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PREFACE

This volume was prepared by i4r. Jean Baneth. It was written i n the spring and summer of 1965, on the basis of data gathered i n India between September 1964 and March 1965. Fklitorial revisions were made i n the spring of 1966, but no e f fo r t was made to bring it up to date. Hawever, relevant new information has been noted i n footnotes marked by an aster isk (*).

TABLE OF CONTBJTS

Page No.

BRIEF SUIDIARY OF FINDINGS AND RECOl4PIENDATIONS

Findings: Controls and Plan Implementation Controls and Import Substitution Controls and the Foreign &change Budget Effects of the Control System

Recommendations: Controls on Investment Import Controls Special Problems

Conclusion

THE ROLE OF ADp¶INISTRATIVE CONTROLS I N INDIA

Introduction

Part I - THE BROAD FRMdORK

Chapter 1 - The F'lan as Guideline to the Control System The Plan and Licensing of Investment The Flan and Controls on the Allocation of

C l ~ ~ e n t Iilputs

Chapter 2 - Import Substitution and the Clearance from the Indigenous Angle

The Fonnulation of Import Substitution Policy Clearance from the Indigenous Angle Indigenous Content

Chapter 3 - The Foreign Exchange h d g e t The Elaboration of t i e Foreign &change Budget Tables: Foreign Exchange Budget - Allocations -

fo r 1kintenance Imports Foreign Exchange Budget - Allocations

for Additions to Capital Stock Foreign &change Allocations for

Commercial Imports The Subdivision of Commercial Imports The Foreign Exchange Budget as a Tool for

Equating Short-run Demand and Supply A. Country-tied Funds B. Earned Foreign Exchange Resources

ii iii iii

v

v i i v i i i

X

Part I1 - THE MECHAiJISN OF THE CONTROLS 2 7

Chapter 4 - Controls on the Public Sector 2 7

Chapter 5 - Controls on the Establishment of Productive Capacity in the Private Sector 29

Chapter 6 - Controls on the Allocations of Current Inputs to the Private Sector 31

The Uncontrolled Flows 33 Evaluation of Controls over the Allocation

Current Inputs 37

Chapter 7 - General Assessment of the Control System 37 Controls as a Protective Device 37 The Incentive to Invest and Under-utilization

of Capital 38

Part I11 - CONCLUSIONS AND R%COWIf3JDATIONS 41

Chapter 8 - Controls on Investment 4 l Industrial Licensing 4 l Selective Credit Controls 42 Summary Recommendations for Controls on

Investment 44

Chapter 9 - Controls on Imports and Scarce Domestic Naterials bb The Raj Committee Report 44 The Decontrol of Imports 46 The Determination of the Long-term Equilibrium

Exchange Rate 48 The Short-term Equilibrium Exchange Rate 48 Capital Goods Imports: A Special Case 49 Direct Private Investment 51 Invisibles 51 i m t i p l e &change Rates and Possible Distortions 52 Customs Duties 53 The &change Rate fo r Exports 54 Alternative Solutions 54

Complete Decontrol and Stable Unitary Rate 55 Depreciated Stable Unitary Rate and Decontrol

Limited to Production Materials 55 Depreciated Stable Unitary Rate and Mainte-

nance of Controls Objections to Decontrol

55

Concluding Remarks 56 58

Appendix I - TH3 BALANCE OF PATPIE~JTS

A p p e n d i x I1 - STEEL CONTROL

A p p e n d i x I11 - LICENSING OF PRODUCTION lJIATER1A.L REQUIREZvlENTS OF S l ~ ~ SCALE INDUSTRY

Appendix I V - ADPENISTRATIVE PROCEDURES FOR CONTROLS OVER LARGE-SCALE INDUSTRY

Appendix V - STATEMENT SUEJIITTED TO THE T4INISTRY OF FINANCE

Appendix V I - EXTRACT FRO14 THE "REPORT OF THE STUDY TEAM ON DIRECTORATE GEQJBAL OF TECHNICAL DEVELOPiJIENTU

1. India has planned and i s conducting a development program which, by i t s magnitude and composition, inevi tably puts pressure on both pr ices and the balance of payments, pa r t i cu l a r ly the l a t t e r . Instead of so l inli t ing the s i z e of the Government investment program as t o ellsure the absence of such pressure - which would have been undesirable - or of per- mitt ing pr ice and spec i f ic excise taxes t o r e s t r a in demand, o r of depreciating the exchange r a t e and thereby ra i s ing the pr ice of imports su f f i c i en t ly t o reduce import demand, the Government has attempted t o meet the problems of excessive demand, i n the aggregate and f o r spec i f ic commodities, by the use of d i r ec t administrat ive controls - on the pr ices of se lected commodities, on the d i s t r ibu t ion of certain commodities, on imports and on pr ivate i ndus t r i a l investment. The Government used such controls t o attempt t o ensure t ha t pr ivate investment and production, notably i n industry, and the use of scarce resources, including foreign exchange and spec i f ic goods and services, was i n accordance with the investment and other p r i o r i t i e s established i n the development plan and with i ts basic econonic and soc i a l objectives. I b r e specifically, t h i s has meant t h a t the Government r e l i ed very la rge ly on the control system i n i t s attempt t o ensure t h a t investment went t o e s sen t i a l sectors , t h a t the establishment of redundant capacity w2s avoided, t h a t the expansion of both capacity and output i n spec i f ic sectors was conducive t o the opti,ml balanced growth of t o t a l output, t h a t the ownership and control of yroduction f a c i l i t i e s and t h e i r geographic location were not exces- s ive ly concentrated, and t h a t a number of re la ted purposes were served.

2. This report attempts t o examine the operation of the major administrat ive controls and t h e i r impact on the operation and development of the economy, including t h e i r effectiveness i n serving the purposes f o r v11ich they were designed and a l so t h e i r inadvertent and perhaps unanticipated e f fec t s . The examination does not proceed on the basis of a p r i o r i o r philosophical convictions regarding the appropriate ro le of administrat ive controls i n developing or developed economies. The focus of examination i s on d i r ec t administrat ive controls a s distinguished from influence or control exercised through f i s c a l , monetary or other measures which operate i nd i r ec t l y and generally through the market and pr ice system.

3. The general conclusions which emerge from the examination are: first, t h a t most d i r e c t administrat ive controls have i n f a c t not served t o shape e i t h e r production o r investment i n accordance with the Plan and tha t , indeed they cannot so serve because the Plan, f o r a va r i e ty of reasons, o f fe rs no, l i t t l e or only Uncertain guidance t o the pa r t i cu l a r control decisions which must be made; second, t h a t a major undesired and probably unanticipated e f f e c t of t he controls has been t o f o s t e r ineff ic iency i n the use of the resources ava i l ab l e t o India and thus subs tan t ia l ly t o handicap the expansion of output and capacity and the improvement of productivity; th i rd , t h a t the Governinent could more effective1.y influence i ndus t r i a l development by generalized and spec i f ic f i s c a l and monetary measures a s wel l a s published rules, designed t o

r e s t r a i n demand i n general and spec i f i c demands,and t o provide incentives t o pa r t i cu l a r types of production; fourth, t h a t giv'lng a much grea te r r o l e t o t he market and p r i ce systm,influenced by such f i nanc i a l measures i n the a l loca t ion of resources and the guidance of investment and production, would be more l i k e l y t o achieve India ' s development purposes; f i f t h , t h a t a sharp reduction in d i r e c t administrat ive controls would not only remove counter-productive restraints on i n d u s t r i a l a c t i v i t y but, perhaps even more importantly would remove much of t he protection from compe t i t i~n which now e x i s t s and permits ine f f ic iency t o go unpunished and even t o be rewarded. The need f o r e f f i c iency i n the use of resources i s c l ea r ly a t l e a s t a s necessary a s the expns ion of production f a c i l i t i e s i f s i gn i f i c an t economic progress i s t o be achieved i n India.

Findings

Controls and Plan Implementation

4. Many of the Governmentls aims a r e e x p l i c i t l y embodied i n a s e t of documents forming the Five-Year Plan. The Plan describes t he desired path of evolution, both i n terms of the overa l l growth i n income and i n terms of t he quant i ty and nature of public and pr iva te investment. It a l s o spec i f ies the volume of t he resources t o be mobilized and describes spec i f i c produc- t ion , import and import subs t i tu t ion , and export t a rge t s .

5 The Plan describes required investment i n a f a i r degree of de t a i l . However, the i n d u s t r i a l l i cens ing mechanism - the main means of Government control over p r iva te investment - seeks t o control investment i n much grea te r d e t a i l st i l l . Thus, control decisions and l i censes cover i s sues not covered by the Plan, such a s de ta i l ed product-breakdown, techniques t o be used, e tc . For these decisions the con t ro l le r s receive no precise guidance. Moreover, investment decisions of ten must be made wel l i n advance of t h e i r a c tua l implementation. Licenses a r e of ten granted f o r projects t o be carr ied out a f t e r t he current plan period. Therefore l icensing decisions of ten must r e l y on much vaguer longer term projections, and on the l icensing agents1 own in te rpre ta t ion of fu tu re needs. Finally, t he man, imperfect t o begin with ( l i k e a l l hunan documents) necessar i ly becomes rapidly outdated. Although individual t a rge t s a r e revised from time t o time, there i s no se l f -cons i s ten t revision of the Plan a s a whole. It rapidly ceases t o furnish any r e l i a b l e guidance a t a l l .

6 . The guidance given by the Plan t o import l icensing decisions i s even l e s s sa t i s fac tory . Import l icensing now determines the imports of each individual firm, including i n considerable p a r t even t h e i r de ta i l ed and spec i f i c commodity breakdown. It thereby i n d i r e c t l y f a i r l y s t r i c t l y determines the whole production pa t te rn of the economy, on which i n tu rn t h e fu l f i l lment of t he Five-Year Plan obviously c lo se ly depends. Yet r e l a t i v e t o t he t o t a l number of products of Indian industry, the re a r e few production t a rge t s i n the Five-Year Plan and even these become rapidly outdated. Thus, import a l loca t ion decisions a r e perforce taken without precise quan t i t a t ive guidance from the man. Paradoxically, therefore, the fu l f i l lmen t of t he output t a r g e t s of t he Plan depends on a s e t of Government act ions taken without c lose reference t o the Plan.

- iii -

7. There are , of course, general aiins of the Government, such a s the banning of production o r import of luxury goods, which a r e e f fec t ive ly implemented by the controls. But this does not require deta i led individual l icensing decisions; it would be j u s t as w e l l ensured by general orders and prohibitions.

Controls and Import Subst i tu t ion -- 8. One of the main long-term aims sought t o be implemented through the use of administrative controls is the acceleration of import subst i - tu t ion. The protection of domestic industry consis ts of absolutely prohi'siting imports when equivalent domestic products a r e available, regardless of price. I n practice, each import request i s subject t o the proper au tho r i t i e s1 granting a c e r t i f i c a t e t h a t domestic goods equivalent t o the ,requested imports a r e not available; t h i s process i s cal led Itclear- ance from the indigenous anglett. This is a time-consuming process which can and sometimes does r e s u l t i n considerable losses of output. However, the most important e f f e c t of the process is t h a t the encouragement given t o import subs t i tu t ion i s t h e sane whatever the dorilestic cos t i n re la t ion t o the import saving achieved. Domestic producers a r e completely insulated from the pressure which import competition might exer t toward improvement of the qua l i ty and reduction of the cos t of t h e i r products. Prices several times higher than those of equivalent imports a r e not a r a r i t y . This cannot be shrugged off a s the inevi table pr ice of import subst i tu t ion. The t o t a l volum of import subs t i tu t ion feas ib le during a given period i s necessar i ly l imited. 'Jndertaking import subs t i tu t ion a t r e l a t i ve ly high cos t necessar i ly means t h a t other, r e l a t i ve ly low cost , import subs t i tu t ion p o s s i b i l i t i e s must b e foregone. Even i f it were true tha t i n the long run everything t h a t can physically be produced i n Iadia should be produced t h e r e - a highly questionable proposition-some goods should nevertheless be produced p r io r t o others.

Controls a.nd the Foreign Dcchange Budget - 9. d budget determining the a l locat ion of India 's foreign exchange resourcesl/ is prepared every six months2/, and is the basic framework within whych individual import licensing-decisions a r e made. A primary objective of the foreign exchange budget is t o a l loca te a shor t supply of foreign exchange i n accordance with the economic and soc ia l p r i o r i t i e s which a r e attached t o various categories and elements of f i n a l demand. Another objective is t o protect Ind ia ' s slender foreign exchange reserves by equi l ibrat ing t o t a l authorized demand and t o t a l avai lable supply, and t o ensure t h a t India can f u l f i l l punctually a l l her payment obligations.

1/ Other than project-t ied loans. - 2/ Annual budgeting was introduced i n 1965/66.* -

The budgeting process must a l s o deal with the f a c t t h a t same of the foreign exchange supply i s not f r e e l y usable but i s t i e d by country, by commodity, or by both.

10. The budgeting process has permitted India always t o f u l f i l l without delay her foreign payments obligations and t h i s i n i t s e l f i s an important achievement. The foreign exchange budgeting and import l icensing process has not,however,provided an accurate forecast of payments obligations. Nor has it prevented e i t h e r excessive pressure on foreign exchange reserves from t i n e t o time o r sharp an unanticipated f luctuat ions i n a l locat ions fo r various purposes. Some uncertainty i s unavoidable i n the circumstances where exports and a id receipts and cap i t a l movements a r e ne i t he r f u l l y predictable nor i n Ind ia ' s control. The unavoidable degree of uncertainty, has, however, been enormously heightened by the unsat isfactory gathering and processing of the relevant information.

