth, the changes in the stocks of food are perhaps more
of food in a growing economy.
crucial insofar as they determine the availability
The proportion of the output that is marketed is very significant in the case of food
than in regard to comwhere subsistence
predominating
farming is comparatively
Because of this, the magnitude of changes in marketed surplus is
mercial crops.
between technical
Any small discrepancy
larger than that of changes in production.
conditions of demand for food and supply of food brings about a more than proporIf demand is expected to
in prices.
tionate variation in the stocks and, therefore,
to inand consumers
exceed the supply of food, it induces the producers,
traders,
crease their stocks in view of the expectation of a price rise, and its impact is
Thus, in the wake of economic development of underdevelvery much magnified.
tne crucial role of stock variation has to be recognized.
oped countries,

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366

THE IMPACT OF INFLATION

The modus operandi of inflation in a developing economy differs in one
more respect.
it is to be expected that in an inflationary
situation any
Normally,
the assumption
import surplus should result in reducing inflationary
pressures,
domestic incomes absorb imported consumer
underlying this being that increased
If the type of import surplus that the developing economy develops is disgoods.
it will be easily seen that it would consist mainly in capital goods,
aggregated,
wlich constitute the direct requirements
of investment
planned, because the economy of the underdeveloped
country, being incapable of producing a significant volhas to rely on imports.
ume of capital goods internally,
Thus, such import surforce, would on the contrary be inplus, instead of constituting a disinflationary
investment
flationary to the extent to which it would necessitate
complementary
expenditure,
thereby generating an additional demand for consumer goods.

The Impact of Inflation--The

Indian Experience

to the analytWe would now discuss the Indian experience
with reference
ical framework set out above.
Our study will be confined mainly to the period
beginning from 1951 when India embarked upon a deliberate process of economic
India, no doubt, had passed through
development under the First Five Year Plan.
the phase of inflationary
before 1951, more particularly
pressures
during the war
and postwar period due to a combination of circumstances
arising from war exdevaluation of the rupee, and the Korean war boom.
However, the kind
penditure,
of inflation that was so generated was largely the result of the operation of external
factors and was unconnected with the process of growth of the economy as such.
The goal that the economy has set before itself is to attain the level of investment by 1960-61 which would form about 10 percent of the national income.
that investment formed only about 5 percent of national income in 1951
Considering
when the First Plan was launched, this would naturally involve a large amount of
It is however noteworthy that in the earlier phase of economic development,
effort.
from 1951-52 to 1954-55, no impact of inflation was felt either on the
particularly
domestic situation or on the Indian balance of payments position,
despite the accelthe prices
eration in the rate of investment
On the contrary,
during that period.
item
of all commodities,
but more significantly
of food, which is the most essential
of the community's
tended to slump till the end of 1954-55 when sympconsumption,
which can be
toms of inflation began to emerge.
The index of wholesale prices,
taken as reflecting the intensity of inflationary
demand, witnessed a sharp fall to
the extent of about 14 percent in the very first year; the fall in food prices was
while the sharpest decline of 30percent was in
slightly more, at about 17 percent,
somewhat in 1952-53 and
respect of raw materials.
Though the prices recovered
fashion through 19541953-54, the declining price trend continued in an accelerated
55, with food prices bearing the major impact, inasmuch as they fell by 22 percent.
From then onwards, however,
there was a distinct and clear break with the declinand they rather suddenly started increasing.
Thus, food prices
ing trend in prices,
showed a striking increase.of
the order of 43 percent between June 1955 and March
rose by 26 and 19 perand semi-manufactures
1958, while prices of raw materials
cent respectively.
But the smaller increase of only 4 percent was in prices of maniWhat is striking in this connection is the fact that it was food and raw
factures.
materials
which felt the pressure
of demand.
One special feature of this price inflation is that the duration of this phase has been much longer and continuous than
earlier phases experienced
since 1949.

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ECONOMIC DEVELOPMENT

AND CULTURAL

CHANGE

367

The real explanation of this paradoxical
situation of accelerated
price fall
in the wake of rapid expansion of the economy in the earlier phase of planning, and
of demand on food, has to
a subsequent emergence
of acute inflationary
pressure
between various variables like the rate of investbe sought in the interrelationship
of food, and the behavior of stocks of foodgrains.
It will be
ment, the availability
seen from Table 1, which gives figures relating to the variation in the rate of investment both in the public and private sectors in each year from 1951-52 and the
in food supply, that, till 1954-55 when the food position had substantially
movements
were not permitted to creep into the economy,
the inflationary
pressures
improved,
even though investment was stepped up at a rapid pace.

