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The Impact of Inflation on India's Economic Development Author(s): D. R. Khatkhate Reviewed work(s): 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 . Accessed: 10/02/2013 17:32
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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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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
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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
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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. Volume of Investment
Table I.
and Availability
of Food
Year 1951-52 1952-53 1953-54 1954-55 1955-56 1956-57 1957-58
Private investment (in millions of rupees) 3,630 3,730 4,250 4,220 4,790 5,940 5,670
Public investment (in millions of rupees) 1,820 1,970 2,490 3,880 4,960 5,100 6,710
Total investment (in millions of rupees) 5,450 5,700 6,740 8,100 9,750 11,040 12,380
% change over previous year - 6.2 + 4.6 +18.2 +20.2 +20.4 +13.2 +12.1
Availability of food (in thousands of tons) 56,956 61,711 71,166 68,198 67,010 73,367
% change over previous year + 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 by V. V.
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.
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368
THE IMPACT OF INFLATION
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 the reverse takes 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 35.1 27.7 24.8 28.4 27.2 27.2 25.6 29.8 16.8
District Nizamabad
Year 1954-55 1955-56 1956-57a 1954-55 1955-56 1956-57a 1954-55 1955-56 1956-57a
% change in production -24.4 +14.0 + 4.0 +22.3 + 0.8 +22.1 -35.4 + 1.8 +34.4
% change in prices -24.0 +20.6 +26.2 -15.4 +11.8 +17.6 -25.2 +27.4 +22.5
% change in marketed surplus +64.3 -10.2 + 8.3 +32.5 - 3.5 +34.9 + 3.7 +18.5 -10.3
Mahboobnagar
Warrangal
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
CHANGE
369 to which
sharply
upward from the low levels
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. 4. Government of India, Ministry of Food and Agriculture, Report of the Food1957, New Delhi, 1957, p. 48. grains Enquiry Committee 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
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. 6. See V. V. Bhatt's India, Planning 1957, p. 13. article elsewhere Review in this issue. of the First Five Year Plan, Delhi,
Commission,
7.
Report of the Foodgrains
Enquiry
Committee,
op. cit.,
p. 51.
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ECONOMIC DEVELOPMENT External
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371
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
1951-52 to 1955-56 of rupees) Total current transactions (net) -162.6 + 60.2 + 47.4 + 6.0 + 16.9 -306.8 -450.6 Movement in foreign exchange reserves -164.7 + 16.7 + 28.9 - 18.1 + 10.5 -221. 3b -259.9b
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. 730.1 601.9 539.7 596.6 641.1 635.1 594.5
Trade balance -232.8 - 31.1 - 52.1 - 87.2 -109.5 -460.5 -579.8
Official donations + + + + + + + 5.3 10.8 19.0 15.8 42.0 44.7 29.2
Other invisibles + 64.9 + 80.5 + 80.5 + 77.4 + 84.4 +109.0 +100.0
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
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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372 Table IV.
THE IMPACT OF INFLATION India's Imports of Capital Goods (in millions of Rs. )
Private 1951-52a 1952-53a 1953-54 1954-55 1955-56 1956-57 1957-58b a. Estimated. b. Preliminary 155.90 131.90 118.80 173.69 237.70 371.30 321.20
% increase
Government 21.50 20.50 40.70 47.77 76.60 129.80 212.70
% increase
Total 177.40 152.40 159.50 221.46 314.30 501.10 533.90
% increase
-15.4 - 9.9 +46.2 +36.9 +56.3 -13.5
- 4.7 +98.5 +17.4 +60.4 +69.4 +63.9
-14.1 + 4.7 +38.8 +41.9 +59.4 + 6.5
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 See S. Sachi, The Economic "A Basic Weekly, Fallacy in Planning Commission's May 17, 1958, pp. 676-677.
8.
Appraisal",
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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.
cit.,
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374
THE IMPACT OF INFLATION
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
A.
Composition
of India's
Imports
(in Rs.
lakhs)
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)
1951-52 Govt.
Total n.a. n.a. n.a. n.a. n.a. 17,740a 30a
Priv.
1952-53 Govt.
Total
Priv. 280 2,650 2, 930 11,340 19,660 11,880 50 7, 070 2,860 1,440 460 -
1953-54 Govt.
Tota
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
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 460a
6,503 6,78 460 3,11 6,963 9,89 - 11,34 300 19,96 4,070 15,95 2,550b 720 800 2,038
9,62 3,58 2,24
460a
46 2,03
66,820
29,470
96,290
44,270
18,611
62,881
45,810
13,371
59,181
(Continued
on next page; notes
on next page)
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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. 3,240 3,080 13, 200 21,290 23, 770 11,250b 8,210 4,310 1, 030 3,240 Total 3, 240 6,320 13, 200 21, 290 31,430 Priv. 1956-57 Govt. 10,610 Total 10,610 10,610 9,520 18,240 50,110 250 24,590 16,990 6,880 1,400 21,100 Priv. 1957-58 Govt. 15,240 Total
15,240
7,660
5, 13Cb 16,380b 1,210 9,420 1,320 3, 110 5,630 4, 140
- 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
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 3,430 460 15,790 12,720
460 28,510
62,370
14,010
76,380
80,430
29,150
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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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. Volume of Investment
Table I.
