financing for development in india

* Adviser, Perspective Planning Division, Planning Commission, Government of India. This paper reflects the personalviews of the author and not necessarily those of either the Government or the organization to which he belongs.

Financing for DevelopmentIndia: Lessons from the Past;

Needs of the Future

United Nations Development Programme55, Lodi Estate

New Delhi - 110 003India2002

by

Pronab Sen*

The analysis and policy recommendations of this Paper do not necessarily reflect the views of theUnited Nations Development Programme, its Executive Board or its Member States.

Discussion Paper Series - 3

CONTENTSCONTENTS

1. INTRODUCTION 1

2. THE ZEDILLO PANEL REPORT: A CRITICAL REVIEW 3

Domestic Resource Mobilisation 3

Private Capital Flows 6

Trade 9

International Development Cooperation 12

Systemic Issues 16

3. INDIAN PROSPECTS AND DEVELOPMENT FINANCE NEEDS 21

4. THE MONTERREY CONSENSUS: DOES IT MEET THE BILL ? 26

1

Introduction

Over the past few years, there has been an up-surge of international concern regarding thegrowing gap between developed and develop-ing countries and the persistence of acute dep-rivation in several parts of the world. It is againbeing recognized that poverty and deprivationare not matters of concern merely for nationalgovernments, but for humanity as a whole1.As a consequence, the issue of developmenthas come back to the centre-stage of interna-tional discourse after a gap of almost two de-cades. The tragic events of September 11, 2001have further underscored the dangers to sta-bility and peace in the world from poverty,underdevelopment and, most importantly,disenfranchisement.

A number of high level international con-ferences were held during the 1990s cover-ing various facets of development and thechallenges thereto. The Earth Summit in Riode Janeiro in 1992, the 1994 Population Sum-mit in Cairo, the 1995 Beijing Summit onWomen, the Summit on Social Developmentin Copenhagen and the 1996 Summit on Hu-man Settlements in Istanbul are a few no-table instances. In each of these, it was re-peatedly highlighted that the objectives andapproaches would require significant com-mitment of financial resources to make themcredible.

This process culminated in the historic UnitedNations Millennium Declaration adopted bythe United Nations General Assembly in Sep-tember 2000, in which the various strands ofdevelopment were brought together into acomprehensive framework. The Declarationendorsed a set of International DevelopmentGoals to be attained by 2015 towards whichthe international community and the nationalgovernments would collectively work. Broadly,these Goals were :

l To cut in half the proportion of people liv-ing in extreme poverty, of those that arehungry, and of those who lack access to safedrinking water.

l To achieve universal primary education andgender equality in education.

l To achieve a three-fourths decline in mater-nal mortality and two-thirds decline in mor-tality among children below the age of 5.

l To halt and reverse the spread of HIV/AIDSand provide special assistance to AIDSorphans.

l To improve the lives of 100 million slumdwellers.

The Millennium Declaration also explicitly ac-knowledged the importance of developing a

Introduction

1 Such concern was also much in evidence during the 1950s and 1960s when the world was experiencing the decolonisationprocess with all the idealism that it generated. From the 1970s, however, the focus shifted from idealism to ideology. Developedcountries were preoccupied with economic stabilisation consequent to the two oil price shocks and the Latin American debtcrisis, on the one hand, and global real politik, on the other. During this period, developing countries were more or lessexpected to boot-strap their own development.

2 FINANCING FOR DEVELOPMENT

strategy for raising the necessary resources tofund the attainment of the International De-velopment Goals. To this end, an InternationalConference on Financing for Developmentwas held in Monterrey, Mexico, in March 2002.A number of preparatory steps were taken forthis Conference, the most important of whichwas the convening of a High Level Panel onFinancing for Development by the SecretaryGeneral of the UN. This Panel was chairedby Mr. Ernesto Zedillo, former President ofMexico, and its terms of reference was to“... recommend strategies for the mobilizationof resources required to accelerate equitableand sustainable growth in developing coun-tries as well as economies in transition, and tofulfill the poverty and development commit-ments enshrined in the United Nations Mil-lennium Declaration”.

The Report of the Zedillo Panel was circu-lated by the Secretary General in June 2001for consideration by the Member States. ThisCountry Paper is an attempt to critically ex-amine the Zedillo Panel Report and its rec-ommendations from the Indian perspectiveand experience. There are two important

dimensions to such a review. First, India’s longexperience in development planning for a largefederal democracy with a more or less market-oriented economic system makes it perhapsunique in terms of the problems it has facedand the lessons that have been learnt. Someof this could possibly be of value to othercountries as they attempt to reorient theireconomies. Second, despite considerableprogress over the years, India as a nation con-tinues to be home to the largest number ofthe world’s poor, and no international devel-opment goals can be achieved unless Indiaperforms adequately. Thus, the implicationsof the Zedillo Panel recommendations forIndia are important not only for itself, but forthe attainment of the Millennium Declaration.

It is hoped that this study will contribute tothe broader debate regarding the consider-ations that need to inform the strategies formobilisation of developmental resources. Inparticular, if this study can help sensitize thedeveloped world to the constraints and trade-offs faced by developing countries in manag-ing their economies and improving the lot oftheir peoples, it would have served its purpose.

3

The Zedillo Panel Report: A Critical ReviewThe Zedillo Panel Report: A Critical Review

The Report of the Zedillo Panel is a remark-able document. Its breadth of coverage placesit well beyond any other such attempt and re-flects not only the lessons learnt over five de-cades of development experience, but also thecomposition of the Panel. Although it is aterse document, it is backed by a fairly detailedTechnical Report, which lays out the theoryand logic underlying the key findings of thePanel2. The objective of this section is to ex-amine the main features of the Zedillo PanelReport in light of India’s development experi-ence. No attempt is made to describe or dis-cuss the details or the logic and argumentsbehind the recommendations of the Report,since these are readily available in the publicdomain. The principal objective is to high-light some inadequacies and to give an indica-tion of those features of the Report whichneed to be strongly supported.

Domestic Resource MobilisationThe Report clearly and unambiguouslyrecognises that: “The primary responsibility forachieving growth and equitable developmentlies with the developing countries themselves”3.In other words, it is up to the governments of

developing countries to create the conditionswhich make it possible to obtain and effec-tively utilise the financial resources necessaryfor development. It is, however, alsorecognised that many developing countries lackthe institutions and the capacities for doing so,and that more and better assistance is neededfrom the international community to help cre-ate these conditions4. We will have more tosay about this issue later. There are five mainelements to this responsibility that have beenidentified, and which are discussed below adseriatim.

The first is good governance, which is de-fined to include: (a) the consent of the gov-erned; and (b) the existence of effective andimpartial rule of law5. While there can be noquarrel with the latter, the explicit preferencefor a democratic mandate appears question-able, whatever its ethical merits6. There is nocompelling evidence to suggest that non-democratic forms of government have sys-tematically performed less well in terms ofeconomic growth and development than thedemocratic. An unfortunate consequence isthe impression conveyed that for a large

2 It should be noted that the Report of the Panel is by no means a condensed version of the Technical Report. There areclearly approaches and proposals on which the Panel has differed with the Technical Report. Nevertheless, the TechnicalReport provides valuable insights on issues which have found place in the Report of the Panel and has, therefore, been usedextensively by us.

3 As the Technical Report points out: “The domestic economy is virtually always the dominant source of savings for investment,and the domestic policy environment is a decisive determinant of the desire to invest.”

4 In this context the Report makes the most valid point that “... experience shows that imposing tough policy conditionality onpoor countries without helping them to build their domestic capacity is a recipe for frustration and unsatisfactory results. ”

5 Combating corruption is an integral component of any reasonable rule of law, and is so recognised.6 It is of course recognised that the UN by and large supports democratic forms of government. While this preference is

perfectly valid in the political spheres, it may not necessarily be justified in the economic.


number of developing countries politicalchange would have to precede development;and, worse, that international support couldbe conditional on such change. Surely this isnot the intent. It should be sufficient to in-sist upon good governance and, at the most,social legitimacy of laws and rules, regard-less of the form of the government.

The second is macroeconomic discipline,which is deemed essential for promoting do-mestic savings and high quality national invest-ment. This has been interpreted to mean thatinflation and the current account balanceshould be consistent with sustained growth.In general terms this is certainly true. Indeed,the point should have been made with evengreater force since all evidence suggests thathigh inflation has a disproportionately largerimpact on the poor. What is less supportableis the excessive reliance that the Report ap-pears to place on monetary policy for correct-ing inflationary pressures. For a number ofcountries, including India, inflationary episodeshave been the outcome of transient exogenousshocks, which have frequently beencontractionary in nature7. In such situations,contractionary monetary policy will prevent thenecessary realignment of relative prices andmay indeed precipitate an entirely avoidablerecession. The consequences of such an even-tuality on the poor may be even worse thansome amount of inflation. A judicious mixof supply-side initiatives with perhaps a slightlyaccomodative monetary stance may serve thepurpose better in such situations. This is onlyone instance of the rigidities that have to betaken into account in developing countrieswhile devising a suitable and sensitive macro-economic policy. These kinds of problemsare less likely in developed economies with

more complete and better functioning markets,and in any case the human impact is signifi-cantly lower.