Table I.

Year
1951-52
1952-53
1953-54
1954-55
1955-56
1956-57
1957-58

Volume

of Investment

and Availability

Private
investment
(in millions
of rupees)

Public
investment
(in millions
of rupees)

Total
investment
(in millions
of rupees)

% change
over
previous
year

3,630
3,730
4,250
4,220
4,790
5,940
5,670

1,820
1,970
2,490
3,880
4,960
5,100
6,710

5,450
5,700
6,740
8,100
9,750
11,040
12,380

- 6.2
+ 4.6
+18.2
+20.2
+20.4
+13.2
+12.1

of Food

Availability
of food
(in thousands of tons)

% change
over
previous
year

56,956
61,711
71,166
68,198
67,010
73,367

+ 2
+ 8
+15
- 4
- 2
+ 9

This would throw in bold relief that, because the food availability
increased
till 1953-54, the money demand generated by rising investment
expenditure in the
on general prices.
It is true that the
economy did not exert excessive
pressure
food supply did decline in 1954-55 by about 4 percent as compared to the peak level
reached in the preceding year.
However, it did not result in price rise in the
same year, because of the inevitable lag that intervenes
between production and its
manflow to the market.
After 1954-55, as we have observed above, the stresses
in food prices.
It so happened that an expanding investment
exifested themselves
penditure was set against a falling or stationary level of food supply, so that the
the aggregate demand for food which
higher level of money incomes increased
could not be met at the old level of prices.
of the
Thus, from the juxtaposition
rate of investment
and level of food availability,
it is apparent that the bottleneck
of food made it difficult to sustain the rising rate of investof relative insufficiency
ment projected in the Second Five Year Plan.
But mere technical maladjustment
between demand and supply conditions2
does not explain either the accelerated
price fall in 1954-55 or the accelerated
1.

The figures of private and public investment
are as estimated
in this issue.
Bhatt in his article appearing elsewhere

2.

For an illuminating
see S. Sachi, "Changes in
analysis of food problems,
Stocks and Fluctuation in Food Prices,
The Economic Weekly, November
23, 1957.

by V. V.

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THE IMPACT OF INFLATION

368

price rise since 1955 onward; the behavior of stocks which is the most volatile
factor did play a significant role in accentuating the price trends in either direcThe distinction has to be drawn between the tendency for food prices to
tion.
When the food position is comfortable
change and the actual extent of that change.
in relation to the current demand, the stocks all along the line--with
producers,
of a price fall
to decline in view of the expectations
and traders--tend
consumers,
between demand and supply is very much magnified in
and the initial discrepancy
reverse
takes
the
place in the opposite situation when demand for
consequence;
the same seems to have happened
food tends to outstrip the supply.
Precisely
the variations in
It is very difficult to assess
in India over the last few years.
regarding volume
quantitative terms, because of the dearth of relevant statistics
Whatever little evidence there is to support
of stocks with producers and traders.
some statistics
our hypothesis is of a qualitative nature.
However,
regarding the
changes in marketed surplus which can be taken as a good indicator of stock variation with the producers are available from the Foodgrains Enquiry Commission's
report, published some time towards the close of 1957.

Table II.

Marketed

Surplus

of Rice
Marketed
surplus
as a % of
production
in each year

Year

% change in
production

% change
in prices

% change in
marketed
surplus

Nizamabad

1954-55
1955-56
1956-57a

-24.4
+14.0
+ 4.0

-24.0
+20.6
+26.2

+64.3
-10.2
+ 8.3

35.1
27.7
24.8

Mahboobnagar

1954-55
1955-56
1956-57a

+22.3
+ 0.8
+22.1

-15.4
+11.8
+17.6

+32.5
- 3.5
+34.9

28.4
27.2
27.2

Warrangal

1954-55
1955-56
1956-57a

-35.4
+ 1.8
+34.4

-25.2
+27.4
+22.5

+ 3.7
+18.5
-10.3

25.6
29.8
16.8

District

a. Nine months.
Source:
Report of the Foodgrains

EnquiryCommittee,

pp. 188-189.