11. This point i s i l l u s t r a t e d by the recording of the balance of payments, important pa r t s of which obscure ra ther than i l luminate the fac t s . Wen the documents prepared spec ia l ly f o r the Government do not allow a s a t i s f ac to ry analyasis of i nv i s ib l e movements and c a p i t a l flows. The con- ventional published accounts were even l e s s adequate; however, i n 1965 and again i n 1966 the 18nis t ry of Finance i n the Annual Econo.mic Survey published summary accounts i n a s ign i f ican t ly improved presentation.1,' - 12. A s f o r the implementation of economic p r i o r i t i e s , a s was sa id above, these a r e not deta i led, quantif ied and assembled i n an annual operational plan. Therefore there is no systematic and consistent scheme of p r i o r i t i e s which can guide the preparation of the foreign exchange budget. What ac tua l ly occurs is t h a t a r e l a t i ve ly l imited number of l a rge production operations, most, but not a l l of which a r e i n the public sector, a r e provided a l l the foreign exchange they require f o r t h e i r mai,ntenance and operation, and a t times f o r construction, subject only t o the attempt a t ver i f ica t ion t h a t these needs a r e rea l , and t o clearance from the indigenous angle.2/ T11e r e s t is allocated t o the r e s t of the economy following .mainly rough and ready c r i t e r i a re la ted t o general p r i o r i t i e s , such a s the general ban on consumer goods imports and the absence of r e s t r i c t i ons on imports of contraceptives. Other c r i t e r i a a r e unrelated e i t h e r t o any r e a l scheme of p r i o i i t i e s , t o any estimates of the requirements of a consistent s e t of imput-output relat ionships, o r t o any concept of efficiency. Inevitably there is a tendency t o make al locat ions on a bas i s heavily weighted by h i s to ry and by considerations of equity.

1/ This i s discussed i n Appendix 1. - 2/ T h i s can, of course, be a time-consuming operation and, when campounded -

as it sometimes i s by administrat ive inefficiency, m y subject production o r construction t o serious interrupt ions or delays.

Effects of the Control System

13. A l l investment decisions of i ndus t r i a l firms above a c e r t a h s i ze ( a t present, those with fixed cap i t a l of more than Rs. 2,500,000) a r e subject t o spec i f ic authorization o r l i cense by the Government prescribing, i n t e r a l i a , locat ion and capacity. Once the firms have been established t h e i r production programs must conform t o these authorizations, unless new l icenses a r e obtained. A l l imporis a re s imi la r ly subject t o specif ic and detai led l icense. Yet, a s has been said above, detai led c r i t e r i a o r guidelines, which would allow the control lers t o take these detai led l icensing decisions i n accordance with a consistent e c o n d c plan a re not furnished t o them. O f course there are same effect ive c r i t e r i a . Indus t r ia l l icensing effect ively prevents investments i n forms c l ea r ly undesirable social ly , and s imi la r ly import controls prevent the importation of luxury consumer goods (and indeed of most other consumer goods too). But beyond these simple ru les of thumb, there i s no guidance.

14 In the case of i ndus t r i a l l icensing, the lack of c r i t e r i a f o r detai led decision making i s compounded by the f a c t t h a t the l icensing too l i s purely negative by nature. It cannot prescribe, it can only prevent the establishment or expansion of i ndus t r i a l production f a c i l i t i e s . It can e f fec t ive ly serve t o prevent the use of scarce resources f o r demands which a re c lear ly non-essential. It can prevent What may, r i gh t ly c r wrongly, be regarded a s undue concentration of econarzic power or undesirable geographic concentration of industry; it cannot,ho~~ever, easure the establishment of e f f i c i e n t competing enterpr ises o r a geographic dispersion of industry conform t o the desired regional d i s t r ibu t ion of income. Once again, however, even the purely negative control which l icensing permits with reference t o these considerations, i s exercised by the l icensing au thor i t i es on an ad hoc basis o r i n the framework of only generalized knowledge ra ther than a considered and developed scheme. The decision t o r e j ec t an application can be based a l s o on the technical ui lsui tabi l i ty of the contemplated inveshnent project , or on the f a c t t h a t l icensed investment already exceeds the Plan's targets . However able, cen t ra l government administrators working on sometimes poorly prepared documents a r e not i n the best posit ion t o judge the former. A s f o r the l a t t e r we have seen t h a t the Plan's t a rge ts a re not kept r e a l i s t i c by periodic revisions. Thus i n f a c t i ndus t r i a l l icensing does not prevent the developlent of considersble excess capacity i n several sectors . On the other hand, when i n a spec i f ic sector investment is lagging, l icensing does not provide the control lers with the means f o r stimulating it.

15. The granting of an investment l icense i s said no t t o imply a Government guarantee t h a t there w i l l be a market f o r the licensed production, nor t h a t the required scarce inputs (xlainly imports) w i l l be allocated. In f ac t , however, both the l icensor and the l icensee f e e l t ha t some responsi- b i l i t y i n t h i s sense is being assumed. The l icensor has an easy way of f u l f i l l i n g t h i s responsibi l i ty through the a l locat ion of foreign exchange. The f u l l requirements of new un i t s are met no more than those of other films. But within each sec to r the control lers a h a t an iden t i ca l r a t i o bet%~een the a l locat ions of each f i r m and the full theore t ica l requirements of i t s

licensed capacity. Each f i rm receives some import a l locat ion; each firm can function. The import a l locat ions f a i r l y strictly determine the volume of production of each f i r m , and thus play the ro le of forced market- sharing arrangements. The import a l loca t ion given t o each sector determines i t s production. Product prices, which a r e generally not subject t o control , r i s e t o meet demand. A t these pr ices even i n e f f i c i e n t firms can generally cover t h e i r costs, including the excessively high overheads occasioned by the low volume of production (especial ly a s imported inputs a r e bought with over-valued rupees). There i s of course no competition from imports; there i s no competition between domestic firms e i t he r because none, however e f f ic ien t , can r a i s e i ts output above what i t s foreign exchange a l loca t ion a l l o ~ ? s it;l/ almost none, however i ne f f i c i en t , can therefore l o se i t s market. Of course,-when there are no rewards f o r eff ic iency and no punishment f o r inefficiency, the l a t t e r tends t o pers i s t .

16. I n addit ion t o this general fos ter ing of inefficiency, the controls have a spec i f i c bias toward excessive use of cap i ta l . Imported machinery i s re la t ivehr cheap because it i s d i r e c t l y imported and therefore i t s pr ice does not r e f l e c t the scarc i ty of foreign exchange generally ref lected i n high Indian product prices. This i s compounded by some aspects of the t a x incentives granted t o investors. Finally, and most importantly, the only ground on whtch requests f o r higher current foreign exchange a l locat ions a r e normally accepted i s the increase i n l icensed capacity. Therefore firms a r e induced t o inves t even when they do not use f u l l y t h e i r exis t ing cap i t a l stock.

17 Intensive trading i n controlled products goes on outside a l locat ions . Because of the pecu l i a r i t i e s of the control system, which contains no mechanism whatsoever f o r ensuring tne technical balance of a l locat ions t o individual small-scale firms, fo r small-scale industry uncontrolled flows have grea te r importance than controlled allocations.2/ Large-scale i ndus t r i a l firms f o r which ne t s a l e s on the black market cons t i tu te a major source of income are probably a r a r i t y . However, there i s perhaps no f i rm which does not r e l y t o some extent on uncontrolled trading t o correct f o r the irriaalances, delays and quirks of the a l loca t ion mechanism. The parallelf lows no doubt contribute t o defeating some purposes of the al loca- t i o n system, and ~ r e t without the real locat ions which they accomplish the i ndus t r i a l economy would operate even l e s s e f f i c i e n t l y than a t present.3/ -

1/ No doubt, they can t r y t o use t h e i r foreign exchange a l locat ion be t te r , - t o make it go fa r ther . But even the firms making the bes t use of t h e i r foreign exchange w i l l not g e t any more of it; indeed, they may well ge t l ess .

2/ Allocation procedures t o small-scale industry a r e described i n Appe:ndix - 111. Improved procedures a r e s a id t o have Seen introduced l a t e ly . *

3/ Import enti t lements and s imi la r c e r t i f i c a t e s which have a l imited but - r e a l t r ans fe r ab i l i t y , have acquired an increased importance recently. *

Recommendations

Controls on Investment

18. A rapid and profound s t r u c t u r a l modification of the econow, and indeed of t he whole society, is an e s sen t i a l a.im of the Indian Government. It is unl ikely t h a t the desired modification could be accomplished exclusively by re l iance on the f ree play of market forces. Sole re l iance on purely i nd i r ec t measures - f i s c a l , monetary and o ther - would i n theory be possible, but might well prove t o be i n su f f i c i en t l y e f f ec t i ve i n correct ing t he demand e f f e c t s of the present d i s t r i bu t i on of income. It is therefore d i f f i c u l t t o see how India could, and there i s no reason why it should, do without some d i r e c t controls preventing undksired investment and attempting tochannslinvestment i n t o the desired direction. However, the present i ndus t r i a l l i cens ing procedures do no t serve t h e i r major purposes well. Two types of change a r e desirable.

19. Detailed Government examination of individual investment p ro jec t s should be discontinued a s much a s possible. l / It is of ten point less , ye t tends unavoidably t o iinply some guarantee 07 f inanc ia l success, thereby a l l ev i a t i ng the n o m l pressures f o r entrepreneurial efficiency. Sectors i n which investment i s considered t o be undesirable on durable grounds should be put on a banned investment l i s t published and revised from time t o time. I f it i s desired t h a t c e r t a in investments should follow spec i f i c c r i t e r i a , these c r i t e r i a a l so should be published i n advance. There w i l l be no need f o r p r i o r examination of preliminary plans submitted f o r l icensing - anyway such plans a r e not always followed c lose ly when execution comes - i f there i s ex post l e g a l enforcement of the published rules. It may, however, be desi rable t o r e t a i n the formali ty of l icensing anyway, mainly f o r information gathering purposes - it i s indeed unfortunate t h a t a t present very l i t t l e p r o f i t is taken of the infor~nat ion gathering possi- b i l i t i e s of the l i cens ing system - but i n general l i censes should be granted automatically. O f course there w i l l always be a few very la rge investors, both domestic and foreign who 1,511 continue t o discuss t h e i r plans d i r e c t l y with the Govemnent . 20. Within the f i e l d of permitted investment, one should equ i l ib ra te the negative l i cens ing t o o l 1~5th a pos i t ive too l f o r the se lec t ive d i r e c t prolnotion of investment. Tax incentives and dis incent ives can discriminate between a few broadly defined sectors . A t a f i n e r l e v e l of s p e c i f i c i t y g r ea t e r re l iance silould be placed on se lec t ive c r e d i t controls. These can

1/ A t present it may well be t h a t individual investment decisions taken on The bas i s of ex i s t ing pr ices would systemat ical ly d i f f e r from the soc i a l l y preferred pat tern . A reform of the exchange r a t e and of import controls along the l i n e s suggested i n t he following sect ion would remove t he primary cause of this contradiction. Thereafter, whatever c l e a r and precise preference the Government has could be enforced through general rules.

- v i i i - be se lec t ive towards more f i n e l y defined sectors but t h e i r operation does not involve the f i xa t i on of precise investment t a rge t s t o given sectors, l e t alone given firms. They a r e most usefiil t o influence the r a t e of . expansion o r production of indus t r ies which obviously diverge from the broadly planned pattern, by act ing on the volume and the pr ice of c r ed i t s made t o ce r t a in a c t i v i t i e s , but without intervening i n t h e i r f i m d s e dis t r ibut ion. The general t ightening of c r ed i t undertaken by the Xeserve Bank during the pas t year has probably prepared the ground f o r e f fec t ive u t i l i z a t i o n of se lec t ive c r ed i t measures.

Import Controls - 21. It i s urgent t o el iminate the ill e f f ec t s of the present control system; i t s fos te r ing of ineff ic iency, pa r t i cu l a r ly i n the use of cap i ta l ; i t s often haphazard use of scarce foreign exchange; and, not l e a s t , the waste involved i n the delays of the a l loca t ion mechanism and i n the time lcey personnel now spend on pushing paper. This aim has t o be reached without endangering the s t r a t eg i c t a rge t s of the development plan and without drawing down Ind ia ' s already slender foreign exchange reserves. The proposed a l t e rna t ive a l s o must f i t with the f a c t t h a t a subs tan t ia l par t of Ind ia ' s foreign exchange resources i s not convertible.

22. The import control and a l loca t ion system is now used t o protect an un rea l i s t i c exchange ra te . The r e a l s ca rc i t y of foreign exchange i s not f u l l y ref lected i n the calculat ions of economic agents. The technology b u i l t i n t o pas t c ap i t a l formation i s i r r a t i o n a l from the point of view of r e a l r e l a t i ve scarc i t i es . It i s excessively import-saving i n some instances, thus re f lec t ing the d i f f i c u l t y of obtaining foreign exchange a l locat ions ( e . g . when indigenous angle clearance cannot be obtained) , but on the who1.e it i s excessively import-using. A modification of the e f fec t ive exchange r a t e t o r e f l e c t the equilibrium value of foreign exchange has become indispensable t o the e f f i c i e n t functioning of the Indian economy.