Fiscal discipline too has been recognised as acritical element. Deficit financing and exces-sive accumulation of public debt are consid-ered inimical to avoiding inflation and to pro-moting private investment. These are certainlyvalid principles, but at particular stages of de-velopment it may be necessary to violate them.Indian experience suggests that at low levelsof development, particularly of the financialsector, and of monetisation of the economy,both deficit financing and accumulation ofpublic debt can have a positive role to play.There is an implicit presumption that privateinvestment demand is at all times adequate toabsorb the available investible resources. Thisis a questionable assumption and there areample instances in Indian economic historywhen unconstrained private investment de-mand has simply not been adequate. In suchsituations, if public investments are not ad-equately stepped up, considerable growth po-tential may be lost.

An important point that is made in the con-text of fiscal policy is that the most potent wayto empower the poor and to integrate theminto the market economy is to make publicinvestments in social development. The Re-port rightly enjoins governments not to treatthese investments as marginal expenditures, tobe cut when times are difficult. Curiouslyenough, there is no mention of physical infra-structure, which is often as important and, inthe short run, perhaps even more so. If a cuthas to be made in public expenditures, thechoice between these two forms of investmentcan be very difficult.

7Periodic failure of the monsoons and the oil-price shocks are cases in point.

5

The real choice lies between public investments,whether in social or physical infrastructure, onthe one hand, and transfers and subsidies, onthe other8. It would have helped if the Panelhad taken a clear position on this. It is of courseaccepted that the choice is not always obvious.Well-targeted transfers and subsidies can playan important role in mitigating immediate hard-ship and deprivation9. Nevertheless, the politi-cal attractiveness of transfers and subsidies,particularly for democratic governments, canlead to excessive deployment of public resourcesin such measures. Once begun, such expendi-ture is notoriously difficult to control. There-fore, an agreed-upon position on this issue canhelp national and sub-national governments intaking difficult decisions.

Raising sufficient tax revenues to fund neces-sary public expenditure and control fiscal defi-cits is undoubtedly of the highest importance.There are, however, two issues which need con-sideration. First, in poor developing economies,raising taxes without impinging on the consump-tion of the poor is not easy. Excessive concen-tration on a limited tax base of the relatively af-fluent can lead to serious incentive problems, andthereby retard the growth process. Second, mostdeveloping countries have tax systems which arebased either on traditional practices or on thosewhich were prevalent in the West in the past.Most of these have the virtue of being adminis-tratively convenient and informationally unde-

manding. Modern tax systems, however, requireboth efficient tax administration and a certaindegree of sophistication among taxpayers. It isquite likely that these conditions may not be metin several developing countries. The process oftax reforms, therefore, should be viewed in anevolutionary manner, and not something that canbe transplanted readily.

The fourth critical element is the financial sys-tem. As the Report points out: “Every coun-try needs a financial system that promotes sav-ings and provides credit efficiently ...”. Toachieve this, the Report recommends a mod-ern framework that progressively incorporatesaccepted international standards10. It also rec-ommends arrangements for corporate gover-nance and bankruptcy. While this is unexcep-tionable, and it is necessary for every develop-ing country to establish a vibrant and modernfinancial sector, a certain degree of clarity isnecessary regarding the position to be takenon traditional financial institutions. It needsto be pointed out that whatever the shortcom-ings, these informal financial institutions havean important role to play at different stages ofa country’s development. Premature closureof such institutions can prove extremely de-structive and may in fact impinge adversely onthe poor11. The objective should be to gradu-ally supplant such organisations by formal fi-nancial institutions, and this process can takeconsiderable time.

8 For the purposes of discourse, we shall treat salary payments to excess government staff as transfers.9 Not to mention desirable relative price configurations.10 Uncritical adherence to International standards can sometimes lead to unintended consequences. For instance, international

norms for recognition of non-performing loans, which are usually 6 weeks of non-payment of servicing obligations, aredesigned on the basis of continuous income generating activities such as manufacturing or most services. In the case ofagriculture, however, where the income streams are naturally discrete, occurring say every 4 to 6 months, almost every loanwill necessarily have to be classified as non-performing, thereby forestalling further advances to the borrower.

11 Normal operating practices and prudential requirements of modern banking usually require a level of documentation that isseldom possible to be met by relatively small borrowers. Such agents therefore have recourse to no other form of financethan traditional financial organisations which depend more on personal knowledge and relationships.

The Zedillo Panel Report: A Critical Review


It needs also to be recognised that establish-ing a comprehensive modern financial systemmay be beyond the abilities of even the rela-tively more sophisticated developing econo-mies. The banking sector, including post of-fices, is relatively easy to establish, but equityand long-term debt markets are difficult to cre-ate even with technical assistance from the in-ternational community. Such markets requirenot only considerable institutional expertiseand credibility, but more importantly a suffi-cient number of companies whose paper canbe considered for long-term investment. Boththese are usually in short supply in developingcountries. In such situations, developmentbanks have an important role to play andshould be considered seriously, at least as atransitional arrangement. Since developmentbanks require long-term funds to carry outtheir mandate, the modalities for funding themhas to be clearly thought out. It is most un-likely that there will be sufficient availability oflong-term funds in developing countries, exceptthrough the intermediation of the government.International support is thus critical.

The final element is the establishment of apension system, which is desirable both as asocial safety net and as a source of savings.The report recommends that for the greatestpositive impact on savings, a defined-contri-bution pension scheme is to be preferred. Itfurther recommends that such a scheme shouldbe complemented by a tax-financed schemeto provide a minimum pension to the poor.There is merit in this proposal, but there is aglaring omission that needs to be noted. Pen-sion schemes can provide a social safety net

for the elderly, but it leaves out other vulner-able groups in society. It is for every societyto consider whether the elderly are necessarilythe most vulnerable, and therefore entitled toclaim first charge on scarce resources.

An essential issue that remains unaddressed inthe Report is the potential conflict betweenraising adequate domestic savings and meet-ing the Millennium goals. At low levels ofincome, increases in the savings rate inevita-bly involves a certain degree of exploitation,whether of agriculture or of labour. Thereare practically no historical instances wheresuch exploitation has not taken place in theearly years of development12. Thus, merely thecreation of the enabling conditions as describedby the Report is not enough. Considerationalso needs to be given to the manner in whichdomestic savings can be raised without leadingto significant worsening of income distributions.There is no ready answer, but accessibility toforeign savings is an option for bridging thisdivide, at least in the initial years. This consid-eration would need to underlie the discussionson the flow of international capital and themeasures that developed countries can take toensure that there is a trend towards equalisationof investment rates among countries.

Private Capital Flows

The Report points out that although “the bulkof savings will come from domestic sources,but foreign capital can provide a valuablesupplement to finance investment andgrowth.” It also talks about “tapping the vastpool of funds available in the forms of for-eign direct investment, portfolio investment

12 In the Indian case, for instance, the sharp rise in the savings rate during the 1950s, 60s and 70s was engineered first by adeliberate policy of capital intensive industrialisation, which was in effect anti-labour, and later by turning the terms of tradeagainst agriculture.

7

and bank loans”. The necessary measures aredivided into three parts: (a) actions by develop-ing countries; (b) actions by industrial countries;and (c) actions by the international community.

The actions required of developing countriesare broadly similar to those outlined for creat-ing a conducive environment for investment.In addition, the report recommends that for-eign investors should be “treated no lessfavourably than domestic investors”, and thattheir interests should be fully protected. Con-versely, the report also recognises that foreigninvestors should not be exempted from domes-tic laws governing corporate and individualbehaviour and should come under the purviewof the domestic legal system. There are twoissues which need consideration in this context.

First, it would have been desirable for the Panelto qualify the term “no less favourably”. Whilethere is certainly a case to be made out for freerepatriation of capital and earnings by foreigninvestors in the context of restrictions on do-mestic agents, surely it is not intended that thedeveloping countries cede all authority in de-termining the type of activities in which for-eign investment would be permitted. The is-sue of “pre-establishment national treatment”is being hotly debated in the context of a mul-tilateral agreement on investment, and the im-pression that is given by the Report is that itfavours such treatment. This is unfortunate,particularly since most developing countriesare agreed that while post-establishment na-tional treatment is desirable, it is not the casewith pre-establishment national treatment.