It would be clear from the above table that the marketed surplus of rice,
in 1954-55 in relation to 1953-54 when prices declined
by and large, increased
On the other hand, during 1955-56
even when production had fallen substantially.
less
and 1956-57, the marketed surplus either decreased
sharply or increased
As a rethan in proportion to expansion of production because of the price rise.
sult, the actual extent of price rise since 1955 was much more than the technical
This conclusion
between aggregate demand and supply warranted.
discrepancy
was further supported by the firsthand qualitative information collected by the
which stated, "With a situation thus generally
Foodgrains Enquiry Committee,
in production and
favourable to prices of foodgrains,
it was first the short-fall
later the slowing down in market arrivals which released the spring, as it were,

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ECONOMIC DEVELOPMENT
and pushed the prices of foodgrains
3
they had falled in 1954-55".

AND CULTURAL

sharply

CHANGE

upward from the low levels

369
to which

the traders could and did aggravate the presTogether with the producers,
the stocks beyond the normal level to take adsure on food prices by increasing
are available about the stocks
No data, however,
vantage of the rise in prices.
with traders,
though bank advances against foodgrains may give a fair idea about
the variation in traders' stocks.
Thus, scheduled bank credit against the security
i. e., 104 percent,
between April
of foodgrains increased
by Rs. 16. 5 crores,
1955 and the end of March 1956. Even granting that a portion of this expanded
to some extent by growing economic activity in agriculture
credit was necessitated
and trade, the fact remains that a sizeable proportion of that credit was harnessed
If it is recognized
that this was the period which
to build up stocks by traders.
an upsurge in food prices and that subsequent monetary restrictions,
experienced
both quantitative and qualitative,
by the Reserve Bank of India did bring
imposed
would not be
down the credit totals and to some extent inflationary
pressures,it
difficult to see the link between the stock variations with traders and changes in
food prices.
of demand aggravated
Although food prices were under constant pressure
by a fall in food output and in marketed surplus on the one hand, and rising money
incomes on the other, the inflationary
process was not all-pervading,
bringing
within its orbit all manner of consumer goods, as usually occurs in a well-developed
but
The index of finished manufactured
articles increased
industrial
economy.
the
As a consequence,
out of step with food prices.
slowly and was subsequently
sector turned
sector and the industrial
terms of exchange between the agricultural
commodities
increased
adverse to the latter.
Thus, the prices of agricultural
by
as much as 53 percent during April 1955 to July 1957, while those of industrial
it
In such circumstances,
by only 4 percent in the same period.
goods increased
should be normally expected that an increasing
proportion of rural incomes should
the trends in foodgrains in
be spent on industrial goods such as cloth.
However,
bear out the fact that food output, instead of expanding in response to
particular
showed a fall, apart from a recognized
increase in self-consumpprice stimuli,
the demand for foodgrains
tion and stock holding by the producers.
Furthermore,
The latest series
rose more than in proportion to the increase in money incomes.
of national income statistics
reveals that money income rose by around 4 percent
Taking the best estimate of incomeduring 1955-56 and 14 percent during 1956-57.
in India of 0. 8 percent, 4 the food consumption demand must have grown
elasticity
If a rise of 2 perat a 3. 2 percent rate in 1955-56, and 11. 2 percent in 1956-57.
cent is added to this consumption demand on account of a population growth of
it would follow that the demand for food during the year
about 2 percent,
beginning
from 1955-56, was almost rising faster than the annual rise in money incomes.
This meant that a portion of income which was previously
spent on other goods was
This was why the demand for cloth slackened of late leading
now diverted to food.
on
of stocks, while at the same time, inflationary pressure
to the accumulation
food was accentuated.
3.

Government of India, Ministry of Food and Agriculture,
Report of the Food1957, New Delhi, 1957, p. 48.
grains Enquiry Committee

4.