23. The process of adaptation t o a nets e f fec t ive exchange r a t e i s time- consuming. Some mechanism nay have t o be provided t o f a c i l i t a t e adaptation t o the new rate . Temporarj naintenance of the present a l loca t ion system is t o be rejected, because it would prevent the t r ans i t i on from ac tua l ly taking place. A t the other extreme, subs tan t ia l rel iance on d e f l a t i o n a q f inanc ia l po l ic ies camlot be recornended e i ther . Greatly increased foreign a id t o finance the temporary upsurge of inports, which would tend t o occur upon the l i f t i n g of controls despi te the increase i n the e f fec t ive pr ice of imports, ~rould of course ease the t rans i t ion . Combined with t h e maintenance of bans o r high excise and im2ort dut ies on most f in ished consumption goods and components d i r e c t l y used f o r producing consumption goods, this may indeed be the most desi rable path.

2L. Another a l t e rna t ive i s a l s o conceivable i f one were t o take a l e s s optimistic v i e w about the magnitude of fu ture foreign a id and a l so t o assume t h a t a l a rge p a r t of this a id w i l l remain t i ed t o purchases i n the donor countries. I n t h i s a l t e rna t ive a two-tiered system would be i n s t i t u t e d

with a new basic exchange r a t e applicable t o the imports of a l1coret1 of high p r i o r i t y a c t i v i t i e s and a f luc tua t ing market r a t e applicable t o a l l o ther transactions. It i s desirable t o protect c e r t a in sectors - the most capi ta l - in tensive par t s of heavy industry whose development plans a r e s t r l c t l y determined by the Government i n function of long-term development s t r a t egy - so t h a t t h e i r development should no t Se affected by the temporary phenomena of the adjustment period. Therefore, these sectors - the r e s t r i c t W e l y defined core of development - should s a t i s f y t h e i r import requirements a t the exchange r a t e which appears capable of ensuring equilibrium a f t e r t he adjustment period, say a f t e r f i v e years. It i s extremely important t h a t the de f in i t i on of t h i s "core" be very r e s t r i c t i ve . Not more than four o r f i ve major groups of firms should be included i n it. S t e e l mills, f e r t i l i z e r production, perhaps heavy machinery, form almost a l im i t a t i ve enumeration.

25- The brunt of the burden of adjustment, i n t h i s a l t e rna t ive , i s put on the r e s t of the economy. Direct bans on a number of undesirable foreign expenditures such a s imports of luxury consumer goods would be retained; i n view of India 's poverty the def in i t ion of ftluxuyyll should be very extensive indeed. However, some freedom sholfid be introduced even i n consumption goods imports, a t l e a s t gradually, t o remove the d i s to r t i on due t o the present complete protection. Ultimately, imports should be banned only i f investment f o r the production of the same items i s a l s o banned. The e f fec t ive exchange r a t e would be so se t t h a t the permitted foreign exchange demands would be equal t o supplies without re l iance on unduly def la t ionary f inanc ia l policies. A s the precise e f f ec t s of the phenomena of the adjustment period cannot be measured, f o r some time the exchange r a t e would be l e f t f r e e t o move and find i t s own short-term equilibrium leve l .

26. A high proportion of Ind ia ' s foreign exchange resources a r e acquj-red through b i l a t e r a l t rade agreements and b i l a t e r a l aid, much of the l a t t e r from the United States. Such funds a r e not f r e e l y convertible. A t present t h e i r l e s s e r s ca rc i t y i s notably ref lected by the greater f a c i l i t y with which l i censes a r e issued f o r imports from some areas. I f d i r ec t controls a re abolished, the equilibrium between danand and supply of the various types of funds w i l l have t o be re-established by pr ice differences. A mul t ip l ic i ty of nominsl cross r a t e s of exchange may appear undesirable. For t h i s reason, and reasons of convenience, it i s proposed t h a t f r ee t rading should bear on l i censes usable f o r imports against spec i f ic types of foreign exchange. The t o t a l foreign exchange value of l icenses t o be sold could be determined from time t o time within an exercise s imi la r t o the foreign exchange budget.

27 The system could be introduced gradually. The establishment of a new ef fec t ive basic exchaage r a t e would intervene f i r s t , This would complete the r e f o m a s f a r a s the f f s t ra teg ic" sectors a r e concerned. Exporters would be granted f r e e l y t radable import entitlements, usable within the currency area of t h e i r exports without r e s t r i c t i ons other than the published general bans. The foreign exchange value of these l icenses would be gradually enlarged and other import a l locat ions be cut. Firms

outside the s t ra tegic sectors would have t o purchase t h e i r mart en t i t l e - ments i n the market where exporters s e l l the entitlements they obtain. Indials permissible imports are much larger than i ts export earnings, thanks t o foreign aid and loans. The exchange control authority can therefore enter the market as a s e l l e r - especially as it may well be undesirable t o give t o exporters of staples such as jute and tea, import entitlements equivalent t o the f u l l value of the i r exports. Government sales could be varied i n accordance with the foreign exchange budget and so a s t o attenuate price fluctuations. The new system should be introduced over no more than three or four licensing periods, two years a t the utmost. During some future period the premium paid f o r import entitlements would hopefully be brought down t o zero (except t h a t f r ee foreign exchange might re ta in a premium above t i ed funds). Thereafter, the same exchange ra te would prevail f o r a l l transactions. I f t h i s is rea l ly t o be accomplished, as it must be i f one i s t o avoid creating new t m e s of distortions, it is essent ial tha t the new basic exchange ra t e should be established a t a leve l r e a l i s t i c i n the long run.

Special Problems

28. Capital Goods imports: A t present foreign exchange usable f o r capi tal - - goods purchases i s l e s s scarce than f r ee foreign exchange. T h i s i s because foreign loans are often t ied t o investment projects, or a t l e a s t t o capi ta l goods purchases. I f t h i s remains the case a f t e r decontrol, the difference i n the scarc i ty of the two tries of foreign exchange funds should be reflected i n a difference i n the effect ive exchange rates, including customs duties, applicable t o the two types of transactions. Rowever, t h i s would perpetuate and accentuate serious s t ruc tura l distortions. It would be much preferable i f foreign a id could be rendered usable without such limitations. It should be possible t o work out pract ical ways of doing this which would s t i l l protect the donor's legitimate interests . But of course t h i s does not depend on India alone.

29. Invisibles: The expatriation of capi ta l must normally continue t o be forbidden, and t h i s involves the maintenance of exchange controls. Same invisibles, such a s pleasure t r i p s abroad, must also remain forbidden f o r reasons s imilar t o the banning of 1w;uq- imports. Authorized invisible transactions should be treated i n the same way as the trade of the non- s t ra tegic sectors; tha t is, payment should be subjected t o the purchase of import en t i t lemnts , and the beneficiaries of receipts should be granted import entitlements which they may s e l l . This .my have l i t t l e e f fec t on the actual volume of transactions, but would certainly reduce the volume of those channelled through black markets.

30. The repatriation of prof i t s of foreign investors i s a similar case. Most d i rec t foreign investment i n India takes the form of d i rec t import of goods financed by the investor. The high value of such goods i n India ref lec ts the acute scarc i ty of foreign exchange; the investors earn correspondingly high profi ts . Some of these p ro f i t s are reconverted in to foreign exchange a t the o f f i c i a l rate, thus often exacting a high price fo r the benefits of foreign investment. Partly by reaction t o th is , private foreign investment i s subjected t o a ser ies of exasperating checks and

controls. The inflow of benefits is thus cut down, but the i r high pr ice remains. The conversion of prof i t s of foreign investors should therefore be effected a t the short-term equilibrium exchange r a t e s e t by the market a s i n the case of other invisibles.

31. Customs Duties: The average r a t e of customs duties i n India is high, as they seek to make up part ly for the overvaluation of the nominal r a t e of exchange. The present average level of duties on imports other than foodgrains is above 50 percent, on an import b i l l which contains almost no finished consumer goods. Yet these duties do not play an important protect ive role; for th is , primary reliance is placed on d i rec t controls, especially the indigenous angle clearance mechanism. Some of the highest duties a re i n f ac t levied on imports where pract ical ly no indigenous production exists: for instance, s ta in less s t e e l and copper.

32 Once administrative controls over imports a re substantially l i f t ed , i t is important tha t the average r a t e of customs duties should not be too high. Infant industries may need some customs protection but high customs duties tend to ra i se the level of domestic pr ices re la t ive to the international pr ice level, and thereby t o encourage production for the domestic markets rather than for exports. Allowing drawbacks of import duties to exporters does not eliminate this distortion; rather, it tends to d i s t o r t the export pat tern i n favor of goods with high import content. These dis tor t ions should be minimized by relying as much as possible on other means of promotion new ac t iv i t ies . Some of those industries which have grown up i n the existing highly protected shel ter w i l l a lso need help t o adapt t o new conditions; but one must remember tha t the premium t o be paid fo r import entitlements t r i l l by i t s e l f tend t o discourage those imports for which there are domestic substitutes.

Conclusion

33 One objection frequently made t o the proposed relaxation of d i rec t administrative controls i s tha t a large measure of reliance on such controls is indispensable to planning. There is no evidence for this. There a re examples of planning, sometimes very effect ive planning, which re ly primarily on other means of implementation. In any case, and however useful controls may be for some purposes, there can be no point whatsoever i n having controls cover a wider f i e l d and a greater degree of d e t a i l than does planning. Yet t h i s i s precisely w h a t has been happening i n India. Administrative controls should be used only t o enforce precise and detai led quantified aims. I f India had a production plan which specified precisely the detailed production programs of a l l indus t r ia l firms, then there might be some point i n making detailed import allocations t o each individual firm. Of course, it is doubtful whether such a plan would be an effective instrument of development, even i f i t were possible to elaborate one. Anyhow, it does not ex i s t a t present; and the detailed allocations serve no purpose to the existing Plan.

3h A second objection re la tes t o a possible r i s e in prices following import decontrol. Some prices w i l l r i se ; and it is desirable tha t they should. It is only i f foreign markets become more expensive tha t export and

import substitution w i l l be encouraged. Hotiever, there i s no reason to expect a big spurt i n f i n a l product prices. Prices are i n general f reely s e t a t the equilibrium of demand and supply a t present. There i s no question of cutting the volume of t o t a l imports and thereby reducing overall supply. On the contrary, foreign exchange would be more ef f ic ient ly ut i l ized; thus overal l supply of f i n a l products should increase and thereby exert a downward pressure on prices. This downward pressure would of course be even more notable i f the reforms were coupled with an increase i n foreign aid. The gross prof i t s of the firms which a t present get import l icenses w i l l be cut, the p ro f i t s of exporters w i l l increase, but no general pr ice increase should ensue. Of course, one has to bear i n mind tha t prices have r i sen qui te f a s t i n India since 1963, and t h i s may continue independently of decontrol.

35 The proposed decontrol measures should not endanger any of the main objectives of Indian economic planning. They should stimulate adaptabi l i ty and efficiency i n indus t r ia l enterprises, and allow India t o make be t t e r use of its limited foreign exchange and capi ta l resources. Their adoption should not be expected t o r e su l t i n an economic miracle, yet it should substant ial ly f a c i l i t a t e the process of planned development.

Introduction

1. India places great re l iance on d i r e c t administrative or physical controls t o shape the development of the economy according t o t h 5 projec- t i ons of i t s planners and the soc ia l preferences of i t s Government. Controls a r e a l so used f o r the purpose of achieving the best a l locat ion and use of the resources considered t o be scarce. In pr inciple , a l l controls a re t o som extent designed t o fur ther both s e t s of aims but some a re more part icu- l a r l y directed towards the former, some towards t he l a t t e r .

2. The indus t r i a l l icensing procedures i n s t i t u t ed by the Industr ies (~evelopment and Regulation) Act, 1951, a re the main d i r ec t control t o o l used t o achieve the desired investment pat tern . Almost a l l large-scale and a good many small-scale i ndus t r i a l en te rpr i ses require the permission of the Union Government before undertaking new investment o r changing t h e i r product l i n e s or t h e i r location. It i s generally taken f o r granted t h a t such o r s i m i l a r procedures are an e s s e n t i a l and permanent fea ture of planned development. Controls on the a l loca t ion of scarce domestic resources - such a s ce r t a in categories of s t e e l - are considered t o be ad hoc means of -- dealing with temporary s i tua t ions . This has been demonstrated by the w i l l - ingness of t he Indian au tho r i t i e s t o end such controls, when the scarc i ty no longer pe r s i s t s . Thus a l a rge proportion of s teel products a r e no longer subject t o s t r i c t government a l locat ion; controls over coal d i s t r ibu t ion have been grea t ly eased; and controls over a nuniber of other domestic materials have been completely l i f t e d . The posit ion with regard t o import controls, which a r e by f a r t he most important of a l l , i s less clear . It is cer ta in ly considered t h a t the need fo r ra t ioning imports i s due t o the acute scarc i ty of foreign exchange. On the other hand import subs t i tu t ion a t great speed over a very broad f ron t i s a keystone of Ind ia ' s development strategy, and it is considered t h a t physical controls should play a great , perhaps a dominant, r o l e in or ient ing and s t inu la t ing it. Therefore import controls are not considered t o be a purely temporary phenomenon, although undoubtedly it is assumed t h a t some of t h e i r aspects, including t h e i r stringency, a re due t o temporary circumstances.