Second, the Report explicitly warns againstexcessive investment incentives and eroding oflabour and environmental standards by devel-oping countries for attracting foreign invest-ment. Although the evidence supporting a“race to the bottom” is not very strong atpresent, the danger is very real13. Neverthe-less, a distinction may have to be drawn be-tween countries at different stages of devel-opment. In the case of some of the poorestcountries, there may be no option but to offersignificant incentives and exemptions fromstandards in order to attract foreign investment.Beyond a point, however, it would be neces-sary to evolve a code of conduct in order toprevent developing countries from followinga “beggar my neighbour” policy.

Industrial countries are enjoined to facilitateprivate capital flows into developing countriesthrough enhanced flow of information, insur-ance schemes and market access provisions14.They are also expected to discipline and mod-erate their own tax concessions which erodethe relative attractiveness of investment in de-veloping countries. An important suggestionis that industrial countries should remove anumber of policy constraints that exist in per-mitting certain categories of the investors toenter emerging markets. These are very valu-able suggestions and should be made withconsiderable force. In fact, it may be possibleto argue in favour of a certain degree of pref-erential treatment.

Another important suggestion is that in orderto prevent herd behaviour among privatelenders, bonds issued by emerging marketeconomies should have collective action

13 See, for instance, G.H. Hanson, Should Countries Promote Foreign Direct Investment? (UNCTAD, G-24 Discussion PaperSeries, No. 9, Feb. 2001) and C. Oman, Policy Competition for Foreign Direct Investment: A Study of Competition AmongGovernment to Attract FDI (OECD Development Centre, 2000).

14 The importance of insurance cover for foreign direct investments cannot be overstated. Arrangements like the OPIC of theUnited States have played an extremely important role in directing FDI to developing countries.



clauses15. Collective action clauses essentiallypermit a qualified majority of bondholders toapprove changes in the payments obligations.

In order for such clauses to be introduced bydeveloping countries without making theirbonds relatively less attractive, the report sug-gests that all industrial countries should firstmake it mandatory for these clauses to be in-troduced in their own bond issues. Perhapsit should have been added that the institu-tional mechanism for making such clauseseffective with sufficient speed needs to be putin place.

As far as action by the international commu-nity is concerned, the principal recommenda-tion is that multilateral development banksshould increase their role in co-financing andproviding guarantees to foreign direct invest-ment. It is also suggested that the prudentialnorms for banks should not be such as to makeinternational bank loans prohibitively expen-sive for most developing countries. The lattersuggestion appears slightly questionable.Surely what should matter is whether there isdifferential treatment between developed anddeveloping countries in terms of prudentialnorms. If there is merely a scaling, it shouldnot matter very much, particularly if it leadsto greater stability of international bankingsystem, and therefore a lesser need for bail-out mechanisms.

The above comments apart, the treatment ofprivate capital flows appears somewhat incom-plete. The first point that needs to be noted isthat the approach taken to external capital in

the Report appears to be restricted primarilyto the financing aspect. This is, no doubt, thetraditional approach, which stresses upon therole of external savings on bridging the sav-ings and the foreign exchange gaps. There isalso an implicit preference for foreign directinvestment in the Report as compared to purelyfinancial flows, such as portfolio investmentand debt. The evidence on this, however, isby no means unambiguous. Numerous em-pirical studies suggest that foreign direct in-vestment (FDI) should not be viewed as asource of balance of payments support overthe medium run since quite often the foreignexchange outflows associated with FDI can besubstantial16. To this extent, at least, externalportfolio and debt flows would be more inconsonance with the pure financing needs.

There is, however, another dimension whichneeds to be taken into account. In the case ofa number of developing countries, foreign di-rect investment can make up not only deficien-cies in the availability of savings and foreignexchange, but also weaknesses in domesticentrepreneurial capacity17. It is very often thecase that developing countries simply do nothave sufficient indigenous entrepreneurial ca-pacity to effectively absorb the investible re-sources available. In such situations, foreigndirect investment may not only raise the levelof investment through utilisation of externalfunds, but also through better absorption ofdomestic savings. Entrepreneurial dynamismis central to achieving high rates of growth,and its absence may indeed be the dominantbottleneck in following a market-oriented

15 Collective action clauses essentially permit a qualified majority of bondholders to approve changes in the payments obligations.16 A strong theoretical case has also been made for arguing that FDI flows can lead to a worsening of balance of payments even

in the short run if domestic multipliers are strong enough.17 The role of foreign direct investment in transferring product, process and organisational innovations has been stressed in the

literature and is quite well known. The point being made here is somewhat different, and is not widely understood.

9

development strategy in a number of devel-oping countries18.

To make matters worse, access to internationalfinancial capital is driven largely by the exist-ence of a sufficient number of firms whichcan either borrow abroad directly or whosestocks are attractive to foreign portfolio inves-tors19. In the absence of such companies, it isunlikely that the country would be able to at-tract external financial flows regardless of howappropriate the enabling conditions. It is littlewonder then that most developing countriesaccess external capital either in the form ofsovereign loans or, at the very least, with sov-ereign guarantees in one form or another. Theother option, namely routing such fundsthrough the banking system, has proved to bepotentially even more damaging, as the EastAsian crisis has shown.

On the other hand, for countries which havesufficient entrepreneurial activity, relatively freeaccess for foreign direct investment with re-strictions on other forms of external capitalmay put domestic entrepreneurs at a seriousdisadvantage. This has not only to do withthe access to relatively lower cost externalfunds, but also in terms of the competitionfor accessing domestic finance. Thus, the rolethat external private capital flows can play in adeveloping country is sensitive to the natureand extent of domestic entrepreneurial talent.

If the issue is seen in this perspective, thenthe treatment of private capital flows in theReport will need to be slightly different. Inthe first place, the emphasis should be shiftedfrom the purely financial aspects to the

contributions that foreign capital can make tothe investment activity in general. Second,there should be some reflection of the limita-tions that exist in attracting private capitalflows, especially in the less industrialised de-veloping countries. Related to this issue, thereis also need to discuss the balance that shouldbe struck between FDI, on the one hand, andthe pure financial flows, on the other; and thepossibility of complementarity between thesedifferent forms of external capital. Finally,there should have been some reflection on therelationship between the financial sectors indeveloped and developing countries.

Trade

One of the most pleasant surprises in the Re-port is to find trade issues being included in astudy of development financing. This is notstandard, and many economists will no doubtquestion the validity of this inclusion. The tra-ditional approach views development financ-ing from the savings-investment balance of acountry. The difference between the desiredrate of investment and the rate of domestic sav-ings determines the current account balance,which represents the external finance require-ment. Although trade is implicit in the currentaccount balance, it is not the determining fac-tor. The focus is primarily on domestic savingsand on the financing of the current accountbalance. It is, therefore, necessary to lay downclearly why we believe that trade issues are cen-tral to any discussion of external finance fordevelopment, and why the approach taken bythe Report is to be strongly supported.

18 Although this was not a problem in India earlier, recent evidence tends to suggest that ex-ante savings, both domestic andexternal, may be greater than ex-ante investment demand, and therefore some of the growth potential is not being realised.

19 By and large, this condition requires the companies to be of a minimum size and/or with a fair degree of market capitalisation.Portfolio investment further requires the existence of an active and secure stock market and a secondary debt market. It isunlikely that countries in the initial stages of industrialisation will meet these conditions.



The traditional approach is perfectly valid in acontext where the flow of external resourcesis in some sense exogenous or that it is notinfluenced by factors internal to the countryunder consideration. Thus, in a situation wherethe external flow of funds is limited to devel-opment assistance, issues of trade can moreor less be ignored20. However, with the in-creasing importance of private investmentflows in financing investment and growth, itbecomes essential to take into account factorswhich influence the decisions of private in-vestors. There are at least two important waysin which trade issues impinge on private in-vestment decisions.

First, in any reasonable long-term or multi-pe-riod model of private capital flows, the deci-sion to invest in a particular country would becontingent upon an appraisal by the potentialinvestors of the country’s ability to service theinvestment over the longer time period. Thereshould, therefore, be at least some degree ofassurance that the country will be able to gen-erate a trade surplus in the future, which can beused to service its past external liabilities21. Thiswill certainly be contingent upon the exportpotential and prospects of the country.

Second, at the micro level, the choice of theproduct or service in which investment willbe made will depend upon the size of the po-tential market, particularly in such activities inwhich the country has comparative advantage.If the market is restricted to the domesticeconomy, it places a limitation on the amountof investment that can be attracted and

absorbed. Exports provide an importantmeans to widen the market and thereby in-crease the flow of investment. In brief, there-fore, the ability of the country to attract pri-vate investment flows will depend to a largeextent on its export potential. Thus, trade is-sues must be central to any discussion of pri-vate capital flows.