A. J. Coale and E. M. Hoover,
ment in Low-Income
Countries,
op. cit.

Population
Princeton,

Growth and Economic Develop1958, p. 126; see also Sachi,

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THE IMPACT OF INFLATION

370

Thus the concentration
of demand on only food as also the long gestation
period of many of the investment
projects under the Second Plan brought about a
fall in the profit-wages
ratio, as is apparent from a slight decline in the proportion of domestic savings to national income from 7. 6 percent in 1955-56 to 7. 5
percent in 1956-57. 5
If the main bottleneck in the economy, which is getting into stride for
is the shortage of food, it follows that the feasible
rapid economic development,
in a period of spurt in food supply would be very much higher
rate of investment
It would therefore mean that in the first four years
than it would be in its absence.
of the First Five Year Plan the Indian economy never could reach the level of inIn other words, the actual rate of
vestment which it could have done otherwise.
investment
then was much smaller than the potential investment
rate.
That this
was so is also obvious from a very small order of deficit financing incurred durThus, while in the first year of
ing that period by both the center and the states.
in the subsequent three years together it
the First Plan no deficit was incurred,
When there is an adequate volume of food in the
amounted to Rs. 257 crores.
it invariably provides a leeway for either
economy available for consumption,
credit creation by the banking system or deficit financing by the state to step up
as any resulting increased
demand would be easily satisfied.
investment,
Since,
the rate of investment
was not raised to the feasible level indicated by
however,
of food during that period, the prices of food declined,
availability
thereby dissiIt is no doubt true that the actual rise in real national income
pating the savings.
from 1951-52 to 1954-55 was ev:, more than planned for; but it is not so much the
result of attaining a maximum rate of investment
as due to the fact that the relaand
tionship which was initially presumed to have subsisted between investment
increase in food output in 1952-53 and 1953output was falsified by the adventitious
54. Perhaps a larger investment
during this period would have obviated some of
the strains and tensions the Indian economy passed through at subsequent stages.
The Planning Commission
has spotlighted this aspect when it pointed out that "In
it appears that at certain stages in the Five-year
retrospect
period, investment
6
have been stepped up beyond the levels then current.
could, with advantage,
Of course,
it is to be realized that a spurt in food output in a particular
rise in inyear does not make it possible to bring about promptly a corresponding
vestment outlay to match it; there is bound to be a substantial lag between the chang
in food output and the consequent change in the volume of investment.
Notwithstanshould not have linked up both
ding all this, it is arguable whether the authorities
so that it would have absorbed the
through the flexible operation of buffer stocks,
surplus food output when prices were falling all around and released it when the
the Government of India did build up stocks
Actually,
prices were moving upward.
up to a limit and pursued a policy of price support in respect to food; it was not of
much avail, however,
since it was divorced from the main objective of investment
as rightly emphasized
Enquiry Committee. 7
by the Foodgrains
programming
5.

See V. V. Bhatt's

6.

India, Planning
1957, p. 13.

7.

Report of the Foodgrains

article

in this issue.

elsewhere

Commission,

Review

Enquiry

of the First

Committee,

Five Year Plan,

op. cit.,

p. 51.

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Delhi,

ECONOMIC DEVELOPMENT
External

AND CULTURAL

371

CHANGE

Disequilibrium

A sort of perpetual shortage of foreign exchange is another limiting factor
in a growing economy like India's, because of the low capacity to manufacture
Over the first
etc., in adequate volume.
capital goods like steel, machinery,
five years, therefore,
it was anticipated that India would have an average payments
deficit of the order of Rs. 180-200 crores per annum, and it was expected to rise
This was found to be
to about Rs. 300 crores per annum over the next five years.
to import mostly capital goods for many a capital-intensive
necessary
project apart
from some quantum of food.
The actual balance of payments of India, together with
in her foreign exchange reserves
since 1951-52,is
the variations
presented in
Table III.

Table III.

India's Balance of Payments,
(Current Account, in millions

Imports
c.i.f.
1951-52
1952-53
1953-54
1954-55
1955-56
1956-57
1957-58a

962.9
633.0
591.8
683.8
750.6
1,095.6
1,174.3

Exports
f.o.b.