3 The basic argument i n favor of i ndus t r i a l l icensing i s t h a t the f r e e play of market forces i s not able t o achieve t he desired development of India. The extremely uneven d i s t r i bu t ion of income and the personal preferences of the high income earners stimulate soc ia l ly undesirable a c t i v i t i e s and absorb resources needed f o r more e s sen t i a l purposes. Similarly, the f r ee play of market fo rces would tend t o fur ther concentrate wealth and economic power. The Government must intervene t o prevent formation o r consolidation of p r iva te monopoly power, t o or ient investment i n t o soc i a l l y

1/ Throughout t h i s document the terms "administrative controls" and "physical - controls" are used interchangeably. No d i s t i nc t i on i s intended by the use of one r a the r than the other term.

desirable di rect ions , and t o prevent ce r t a in regions from being by-passed by development. Some of these sins, for instance the i d l i b i t i o n of monopoly power, are generally implemented through d i r ec t control means i n developed countries too.

h. The ra t ionale behind s t r i c t physical a l locat ion of scarce resources i s less c l ea r ly exp l i c i t . There i s a tendency i n India t o overlook the ro l e of the pr ice - pro f i t mechanism in overcoming sca rc i t i e s . It is, h o ~ ~ e v e r , true tha t t he market mechanism works best when changes i n the econoiny a r e sinall r e l a t i v e t o the absolute magnitudes involved. In India, t h i s i s often not the case; a t i t s beginnings i ndus t r i a l development proceeds by leaps and bounds.&/ A s new indus t r ies appear o r large new fac tor ies a r e added t o a small base, very la rge r e l a t i ve changes i n dernand and supply s i tua t ions can occur almost overnight. The pr ice changes required t o equi l ib rz te demand and supply would a l so be very large, f o r longer than i n the developed economies i n normal circumstances. The temptation is then great t o seemingly obviate the need f o r these pr ice changes by determining administratively the a l locat ion of the scarcest resources. Because Ind ia ' s circumstances a r e d i f f e r en t from those of the developed countries, one must examine the Ind im control system without any preconceived ideas, without t he a p r i o r i conviction t h a t time-honored methods which worked elsewhere i n qui te d i f fe ren t circumstances should necessari ly a l so work i n Lidia.

5 This Report aims a t such an examination of the Indian control system, i n order t o judge i t s effectiveness i n implementing the aims en- t rus ted t o it and t h e perhaps in,dvertent and unanticipated side-effects of i t s operation. It ~rould have been highly desi rable t o conduct the examina- t i on and formulate t'ne f i n a l assessment i n quant i ta t ive terms. It was obvious alrr~ost from the s t a r t t ha t , however l a rge the share of t h e exis t ing quant i t a t ive information which t he Eission could hope t o gather, it would not be suf f ic ien t f o r a comprehensive quant i ta t ive assessment of the e f f ec t s of the control system. It i s now c l ea r t h a t even nach l e s s ambitious hopes were vain. The 2~I;ission wzs unable t o obtain a deta i led quantified descrip- t i on of the flows of resources subject t o physical controls, o r of the impact of these controlled flot,:s on the volume and qua l i ty of production ac t iv i ty . It could not, f o r example, obtain a quant i ta t ive evaluation of the most generally reported phenomena a t t r ibu ted a t l e a s t i n par t t o the control system, fo r instance, t he under-uti l ization of productive capacity. There- fore, it was d i f f i c u l t t o s t a r t f ron observed phenomena and t o analyze them and t h e i r causes i n order t o assess the r o l e played by the control system i n the evolution of the Indian economy.

6. Perforce, another mthod hzd t o be chosen. The assessment of the control system presented i n t h i s Report proceeds from a study of the mechan- i s m s ~rhereby decisions governing the magnitude and direct ion of the controlled florqs a re reached. The judgments on t he e f f ec t s of the control system a re

1/ This was not necessari ly so fo r the f i r s t countr ies t o indus t r ia l i se ; the - technical ly o p t i m l uni t s i z e has increased in l i n e with the growth of production i n the leading countries. India 's t o t a l iron and s t e e l produc- t i on i n t he mid-1950's was about half of t ha t of t h e United Kingdom one hundred years e a r l i e r , when the optimal s ize of individual un i t s was more than ten times smaller.

based i n par t on deductions rather than on comprehensive and quantitative observations. These deductions, however, are borne out by a l l the particular pieces of evidence and information that the Mission has been ,able to gather by diroct observation and from the reports of qualified observers.l/ - 7. The examination of the control system contained i n t h i s Report focuses pr incipal ly on the controls on imports. This i s so mainly because the most serious, pervasive and durable shortage, on which the greatest a t tent ion has r igh t ly been focussed, is the shortage of foreign exchange and because it is the most comprehensive area of detailed control. Also for reasons of convenience, the examination i s centered on large-scale industry. This i n a way is unfortunate, fo r small-scale firms play an important ro le i n India and account f o r almost as large a share of industrial production as large-scale industry.z/ However, as i s shown l a t e r i n t h i s Report and i n Appendix 111, controlled allocations t o small-scale industry seem t o be very small; moreover, i n the i r case, controls as a means of determining the f i n a l dis tr ibut ion of resources and the pat tern of production can be said t o work hardly a t all.

8. The Report deals with pr ice controls only insofar as they r e l a t e t o the allocation of scarce resources. I n Indian conditions it would seem d i f f i c u l t t o argue tha t a l l pr ice controls should be abandoned. In reasonably competitive industr ies acute scarc i ty may yield unreasonably high p ro f i t s i f imports are res t r ic ted . Excise taxes should then be levied with the expl ici t purpose of reducing the p ro f i t s retained by the producers t o a reasonable level . Other sectors may be dominated by an oligopoly. For instance, there are only three s t e e l producers, the most important of which is a public enterprise. It would be unreasonable t o allow an oligopoly f u l l y t o exploit i t s powers. The knowledge tha t the Government is ready t o resor t t o such controls i f needed may well in- h i b i t monopolistic collusions. I f it should not, and i f import compe- t i t i o n should not be suf f ic ient ly effective, then price controls are necessary and the controllers must grapple with the d i f f i c u l t task of combining pressure for efficiency with allowance of suff icient prof i t s t o finance required expansion.

1/ See i n part icular Volume VI, Problems i n the Development of - Manufacturing Industry.

2/ According t o a defini t ion somewhat different from tha t used for the - purpose of controls and also t o admittedly rather unsatisfactory s t a t i s t i c s .

P a t I - THE BROAD F3AKEb~ORK

9. Administrative controls are c r i t i c a l l y related t o certain economic ins t i tu t ions and policies. India has a planned economy. The views of i t s Government on the most desirable feasible path of development are embodied i n a s e t of documents - the Five-Year Plan and supporting materials. In principle physical controls a re subordinated t o the Plan and are only a means of obtaining conformity of actual evolution t o the planned pattern. However, owing to certain character is t ics of the man it i s very d i f f i c u l t t o enforce it by means of physical controls.

10. While i n many f i e l d s only a temporary r o l e i s at t r ibuted t o physical controls, they are r e l i ed on as a quasi permanent instrument for promoting the substitution of domestic production fo r imports. It i s one of the basic assumptions of Indian development policy t h a t the growth of India 's exports i s greatly limited by external circumstances, and therefore specif ic action must be taken t o reduce the import content of national income as the economy grows. Otherwise, the r a t e of growth would be kept down by the shortage of imports despite a l l conceivable foreign aid.

U. The acute shortage of foreign exchange, the inconvert ibi l i ty of much of foreign exchange resources and the system of physical allocation of imports have made it necessary t o carefully match against each other foreign exchange receipts and disbursements over short periods. Every s ix months a Foreign Exchange Budget i s established;l/ it regulates the distr ibut ion of a large proportion of available forgign exchange resources among competing requirements and thus plays an essent ia l r o l e in determining the pattern of economic ac t iv i t i e s over the coming periods.

Chapter I - The Plan as Guideline t o the Control System

12 . Physical controls a r e one of the "main instruments fo r securing the developent of industries in conformity with the objectives . . .I1 of the Government. 2/ These objectives are embodied and quantified in the s e t of documents wfich form the Five-Year Plans. The Plan i s the f i r s t broad framework of reference within which the controls work. This i s evident and expl ic i t for controls on investment exercised under the name of Indus t r ia l Ucensing. The Plan ?rescribes a s e t of investment targets t o which controls on private investment have t o refer.

13 . The Plan a lso prescribes a s e t of production targets. The pattern of production i s strongly dependent on the pattern of resource allocations determined by physical controls. Controls on resource allocations have to re fe r t o the f i n a l production targets of the Plan.

1/ - In principle, every year since 1965.* 2/ - The Second Five-Year Plan, Chapter 19, paragraph 10.

14. The main argument of this chapter i s t ha t t h e guidance provided by t h e Plan t o the con t ro l le r s i s i n su f f i c i en t . O f course, inasmuch a s t he Plan r e f l e c t s t h e general asp i ra t ions t o economic growth and soc i a l jus t ice , these tend t o be re f lec ted i n control decisions. Yet physical con t ro l decisions a r e p rec i se measures; they determine precise values of investment, and s e t precise l e v e l s of resource a l locat ion. Such precise decisions cannot be well taken i n the l i g h t of general considerations alone; precise c r i t e r i a , such as quant i f ied investment and production t a rge t s a r e required. Such c r i t e r i a a r e provided by t h e Plan only t o a very l imi ted degree.

15 There a r e two kinds of reasons fo r t h e i n a b i l i t y of t he Plan t o provide t h e p rec i se guidance required f o r physical control decisions. The Plan does not go beyond a ce r t a in l e v e l of d e t a i l and fineness. Licensing of individual firms goes much fur ther . Thus i n d u s t r i a l l i cens ing spec i f ies t he product-breakdown of individual new enterpr ises . The l i c ense a l s o spec i f i e s the pa r t i cu l a r technical process t o be used, the production capaci ty of t h e pa r t i cu l a r project , i ts locat ion, and other cha rac t e r i s t i c s . Yet the Plan provides l i t t l e o r no guidance i n these matters and furnishes no means of evaluating t h e possible divergence between the prospective f inanc ia l r e tu rn t o the individual inves tor and t h e re turn t o t h e economy.

16. There i s a l s o the d i f f i c u l t y t h a t t h e time when l icensing decisions must be made coincides only i n p a r t with t h e time period covered by t h e Plan. Investment p ro jec t s normally take severa l years t o be implemented. This means t h a t l i cens ing decisions made i n the last th ree o r four years of the Plan period and sometimes even e a r l i e r r e l a t e t o investments 1-~hich w i l l be made and production which w i l l occur only i n t he next Plan period. There- fo re t h e current Plan provides l i t t l e guidance t o current l i cens ing decisions; they have t o r e l y on much vaguer long-term projections and often on t he con- t r o l l e r s f estimate - not necessar i ly consis tent from one con t ro l le r t o the other - of what w i l l happen a f t e r t h e end of t he current Plan period and of the ro l e of t he spec i f i c sec tor within this evolution.

17. Moreover, such d e t a i l a s is ac tua l l y provided by t he Plan i s often outdated by t h e time the re levant l i cens ing decisions a r e taken. The Five- Year Plan s e t s t a rge t s of investment and output f o r t h e period a s a whole,and i n l e s s d e t a i l f o r each of i t s years. Presumably when t he Plan was worked out it foresaw a se l f -consis tent economic process and prescribed a s e l f - consis tent s e t of actions. Holiever, pas t experience has been t h a t ac tua l developments diverged f a i r l y soon and q u i t e subs t an t i a l l y from those planned. This i s ne i ther surpr is ing nor necessar i ly bad. It i s inev i tab ly impossible t o predic t accurate ly a complex s e t of economic developments and re la t ionships o r t o or ient economic evolution on a predetermined path f o r any long period; it i s qu i t e normal t h a t some est imates and judgments should l a t e r prove t o have been mistaken. Hovever , when re levant c ruc i a l i n f o m t i o n i s obtained, f o r instance about the r a t e of execution of works di rected toward spec i f ic t a rge t s which i n t u rn influence resource a v a i l a b i l i t i e s and requirements, t he Plan is not revised. Specif ic t a r g e t s may well be revised by the agencies d i r e c t l y i n charge, but this i s qu i t e d i f f e r en t from assessing t he consequences of each individual revision and incorporating them i n a new sel f -consis tent Plan.

The Plan and Licensing of InvesCJment

18. Large s c a l e p r iva te i n d u s t r i a l investments must be l i censed by t h e Government. I n p r inc ip le , i n d u s t r i a l l i c e n s i n g i s one of t h e t o o l s used t o ensure t h a t a c t u a l investment i s i n l i n e wi th t h e Plan t a r g e t s . I n f a c t , however, a s ind ica ted above, the Plan provides ve ry inadequate guidance t o the l i censors . The c o n t r o l l e r s can s t i l l exerc ise t h e i r i n t e l l i g e n c e and good judgment; they have t h e s e q u a l i t i e s t o a h igh degree. Yet t h e whole l o g i c of planning i s prec i se ly t h a t ind iv idua l judgments based on such q u a l i t i e s alone a r e not s u f f i c i e n t but must b e f i t t e d i n t o a se l f -consis tent framework.

19- The con t r ibu t ion of t h e l i cens ing process t o the planning process i s a l s o unsat is fac tory . A s i n d u s t r i a l l i cens ing determines i n g r e a t t echn ica l d e t a i l a l a r g e p a r t of f u t u r e i n d u s t r i a l a c t i v i t y , it could be expected t o f u r n i s h valuable information t o t h e planners. It does not do so. The in - formation gathered through t h e l i cens iqg mechanism i tself and on t h e progress of l i censed investment i s n e i t h e r accura te nor up-to-date. The g r e a t e s t s h o r t f a l l i s n o t in c o l l e c t i n g information but i n processing it. For ins tance , one of t h e important points taken i n t o account i n evaluat ing t h e merits of a given projec t i s i t s need f o r imported materials . The l i censee has t o present d e t a i l e d est imates of his needs f o r imports over s e v e r a l years. Correct ly processed and updated, these da ta could provide t h e planners wi th estimates of o v e r a l l demand f o r scarce resources i n t h e fu ture . But this v i t a l information has never been summed up and i s ava i l ab le only i n a r a v form on an ind iv idua l p r o j e c t bas is . It cannot be fed back from t h e l i c e n s i n g system t o t h e Plan.

