Economic planning series: Prelude to chaos?

In the last three articles, we discussed India’s foreign trade as well as its direction and pattern over the five-year plans. In other words, we looked at how exports and imports of goods and services behaved through the plans. However, this is not a complete picture of a country’s international economic engagement. For that, we need to analyse the balance of payments of a country. We will now look at how balance of payments has evolved through the five-year plans: in this article, we will look at the first seven plans and in the second part, we will take up the BOP experience in the eighth to twelfth plans.

The balance of payments: current and capital account

Before we go on, a brief discussion on what constitutes balance of payments (BOP) follows. In simple terms, balance of payments reflects all the economic transactions of a country’s residents with the rest of the world. Typically, BOP is classified into the current account and capital account. The current account includes trade in goods and services (or invisibles) and unilateral transfers, and the capital account includes the capital or financial flows and measures the flow of a country’s assets and liabilities. A capital account reflects foreign investment, foreign loans and banking assets and liabilities. The current and capital account are inversely related and the sum of the two accounts is always zero. This is because a surplus in the current account offsets a deficit in the capital account. For example, if a country exports goods and services (which leads to a current account surplus), it imports foreign financial assets, (which means a capital account deficit). In other words, the surplus or deficit in the current account are reflected in the capital account through a change in forex reserves.

India’s BOP through the five-year plans

In the first plan, agriculture production was high because of favourable monsoons, and industrial activity was on a high because of the pressure to finish ongoing projects. On the whole, the focus was to get the economy back on track after the war and the Partition. In terms of balance of payments, India had a trade deficit but enjoyed a surplus on the invisibles account. Furthermore, the sterling reserves built up after the war allowed some deficit in the balance of payments. However, after the war and during the first plan, import requirements rose and exports did not rise fast enough, leading to a trade deficit of Rs 542 crore. The positive invisibles account of Rs 500 crore led to a small BOP deficit of Rs 42 crore.

In the second plan, as we saw above, the ‘Mahalanobis’ model came into play and there was an emphasis on developing heavy industries that made capital goods. This entailed rising imports of more capital goods, equipment and machinery. Moreover, there was a shortfall in agricultural production, leading to a rise in import of food grains. Exports did not rise fast enough and there was a necessity to make ‘maintenance imports. All this fed into the expectation of a large trade deficit. It was expected in the plan document that there would be a current account deficit of Rs 1,100 crore, which would have to be financed by drawing down foreign exchange reserves, foreign aid and foreign investment. As it turned out, the trade deficit in the second plan was Rs 2,339 crore, and with positive net invisibles of Rs 614 crore, the BOP deficit ended up at Rs 1,725 crore.

In the third plan, the deficit story continued because of massive defense imports on account of the war in this period and import of food grains. At the same time, export growth was slow. This led to a trade deficit of Rs 2,382 crore, which was softened by a positive balance of invisibles of Rs 431 crore, leaving a BOP deficit of Rs 1,951 crore. This was financed by loans from the World Bank and IMF, foreign assistance such as PL480 loans, and drawing down foreign exchange reserves. The story became worse during the Annual Plans, with even the invisible account turning into a deficit.

The fourth plan’s (1969-74) main objective was self-reliance, which was reflected in the import substitution strategy. Consequently, there was an attempt to restrict imports and shift to domestic production of these items. There was also an emphasis on exports through various incentives. Food grain imports also fell because of the good crops in 1968-71. Invisibles shot up mainly on account of hefty receipts from the US on disposition of PL480 and other rupee funds. Accordingly, the trade deficit was Rs 1,564 crore, and net invisibles were Rs 1,664 crore, which left a surplus in the BOP for the first time.

In the fifth plan (1974-79), India had to struggle with a massive rise in the fuel import bill due to the oil price shocks of 1973 and 1979. The exports were also rising because of a mix of incentives, which led to decline in the trade deficit and even a trade surplus in 1976-77. However, the continued rise in imports and an insufficient rise in exports led to a trade deficit in the last two years of the plan. An interesting development during this plan was the massive rise in net invisibles between 1975-76 and 1978-79 on account of a crackdown on smuggling, rise in tourists’ earnings, growth from services earnings, and rising remittances because of greater numbers of Indians going abroad. The trade deficit was Rs 3,179 crore, but the surplus on the invisibles account of Rs 6,221 crore ensured a BOP surplus of Rs 3,082 crore.

The sixth plan (1980-85) began on a difficult note because of the impact of the 1979 oil price hike. Despite the difficult circumstances and a lacklustre export performance, the economy managed to do well on the growth front as well as the BOP front. The current account deficit, which was projected to be about 9 per cent of GDP, ended up at 6.4 per cent of GDP. This was mainly because of better management of energy imports in the face of high prices and efficient

import substitution in steel, cement and fertiliser industries. Of course, India did have to rely on the Extended Fund Facility (EFF) of SDR 5 billion

from the IMF as well as drawing down of foreign exchange reserves. Net invisibles of Rs 19,072 crore also played a role in muting the BOP deficit. With a trade deficit of Rs 30,456 crore, the BOP deficit ended up at Rs 11,384 crore.

The seventh plan (1985-90) also witnessed a worsening BOP position, in spite of an impressive export performance wherein exports grew at a rate of 18 per cent per annum. The EXIM policies of 1985 and 1988 were also announced during this period, which sought to strengthen the export base and facilitate technological upgradation in a number of areas such as telecommunications, electronics and transport. However, the EXIM policies led to a liberalisation of imports (208 items came on the Open General List), including microprocessor-based equipment, machine tools and white goods such as refrigerators and colour TVs, which were in high demand by the middle and upper classes. Thus, there was technological dumping in the name of technological upgradation and no technological transfer. The rupee also witnessed a sharp depreciation in 1987 from Rs 12 per USD to Rs 18 per USD. The trade deficit widened to Rs 54,204 crore and with a positive invisibles account of Rs 13,157 crore, the BOP deficit was Rs 41,047 crore. This was almost a four-fold jump from the sixth plan. Sukhamoy Chakraborty, in his work of 1987, ‘Development Planning: The Indian Experience’, suggested import substitution in certain crucial sectors if the BOP was to be better managed. These sectors were fuel and energy, fertilisers and edible oils, which were dominant contributors to the rising import bill and the high trade deficit.

Conclusion

Even as the seventh plan was ending, India was staring at an economic crisis: external debt had risen from 17.7 per cent of GDP in 1984-85 to 24.5 per cent in 1989-90,

and the combined fiscal deficit of the states and the central government rose from around 8 per cent in the sixth plan to 10 per cent in the seventh plan. These deficits led to high levels of public debt, with interest payments accounting for a large proportion of the government revenues. They also led to a rise in the current account deficit, which kept rising steadily until it reached 3.5 per cent of GDP and 43.8 per cent of exports in 1990–91. The economy needed to be put on track through more rational and liberal policies in the trade and industrial sectors. The stage was set for the 1991 economic reforms.

The writer is Addl. Chief Secretary, Dept of Mass Extension, Education and Library Services, Govt of West Bengal.