and Availability
of Food
Year 1951-52 1952-53 1953-54 1954-55 1955-56 1956-57 1957-58
Private investment (in millions of rupees) 3,630 3,730 4,250 4,220 4,790 5,940 5,670
Public investment (in millions of rupees) 1,820 1,970 2,490 3,880 4,960 5,100 6,710
Total investment (in millions of rupees) 5,450 5,700 6,740 8,100 9,750 11,040 12,380
% change over previous year - 6.2 + 4.6 +18.2 +20.2 +20.4 +13.2 +12.1
Availability of food (in thousands of tons) 56,956 61,711 71,166 68,198 67,010 73,367
% change over previous year + 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 by V. V.
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.
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368
THE IMPACT OF INFLATION
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 the reverse takes 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 35.1 27.7 24.8 28.4 27.2 27.2 25.6 29.8 16.8
District Nizamabad
Year 1954-55 1955-56 1956-57a 1954-55 1955-56 1956-57a 1954-55 1955-56 1956-57a
% change in production -24.4 +14.0 + 4.0 +22.3 + 0.8 +22.1 -35.4 + 1.8 +34.4
% change in prices -24.0 +20.6 +26.2 -15.4 +11.8 +17.6 -25.2 +27.4 +22.5
% change in marketed surplus +64.3 -10.2 + 8.3 +32.5 - 3.5 +34.9 + 3.7 +18.5 -10.3
Mahboobnagar
Warrangal
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
CHANGE
369 to which
sharply
upward from the low levels
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. 4. Government of India, Ministry of Food and Agriculture, Report of the Food1957, New Delhi, 1957, p. 48. grains Enquiry Committee 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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370
THE IMPACT OF INFLATION
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. 6. See V. V. Bhatt's India, Planning 1957, p. 13. article elsewhere Review in this issue. of the First Five Year Plan, Delhi,
Commission,
7.
Report of the Foodgrains
Enquiry
Committee,
op. cit.,
p. 51.
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ECONOMIC DEVELOPMENT External
AND CULTURAL
CHANGE
371
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
1951-52 to 1955-56 of rupees) Total current transactions (net) -162.6 + 60.2 + 47.4 + 6.0 + 16.9 -306.8 -450.6 Movement in foreign exchange reserves -164.7 + 16.7 + 28.9 - 18.1 + 10.5 -221. 3b -259.9b
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. 730.1 601.9 539.7 596.6 641.1 635.1 594.5
Trade balance -232.8 - 31.1 - 52.1 - 87.2 -109.5 -460.5 -579.8
Official donations + + + + + + + 5.3 10.8 19.0 15.8 42.0 44.7 29.2
Other invisibles + 64.9 + 80.5 + 80.5 + 77.4 + 84.4 +109.0 +100.0
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
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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372 Table IV.
THE IMPACT OF INFLATION India's Imports of Capital Goods (in millions of Rs. )
Private 1951-52a 1952-53a 1953-54 1954-55 1955-56 1956-57 1957-58b a. Estimated. b. Preliminary 155.90 131.90 118.80 173.69 237.70 371.30 321.20
% increase
Government 21.50 20.50 40.70 47.77 76.60 129.80 212.70
% increase
Total 177.40 152.40 159.50 221.46 314.30 501.10 533.90
% increase
-15.4 - 9.9 +46.2 +36.9 +56.3 -13.5
- 4.7 +98.5 +17.4 +60.4 +69.4 +63.9
-14.1 + 4.7 +38.8 +41.9 +59.4 + 6.5
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 See S. Sachi, The Economic "A Basic Weekly, Fallacy in Planning Commission's May 17, 1958, pp. 676-677.
8.
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.
cit.,
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374
THE IMPACT OF INFLATION
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
A.
Composition
of India's
Imports
(in Rs.
lakhs)
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)
1951-52 Govt.
Total n.a. n.a. n.a. n.a. n.a. 17,740a 30a
Priv.
1952-53 Govt.
Total
Priv. 280 2,650 2, 930 11,340 19,660 11,880 50 7, 070 2,860 1,440 460 -
1953-54 Govt.
Tota
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
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 460a
6,503 6,78 460 3,11 6,963 9,89 - 11,34 300 19,96 4,070 15,95 2,550b 720 800 2,038
9,62 3,58 2,24
460a
46 2,03
66,820
29,470
96,290
44,270
18,611
62,881
45,810
13,371
59,181
(Continued
on next page; notes
on next page)
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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. 3,240 3,080 13, 200 21,290 23, 770 11,250b 8,210 4,310 1, 030 3,240 Total 3, 240 6,320 13, 200 21, 290 31,430 Priv. 1956-57 Govt. 10,610 Total 10,610 10,610 9,520 18,240 50,110 250 24,590 16,990 6,880 1,400 21,100 Priv. 1957-58 Govt. 15,240 Total
15,240
7,660
5, 13Cb 16,380b 1,210 9,420 1,320 3, 110 5,630 4, 140
- 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
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 3,430 460 15,790 12,720
460 28,510
62,370
14,010
76,380
80,430
29,150
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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