The Plan and Controls on t h e Allocation of Current Inpu t s

20. The lack of up-to-date, f e a s i b l e and p rec i se production t a r g e t s completely v i t i a t e s t h e system of controls on current inputs . Only i n d i s - pensable sca rce inpu t s a r e sub jec t t o physical a l loca t ion . A t present t h e s e a r e p r i n c i p a l l y f la t s t e e l products, and a l l imports ( t h e government a l s o in tervenes , b u t l e s s s t r i c t l y i n t h e a l l o c a t i o n o f coa l and cement) .l/ The a l l o c a t i o n of such inpu t s i s made f o r r e l a t i v e l y s h o r t (one t o twelve-month) time periods and s t rong ly influences and f requen t ly determines t h e l e v e l of t h e production a c t i v i t y t o which t h e a l l o c a t i o n i s made. Therefore, i n p r inc ip le , t h e a l l o c a t i o n s should be made i n such a way a s t o achieve t h e most des i rab le f e a s i b l e p a t t e r n of a c t i v i t i e s i n t h e re levant time period. Y e t , t h e P lan sets few annual production t a r g e t s , and even these a r e r a p i d l y outdated. Thus, it provides no guidance a s t o what t h e p a t t e r n of a c t i v i t i e s should be. The c o n t r o l l e r s must determine t h e l e v e l of each production a c t i v i t y without r e a l l y knowing l e v e l of output of p a r t i c u l a r products i s required t o achieve t h e desired p a t t e r n of output.

21. I n the public s e c t o r and i n a number of l a r g e s c a l e p r i v a t e - i n d u s t r i e s , such a s s t e e l p lan t s and petroleum r e f i n e r i e s it i s usual ly , though not a l ~ , ~ a y s , assuined t h a t t h e des i red l e v e l of production i s t h e one

Controls on cement were f u r t h e r eased i n l a t e 1965.*

which f u l l y u t i l i z e s ex i s t i ng c a p i t a l capacity. Allocations a r e therefore designed t o permit t h a t l e v e l of activity,al though the a l l oca t i ng au tho r i t y of ten quer ies ~~rhether a given request f o r mater ia ls i s r e a l l y indispensable t o this end or , i n the case of import a l loca t ions , whether t he product re - quested cannot be obtained indigenously. However, i n most instances nothing which can be shmrn t o be indispensable f o r t h e achievement of f u l l capaci ty u t i l i z a t i o n i s i n p r inc ip le refused.

22. Absolute p r i o r i t y i n this sense i s given t o few indus t r i es . There- fo re t h e capacity l e v e l of production cannot be used a s an automatic and easy t a r g e t by t he con t ro l le r s . 110 other t a r g e t i s avai lable from t h e Plan except f o r a few zero t a r g e t s of production f o r indus t r i es considered t o have very low p r io r i t y .

23 The r e s u l t i s t h a t t he a l l oca t i on decisions a r e guided pr inc ipa l ly by considerations of equ i ty ( a l l producers should be permitted t o operate a t t h e same l e v e l of capaci ty) , o r by h i s t o r y (a l loca t ions should s o far as possible be whatever they were i n e a r l i e r periods). Clearly, a l locat ions made on these bases do not contr ibute toward the achievement of t h e par t i cu la r pa t t e rn of t o t a l output s e t by t he Plan. Neither do they f i t the pa t te rn of demand which ac tua l l y e x i s t s a t any time, trhether planned or unplanned. Nor do they maximize t he output of any given product from a given supply of material inputs .

Chapter 2 - Import Subs t i tu t ion and t he Clearance from t h e Indigenous Angle

The Formulation of Import Subs t i tu t ion Pol icy

24. The e a r l y Plans were based on the assumption t h a t , as t h e l e v e l of investment had t o r i s e manifold t o obta in the desi red accelera t ion of economic growth, a similar manifold increase i n t he production of c a p i t a l goods was needed. This assumption was formulated as being obvious: I1Rapid i ndus t r i a l - i s a t i o n and d ive r s i f i cp t i on of the economy i s thus t he core of development. But i f i ndus t r i a l i s a t i on is t o be rap id enough, t h e country must aim a t developing bas ic indus t r i es and i ndus t r i e s rJhich make machines t o make t h e machines needed f o r f u r the r development. ";/

2.5. It i s of course t r u e t h a t an increase i n the r a t e of economic growth requires a higher increase i n t h e r a t e of investment. However, this does not necessar i ly require a comparable increase i n the domestic production of i n - vestment goods. It i s q u i t e conceivable t h a t some of t he required investment goods might be obtained more cheaply by developing export indus t r i es t o pay f o r imports. This is, of course, only a p o s s i b i l i t y which deserves spec i f i c examination; but it i s s t r i k i n g t h a t , e spec ia l ly i n the e a r l y stages, t h e r e w a s l i t t l e i f any e x p l i c i t consideration of this a l t e rna t i ve i n India. ' k e n

I-/ Second Five-Year Plan, Chapter 11, paragraph 7. -

such consideration did come, it of ten appeared t o be an ex post j u s t i f i c a t i on of t h e or ientat ion of inastrial development. It consisted in arguing, generally qu i t e rouwy, t h a t t h e volume of c a p i t a l goods imports t h a t would be required i n the absence of del iberate import subs t i tu t ion e f f o r t s was so high t h a t no conceivable increase in export values could pay f o r it, especial ly a s t h e developed countries could be expected t o prevent India, by t h e applica- t i o n of quotas o r by other means, fran expanding some of those exports i n which it had the grea tes t competitive advantage.

26. This argument may already have been imp l i c i t i n the previous reasoning, espec ia l ly a s much of t he thought on development had been done i n t h e l i g h t of t h e unhappy experience of t rade i n t h e 19301s, and of Ind ia ' s own d i f f i c u l t i e s with i t s cotton goods exports. A t any r a t e , i f it is t r u e t h a t exports and import subs t i tu t ion can be expected t o grow a t a much lower r a t e than imports in the absence of a spec ia l import subs t i tu t ion e f fo r t , and i f fore ign a i d cannot be expected t o f i l l t he gap completely, a del iberate e f for t must be made t o modify and reduce t h e import content of nat ional product. The main desired modification of national product went i n the d i rec t ion of i ndus t r i a l i za t i on and i n d u s t r i a l investment; the increased import requirements therefore mainly came from t h e i ndus t r i a l sector, both i n t he form of machinery and in the form of current production materials. The import subs t i tu t ion e f f o r t had t o be greates t i n that sector.

27. The argument i s not incor rec t by i t s e l f . It is i n applying it t o t h e determination of pol icy t h a t tliree serious mistakes were made. First, the exogefious character of the determination of exports was se r ious ly overestimated Because of this, much too l i t t l e emphasis was placed on export promotion; t he re can be l i t t l e doubt that, had ' t been otherwise, export performance would have been b e t t e r than it MS.$ Seccnd, it was considered t h a t import subs t i tu t ion i s a r ad i ca l l y eas ie r and f a s t e r process than export promotion. To the under-emphasizing of export aims corresponded overambitious import subs t i tu t ion ta rge t s . The increased need f o r imports resu l t ing from the development of new a c t i v i t i e s was a l s o not taken i n t o account adequately. The t h i r d mistake, which i s the only one t h a t d i r e c t l y concerns this report , consis ted in implementing import subs t i tu t ion by means which toolc l i t t l e o r no account of India 's comparative cos t advantages.

28. Some of t he pressure of demand f o r imports could be eliminated by su i tab le modifications of the ef fec t ive exchange ra te . An exchange r a t e i s e s sen t i a l l y a device f o r deciding autamatically which goods should be traded and ~rh ich should not, by determining comparative advantages. It is qu i t e widely argued in Ind ia today t h a t this device i s not re levant t o I n d i a ' s problems. It is s a i d t h a t t he shortage of foreign exchange is s o grea t t h a t only those goods can be allowed t o be imported which can physically not be produced indigenously. Conversely, everything t h a t can be produced indigenously should be s o produced. This is ce r t a in ly a f a i r l y extreme rendering of t h e position; i n par t i cu la r , as f a r a s the development of indus t r ies f o r ib ture production i s concerned, comparative costs a r e t o some extent taken i n t o

- l/ See Volume VII, Export Policy.

account, i n princi?le. But t h e above formulation corresponds t o the nature of t h e main mechanism designed t o promote import subs t i tu t ion , and t o t h e opinions of many c a t r o l l e r s . To quote one of them: "Foreign exchange has no pr ice , because it i s i r replaceable . If somethirlg can be bought indigenously for R s . 1 mil l ion, it is b e t t e r t o spend t h a t milllijn r q e e s f c r it than t o spend even one dollarmfl&/

Clearance frcan t h e Indigenous Angle

29. The indigenous angle clearance procedure i s the main i n s t i t u t i o n a l embodiment of the import subs t i tu t ion policy. It means t h a t no good i s allowed t o be imported unless it can be sho~m t h a t it i s not being produced i n Ind i a i n s u f f i c i e n t quanti ty. Relative p r i ce and cos t a r e not considered t o be relevant points. A l l imports have t o be c lea red fran the indigenous angle.

30 I n general , the clearance from the indigenous angle has t o be given by t h e technical organization of the Centra l Government ac t ing as supervisor of t h e industry which could po t en t i a l l y manufacture t he required product. Production mater ia ls and machinery - which a r e the only goods t h e import of which i s normally even requested - a r e produced by c e r t a i n well-defined i n d u s t r i a l sectors . The technica l sponsors of these sec tors - t h e most impor tant being t h e Directorate General of Technical Development, responsible f o r all large-scale pr ivate firms in the engineering and chemical sectors - have t o ve r i fy indigenous a v a i l a b i l i t y and provide clearances from t h e in - digenous angle.

31 The procedure i s necessar i ly slow. an appl icat ion f o r an import l i c ense i s received, the administrat ion dealing with it has a t f i rs t t o determine whether it i s unobjectionable frum points of view other than t he indigenous angle. If it is s a t i s f i e d on t h i s account, it has t o f i n d out whether the goods, t he import of which i s requested, can be obtained i n - digenously i n reasonable time. Even i f the product i s f a i r l y homogenous, it is not always a simple matter t o determine whether it i s being produced, and by whom. The information possessed by the various Sponsoritlg Authori t ies, e spec ia l ly concerning small-scale industry, i s patchy. True, this i s mainly an organizational problem, but a formidable one i f one th inks of t he l a r g e number of products and firms involved.

32. I n fac t , however, producer goods a r e r a r e l y simple, homogenous, e a s i l y defined products. The constant growth of industry, generally a t a high r a t e i n t h e engineering and chemical sectors , continuously c rea tes new requirements which already ongoing production cannot s a t i s fy . On the other hand, the

1/ The neglect of comparative advantages a l s o dominates t h e export f i e l d , - which provides t h e nost recen t c learcut i l l u s t r a t i o n of it. " . . . emphasis i s l a i d oil the pol icy t h a t each and every industry should become self-f inancing and self-supporting i n respect of i t s import requirements gradually, and, i n the long run each manufacturing industry w i l l have t o export a pa r t of i t s products s o a s t o earn its requirements of imported raw mater ia ls and componentsn (Report of t h e Ministry of Commerce, 1965/66, Government of Ind ia , Nev Delhi, March 1, 1966). This may not be t h e so le expression of o f f i c i a l policy, but it c e r t a i n l y is an expression of it. *

novelty of the requirement may only concern ce r t a in spec i f ica t ions which can be met by ex i s t ing firms with t h e i r ex i s t ing machinery. Capital goods a re often manufactured t o t he purchaser's specif icat ions and on his order. Clear- ance from the indigenous angle f o r such goods i np l i e s making the decision t h a t ex i s t i ng firms would not be ca2able of manufacturing t he required goods t o s a t i s f a c t o l y spec i f ica t ions within a s a t i s f a c t o r y time per50d. There i s no easy tray f o r t he Sponsoring Authority t o make such a decision and i n f ac t no uniform method has been established. Sometimes t he sponsor tr i l l be satis- f i ed by ver i fying that his f i l e s l i s t no firm manufacturing the required product. The lack of response t o advertisements i n t r ade journals may a l s o be considered s u f f i c i e n t evidence. I n o ther cases, t he applicant may be required t o obtain from those firms the technical sponsor deems most l i k e l y t o be capabla of producing t h e required product a c e r t i f i c a t e t h a t they a r e i n f a c t not capable of doing so.