The Report rightly states that “... the mainbeneficiaries of trade liberalisation have beenthe industrial countries. Developing countries’products continue to face significant impedi-ments in rich country markets”. To correctthis problem the Panel strongly endorses thelaunch of a new round of trade liberalisationto focus mainly on the trade needs of devel-oping countries. The broad agenda for such a“development round” in the WTO should in-clude the following:

The implementation of the Uruguay Round: In brief,this refers to the implementation issues thathave been stressed by the developing coun-tries at the Doha Ministerial, especially relat-ing to the special and differential treatment tobe accorded under the various WTO agree-ments. This is by and large unexceptionable,except perhaps a mention could also have beenmade of Sanitary and Phyto-sanitary measures,which are of relevance to market access foragricultural products in particular.

Liberalisation in agriculture: the Report hasstressed upon obtaining significant improve-ments in market access is, elimination of ex-port subsidies and tightening of support todomestic producers in developed countries.

20 Much of the theory behind development finance was developed at a time when the bulk of international flows were in theform of aid and/or debt, and private investments were perceived to have little role to play. In the case of debt as well, therole of domestic factors was underplayed by an implicit assumption of sovereign guarantees.

21 In the short run, it may be possible to manage the balance of payments through some form of Ponzi finance, which wouldin any case not be credible for any length of time and would only attract speculative capital.

11

Although this has been a long-standing de-mand of developing countries, it is not entirelyobvious that the benefits of such liberalisationwill accrue predominantly to them. As thingsstand at present, the main beneficiaries will bethe Cairns group, which consists mainly ofdeveloped and the better-off among the de-veloping countries. The agricultural sectorsof most of the developing countries do not asyet have levels of productivity which wouldenable them to address the international mar-ket in any meaningful way. A danger that needsto be guarded against is that in attempting toimprove market access in developed countries,the developing countries do not also lose con-trol over their own agricultural sector. Themain issue that needs to be addressed in thiscontext is the agricultural subsidies that aregiven under various forms by a number ofdeveloped countries, which are seriously dis-torting the international market for agriculturalproducts. The net result is that a number ofdeveloping countries, including India, are find-ing it increasingly difficult to provide adequateprice support for encouraging productivitygrowth in their agricultural sector. Emphasis,therefore, must be placed more on controllingagricultural subsidies than necessarily on in-creasing market access22.

The total elimination of remaining trade barriers inmanufacturing: The Report also calls for theremoval of all trade barriers in manufacturedproducts, which are mostly at the expense ofdeveloping countries. Presumably this refersto the existing tariff peaks and tariff escala-tions that are directed at protecting the rela-tively low skilled occupations in developedcountries. Although this is certainly true,

particularly for textiles, clothing, and a widerange of processed foods, the non-tariff barri-ers are more pervasive and pernicious. Someof these issues may be covered under the imple-mentation agenda, but it would be desirable tospecifically identify these for further action.

There is a brief mention of the welfare gainsthat could accrue if the new round alsoliberalises trade in services. It appears that thePanel was hesitant to address this issue morestrongly, perhaps on the grounds that migra-tion and movement of natural persons wouldbe too delicate a matter to take up at this stage23.Nevertheless, liberalisation of trade in services,particularly in non-financial services, evenwithout the movement of people would be ofimmense benefit to developing countries, pro-vided that international assistance was forth-coming for providing the appropriate tech-nologies and for developing the necessary in-frastructure and human resources. The non-binding nature of the existing general agree-ment on trade in services (GATS) seriouslydilutes the benefits that can accrue.

It is also recommended that international assis-tance be provided to the least developed coun-tries to build up the capacity for trade negotia-tions and to help them to diversify their exports.To this end, generous financing of the Inte-grated Framework is proposed. This is no doubtan important recommendation, but perhapssome reflection on the effectiveness of the In-tegrated Framework would have been desirable.It is not possible to develop either trade strat-egy or effective negotiation without consider-able analytical work going in to the role of trade

22 If the choice is to be made between reduction in tariffs or reduction in subsidies, the overall impact would be significantlygreater for the latter.

23 Although there is a brief mention towards the end of the Report.



in the development strategy of a country. Anumber of the least developed countries sim-ply do not have the technical expertise to carryout any meaningful strategic analysis, and in sucha situation merely emphasising the trade issueswould be incomplete.

There are two other suggestions which aremade and deserve further consideration. Thefirst is the restoration and improvement of theIMF Compensatory Financing Facility, whichwas scaled back during the 1980s. The issuehere is that the CFF, when it existed, was notparticularly successful in preventing erosion ofearnings from commodities from destabilisingthe countries concerned. In order to makesuch a facility effective, there would have to beconsiderably greater support from the devel-oped countries as well as a more sophisticatedimplementation system. It is to be consideredwhether the IMF, which is already hard pressedto meet its primary obligations in an increas-ingly volatile international financial scenario,will have the capacity to take up this functionas effectively as would be desired.

The second suggestion is the establishment ofa multilateral commodity risk managementscheme for less developed countries. Althoughthe main report does not discuss the natureof the scheme, there is some information pro-vided in the Technical Report. In essence, thescheme appears to be a combination of a mini-mum support price mechanism and an insur-ance scheme. Although the idea is a good one,its effectiveness would depend largely upon theefficiency and sensitivity of the internationalagency which administers it. It is felt that thereis a serious underestimation of the complexi-ties involved in administering such a schemeat the level of a small farmer in a less devel-oped country, especially given the complexchain of intermediaries that are usually

involved in trade in a gricultural products. In-deed, such a scheme if not administered prop-erly can possibly lead to perverse results forthe farmers.

The main weakness of this analysis, however,is that it does not go far enough in addressingthe constraints that limit the exports of devel-oping countries to developed country markets.Improving market access in the sense of cre-ating enabling conditions addresses only partof the problem. The larger problem lies inthe institutional framework which actualises theexport potential of a country. Unless a coun-try has the right type of companies which cantake advantage of more liberal market access,little progress can be made. Therefore, de-manding greater market access, which invari-ably has some quid pro quo involved, must gohand in hand with taking measures, usuallydomestic, to ensure that the full benefits canbe realised. Otherwise the net effect is onlygreater concessions being granted to the de-veloped countries. The Integrated Frameworkis only partial solution to this dilemma. Moreactive participation by developed countriesthrough various forms of marketing assistanceand linkages is called for. It is also necessaryto link trade issues with the foreign investmentissues discussed earlier.

International DevelopmentCooperation

The Report recognises that even if sufficientprogress is made in domestic policy reforms,private capital inflows and trade liberalisation,international development cooperation will re-main vital to the process of development. Thereare four principal roles that are envisaged:

l Helping to initiate development

l Coping with humanitarian crises

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l Providing or preserving the supply of glo-bal public goods

l Confronting and accelerating recovery fromfinancial crises.

An attempt has also been made to estimate theinternational resources required to fund theseroles. As far as pure development aid is con-cerned, it is estimated that roughly $50 billionwould be required annually just to meet theInternational Development Goals, which isalmost double the present level of ODA. Thefunding of humanitarian crises is currentlymade out of the available ODA funds, whichleads both to a serious underfunding of hu-manitarian aid as well as a diversion of re-sources from the development function. It issuggested that the donors need to make a long-term commitment for humanitarian reliefthrough a contingency budget without divert-ing funds from other assistance. The estimatedprovision for humanitarian relief is $8-9 bil-lion in a typical year as compared to around$3 billion at present24. As far as global publicgoods are concerned, it is again the case thattheir funding is made out of the existing aidbudgets. The estimated requirement for thispurpose is at least $20 billion. Thus, the totalrequirement on these three counts works outto around $80 billion annually, which is almostfour times the total ODA available at present.

The Report clearly makes the point that it isimperative to separate the funding for each of

these three causes, so that there is no ambigu-ity regarding the resources available for eachof them25. This is an extremely important rec-ommendation since development assistancecan be effective only when there is sufficientassurance that the resources would be avail-able over an extended period of time. Placingall the requirements in one basket invariablyleads to a certain degree of uncertainty regard-ing the volume of resources that can be avail-able for a particular cause at a particular pointin time. More importantly, the considerationsunderlying each of these needs are very dif-ferent, and would have to be reflected not onlyin the nature of the funding but in the institu-tional arrangements as well.

Consider first the issue of humanitarian assis-tance. By its very nature, such requirements areepisodic, non-country specific and often for alimited duration26. Thus, provisioning for suchassistance has to be made on a contingent basiswithout disturbing the regular system of aidflows. Since the expenditures involved are usu-ally either in the nature of consumption or ofreconstruction of assets, the assistance must bemade in the form of grants. A distinction fre-quently has to be made between such flows onthe basis of the cause of the emergency. Thereare two main categories of disasters – naturalcalamities and those arising from breakdownof governance27. In the case of the former, thenormal governmental channels, with perhapssome strengthening, can be used for the

24 Presumably this estimate does not include adequate financial support of the UN system, which is the central actor in practicallyall humanitarian aid efforts.