Trade
balance

730.1
601.9
539.7
596.6
641.1
635.1
594.5

-232.8
- 31.1
- 52.1
- 87.2
-109.5
-460.5
-579.8

1951-52 to 1955-56
of rupees)

Official
donations
+
+
+
+
+
+
+

5.3
10.8
19.0
15.8
42.0
44.7
29.2

Other
invisibles

Total
current
transactions
(net)

+ 64.9
+ 80.5
+ 80.5
+ 77.4
+ 84.4
+109.0
+100.0

-162.6
+ 60.2
+ 47.4
+ 6.0
+ 16.9
-306.8
-450.6

a. Preliminary.
from the I. M. F.,
b. Without taking credit for borrowings
during 1956-57 and 1957-58 would be Rs. 282.3 crores
respectively.
Source:

Reserve

Bank of India,

India's

Balance

of Payments

Movement
in foreign exchange
reserves
-164.7
+ 16.7
+ 28.9
- 18.1
+ 10.5
-221. 3b
-259.9b

the decline in reserves
and Rs. 294.4 crores,

1948-49

- 1955-56.

It would be observed that during the first five years,
except in 1951-52 when there
was a draft on foreign exchange reserves
of about Rs. 165 crores mainly because
of massive
food imports and in 1954-55 which had a nominal deficit, there was acof
the utilization
tually a surplus on current account till 1955-56.
Similarly,
grants and loans over that period amounted to Rs. 188 crores against Rs. 298
crores authorized.
The rate of capital goods imports (Table IV) had actually declined in 1952-53 and rose by only 4. 7 percent in the following year, while it
showed a steady but significant bulge in 1954-55,
1955-56, and 1956-57; only in
of
1957-58, the capital goods imports slowed down as a result of the imposition
When the foreign exchange should normally prove to be a
import restrictions.
serious limiting factor, this so-called
stability in the foreign payments position of
India during 1951-52 to 1955-56 could only mean that the available foreign exchange
In fact, tensions and
were not utilized to the maximum possible
extent.
resources
frictions are rather unavoidable in the process of growth, which implies a rupture
of the existing equilibrium
to attain a new one, and anything to the contrary points

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THE IMPACT OF INFLATION

372
Table IV.

1951-52a
1952-53a
1953-54
1954-55
1955-56
1956-57
1957-58b

India's

Imports

of Capital

Goods (in millions

of Rs. )

Private

%
increase

Government

%
increase

Total

155.90
131.90
118.80
173.69
237.70
371.30
321.20

-15.4
- 9.9
+46.2
+36.9
+56.3
-13.5

21.50
20.50
40.70
47.77
76.60
129.80
212.70

- 4.7
+98.5
+17.4
+60.4
+69.4
+63.9

177.40
152.40
159.50
221.46
314.30
501.10
533.90

%
increase

-14.1
+ 4.7
+38.8
+41.9
+59.4
+ 6.5

a. Estimated.
b. Preliminary

towards the fact that the economy has failed to reach its potential rate of investment.
Thus, the presence of stability either in the internal economic situation or
in the balance of payments is not necessarily
indicative of the maximum growth
of the economy any more than credit creation in the face of availability
of food is
of emergence
of inflationary
pressure.
suggestive
But the real impact of investment
on the Indian balance of payments was
observed in 1956-57 and 1957-58 when, under the Second Five Year Plan, a much
The total deficit on current account was as
was planned.
higher rate of investment
large as Rs. 757 crores during both the years, and a consequent draft on foreign
such a huge dip in foreign
However,
exchange assets amounted to Rs. 481 crores.
which was higher than planned for mainly due to the initial
exchange reserves,
did not arise from the internal inflationary
but was in
underestimation,
pressures,
the main related to the structure and size of the Second Five Year Plan.
Normally,
it would have been expected than an import surplus of this order would act as a
far from
In India, on the contrary,
force.
the very import surplus,
disinflationary
force as is very often believed,
was a positively
active agent
being a counteracting
This was bewhich intensified
the pressure
of demand on inelastic
food supply.
cause a major portion of imports comprised
capital goods like steel, iron, macould not satisfy the consumption
which, however,
chinery, and defense stores,
demand for food, stemming from rising money incomes in the economy (Appendix
A). The only item in the import surplus which went some way to attenuate the
demand was the heavy imports of food which aggregated
pressure
of.consumption
to Rs. 200 crores obtained under P. L. 480 from the United States.
On the other
hand, the imports of capital goods, financed mainly by drawing on foreign exchange
created demand for consumption inasmuch as they called for a compleassets,
mentary domestic investment
expenditure and thus to a great extent aggravated
domestic inflationary
conditions. 8
It is arguable that import surpluses
reduced domestic inflationary
pressures
via their impact on foreign exchange reserves;
to the extent to which they are

8.