33 The ease with which such c e r t i f i c a t e s ( i n jargon: ' ' l e t t e r s of regrets") a r e obtained does not depend only on t h e actual p o s s i b i l i t y of producing t h e goods. Firms a r e sometimes re luc tan t t o admit t h a t they a r e not capable of doing something; o thers want t o have f u l l e r order books than would be thought reasonable by t he technical sponsor. Firms may a l s o take too l e n i e n t a view of t he qua l i t a t i ve def ic iencies of t h e i r arm products. I n such cases the indigenous angle clearance would be refused, and, a t best , would be f i n a l l y granted only a f t e r another long delay. It could a l s o happen t h a t t he indigenous angle clearance i s granted even though s a t i s f ac to ry domestic subs t i t u t e s could be produced. The technical sponsor may not have knam t h a t a given firm was capable of manufacturing t h e required product. Some a n c i l l a r y producers of semi-manufactures a r e so d i f f i c u l t t o c l a s s i f y t h a t they may not even have been consulted.k/

34. Because of the acute shortage of fore ign exchange, t h e control l ing agencies s e t very g rea t s t o r e on avoiding t he issuance of indigenous clearance f o r goods which a r e i n f a c t avai lable dmes t i ca l l y ; by and l a rge , they succeed i n t h i s . Hobjever, in order t o do so , and t o o f f s e t t he l a r g e general preference fo r imports, they a r e often wi l l ing t o make mistakes of t he other type, by refusing indigenous clearance despi te the absence of acceptable subs t i tu tes . No douSt, many of these a r e corrected a t some time; and t h e control l ing agencies a r e r i gh t t o argue that i f they r-~ere t o authorize an import which was not indispensable, no one would protes t and an avoidable foreign exchange l o s s would have t o be incurred permanently. On the other hand, i f indigenous angle clearance i s un jus t i f i ab ly refused, t h e applicants p ro tes t , appeal, and apply again; and f i n a l l y succeed i n proving t h e i r point. This argument dis- regards t h e cos t of delays t o projects , and the perhaps even grea te r cos t of using t he time of key personnel oil both sides.

1/ O f course, small-scale indus t r i es do not have cen t r a l technical sponsors, - - and t h e i r capab i l i ty t o produce spec i f ic new products i s taken i n t o account only inc iden ta l ly , o r on t he basis o f d i r ec t representations made t o t he cen t r a l con t ro l l ing au thor i t i es .

Indigenous Content

35 The indigenous clearance procedures generally ensure s t rong protec- t i o n t o dmes t i c producers. The Government was aware tha t this would tend t o s t imulate most t he simplest s tages of production; t he re was a danger that the main developments would take place i n assembly-type operations. To obviate t h i s danger, domestic producers were obligated t o reduce t h e i r dependence on imports and t o increase t he indigenous content of t h e i r product according t o spec i f i c schedules. For t h i s purpose, only the import of manufactured components i s taken i n t o account; it is considered t h a t t he producer can be held "responsiblen only f o r those items which he can be expected t o manufacture himself. Import content is therefore defined a s being the r a t i o of the ex- factory pr ice of the imported manufactured components t o the ex-factory pr ice of t he whole assembled product i n the o r ig ina l country of manufacture. It does not take i n t o account t h e use of imported raw materials and machinery, nor t h e import content of materials , components and machinery purchased from indigenous suppliers.

36. A t the e a r l y stages of import subs t i tu t ion , when domestic manufacture is not much more than t h e assembly of imported components, indigenous content so defined i s an acceptable rough and ready indicator . However, by now domestic production has i n most cases proceeded well beyond this stage. In- digenous content i s no longer a s a t i s f ac to ry measure, even by the standards of t he most extreme expression of the doctrine t h a t no domestic cost i s too high a p r i ce t o pay f o r import saving. It does not even necessar i ly r e f l e c t cor rec t ly foreign exchange costs; r e l a t i ve ly small increases i n indigenous content can sometimes be achieved only by i n s t a l l i n g c o s t l y foreign machinery whose capaci ty i s only very p a r t i a l l y u t i l i z ed . A manufacturer with high indigenous content may use designs and specif icat ions which require heavy imports of machinery and raw materials and a l s o purchases from anc i l l a ry firms which themselves may be grea t users of imported equipment, mater ia ls and a l s o components. Conversely, another firm may have lower indigenous content because it imports more components, and ye t avoid t h e use of imported materials and machinery and have lower t o t a l import needs. The system encourages only ce r t a in types of import subs t i tu t ion , and does it ind is - criminately, even though this type of import subs t i tu t ion may mean a net increase i n import costs . These negative e f f ec t s a r e probably not infrequent i n Ind ia today.

37 Thus, despi te the obligation t o increase gradually t he indigenous content of production a d i s to r t ed pa t te rn of production develops. The problem is only pushed one s tage back. Because of the absolute protection given t o anything produced indigenously the p r i ce of indigenous products i s often r e l a t i v e l y high. Producers have a strong i n t e r e s t i n importing a s high a par t of t h e i r requirements a s possible, because even a f t e r payments of custom duties imported goods, including semi-manufactures, of ten cost much l e s s than domestic ones. Obtaining a higher proportion of one's requirements from abroad i s the most obvious way t o reduce cos t s . A great deal of e f f o r t i s made t o Ifput up a casen t o the control lers . Moreover, i f import subs t i tu t ion cannot be avoided, each f i r m has an incentive t o t r y and produce the new component o r product i t s e l f , i n order t o be e n t i t l e d t o continuing raw material

or machinery imports and therefore keep f o r i t s e l f the s c a r c i t y p r o f i t accruing with such imports. The Ifpresent p rac t ice of l a r g e r engineering firms usua l ly ( i s ) producing almost a l l t he p a r t s of a machine within t h e i r own f ac to ry premises, importing any other p a r t s needed . . .I1 .!/ Uncertain delivery and qua l i ty con t ro l problems undoubtedly a l s o contr ibute t o t h i s tendency, but the reluctance t o l o s e the import p r o f i t i s a major reason f o r t he de s i r e t o achieve autarchy within each f i r m .

38 The r e su l t i ng v e r t i c a l in tegra t ion i s of ten wasteful because each f i r m pe r s i s t s i n performing operations which could much more economically be performed by separate specia l ized enterpr ises . To counter this tendency new cont ro l s a r e introduced t o l i m i t v e r t i c a l in tegra t ion i n ce r t a in indus t r i es and promote r e l i ance on a n c i l l a r y producers, but not always f o r t h e operations which a r e bes t s u i t e d f o r this purpose. Thus, in the au tmot ive indus t r i es , where v e r t i c a l in tegra t ion i s most severely r e s t r i c t ed , according t o a recent IDA appraisa l repor t 2/ f o r t h e most pa r t t h e ccunponents thus reserved t o a n c i l l a r i e s a r e wel l Fui ted f o r them, but qu i t e a few could be b e t t e r produced by t h e o r ig ina l equipment manufacturers. On the o ther hand, severa l companies have, with Government approval, extended t h e i r a c t i v i t i e s " t o t h e operation of s t e e l foundries, pressing and stamping plants, tube plants, foundries and t o o l fabr ica t ion plants . . .I' which increases t h e i r ineff ic iency.

39 Thus the indigenous angle clearance and r e l a t ed procedures ensure f a i r l y wel l that no goods which a r e produced i n Ind i a i n s u f f i c i e n t quan t i ty should be imported. But t h i s i s a l l . The procedures do not even ensure t h a t a l l i n t e rd i c t i ons t o import should y i e ld a ne t foreign exchange saving. More generally, t he import subs t i t u t i on e f f o r t i s not r a t i ona l l y composed. The domestic manufacture of components and goods i den t i ca l t o those produced elsewhere is encouraged, but not t h e development of techniques based on domestic resources and raw materials . The same encouragement i s given whether t he danestic cos t i s small or l a r g e i n r e l a t i o n t o the import saving achieved. Comparative advantages a r e neglected. Yet t he t o t a l volume of import subs t i tu t ion t h a t can be accomplished during any one period i s limited. Therefore, undertaking import subs t i t u t i on a t r e l a t i ve ly high cost necessar i ly means t h a t other, r e l a t i v e l y low-cost import subs t i tu t ion p o s s i b i l i t i e s have t o be by-passed. Even i f the o f f i c i a l import subs t i tu t ion policy were correct i n the long run--which is , t o say t h e l e a s t , unlikely--and everything t h a t can be produced i n I n d i a should be produced there , some goods should neverthe- l e s s be produced p r io r t o others.

1/ ttSub-contrac t i n g i n Indian Engineering IndustryIf (The Economic Times, - May 10, 1965).

2/ Appraisal of a Second I n d u s t r i a l Imports Project , I D A - Ind ia 1965, - Volume 11, paragraph 16-17 - first d ra f t .

Chapter 3 - The Foreign Exchaxge Budget

40. The scarcest resource subject t o d i rec t controls i s foreign exchange. It i s scarcest because t he margin between a v a i l a b i l i t y and demand a t current pr ices is grea tes t f o r it, and a l so because it i s convertible and can be used t o make good the shor t - fa l l of most other resources, while t h e reciprocal i s not t rue . The main respons ib i l i ty f o r a l loca t ing foreign exchange belongs t o t he Ministry of Finance. The a l loca t ion process is s p l i t i n two main par ts , one re la t ing t o foreign c r e d i t s t i e d t o specif ic projects , the other r e l a t i ng t o a l l other foreign exchange resources, including those earned and c r ed i t s not t i e d t o spec i f i c projects . The first category i s al located v ia the negotiat ion of such c red i t s . Their use is determined by t h e nego t i a t i on i t s e l f , (which, on the Indian s ide , i s conducted by the Ministry of Finance). The second category i s al located i n the Foreign Exchange Budget.

41. With project- t ied c r e d i t s , a f t e r the negotiations the r o l e of the Ministry of Finance i s l imited t o supervising disbursements. Drawings by the benef ic iar ies of the loans a r e subject t o the approval of the de t a i l ed requests they submit t o the Ministry of Finance, according t o the procedure described i n Chapter 4. But this implies only a decision a s t o whether a given request corresponds t o an approved project , not one about the ult imate a l loca t ion of the funds.

42. Some other a i d funds a r e usable only f o r spec i f ic categories of transactions, but with a g rea t deal of freedom within these categories. The most important case i n point is that of the funds avai lable f o r financing pr iva te sec tor c a p i t a l goods purchases, such a s ?>iorld Bank loans t o I C I C I , some European c r e d i t l i n e s f o r cap i t a l goods, e tc . Their use is controlled by committees on which the Ministry of Finance plays an important role, but fo r t h e most pa r t they a r e not a l located v i a the Foreign Exchange Budget, mainly because it is considered t h a t these funds a r e avai lable only fo r l imi ted types of projects, which a r e not forthcoming i n a constant flow, but a r e r a the r lumpy by nature.

43 A l l other foreign exchange resources a r e included i n a specif ic Foreign Fxchange Budget prepared by the Ministry of Finance semi-annually.l/ - The foreign exchange resources entered i n t o the Budget a r e made up of a l l rece ip t s from exports t o convertible currency areas , import ce i l ings avai lable under b i l a t e r a l t rade agreements, 2/ and funds provided by c e r t a i n multi- purpose c r e d i t s avai lable f o r f i n Z c i n g imports of current production materials , even when they a r e reserved t o spec i f ic materials o r spec i f ic sectors.

44 A s seen e a r l i e r , a l l funds c l ea r ly t i e d t o spec i f i c investment projects and most of t he a id funds used t o finance pr ivate cap i t a l goods imports a r e l e f t out of the Foreign h h a n g e Budget. Some a i d and other funds, usable f o r import of c a p i t a l goods but not s t r i c t l y project-t ied, and which go

1/ It has been decided t o prepare t h e 1965/66 and following foreign exchange - budgets on an annual basis. *

2/ Somewhat misleadingly ca l led Rupee Trading Funds, o r Rupee Payment imports. - B i l a t e r a l payment accountsare kept by t he Reserve Bank of India i n Rupees, but a gold value conservation clause i s attached t o them.

t o t he publ ic sec to r t o f inance t h e imports it needs f o r investment a r e channelled through t h e Foreign Exchange Budget. However, i n t he recent past

1/ most conver t ib le export proceeds and c r ed i t s usable f o r a wide l is t of g o o d s were a l l oca t ed t o maintenance imports. The t a b l e s reproduced on t h e fo l l a s i ng pages show the 1964/65 Foreign Exchange Budget i n a way similar t o t h e summary form i n which it was presented t o t h e Cabinet.

The Elaboration of t h e Foreign Exchange Budget

45 The e laborat ion of t he Foreign Exchange Budget i s t he r e spons ib i l i t y of a J o i n t Secre tary of the Department of Economic Affairs, Ministry of Finance. The first operation he performs is t o set as ide t h e funds needed t o cover debt se rv ice payments during t h e coming period. Then t h e requirements of t he publ ic sector , o ther than those covered by p ro jec t c r ed i t s , a r e examined. These, including the requirements of t h e regular Government Depart- ments,of t h e Departmental en te rpr i ses , and of t h e Tfautonomousll public sec to r en te rpr i ses , a r e s c ru t i n i zed p r i nc ipa l l y wi thin t h e f i s c a l budget and annual plan exercises , where t h e foreign exchange implications are, i n some general sense, taken i n t o account. A t t h e s t age of t h e Foreign Exchange Budget proper, it i s mainly sought t o v e r i f y t h a t public sec to r requests are l e g i t i - mate, i n t h e sense of r e s u l t i n g from programs previously approved, and cannot be s a t i s f i e d by domestic resources .z/ 46. Included with and t r e a t e d i n much t h e same manner as these dlloca- t i o n s f o r t h e public sector , are a l l oca t i ons t o a few large-scale pr ivate s ec to r en te rpr i ses such as t h e steel m i l l s and t he petroleum r e f i ne r i e s . For ins tance , funds are made ava i lab le t o t h e Department of I r o n and S t e e l f o r t h e requirements of both public and p r iva te s ec to r steel mills on a very similar basis .