25 The resources required for aiding recovery from financial crises has not been specifically mentioned in this context, and it ispresumed that the Panel expects such resources to be found elsewhere, presumably with the IMF, without cutting into theseprovisions.

26 There are of course countries where disasters of one kind or another are a more or less regular phenomenon and thereforerequire a constant inflow of humanitarian relief. In such cases, aid flows can conceptually be accommodated as part of abroader development assistance programme.

27 There are certainly situations where both can occur simultaneously. In such cases, the governance issue will have to takeprecedence in identifying the appropriate delivery mechanism.



delivery of relief, and therefore a temporaryblurring of the line between humanitarian as-sistance and development aid can be accom-modated. In the latter case, however, alterna-tive, non-governmental institutional arrange-ments may have to be established for deliveringrelief. In almost all such situations, the reliefagency will require a certain degree of assur-ance on the adequacy and continuity of sup-port for it to be able to function effectively.

Global public goods are another matter alto-gether28. In the first place, there is as yet nogeneral agreement as to the constituents ofsuch goods. Even in the indicative list giventhe Report, some of the items would mostlikely be questioned by developed countries.Second, as international concern regarding glo-bal public goods has increased, it has mani-fested itself as additional restrictions beingplaced on the utilisation of normal develop-ment assistance. Frequently it is difficult fordeveloping countries to resist this pressuresince some of the activities are clearly in theirown self-interest and, in any case, they needthe funds for balance of payments support.Nevertheless, it leads to a dilution of the re-sources available for attaining other develop-ment targets. It needs to recognised, there-fore, that if the issue of global public goods isto be addressed adequately, a distinction wouldhave to be drawn between those activitieswhich a developing country would carry outas part of its development strategy and thosewhich it would not. For the latter, specificfunding would have to be provided, usually inthe form of grants since such activities arenormally not income generating, and this

would have to be done on an ongoing basis.The former can gradually be absorbed as a partof normal development assistance.

As far as traditional development assistance isconcerned, it is by and large viewed as transi-tional financing until such time as domesticresources become adequate to maintain thegrowth process on a sustainable basis and thecountry is in a position to attract sufficientprivate investment from abroad. Seen in thismanner, the finances can be provided in theform of loans, provided of course that theterms are such that debt servicing does notbecome a burden too early in the developmentprocess. Unfortunately, the experience hasbeen that the net flow of development assis-tance has turned negative much too early inthe case of a number of countries. The prob-lem has been further compounded by variousconditions that are attached to aid, which sig-nificantly reduce their impact. In particular,development aid has rarely been properly in-tegrated with the development strategy of therecipient country. Frequently, parallel deliverysystems have had to be established in order toimplement the externally assisted projects atthe insistence of the donors. As a result, coun-tries have often been saddled with additionalexpenditure commitments even after the aidflow for that particular purpose has ceased.

In recognition of this, the reduction in the debtburden of the heavily indebted poor countriesthrough the HIPC Initiative has been wel-comed by the Panel, despite the fact that it hasnot been fully financed by additional ODA 29.Given the gravity of the situation, there is need

28 The items that have been identified as global public goods are broadly: peacekeeping, prevention of contagious diseases,research in tropical medicines, vaccines and agricultural crops, prevention of CFC emissions, limiting carbon emissions, andpreservation of biodiversity.

29 The implications of the existing and proposed funding of the HIPC Initiative on the other poor developing countries hasbeen admirably done in the Technical Report and bears careful consideration.

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to enhance the HIPC scheme in order to makethe debt position of these countries sustain-able and enable them to attract private fi-nance30. It needs to be noted that an addi-tional inflow of aid is not necessarily equiva-lent to debt relief. The former is usually re-stricted in where and how it can be applied,and therefore reflects more the donor’s pri-orities, whereas the latter allows a greater flowof resources to the entire gamut of develop-ment expenditures31. This difference can be adouble-edged sword. In the case of countrieswith good governance and commitment todevelopment, debt relief will probably be farmore effective than an equivalent amount ofadditional aid. The opposite may, however,be true of countries which do not meet theseconditions. This is not merely a moral hazardproblem, which potentially exists with any debtwrite-off, but an argument for distinguishingbetween countries while deciding upon thenature of the development intervention32.

The more critical issue, however, is how toprevent the re-emergence of such a situationin the future. The lesson that needs to be learntis that the terms and conditions of aid thathas existed in the past are simply not gener-ous enough to prevent developing countriesfrom slipping into the red. It is, therefore,imperative that the existing loan/grant ratioof development assistance be reconsidered,

especially for the poorest countries. In par-ticular, it needs to be considered whether thesoft loan windows of the multilateral devel-opment institutions, such as the IDA, shouldbe converted to grants as has been proposedby the USA. There is merit in this proposal,but it can lead to moral hazard problems. Per-haps a better method would be to evolve a sys-tem by which loans automatically get convertedto grants on the achievement of pre-specifieddevelopment milestones33.

An important suggestion made by the Panel isthat donors should put their aid resources intoa common pool to support the developmentstrategy of a given country. It needs to beclearly clarified that this proposal should ap-ply only to normal development assistance andnot to either humanitarian aid or financing ofglobal public goods. If this suggestion wereimplemented, it would go a long way towardsimproving the effectiveness of aid. The In-dian experience has been that donors actingindividually not only leads to diffusion andduplication of programmes as well as estab-lishment of parallel delivery systems, but moreimportantly impinges adversely on theprogrammes run with domestic resources34.Ideally, the country should be responsible fordesigning the programmatic structure of itsdevelopment strategy and the donor commu-nity should plug in to those which are

30 One of the most positive aspects of debt relief is that it significantly improves the country’s position with regard to attractingprivate capital. An equivalent amount of additional aid does not have this effect since aid funds cannot be appropriated tomeet general financing needs. Thus, this initiative should be seen as a measure to permit leveraging of aid funds.

31 This distinction gets blurred when the HIPC initiative is coupled with restrictions on how the resources saved from debtservicing can be applied.

32 This discussion suggests that the debt write-off route should perhaps be also considered for moderately indebted developingcountries, particularly those for which the net flow of external assistance has already turned negative.

33 Although this proposal reeks of additional conditionalities, some such mechanism is necessary both for the comfort of thedonors and to ensure that the recipients become conscious of their responsibility.

34 Since most governments are fiscally constrained, the counterpart funds for accessing international aid are almost invariablyfound by cutting back domestically funded programmes, which may actually rank higher in development priorities. Theother side of the coin is that when development concerns outweigh balance of payments needs, there is underutilisation ofaid funds.



consistent with their mandate, without neces-sarily demanding ownership and control35.Some initial steps have been taken in this direc-tion with the World Bank’s Comprehensive De-velopment Framework (CDF) and the UN’s De-velopment Assistance Framework (UNDAF),but in neither case are they properly integratedwith the national development strategy. Ofcourse it also needs to be recognised that a num-ber of developing countries simply do not havethe institutions or expertise to draw up a com-prehensive development plan, and externallydrawn up strategies are no substitute for a na-tional effort. For this process to become mean-ingful, the international system needs to sup-port capacity building in development planning,which is easier said than done in view of a morethan 20 year-long successful campaign to deni-grate planning36.

The Panel has also made another extremelyimportant suggestion that donors should dis-tribute ODA across countries according to twocriteria : (a) the depth of poverty; and (b) theextent to which the country’s policy is effec-tively directed to reducing poverty. The intentof this suggestion is clearly to reduce the po-litical content of national aid policies, whichhave led to an extremely skewed pattern ofdistribution of aid funds, and therefore needsto be strongly supported. However, the sec-ond criterion, as it stands, leaves scope forconsiderable subjectivity, and can end up di-luting the intent of the proposal. In order toobviate this problem, it becomes necessary to

evolve a non-partisan, multilateral institutionalframework which is empowered to determinethe distribution of all aid funds on the basisof objective criteria. The existence of such abody is also necessitated by the proposal forthe pooling of aid resources.

Finally, the Report calls upon the donor coun-tries to commit 0.7 per cent of their GNPtowards ODA as recommended by thePearson Commission. Achieving this targetwill lead to an annual availability of aid fundsof around $100 billion, which would be suf-ficient to meet the assessed minimum require-ments plus have something left over for ac-celerating the achievement of the MillenniumGoals. Such commitments are unlikely to beforthcoming without strong political backingand a well-coordinated campaign to raise thelevel of public awareness about the impor-tance of the Millennium Goals, both as ameasure of compassion and to achieve greaterpeace and security in the world. Unfortu-nately, the track record on this count doesnot warrant any great optimism. Therefore,after having made the plea, the Panel shouldhave prioritised the existing commitment offunds to the three broad areas of assistance.The responses of the various donor coun-tries to such a proposed allocation would bemost interesting and revealing.