See S. Sachi,
The Economic

"A Basic
Weekly,

Fallacy in Planning Commission's
May 17, 1958, pp. 676-677.

Appraisal",

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ECONOMIC DEVELOPMENT

AND CULTURAL

CHANGE

373

domestic money supply would be corresfinanced by drafts on foreign exchange,
It is admittedly true that a decline of about Rs. 480 crores
pondingly reduced.
did curtail an expansion of money supply which was brought about by a deficit fiThis by itself, however,
should not be taken to
nancing of about Rs. 700 crores.
mean that the domestic effective demand is curtailed pari passu with the reduction in the money supply, because the effective demand is as well a function of
When the supply of money declines and investment
the velocity of money.
tends
utilized and the same
to be high, the lower quantity of money is more intensively
has happened in India during 1956-57 and 1957-58.
The income velocity of money,
which was around 5 in 1955-56, increased
to 5.4 in 1956-57, which offset a fall
in money supply and thus helped to maintain the effective demand on more or less
the same level. 9 Had the money supply not contracted as a result of the fall in
there was sufficient ground to believe that incomeforeign exchange reserves,
the effective demand
velocity of money would not have gone up as it did. Actually,
pitched at a high level, because the rate of investment was very high, despite the
fact that available consumption goods, i. e., food, were inadequate.

Future

Perspective

in the foregoing paragraphs,
it would
Summing up the entire discussion
clearly appear that the principal limiting factors which tend to bedevil Indian economic development are foreign exchange and food. After correcting initial estithe foreign exchange component of the Second Five Year Plan was expected
mates,
to amount to about Rs. 1700 crores out of which in the first two years of the Second Plan, i. e., 1956-57 and 1957-58 only, approximately
Rs. 800 crores have
been already used up, and the third year's utilization has been placed at around
Rs. 300 crores.
Thus, there would still be a gap of Rs. 600 crores during 195960 and 1960-61.
The magnitude of this gap no less than the manner in which it
should be bridged pose a problem not only for Indian planners but also for the
countries like the U.S. and Germany, who could provide the wherecapital-rich
withal of external resources.
The deterioration
in the Indian balance of payments
position during the last two years, and the consequent sliding down of her external resources,
it should be recognized,
did not result from internal inflationary
as in the case of many a country in 1955 and 1956, but was related in
pressures,
the main to the direct requirements
of the size and pattern of investment
effort
The building up of social overheads like
projected in her Second Five Year Plan.
communication
and transport and irrigation is a sine qua non of economic develsince the resource inputs in
opment insofar as it creates a growth potential,and
such projects have to be obtained from outside the country, the foreign exchange
in required volume has to be made available.
in retrospect
that
Considering
countries like the U. S., Japan, and Sweden attained their peak rates of growth in
the latter half of the nineteenth century and the first decade of the twentieth century, which coincided with a massive inflow of foreign capital into those countries,
the foreign exchange shortage which India is experiencing
at present should not
come in as a surprise.
The average rate of growth of five percent per annum as
with the annual rate of growth of popuplanned by India, when put in juxtaposition
lation of about 2 percent,
can by no means be taken as an ambitious target.
And
9.

See Sachi, "A Basic Fallacy in Planning Commission's
o.
Appraisal",
and D. Shenoy, "Inflation and Import Surplus",
The Economic Weekly,
June 21, 1958.

