Wednesday, August 08, 2007

DEFICIT FINANCING ; Rajaji in Swarajya 1960

DEFICIT FINANCING ; Rajaji in Swarajya 1960

PROF. B. R. Shenoy is bringing out for lay readers a
booklet on inflation in India, in which he deals with
the causes of the evil and the remedy. I have had the
privilege of reading the manuscript and this is what I
have gathered from what the Professor sets out with
clarity and with figures. I have no doubt the booklet,
when published, will help people to understand the
gravity of the situation. In all low income countries,
expansion of money put in circulation results quickly
in price rises. Inflation is the word used when we
look at the cause and discuss the situation in terms
of money. Price rise is the phrase used when we speak
from the point of view of commodities. If the
expansion of money, whatever be the motive or reason
for such expansion, outpaces the physical volume of
output of commodities, we have a state of inflation
and prices rise as a result.

The Ministry of Commerce publishes the average of
wholesale prices. From the hand-outs of the Reserve
Bank of India we can obtain information about money
supply. There has been a continual rise in the general
index of prices. We see also that money supply has
considerably expanded, faster than the output of
national products.

With 1938-39 as base, the general index of prices in
August 1960 was 478, a rise of nearly five times. The
present changeover of the base from 1938-39 to 1952-53
obscures the enormous magnitude of the price rise.

Government collects funds from the people by taxation,
loan issues, small savings and profits of public
sector undertakings.

From these funds disbursements are made for
administrative expenditure, repayment of past loans,
and Plan investment outlay. When these and other items
of disbursements exceed the total receipts, what is
called budget deficit arises. These deficits are
covered by notes printed at the Government Security
Press at Nasik. This is called deficit financing.

This expansion of money is followed by what is called
secondary expansion through credits given by
commercial banks. For every Rs.100 crores of
additional Nasik money, there is usually another
Rs.100 crores of credit creation.

Inflation that now prevails in India began in 1955-56.
Budget deficits rose from 97 crores in 54-55 to 225
crores in 55-56. In 57-58 the Plan outlay was so great
that, with additional defence expenditure, the budget
deficit that year reached a peak of 495 crores. These
yearly deficits have a cumulative action.

The rise in prices due to inflation reduces the value
of money and life becomes unhappy for people living on
wages and fixed incomes. Their real income is reduced,
and some of them would have to draw on past savings
for current expenditure.

The rise in price corrodes all savings. This leads in
the case of the better placed classes to the transfer
of their savings to urban property, to gold and to
concealed exports of capital. Speculative transactions
acquire additional attraction. Hoarding of goods is
encouraged, eating into savings. For a time production
may be deceptively stimulated on account of higher
prices, but soon it gets retarded on account of
increased costs. Foreign purchasers of our goods will
move to other markets. Imported goods rise in price
giving windfall profits to importers and smugglers.

As a result of inflation, income shifts from the
masses to upper income groups. The middle classes are
most hit. The strike of the Union Government employees
was a symptom of this suffering. Industrialists and
their labour force, who are able to extract a share in
the receipts, do not suffer much but the condition of
the vastly larger number of farm lands is worsened.

Inflation must be followed by price controls and
import restrictions. These produce a great deal of
economic and social disorder and injustice. The
controls over steel, coal, cement, sugar, rubber,
fertilizers and food-grains have cast a gloom over the
life of the people.

Far from equalizing incomes, the policy of controls
makes the rich richer. The stagnant percapita
consumption of cloth and of food-grains is the best
evidence of the condition of the people, and this has
resulted from the misguided policies of the present
administration. In the case of all imported goods
including gold, there is a great gap between landed
cost and market price, ranging from 30 per cent to 500
per cent, depending on the nature of the commodity.
The difference between the landed cost of gold and the
market price is seventy rupees per tola. The import
markets are illegal and the gap between cost and
market price is officially ignored but this does not
nullify the reality. The benefit of all the gaps in
cost of imports and market price goes to importers and
smugglers. Excluding government imports where the
difference may be treated as a concealed tax,
according to a reliable estimate, the ill-gotten gains
on imports during two years would be of the order of
Rs.1,000 crores. This amount has several co-sharers -
corrupt officials who handle the issue of licences,
the recipients of the licences, including both those
who just sell them in the black market and real
importers. The accounts of cost are falsified by
inter-sales and the like, so as to bring the declared
cost to near the market price, and so as also to
replenish the importers for their payments for the
purchase of the licences and for corrupt transactions
with officials and go-betweens. All these incomes are
tax-free, being illicit in nature. It is these
earnings that enable some people to give large
political donations to the ruling party and also to
other groups for purchasing peace. The beneficiaries
of the illegal gain, on account of import controls,
are the upper income groups and the money is obtained
from those who consume the imported commodities or
articles into the production of which such imported
materials go. The total anti-social money that goes
thus from consumers' pockets to upper income groups
has been estimated as being of the order of Rs.300
crores per year. Inflation, import restrictions and
other controls have affected the moral standards of
the nation, and have led to the emergence of a new
undesirable profession engaged in touting for
obtaining licences, permits and contracts, in illicit
trafficking in import licences, and in smuggling gold,
diamonds, watches, cigarettes, fountain pens, razor
blades, photographic accessories, etc. The talent for
enterprise tends to gravitate around officialdom and
to practices to become rich quickly without spending

In the absence of inflation and controls, the talent
and resources would be actively engaged in adding to
national wealth under the free play of competition,
the normal road to progress. Inflation and controls
discourage efficiency and progress and honesty.