Systemic Issues

The section on Systemic Issues is perhaps themost important and comprehensive part of theReport. The focus that it brings to bear on

35 On the other hand, at the micro level in India, it has been found that externally assisted programmes have, by and large, beenrun more efficiently than the domestically managed ones. There are many reasons for this, not the least of which is theexpertise and commitment brought by the external programme managers. This would suggest that recipient countriesshould be flexible about ceding management control of key externally assisted programmes to their donor partners. Gettingon to the sovereign high horse does not help matters.

36 This factor is now starting to be recognised. The World Bank’s Poverty Reduction Strategy Papers (PRSP) are nothing butdevelopment plans in another name. No PRSPs are prepared for India. Also, while India has an UNDAF, it is not among thecountries for which a CDF is prepared.

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the importance of global governance and theinternational institutional structure, not onlyfor development financing but also for reduc-ing the sense of alienation and disem-powerment among a number of developingcountries, bears careful consideration. It rightlymakes the point that “... global interdepen-dence without global rules and institutions isin nobody’s long-term interest”, and goes onto elaborate the nature of the problem as itexists today.

The Panel rightly points out that the interna-tional economic system is fragmented, andthere is an absence of a long-term strategicframework that can guide the evolution of theglobal economy. It is, therefore, proposed thata Globalisation Summit of a few key heads ofState be convened as a prelude to establishinga Global Council to provide leadership on is-sues of global governance. The Council wouldnot have legally binding authority, but woulduse its political stature to find solutions to is-sues of global economic and social gover-nance. While this is a proposal that needs tobe supported in principle, since the politicalcontent of the existing global arrangements ismost inadequate, it is not clear what the au-thority of the Council would be. The Panelappears to have stopped short of recommend-ing the economic equivalent of the SecurityCouncil. Thus the credibility and the moralauthority of the Council will be determinedby its membership. This is likely to be a con-tentious issue, since the membership of theCouncil is intended to be limited. It is neces-sary, therefore, to guard against the Councilbecoming a more formalised version of theG-20, and thereby not commanding the fullconfidence of the developing countries37. For

this purpose, the modality of selecting themembership of the Council will have to bethought through carefully. There are sevenmain dimensions of the systemic issues thatthe Global Council is intended to address im-mediately. These are discussed below.

Support for multilateralism : Strengthening of themultilateral approach to handling global issuesis the first principle that should be endorsedby the Council. The developing countriesclearly have a strong stake in promotingmultilateralism, which is possibly the only avail-able bulwark against excessive domination byindividual developed countries. The UnitedNations system in particular, because of itsmore democratic constitution, has been ex-tremely important in this respect. The othermultilateral institutions are less representative,and must be encouraged to move in this di-rection. The obvious merit of this apart, thefact remains that no common pool approachto aid can be effective without the strong po-litical backing that the Council can give.

Reform of the international financial architecture: Thisis an issue that has come into prominence inrecent years due to the spate of financial cri-ses that have occurred around the world. Theneed for such reform, however, should be ar-ticulated from a more long-term strategic per-spective. With the growing importance ofprivate capital flows, a model which was basedessentially upon the flows of public funds isbecoming anachronistic. As things stand atpresent, the international financial architectureis reactive, with little or no direction being pro-vided to private capital. The proposal to shiftthe focus of the IMF to crisis prevention andtimely detection of external vulnerability is

37 The problem is particularly complex today since the developing countries as a collective do not have the kind of solidarityand widely accepted leadership as it did earlier, notwithstanding the G-77.



welcome, but it is by no means clear that theinstruments available to the IMF at present areadequate for the purpose. Similarly, the task ofmaking IMF conditionalities more sensitive tothe capacities of the domestic authorities andto perceptions of private investors will requiresignificant strengthening of the capabilities ofthe IMF and the extent of its engagement withdeveloping country governments.

The Report has also suggested that the WorldBank should accelerate its support to thelonger- and medium-term structural and so-cial reforms, particularly those for preventingcrises. This is no doubt important, but it isequally important that the World Bank signifi-cantly enhances its role in helping to attractprivate capital to developing countries. Thisdoes not mean an expansion of merely thecommercial arms of the World Bank, but anintegration of the entire assistance packagewith the prospects offered by the internationalcapital market.

Reinforcement of the WTO: the Panel has rightlyobserved that the WTO is in need of reformand support in certain critical areas, and thatthese changes are unlikely to be achieved fromwithin. In particular, it has identified the deci-sion-making system in the WTO as selectiveand exclusionary. The WTO also has very lim-ited capacity to provide technical assistance todeveloping countries, arising primarily due tounderfunding and understaffing. Given theobvious importance of WTO in the globaleconomy, and the steadily increasing role thatit is being called upon to play, it would be ineverybody’s interest to ensure that thisorganisation is sufficiently strengthened andempowered.

An additional factor that the Panel should haveperhaps considered is the fact that the WTO,particularly its dispute settlement mechanism,is quasi-judicial in nature and, as a result, manyof the rules of international commerce arebeing determined not so much by the formalAgreements, but by case law. This has twodimensions. First, most developing countriessimply do not have the legal expertise to ef-fectively articulate their position, nor to fullyappreciate the implications of the case law fortheir future action. As a consequence, the ap-plication of the WTO Agreements is beingdriven more by access to legal talent than bymerit. Second, there is no proper mechanismfor the review of case laws by the GeneralBody to ensure that the intent of the Agree-ments is not been violated by its interpreta-tion. It is imperative therefore to ensure thatthe normal processes of legal assistance andlegislative review, which are present in alldemocratic societies, are also introduced in theWTO through suitable strengthening.

Environmental and Labour issues: the Panel hascorrectly diagnosed the pressure on the WTOto address environmental and labour issues asarising from its capacity to impose sanctions.Recognising that this would seriously distortthe mandate of the WTO, it has been recom-mended that alternative fora be given thesefunctions with adequate instruments of en-forcement. Strengthening of the InternationalLabour Organisation and the creation of asingle Global Environment Organisation,through a merger of existing bodies, have beenrecommended. Both these proposals need tobe supported strongly.

Innovative sources of finance: the Panel recognisesthe need to establish stable and contractual new

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sources of multilateral finance, but it alsorecognises that taxing for global problems willbe politically much more difficult than taxing forpurely domestic purposes. This is indeed true,and recent experience shows the unwillingnessof some developed country governments toimpose costs on their own people even if it isfor the common good of humanity38. The Panelhas, therefore, proposed that the first issue thatneeds discussion is whether or not the worldshould have global imposition of taxes insteadof only sovereign ones. This is a very sensiblesuggestion, and there are two issues that need tobe considered carefully. First, there is a distinctpossibility that the imposition of a global tax maylead to a severe dilution of the commitment bydeveloped countries to voluntarily contribute tointernational assistance39. The net result may ac-tually be a decline in the resources that becomeavailable. Second, the effective operation of anytax system is critically dependent upon the coer-cive power of the State. In the case of an inter-national tax, enforcement of compliance may notbe easy unless there is full political commitmentby all concerned governments and these taxesare either built into national tax laws or are givensome alternative form of statutory support. Al-ternatively, a method of sanctions would have tobe developed, which could be further problem-atic, and not to be recommended.

The two taxes proposed in the Report, namelya currency transactions or Tobin tax and a car-bon tax, are both likely to be most unpopularin developed countries. Of the two, the Panelhas rightly been cautious about the first, andhas advised further study before a definitive

conclusion is reached. This is a position weagree with, since the little available evidencesuggests that the negative consequences ofsuch a tax on the international financial sys-tem may significantly outweigh the benefits.The carbon tax, on the other hand, has muchto recommend it. The global negative exter-nalities of carbon emissions are sufficientlywell-documented to merit a system of disin-centives, and such a tax fulfils this role admi-rably. Care, however, has to be taken to en-sure that the basis for application of such atax is properly specified. For instance, if meth-ane emissions are taken into account, then therice growing areas of the world would be un-fairly targeted. It is, therefore, suggested thatthe carbon tax should be restricted to the burn-ing of fossil fuels, which would also have theadded advantage of discouraging the use ofan exhaustible natural resource.

It is actually surprising to find that the Reporthas not discussed the issue of taxing “globalcommons”. This issue has been brieflytouched upon in the Technical Report, whereit has been mentioned that activities such assatellites and seabed mining have been notconsidered on the grounds that the proceedsfrom such tax would be negligible. Even ifthis were the case, there are strong theoreticaland ethical reasons to impose a tax on globalcommons with an eye to the future.