47. The next item i s formed of raw mater ia ls imported i n bulk: food- gra ins , petroleum, f e r t i l i z e r , and newsprint. Foodgrain imports are determined by taking i n t o account t h e incompressible needs of t he country, PL 480 ava i l - a b i l i t i e s and t h e f1 normal marketing" obligations under PL 480 terms. Newsprint imports are determined on t he bas i s of t he d a i l y c i r cu l a t i on of nevsspapers, e tc . , and c e r t a i n paper quotas a l l o t t e d t o them. Petroleum and products a r e not ra t ioned wi thin India . Product p r ices a r e i n p rac t i ce f i xed at a l e v e l r e f l ec t ing import, r e f i n ing and d i s t r i bu t i on cos t s , including company p ro f i t s , plus a s u b s t a n t i a l tax element. The Ministry of Finance determines t h e t a x l e v e l with an eye t o f u t u r e demand and r e su l t i ng import requirements; then, su f f i c ien t fo re ign exchange i s a l l oca t ed t o s a t i s f y demand completely.

48. The renaining fore ign exchange i s ava i lab le f o r f inancing imports of cur ren t production materials, mostly f o r t he p r iva te sec to r . There is , however, a f u r t he r complication due t o t he d i f f e r en t treatment of s t e e l and non-steel imports.

1/ These include t h e IDA i n d u s t r i a l import c r ed i t s , A I D and other non-project - loans , e tc .

2/ It i s reported t h a t the acute c r i s i s of a u t ~ 1965 caused subs t an t i a l cu t s - a l s o t o be made i n public s ec to r a l locat ions .

FISCAL YEU 1%/65, PTrlST AND SECOND SQESTERS

Mil l ion Rupees

A# R " ~ ~ rrcd TOTAL

I I1 To ta l I I1 Tota l I I1 To ta l I I1 To ta l

Comerc i a l Importa

I ron and S t e e l Imp&

-rid

Fbtrolrum, Glls and Lubricants LO 20 60 68 7 0 139 b20 330 750 528 h2O %8

Foodgrains 1018 U 8 2 2500 ll 37 113 212 269 &El 12U 1782 -3

D e p u t u n t of I r on a d S t e e l (311) (20) (5b) (19) (15) (3b) (74) (61) ( U S ) (127) (96) (223) of which Rirate Sector 22 13 35 - - - b8 h8 35 83 26 22

Pub110 S e c t m 12 7 19 1 9 15 3b Id 39 87 79 61 IhO

Depvtrsnt of Fbtmleum f a Rivmte Sector Ref iner ies 5 b 9 - - - h h 8 9 8 17

D s p v t r s n t of Petrolarm f o r Other Uma 7 1 8 2h 15 39 9 7 16 b0 23 63

A i r C a q m i e s

Education

I r r i g a t i o n and Parsr - - - 7 b 11 20 l6 36 27 20 b7

A l l Others 31 1 9 50 h 8 12 55 68 123 88 95 183

TOTAL 2 m 6 2295 h321 L6h 625 1089 2253 2168 b 2 5 h7h3 5088 9831

ORAND TmAL, I n c l u d i m Additions 23h8 2579 b927 6 U 800 lbIh 2%r) 2171 h535 5322 555') 10872

A/ A l l fore ign a i d , inc luding untied a i d and loans, I s i n t h i s ca tegory .

2/ Allocat ions out c f balances available f o r i ~ o r t s under b i l a t e r a l t r ade ag reemn t s .

3/ h e d conver t ib le fore ign exchance. - Note Deta i l s may co t add up t o t o t a l s becar~se of r-bunding. -

This ta ' , la i s a s u m t i o n of the tvo s epa ra t e t ab l e s . bearing on the f i r s t and second h r l vc s of the f i s c a l year r*sr?ct, ively, presented t o t i? Uicsion. Apart f r m tk summation, t h o f o l l a r l n g changes hsve been made '!erg s w 1 1 a:.locati.ins were aggrega+,ed ard preYe?trd ; n the " A l l Others" l i ne . h;ldit ior,al a l l oca t i ons nade i n kb,e course of th- oeri od were aggregated n l t h t , te o r l g ina l a21.rcat'cn f i gu re s . Allpcations -f fr-a f o r e ign pxchange under "h s r t e r " t , re rsac%icns have heen n g g r s ~ a t e d v l t ' o ther f'ree fore ign exchange f i ~ u r ~ s . The t a h l ? !s ?reser!ted ;: ill inns ?f r up re s i n s t , ~ a d of crqrec.

l!

ITmS

1. R.W Cottm 2L.W - - Y.d Y.W - 2b.W. Y.W - 2b.W

2. Raw Jut .

3. Art Si lk ?am

I,. R u s i l h

5. Cawheata

b . Copn md P a h M1

7. f h w woo1

8. fhw Rubbar

9. Nawaprint

lc. S u l W r O.LO 0.56 DV O.# 0.0% L.l2 A I D L.17 - 0.50 3.50 3art.r AID b.03

11. coal-tar dm8

12. c.wtic 5¶&

13. Raw Film

11,. Rock Phosphata

15. Shiiam Nitrat.

70. Other C h d c a l n 3.LO - 3 . u 1.LO - 1.LO 1.32 - 1.32

?I. mchina TOOU 2.m L.m nv 6.W 1.- 0.35 AD 1 . ~ 0 1.10 1.05 A I D 2.95 0.00 Link b.1

22. 9.11 and Roller Baaring. ?.LO - ?.LO 0.W 0 . P AID 1.20 0.60 0.60 A l u l . I t5

0.25 Auetria

23. Scient if ic , Surgioal md Optioal Inatmmmntn 1.00 - 1.m 0.50 - 0.50 0.50 - 6.50

2I,. T u t i l a PachinWrJ. Ineludinl Comporunf. f o r Tu t i lw hob* Induwtr~ 0.55

26. coal, Jute and Twa hehinary 11.60

27. Cmponants, S p u r P u t s end A l l 0tk.r Finished OOOdW R.puind bJ Indvtq 30.60

28. D w a and Hadicinaw

29. Rwka

m. r l l other conwwr 000.18 L.50

j1. CG/HCF 2.15

12. iCI1 8 ad hoc 3.00

(Ra. Cmraa)

19b1-62 l W j 4 h a A . r i r t m @ * TO& h a A a a l l t o c a To t a l

I T W r l ~ g w Amlmt S a w *

35. Non-farmus Hatala 15.25 19.W W 37.90 5.80 23.l1h UD 36.39 0 2 2 . S AID j6.38 2.75 Oo laba Plan 7.15 Colol.. Rm &.la C o l d o r l sn

1. IO 8art+r

j6, mm ( I ) chanical Mua t r i am 51.55 i a . f~ ] DLF 70.38 38.02 15.37 AID 53.88 a . 1 2 11.80 AIU '1.15

0.10 Y . O . r r y 0.90 b . O a n n j 0.29 C o l e Plm 1.Q C o l d 0 P l r n

1.B Dutoh 1.55 B u u r l.ll0 Link h.1.

(b) m g i n 8 a r t y I n d u t r i . a 56.31 9.12 D 67.U U.61, 12.22 ~ 0 . 5 0 11.60 AIJ ~2.01 2.W. UK 2.08 Y.0-r 'ID + l.LB 6.26 b.0.-y • 1.d

1.LO OK 2.L5 U K

37. r.iacellansous rnd sd hoc relesaa ffL2 - - 3.W c 9 L 0.69 AID L.73 6C9L - ' .-,A

0.U) Y. o.lrmJ

T W A L - 5 6 . 6 6 ~ - 2 ) 9 . 5 0 9 ~ m - 2 2 9 . 7 6 ~ A I D =

2.00 UK - * UK u n

C o l d o P l n C o l d o Plan && Colonbo r lan

2.88 Y. O e m - 9.10 m. Germany - C.25 h w r r i a

& -etch

Bart- Link -

5. A National Dabit f o r Coal Hachinary i n Uau of IBIID loan 5L.00

6. r i a c a l l n a o w R q u i m m t a ~ ( ~ j u t n m t f o r addi t ional m l a u a a of f m a f m d a in 1i.u of Dl? ao ru j ) 110.00 -

TOTAL

i h The break-up i s as fOllOn8l

1, :awt ic Sod. 15.00

2. FXp1oair*a

I . Tin

L. Carbon Black

5. Componmts f o r rha h d a o t u m of C a m t Hachin.q 21.00

6. Rock lhoaphata 133.00

7. stmp+oqoin 59.m

8 . Print ins h c h i n a r y 3o.N

9. b h i t f o r Link h a l a llM.00 - TOTAL 39L. 00

h8 bra&-up i 8 aa fol lowl! (m. ~ s k h a )

1. wit f o r ~ l n k h.1. 5c.m

2. Ralmana k a t l j f o r Auto u.1.00 - mAL 9L.00 -

It+= - 1. mu cot*

2. run Jut4

3. C . l h m u t #

ll. uatt1. mark

5. R i d u n d 4h

6. Boob

7. mrt R a o t i o n

- 19 -

10 q x ? , ~ q < r g ? ? ? ? F 9 K 4 u: A M F ? N r ( O , . q N N d N O O d O O d O 0 0 0 0 9 m N d .I

P 0 4

I I I I I I I I I I I I I 1 g g I I 1 1 23 I I

3 , l t I I l I I ~ ~ 8 . 1 t I I I I I N O 0 I 9 0 5 ! 1 I 0 8 4 ?? 4 CV I I

8 4 5 5 + " 1 e I a v y q q q 9 9 N - 0 N U I N . .

j r ( 0 m N N d d d 0 0 4 0 0 9 m c - J 4i d d

H g 8 3 R S 8 8 R E 8 " Q R q 8 4 ! E ? 8 8 E Z

P i d h d o d S o d~ o o - i d c, A ,.i d r(

:: 1 1 1 1 1 1 I 1 1 1 1 1 1 1 I d H l . Ei < I 1

<+I

L L

ill ;i a a F. .f E 8 ? ? ? , I

G m

r l 0 1 1 1 1 1 1 1 . I ' I I I I I I 1 N 0

I I 0 0 0

2 2 , I " N

i W !? . .. ul

S 5 % % 5 4 8 8 3 l Y 2 f i s % 3 " $ S F ? M NN E f d N d d ~ i ~ d N o d o o d ~ o d d o o c 2 4 . . d

a' d d

-z S bl I,: C r& a

T! n

3

4 3 1 . . . . . . . d ~ m = ~ m d C G I d 6 4 r( j 2 3 2 i . ,, . . 2 5 5 i 2 2 . 2 2 Cd L? N

3 : : : m m m m d d d d

49. A l l current imports of the private sector, other than i ron and s t e e l imports, form a chapter of the Foreign Exchange Budget called llCommercial I m p ~ r t s . ~ ' This chapter i s not subdivided fur ther by the Ministry of Finance, but i s made available globally t o the Economic Adviser attached t o the Ministry of Industry, who subdivides Commercial Imports i n t o categories of materials, and suballocates funds t o the Sponsoring Authorities of ultimate users. Of course, freedom of action a t this stage is considerably limited by the composition of the monies available.

50. Requests for s t e e l imports a re submitted through the normal Sponsor- ing Authority by the private sector, and through the Iron and Stee l Controller by the public sector, t o the Department of Iron and Steel, which processes requests and t rans&ts them t o the Ministry of Finance without aggregating them. On the basis of the requests, the Ministry of Finance determines the t o t a l value of s t e e l imports. This t o t a l is re-transmitted through the Depart- ment of Iron and Steel, which subdivides the share of the private sector among Sponsoring Authorities. For non-steel imports, this suballocation i s performed by the Economic Adviser. Thus, Sponsoring Authorities have two un- coordinated import quotas, a quota f o r s t e e l imports se t by the Department of Iron and Steel , and a quota f o r other imports s e t by the Economic Adviser attached t o the Ministry of Industry. Public sector requests a re subdivided d i rec t ly by the Ministry of Finance.

51. It is not c l ea r z t a l l what is thought t o be gained by thus routing iron and s t e e l imports and other imports through different channels. For imports financed by the I D A indus t r ia l imports credi ts , no difference was made between s t e e l and other imports; it i s generally claimed t h a t th i s has greatly speeded up the allocation process, and that no harmful e f fec ts have resulted.l/ - 52 Each chapter of the Budget i s subdivided by type of foreign exchange and by users. The Winistry of Finance takes a view as t o rdhich credi ts a re best sui ted fo r specific expenditures and allocates then i n view of considerations such a s specif ic reservations made i n the credi t agreements, ease of avai labi l i ty of needed goods and t h e i r prices, etc. Similar sub- divisions have t o be made f o r funds available under b i l a t e ra l trade agreements. Only the foreign exchange earned by India ' s exports t o convertible currency areas is usable with perfect freedom; even IDA'S f i r s t two indus t r ia l imports c red i t s had t o be used t o finance specif ic needs of specific sectors.2/ - 1/ T h i s practice has been extended recently; indeed, it is l i k e l y that this -

particular i r r a t i o n a l i t y of the al locat ion system w i l l soon be eliminated.* 2/ Of course, i f those sectors vould have received the same amount of con- -

ver t ib le financing i f the IDA c redi t had been completely unrestricted, then one can consider that the sector-tying of the credi t places no limitations on India 's freedom t o use it. Similarly, the country-tying of loans limits the recipient 's freedom only inasmuch as it obliges h i m t o diverge from the pattern of composition and distribution of h is imports he would have chosen i f he had had the same amount of foreign exchange available i n a freely convertible form.