Easy money being available to some under controls and
inflation, they favour continued 'planning' which to
them means continued inflation and controls which
provide them opportunities to amass money. Political
parties in power also favour controls, as these give
an opportunity for the exercise of power and for
acquiring personal and political gains. Conscience
pricks are quelled by the thought that it is all done
in the national interests and the gains are only an
incidental by-product.

Never were the interests of the anti-social elements
so well looked after as under the present
administration. These controls must go or the
Government should change, if the country is to be
extricated from the morass it has got stuck in. It is
not true, as is argued sometimes, that rising prices
and controls and import restrictions and exchange
controls are inherent in a developing economy. The
experience of other countries-Canada, Belgium, West
Germany, Mexico, Japan, Italy and France-have
demonstrated the untruth of this plea.

It is not true, as is sometimes stated, that prices
all over the world have risen. West German national
income rose in real terms at 13 per cent per year in
each year of the period 1951 to 1958. But prices rose
there by less than one per cent per year, 5 per cent
only in all seven years. And West Germany was in the
forefront to remove restrictions on imports and on
payments abroad. In ever so many countries price
stability and surplus in balance of payments, and
abolition of restrictions on imports and payments,
have gone together with rapid economic growth.

Since 1955, Indian price-rise stands out almost alone.
Prices in May 1960 in India were 33 per cent higher
than in 1954. In France and Italy prices declined
during that period. In Germany, Belgium and Japan and
other countries the annual price rise was 1 per cent
or at most 2 per cent.

There is a notion that curtailing bank credit will
reduce inflation. Bank credit is so closely related to
deficit financing that keeping the latter going and
reducing inflation by control over credit is a
futility. It only adds to the confusion. To restrict
credit against food-grains and certain other
commodities would raise the cost of banking services
generally, and in particular the cost of credit to the
trade in those commodities, which are essential for
the economic life of the community. Naturally, such
policies encourage advances against assets outside the
banned list and drive the business of credit from
scheduled banks to others which are not under control.
The policy of credit controls has demonstrably failed.
Tampering with the credit- machinery will not achieve
anything as long as deficit financing is continuing.

The fact is that the attempt to 'invest' non-available
resources - which is what deficit financing amounts
to—is a wrong and futile policy. No plan can be larger
than the resources available for investment, be it
internal or that obtained from generous outsiders.
Even as water is no substitute for milk, inflation is
no real resource. The fallacy produces high prices and
distress. A plan based on inflation will retard
progress instead of accelerating it.

The Third Plan is tremendously inflationary. The overt
deficit financing of this Plan is Rs.550 crores. This
is misleading. Without totalitarian and physical
suppression of consumption, in order to mop up
people's money by reducing consumption, the amount of
supposed availability of savings estimated at Rs.7,200
crores is an over-estimate. The over-estimate is at
least of the order of Rs.1,300 crores.

Thus what the Plan requires by way of foreign aid,
(over and above the amount required for repayments
due) is not Rs.2,790 crores but Rs.5,350 crores. The
deficit financing therefore will not be only Rs.550
crores as planned but six times that figure. If the
foreign aid does not arrive according to the time
table, whatever the causes may be, the gap will be
much greater. And there are good reasons for
apprehending this.

We know that deficit financing to the extent of Rs.367
crores during the five years ending 59-60 led to a
price rise of 32 per cent. The deficit financing
inherent in the Third Plan will certainly involve
'runaway inflation', like the one that swept over
Germany after the first World War. During the five
months ending August 1960, prices have been rising at
a rate computed at 14.2 per cent per annum. This is an
indication to take note of Deficit financing has
already gone too far. Foreign aid and drafts on
currency reserves, cannot go on indefinitely. Holding
the price line, which is continually promised, would
be just King Canute's command to the waves of the sea.

It is pathetically argued that inflation will be
stopped by increase in production. Inflation retards
production. It drives up costs and the commodities
manufactured must be sold at higher prices. Prices and
costs rise simultaneously with inflation, and will
continue to rise with continuing inflation. Inflation
is the disease and the prices only indicate the
temperature. There is no good attempting to reduce the
symptom while keeping the disease going. Fair price
shops of any kind or number cannot achieve control of
prices. Even if buffer stocks released for sale
depress food prices artificially, this will shift
agriculture to other than food-crops, and render the
food position worse. Any commodity distribution at
arbitrary prices will fail, because the stocks will be
bought up as soon as they are put on the market, and
go to feed the black market. The cost of any remedy
put in action by way of subsidies will ultimately fall
on the shoulders of the tax-payers. The net result, so
far as the price level is concerned will be nil. The
price problem resulting from inflation cannot be
corrected by a change in the machinery of
distribution. The diagnosis must be kept in mind when
treatments are attempted The money let loose being the
cause, remedies other than reducing the money flow
will not avail.

The favourite notion that prices result from traders'
conspiracies is stupid. Such conspiracies are
impossible. The prevailing price rise is not the
outcome of either monopolies or impossible
conspiracies but of deficit financing. Prices have
risen despite bumper crops and heavy annual import of
food-grains of three million tons for four years.

To stop prices from rising, we must restore the
balance between the flow of production and the flow of
money. Inflation and excessive State interference are
the two evils of the Indian economy of today. If and
only when these two evils are removed, can we expect
to be saved from rising prices. If not, it is a case
of the ground being prepared for communists to take
totalitarian charge.

September 24, 1960 Swarajya

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