Finally, the report has suggested the revival ofthe special drawing rights (SDRs) by the IMF,which allows developing countries to build upinternational reserves without imposing realcosts. This is an important suggestion andshould be fully supported since in recent years

38 The withdrawal of the USA from the Tokyo protocol is a case in point.39 The strong motivating factor of compassion can easily be lost if there is perceived to be an imposition, which can actually

lead to further polarisation between developed and developing countries.



the need to build up reserves for precaution-ary reasons is imposing serious costs on de-veloping countries, and this can only grow asprivate capital flows increase relative to ODA 40.

International Tax Organisation: one of the mostimportant suggestions made in the Report isthe establishment of an International TaxOrganisation. The functions of such anorganisation have been spelt out clearly, andeach has considerable merit. This proposalshould be supported strongly, although therewill be considerable resistance from multina-tional corporations and certain governments.Issues of transfer pricing and tax havens havecreated enormous problems for developingcountries, and an organisation that can ad-dress these issues will no doubt considerablyreduce the suspicion that domestic govern-ments have regarding multinationals, andthereby improve their faith in global gover-nance. In addit ion, as globalisat ionprogresses, there will be need for a certaindegree of harmonisation of tax systems,

especially to prevent undesirable tax wars,which will require the existence of a bodythat is already familiar with the diverse taxsystems and carries a certain degree of cred-ibility. At present, the IMF does have somefamiliarity with fiscal matters, but this is byno means its primary function, and norshould it be.

Migration Policies: the Panel has suggested thatthe time may be ripe to develop internationalcooperation on the movement of labour acrosscountries without risking national interests.This is certainly true, particularly in view ofthe demographic changes that are taking placein developed countries which, if not addressedtoday, may cause serious disruptions in the notso distant future. This is, however, a highlycharged political and emotive issue, and itsresolution cannot be left to diplomats andbureaucrats. A high-level political body, suchas the Global Council, will be essential toevolve an acceptable compromise between thecontending interests.

40 Building foreign exchange reserves on the basis of external borrowings and/or investment essentially amounts to reversetransfers in the form of seignorage.

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Indian Prospects and DevelopmentFinance Needs

Indian Prospects and DevelopmentFinance Needs

Having critically examined the Zedillo Panelrecommendations in the light of past Indianexperience, it may be desirable to briefly de-scribe the development finance situation inIndia as it exists today and the strategic ap-proach that is likely to be taken in the immedi-ate future. The objective is to lay out the con-siderations that would need to inform India’sposition not only in the forthcomingMonterrey Conference, which is no doubtimportant, but also in its approach to devel-opment finance in general.

The first point that needs to be appreciated isthat, by all appearances, India seems to havean embarrassment of riches as far as investibleresources are concerned. With a domestic sav-ings rate of above 24 percent of GDP andnon-aid capital flows of nearly 2% of GDP, asustained growth rate of between 6 to 6.5%per annum without serious balance of pay-ments difficulties appears very much on thecards. Such growth rates will almost certainlyplace India among the fastest-growing coun-tries in the world over the next decade. This,coupled with a steady decline in the popula-tion growth rate, should lead to rapid increasesin per capita incomes of somewhere in theregion of 4.5 to 5% per annum – i.e. a dou-bling of real per capita incomes in the next

15 years. Foreign exchange reserves of morethan $60 billion, equivalent to about 12 monthsof imports, lend a further measure of solidityto Indian economic prospects. Indeed, thesefeatures of the Indian economy, taken with thefact that the net flow of external assistancehas turned negative in recent years, haveprompted a number of observers to take theview that today India can do without develop-ment assistance on the strength of her domes-tic savings and private external flows41.

On the poverty reduction and social indicatorfronts too India has been performing reason-ably well over the last two decades. At currentrates of progress, the Millennium Goals arewell within reach. The rate of reduction ofthe poverty ratio has been averaging about onepercentage point per year, and if this rate canbe maintained, the incidence of poverty shouldbe below 15% by 201542. Literacy rates toohave been increasing rapidly in recent years andit is expected that it will reach 75% by 2007and over 90% by 201543. The rate of progressin reducing gender disparities in education isalso reasonably good. As far as the health in-dicators are concerned, the targets on mater-nal and infant mortality rates should be achiev-able, despite the relatively slow rate of progressduring the 1990s.

41 Net development assistance to India at present is a little more than minus half a billion dollars annually.42 Preliminary estimates made by the Planning Commission for the Tenth Five Year Plan indicate that if the economy grows at

an average annual rate of 6.5%, the poverty ratio will decline to about 21% by 2007; and if the growth rate can be acceleratedto 8% per annum, the poverty rate would be about 19%.

43 Universal literacy may take a while longer given the huge back-log of adult illiteracy, but universal coverage of the school-agepopulation should be achieved by the end of the decade.


Despite these positive trends, there is no causefor complacency. To begin with, although asustained growth rate of 6 to 6.5% appearsimpressive by any standard, it needs to be seenin the context of requirements. The most com-pelling factor that will guide India’s develop-ment strategy over the next few years is thefact that although the rate of populationgrowth is dropping quite significantly, the rateof growth of the population in the workingage group will peak during the coming decadeat around 2.5% per year44. There is still con-siderable uncertainty about the likely rate ofgrowth of the labour force, since there are twopossible contradictory forces in operation. Onthe one hand, the increasing trend in the aver-age years of education will reduce the rate ofaddition to the labour force; while, on theother, greater work participation by women willtend to increase it45.

Nevertheless, the likelihood is that the labourforce will increase faster than the economy’scurrent ability to provide gainful and decentemployment. During the 1980s and the earlypart of the 1990s, the average rate of growthof employment, which is a proxy for workopportunities, has been below 2 per cent peryear. There is evidence that this has droppedeven further during the latter half of the1990s46. Therefore, if the past trends in workcreation continue into the future, the countryfaces the possibility of adding at least half apercentage point of the work force - that isover 2 million people - to the ranks of theunemployed each year. Such a situation is

clearly insupportable. Unemployment not onlyentails high human costs, but also imposes sig-nificant costs on society in terms of socialunrest and deterioration of law and order.

This is only the macro picture. The nationaldemographic trends hide wide variations in theregional distribution and skill composition ofthe emerging work force, which are criticalcomponents in devising an appropriate devel-opment strategy. The process of demographictransition has begun in most of the states ofthe country, and it appears that the bulk of thefuture growth of population will be concen-trated in only four or five states. This needs tobe viewed in the context of a poorly integratedlabour market in the country and considerablebarriers to inter-state migration47. Therefore,the geographical pattern of work creation willhave to be such that these states register sig-nificantly higher growth rates of labour ab-sorption than the national average. Attainmentof the national target without the appropriateregional distribution will lead to a situation inwhich certain parts of the country will experi-ence labour shortages and others will have tocope with high unemployment. The inevitablewidening of disparities in wages and standardsof living across regions that is entailed can leadto serious social tensions as migration pres-sures increase. Thus, sub-national consider-ations must also inform the nature, quantumand flow of development resources.

It also has to be noted that the emerging workforce reflects the skill distribution arising from

44 This is the outcome of the rapid rate of population growth that occurred during the 1970s and the early 1980s.45 Although the recent data seems to suggest that women are withdrawing from the work-force, particularly in rural areas, it is

not obvious that this is a voluntary phenomenon and it may simply reflect the non-availability of appropriate work opportunities.With economic growth and improvements in female literacy, the situation can change dramatically.

46 The latest NSS data indicates that the growth rate of employment between 1993-94 and 1999-2000 has been below 1% perannum.

47 There is of course significant seasonal migration that does take place in the country, especially for agricultural occupations.This, however, entails considerable human costs and is in no way an enduring solution to the problem.

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the spread of the educational and training sys-tems in the past, and it has to be ensured thatthe pattern of work opportunities is consis-tent with the skill profile. In this context, cog-nizance has to be taken of the fact that nearly60 per cent of the emerging work force willhave little or no literacy skills. Therefore, thepattern of work opportunity creation in theimmediate short run must be such that it ab-sorbs a large number of persons whose skillsare of a traditional nature. On the other hand,there is also a growing trend of educated un-employment in the country, particularly insome of the states which have attained rela-tively high educational levels in the past. Al-though migration is somewhat less of a prob-lem in such cases, nevertheless the develop-ment strategy cannot ignore the need to cre-ate work for the educated labour force of thesestates in a manner that is least disruptive.

On the other hand, the high rate of growth ofthe labour force taken with the declininggrowth rate of population implies that the“dependency ratio” - which is the number ofdependents per working person - will also bedeclining. This creates a window of opportu-nity during which, if gainful employment isprovided to all job seekers, average family in-comes can increase faster than ever before,thereby leading to rapid decline in the incidenceof poverty.