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cit.,

THE IMPACT OF INFLATION

374

if that be so, it follows that the foreign exchange requirements
of India of the
order of Rs. 600 crores for the next two or three years are not large, either in
relation to her needs or the capacity of the lending countries like the U. S., Gersuch exmany, and the U. K. Even in the larger context of the world economy,
to a country like India which is planning her progress within
ternal assistance
would be a distinct gain, insofar as the volume of
the framework of democracy,
world trade would increase in the course of time, apart from the fact that the
of India would act as a bulwark against
rapid and substantial economic development
and politically
situations.
economically
explosive
The availability
of foreign exchange,
forms only a part of the
however,
story of Indian planning; food being the main sensitive
spot bearing the impact of
to increase food output. 1U The fortunes of Indian
inflation,
steps are necessary
economic development have fluctuated in the past, with the unpredictable
behavior
of rains which governed the changes in food output.
The irrigation facilities
are
of huge dams and irribeing spread throughout the country through construction
of expanded food output in
gation networks which would become the epicenters
have a long gestation period, and
These projects,
the course of time.
however,
Until such time,
their effect on output of food would be felt after a long time.
India should be assured of a supply of food from those countries which have surThis kind of utilization
of food surpluses
ensures a steady growth of
plus stock.
an undeveloped economy without the scourge of inflationary
while
pressures,
at the same time the price support policies in food-lending
countries.
facilitating
in the form of wheat loans to India under P. L. 480 from the U.S.
The assistance
There is
presents a splendid example of the beneficial impact of food surpluses.
no reason, therefore,
should not be offered in times
why more such assistance
in the context of the recessionary
to come, particularly
trends in the U.S.
FurIndia can, by entering into bilateral agreements
with some Southeast
thermore,
Asian countries like Burma and Thailand, import food on a long-term
basis,
against export of some of the manufactured
goods and iron ore or manganese.
countries
This would be mutually advantageous,
inasmuch as the food-exporting
will be insured against the price hazards involved in the export of food, and India
will be assured of a steady supply of the food which is stalling her developmental
efforts.

10.

See D. Shenoy,
nomic Weekly,

"Rephasing the Plan: Some Considerations",
December
3, 1957.

The Eco-

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Appendix

Priv.
Food
Others
a. Total food
b. Consumer goods
c. Raw materials
d. Capital goods
i. Locomotives
ii. Machinery
iii. Metals
iv. Vehicles
v. Ships and aircrafts
e. Others
Total imports
(a + b + c + d + e)

(Continued

1951-52
Govt.

n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
15 , 590
2, 15t
30a
8,810
3, 980
2,310

A.

Composition

Total
n.a.
n.a.
n.a.
n.a.
n.a.
17,740a
30a

460a

Priv.

of India's

1952-53
Govt.

Imports

Total

n.a.
n.a.
13,954
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
13,190
2, 05o1 15, 240a
30
30a
7,630
3,460
1,610
460a

-

(in Rs.

Priv.
280
2,650
2, 930
11,340
19,660
11,880
50
7, 070
2,860
1,440

460a

460
-

66,820

on next page; notes

29,470

96,290

44,270

18,611

62,881

on next page)

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45,810

lakhs)

1953-54
Govt.

Tota

6,503
6,78
460
3,11
6,963
9,89
- 11,34
300 19,96
4,070
15,95
2,550b
720
800

9,62
3,58
2,24

2,038

46
2,03

13,371

59,181

Appendix A (continued)
Priv.
Food
Others
a. Total food
b. Consumer goods
c. Raw materials
d. Capital goods
i. Locomotives
ii. Machinery
iii. Metals
iv. Vehicles
v. Ships and airc rafts
e. Others
Total imports
(a + b + c + d + e)

1955-56
Govt.

Total

3,240

3, 240

3,080
13, 200
21,290
23, 770

3,240

6,320
13, 200
21, 290
31,430

11,250b
8,210

5, 13Cb 16,380b
1,210
9,420

7,660

4,310

1,320

5,630

1, 030

3, 110

4, 140

62,370

14,010

76,380

Priv.
-

1956-57
Govt.

Total

10,610

10,610

- 10,610
9,520
18,240
37, 130 12,980
250
15,550
9,04b
15, 560
1,430C
2,510
4,370
1,400
15,540

5,560

80,430

29,150

Priv.
-

1957-58
Govt.

Total

15,240

15,240

10,610
9,520
18,240
50,110
250
24,590
16,990
6,880

15,240 15,240
7,390
7, 390
- 12,900
12, 900
32, 120 21,270 53,390
15
150
16,440 13, 760P 30, 20
5, 160 16, 80
11,640
5,780
2,350
3,430

1,400
21,100

460
15,790

12,720

460
28,510

109,580

68,200

49,230

117,43

a. Estimate.
b. Includes locomotives.
c. Iron and steel.

Note:
In the years 1956-57 and 1957-58, figures for consumer goods comprise
cutlery and ha
and rayon textiles only; whil
woolen yarn and manufactures
paper, pasteboard and stationery,
mineral oil, cotton raw and waste, jute raw and waste, dyes and colors and chemicals
only.

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