Thus the demographic trends in the countryset the essential parameters of the growth strat-egy that will have to be followed. This is afundamental message that must inform all dis-cussion on financing for development. There

is no a-priori minimum rate of growth which isappropriate for all countries and at all times.Growth requirements will vary depending uponthe manner in which demographic trends evolveover time. For instance, successful health inter-ventions for meeting the Millennium Goals canin themselves generate even further require-ments of development finance in order to en-sure that the income-related objectives of thegrowing population can be adequately met48.Therefore, the notions of resource requirementshave to be sensitive to the changing dynamicsof social and economic developments in everycountry, and international aid flows will have totake these into account.

Returning to the Indian context, at the over-alllevel, it becomes essential to target a GDPgrowth rate that will generate the requisite num-ber of work opportunities and, at another level,it is also essential to ensure that the structuraland regional pattern of growth meets the de-mands of the work force. Consider first theissue of the aggregate growth rate. Estimatesof the elasticities of employment to sectoraloutput suggest that the necessary work oppor-tunities can be created only if the growth rate isat least 7% per annum, preferably closer to 8%if the quality of employment is also taken intoaccount. At the trend value of the incrementalcapital-output ratio (ICOR), which is around 4.3for an average growth rate of 6%, a sustained 7per cent growth rate could be achieved with anICOR of about 4.2 and 8 per cent growth withan ICOR of around 449. Thus, the need to cre-ate adequate employment demands that the

48 In this context, it needs to be noted that in India the poverty ratio actually went up during the 1950s and 1960s despite fairprogress on the economic front (average annual growth rate of about 4.2%) due to rapidly increasing population. Even inthe 1980s, when the growth rate further accelerated to 5.6%, the absolute number of poor rose, although the percentagedeclined, due to population growth.

49 Theoretical and empirical evidence suggest that the ICOR tends to decline as the growth rate accelerates. See P. Sen, “A Noteon Growth Projections for Capital-Constrained Economies”, (Planning Commission Working Paper No. 2/2001-PC).

Indian Prospects and Development Finance Needs


investment rate should be in the range of 29 to32 per cent of GDP over the next decade. Withhousehold sector savings expected to be about20 per cent of GDP and corporate savings alittle above 5 per cent, public savings and exter-nal capital inflows together will need to be some-where between 4 to 7 per cent of GDP. It isthe distribution of this additional resource re-quirement between the two sources that needscareful consideration.

The current trends in public savings in Indiado not give cause for any great optimism inthe near future. Although the savings of thepublic sector undertakings have more or lessremained constant at around 3.5 per cent ofGDP, savings of the government, Centre andstates together, have been falling steadily andstands at over minus 4 per cent at present.Although efforts are being made to reverse thisdeclining trend, not too much can be expectedin the immediate future unless there is a sig-nificant increase in the extent of political com-mitment to a full-scale reassessment of thesystem of subsidies and transfers and tostreamlining of tax administration at all lev-els50. Thus, in the foreseeable future, consid-erable reliance will have to be placed on exter-nal capital inflows for financing the desiredgrowth target.

As far as external capital flows are concerned,in the past the country has relied primarily onexternal debt. Even when a fair component

of this debt was concessional, the country slidinexorably into an external debt trap – exem-plified by the crisis of 1991. The situation isworse now. Over the past two decades, theshare of aid and concessional debt in interna-tional financial flows has been steadily declin-ing, and today, as mentioned earlier, there is anet outflow on this account. Shifting entirelyover to external commercial debt would be avery dangerous strategy indeed, given the rela-tively high interest costs on such debt, particu-larly with India’s external credit ratings as theystand at present. The recent crisis is East andSouth-east Asia exemplifies the danger of un-restricted inflow of external debt. The solu-tion really lies in accessing higher inflows ofnon-debt external capital.

Although the possibilities of attracting higherlevels of non-debt private flows do exist, pru-dential considerations demand that the currentaccount deficit (CAD) not be allowed to widenexcessively. Estimates of sustainable CAD forIndia indicate that to the extent possible itshould be contained in the range of 2.5 to 3per cent of GDP51. If these limits are accepted,then the necessary growth target can beachieved only if either government savingsturn positive or there is a much larger inflowof concessional external assistance, whichwould allow a relaxation of the CAD limit52.

The availability of adequate resources, how-ever, is only half the story. It is becoming

50 Even with such commitment, it is estimated that government dissavings will continue to be around 2.4% of GDP on theaverage over the tenth Plan period (2002-07). It is sometimes argued that much of the problem can be taken care of througha faster pace of disinvestment and privatisation of public sector enterprises (PSEs). This is not entirely correct. It needs to beremembered that disinvestment proceeds are capital receiots, and represent a claim on private savings, not a net increase inthe savings of the economy.

51 Sustainability of the current account deficit takes into account the view that foreign investment is no less a liability of thecountry than external debt, and that the return to such investment flows would be at least the average return on capital in theeconomy. At present, however, the CAD for India is less than 1% of GDP, and therefore no apparent danger is perceived,but any acceleration in growth will reverse this prognosis.

52 External assistance in the form of grants addresses both these dimensions in that it reduces the government’s revenue deficit(expenditures remaining constant), as well as allows a relaxation of the CAD limits.

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increasingly clear that investment demand inIndia may not be sufficient to absorb even theinvestible resources that are in sight. The rea-sons for this vary from sector to sector. Asfar as the government itself is concerned, theCentre is increasingly finding an institutionalconstraint in undertaking public investment.Earlier, the principal vehicles for central gov-ernment investment were the public sectorundertakings (PSUs). With the advent of thedisinvestment/privatisation process, most ofthe PSUs have virtually suspended all invest-ment activity. This applies not only to thegovernment resources, but also to the internalresources generated by these units. Althoughsome PSUs in the infrastructure sectors arecontinuing their investment programmes, mostof them have physical and organisational limi-tations in expanding their investment activityany further. The state governments, on theother hand, have somewhat better institutionalcapability to invest, but practically all of themface serious financial problems, which restrictstheir investment capacity.

To make matters worse, the Indian corporatesector simply does not appear to display thekind of entrepreneurial dynamism that is nec-essary for it to occupy the activities that arebeing vacated by the public sector. There maybe many reasons for this, but it appears thatan unwillingness to dilute the promoters’ stakefor fear of take-overs may be an importantcontributory factor. The private non-corpo-rate sector, on the other hand, has sufficiententrepreneurial dynamism, but face serious

constraints in access to investible funds. TheIndian financial sector, due mainly to policy andlegal rigidities, have high levels of non-perform-ing assets (NPAs), and are therefore becomingincreasingly sensitive to their risk exposure. Thebrunt of this over-sensitivity is borne by thesmall and medium enterprises (SMEs). The onepositive development in recent years has beenthe success of the micro-credit schemes oforganised financial sector companies which tar-get self-help groups (SHGs). But this has a longway to go before it can emerge as a major ab-sorber of investible resources53.

Thus, as can be seen, the future course of de-velopment in India vividly illustrates the propo-sition that is implicit in much of our earlierreview of the Zedillo Panel recommendations– namely, international development financestrategy should not only be about the supplyof resources, but must explicitly take into ac-count the nature of investment demand as well.Flow of resources without the institutionalcapacity to absorb them effectively does notsolve the development problem. A naturalcorollary to this proposition is that the natureof external flows matters. In the Indian case,for instance, FDI is more valuable than FPInot for the foreign currency that is brought in,but for the embodied entrepreneurship. Simi-larly, aid flows to sub-national governmentsare likely to be more productive than those tothe central government. Such considerationsneed to inform every aspect of the discussionon development assistance.

53 Regional imbalances are perceptible even in the disbursement of micro-credit, and therefore it does not appear to solve thesub-national distributive issues.

Indian Prospects and Development Finance Needs


The Monterrey Consensus:Does it Meet the Bill ?

The Monterrey Consensus:Does it Meet the Bill ?

The previous sections reviewed the Report ofthe Zedillo Panel in light of the experiencesgained from the Indian development processand the development strategy that is being pur-sued by India for accelerating its growth anddevelopment. On the whole, despite the vari-ous weaknesses in the Zedillo Panel Reportnoted above, it is an important step forwardin the discussions on development financing.Its most important contribution lies in the factthat it explicitly acknowledges the politicalnature of this activity, and that solutions to themost pressing problems will have to be foundin the political domain.

Seen in this light, the draft Monterrey Con-sensus document comes as a grave disappoint-ment. It no doubt covers every major issue,and indeed is more comprehensive in this re-spect than the Zedillo Panel Report, but it shiesaway from any radical solution. Reading thisdocument leaves one with a lingering sense ofdeja vu – been there, done that; now let us col-lectively just do it better. It is a document byinternational bureaucrats for national bureau-crats; shorn off all the political insights andinitiatives of the Zedillo Panel. In the finalanalysis, the Monterrey process is probably farmore valuable than its likely outcome.

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