53- Each Department 1 s requests, including requests f o r commercial imports, a r e discussed between the Ministry of Finance and the responsible agency. No jo in t confrontation of overa l l needs and a v a i l a b i l i t i e s takes place. There i s no attempt a t comparing the marginal benef i t s derived from the various types of foreign exchange a l locat ions . The de ta i led d ra f t Budget i s a l so discussed r7rith t h e Deputy Chairman of t he Planning Commission. How- ever, i n t he u l t i m t e analysis , the preparation of the Foreign Exchange Budget i s the undivided respons ib i l i ty of the Ministry of Finance.

S t - A s , i n pr inciple , all l e g i t i n a t e requirements of public sec tor projects must be s a t i s f i ed , even though t h e amount a l loca ted t o t he pr ivate sec tor makes up a l a r g e part of t o t a l a l locat ions , it tends t o be t r e a t e d a s a res idual , i n t he sense t h a t whatever is not required f o r other uses i s l e f t t o commercial imports. Conversely, no item included within commercial imports is considered t o be absolute ly incompressible. O f course, the r e l a t i ve str ingency of t h e foreign exchange s i t u a t i o n i s an important consideration i n drawing up public sector programs and other l a rge projects; but it is a qua l i t a t i ve consideration, not a p rec i se quant i t a t ive constra int ; the precise a l loca t ion matches the program, and not vice versa. The remaining foreign exchange i s then a l located t o commercial imports.l/ -

The Subdivision of Commercial Imports

55. The Economic Adviser a t tached t o the E4inistry of Industry i s al located foreign exchange f o r suballocation t o given groups of Sponsoring Authorit ies and f i n a l users. The exercise a s a vhole i s s imi l a r t o t he draw- i n g up of t he Foreign Exchange Budget. The Economic Adviser's freedom of maneuver i s of course l imi ted by the composition of the funds which include a i d monies t i e d t o spec i f i c countries or purposes and b i l a t e r a l trading funds reserved f o r ce r t a in categories of imports.

56. The Economic Adviser makes two s o r t s of sub-allocations. He determines direct ly , t h e values of imports of some materials . I n addit ion, Sponsoring Authorit ies a r e made lump sum a l locat ions of foreign exchange f o r the general import needs of t he firms under t h e i r control . Commodity l icen- s ing concerns l a r g e l y - though not exclusively - materials imported under spec ia l arrangements purchased i n bul!c by t h e Government, o r commodities imported mainly by a l imited well-defined group of industr ies . Cotton, i m - ported from the U. S. under PL 480 or from the Ukil under b i l a t e r a l payments arrangements, i l l u s t r a t e s the f i r s t category well; cashew nuts or wat t l e bark would be a perfect i l l u s t r a t i o n of the second.

1/ Allocations f o r Commercial Imports amounted t o about 35 percent of - maintenance a l loca t ions i n 196L/65. After deducting from the remaining 65 percent foodgrains, f e r t i l i z e r , petroleum, newsprint and i r o n and s t e e l (a spec i a l category, which i s real located f o r f i n a l use by both public and pr iva te sector , i n pror~ortions not known t o the Mission), the remaining pre-emptive a l locat ions amount t o only 7.5 percent of t o t a l maintenance a l locat ions .

57 All groups a r e not so well defined. Firms receiving a group a l lo - cat ion often a l s o need mater ia ls f o r which there i s a separate commodity a l locat ion. Mon-ferrous metals a r e the most important case i n point. Use of t he general foreign exchange a l locat ion f o r such imports is not authorized; t h i s of ten causes technical imbalances t o appear between the imported materials ava i lab le t o a given f i r m . l / There is no indicat ion t h a t anything i s gained by such commodity a l locat i&s, which l i m i t t h e freedom of maneuver both of the lower l e v e l con t ro l le r s and of the firms thmse lves .

58. Tied a i d and t rades funds introduce an added element of complication. Each type of funds must be a l located t o the users expected t o make the r e l a - t i v e l y most e f f i c i en t use of them. Funds reserved t o imports of specif ic commodities have t o be used i n bulk o r a l located t o users needing prec i se ly these co,mmodities. With a dozen dif ferent types of funds, t h i s i s an extremely d i f f i c u l t task. It i s fu r the r complicated by the f a c t t h a t b i l a t e r a l t rade agreements wi th East European countries do not s e t out precisely the quant i t i es and pr ices of goods t o be imported from the a rea , but only ind ica te possi- b i l i t i e s ; precise contracts a r e only s e t t l e d i n the course of the year. Thus the Economic Adviser has t o determine imports from the r e s t of the world before knowing precisely the value of each commodity t o be imported from b i - l a t e r a l t rade partners - although admittedly he has a f a i r l y good idea of what these values w i l l be. The Foreign Exchange Budget a s a Tool f o r Equating Short-run Demand and Supply

A. Country-tied Funds

59. It i s d i f f i c u l t t o evaluate the magnitude of t he problem a r i s ing from the need t o match specif ic imports with specif ic types of funds. If t i e d funds represented only a small proportion of the t o t a l t o be a l located through the Foreign Exchange Budget, they would hardly c rea te a problem, f o r some worthwhile purchase can be made i n every country. However, India disposes of more t i e d than unt ied funds t o f inance i t s imports. I n the two Budget periods corresponding t o t he f i s c a l year 1964/65 funds avai lable f o r a l loca t ion t o imports, a f t e r taking care of debt service and other inv is ib les , amounted t o a t o t a l of l e s s than R s . 10,880 millicn. Only Rs. 4,535 mill ion were foreign exchange earned through exports t o convertible currency areas - l e s s than 44 percent. About Rs. 1 , 4 4 mil l ion a l locat ions r~rere made under import ce i l ings s e t by the b i l a t e r a l t rade agreements with Eastern European (and some North African) countries. These a r e t h e Ifrupee paymentw imports. Rs. 4,927 mill ion were a i d funds, a high proportion of which a r e t i e d t o purchases i n the donor country. S t r i c t l y project- t ied loans are , of course, not included within these f igures .

60. It would, perhaps, be more meaningful t o excluse PL 400 from these

1/ Importers benef i t t ing from the f i rs t and second indus t r i a l import c r e d i t s - of I D A were f r e e t o use t h e i r a l locat ions fo r any permissible import, I n the recent past , increased f l e x i b i l i t y w a s shown on t h i s point; i t i s s a i d t h a t individual firms a r e not l e f t considerable freedom t o use t h e i r foreign exchange a l loca t ions f o r whatever permissible imports they need. This evolution, which i s similar t o t h a t a f f ec t i ng t he evolution of s t e e l imports, i s commendable. It w a s a l l the more necessary t h a t price changes abroad of ten unbalance t he volume of imports f ea s ib l e under the or ig ina l commodity allocation.*

f igures . Even so, roughly Fls, 2,427 mil l ion a i d funds and Rs. 1,414 mill ion rupee payment funds would s t i l l amount t o more than 45 percent of import a l loca t ions excluding PL 480,

61. We do not know the de ta i l ed make-up of t h e a i d funds a l located by t h e Budget. However, on t he basis of a i d f igures avai lable elsewhere, one can estimate, very roughly, that perhaps half o r more of non-project a i d other than PL 480 a i d is t i e d t o purchases i n the United Sta tes . Most rupee payment sums a r e t i e d t o purchases i n Eastern Europe.l/ Thus, about one-third of t h e Budget's resources a r e t i e d t o purchases 5 two currency areas.

62. Evidence as t o t he d i f f i c u l t y of balancing t he regional composition of import demand with t h a t of t h e avai lable funds is a l s o given by t he working of the con t ro l system. Throughout, it has t o deal more severely with requests f o r f r e e foreign exchange than with requests f o r a i d and rupee funds. The Foreign Exchange Budget plays some ro le i n or ient ing t h e use of t i e d funds towards such imports a s a r e no t excessively expensive when o5tained from these sources. More e f fec t ive ly , t he Budget ensures t ha t t h e ac tua l u t i l i z a t i o n of each type of funds w i l l be roughly i n l i n e with t h e i r ava i l ab i l i t y . Even the marginally l e a s t wanted funds do not seem t o be accumulating, a s would tend t o be t he case i f t h e i r u t i l i z a t i o n were not ensured e f fec t ive ly , However, the main source of uncertainty r e l a t e s t o t he s u i t a b i l i t y of spec i f i c funds t o t h e purposes f o r which they a r e a l located; this i s generally resolved by simply not making any subs t i t u t e a l loca t ion during t he Budget period if some- one's a l loca t ion proves t o be unusable.

B. Earned Foreign Exchange Resources

63 Present a l loca t ions of f r e e foreign exchange r e s u l t i n fu tu re payments and have t o be met out of f u tu r e foreign exchange rece ip t s . Only a f rac t ion of the current a l locat ions i s t rans la ted i n t o imports and payments during the current period. Conversely, during t he present period subs t an t i a l payments have t o be made on account of past a l locat ions . Making a l locat ions , therefore , involves extending the mount of fo re ign exchange which w i l l be absorbed by past a l loca t ions during t he current period, and t h e proportion of current a l loca t ions which ~~lill r e s u l t i n cash payments during the current period. These est imates a r e founded on ac tua l report ing by public s ec to r agencies on expected payments, d i r e c t estimates of t he timing of expenditures f o r bulk imports, and on an annual sample study by the Reserve Bank of t h e average l a g between issuance and u t i l i z a t i o n of l icenses . This sample does not d is t inguish between categories of imports and areas of or igins . Ratios estimated on t h i s bas is a r e necessar i ly only approximative. It i s not known whether and how the average payment l a g w i l l be a f fec ted by s h i f t s i n t he composition of imports. Conversely, when the annual sample disc loses a change i n t he average l a g between l icensing and payment, it does no t show whether

1/ I n 1964/65, cotton was a l s o imported from the UAR under b i l a t e r a l payment - arrangements.

this is due t o a s h i f t i n the composition of imports or t o a modified behaviour within import categories. Thus speculative accelerations of payments cannot be ident if ied with adequate accuracy or speed.

64. Export receipts entered in to the Foreign Exchange Budget r e l a t e t o forecasts and not t o monies actual ly i n hand. The forecasts a re inevitably approx5mate. There i s a considerable but not well known lag between shipments and payments, which varies with the composition of exports, with changes i n monetary policy i n India and abroad, and ~ i t h expectations about the exchange rate . I n addition, some of the export promotion procedures employed i n India have affected these lags significantly; indeed, they seem a t times t o have resulted i n s ignif icant though possibly temporary over-valuation of exports .&/

65 The uncertainty of the forecasts on which the Foreign Exchange Budget must be based i s shown by the lack of detailed, analyt ical ly useful knowledge even about past payments, Cn the basis of the available documenta- t ion, it is impossible t o understand i n de ta i l the past evolution of the Balance of Payments. I n particular, out of the R s . 100 crores deterioration of the basic balance from 1963/64 t o 1964/65, there i s an amount of about R s . 60 crores on which the accounts shed no l ight . Moreover, the only published presentation available u n t i l 1964/65, t h a t of the Reserve Bank, presents a part icular ly confused foreign exchange picture. The publication of an adjusted s e t of accounts i n the Economic Survey of 1964/65 constitutes a great s tep f orward.2/ - 66. The defects of the Balance of Payments accounts, and the discrepancies between the three available presentations of it, are analyzed i n Appendix I. Suffice t o say here tha t a l l available accounts present imports on the basis of actual payments defined i n a r e s t r i c t ive sense; imports against creation of short-term debt are taken in to account only when the debt i s repaid. Exports a re presented on a shipment basis. The Reserve Bank's se t of accounts do not distinguish between debts repayable i n foreign exchange and debts repayable i n rupees (such as PL 480 loca l currency deposits). This i s the i r major defect which greatly reduces the usefulness of the capi ta l and invis ib le accounts. I n addition, most t ransac t ims are recorded only when they a re finalized i n an accounting sense, and the picture presented i s not up-to-date. Similarly, the Reserve Bank import data do not distinguish between PL 480 financed imports and others. The t o t a l import figure includes not only the t o t a l amount of freight payments on PL 480 shipments; tha t part of the freight reimbursed by the United States i s included t t~ice.3/ Some of the most obvious inadequacies have been corrected i n the adjusted fTgures published i n the Economic Survey; but many important detai ls a re not published on the adjusted basis, including any detailed breakdown of the capi tal and invisible accounts.

1/ The causes for such overvaluation have been removed recently; import - entitlements are now granted t o exporters only upon repatr iat ion of export proceeds, krhile previously they could be granted upon shipment of exports.*

2/ The accounts published i n the 1965/66 Survey, shmr a fur ther improvement.* - 3/ It would appear from footnote a) t o Table 6.2 ( i i ) i n the 1965/66 Economic -

Survey that t h i s double counting has now been eliminated.*

67. A main aim of foreign exchange budgeting i s t o allow India t o meet punctually i t s payment obligations; t h i s aim has always been fu l ly achieved. It was a lso desired t o make the best use of each type of funds available and, overall, t o allocate foreign exchange t o these uses most valuable to the national economy. Furthermore, sharp fluctuations i n import allocations were t o be presumably avoided a s much as possible. These aims were realized only very part ia l ly . Only the most extreme misallocations of funds and the most extreme fluctuations have been avoided. This pa r t i a l fa i lure i s due part ly t o the lack of adequata c r i t e r i a , which renders impossible any marginalist maximization of the return on allocations; part ly t o the in- adequacy of the content and presentation of the data available t o the decision makers, Yet the main cause of f a i lu re i s the weight of the burden carried by the system. The disequilibrium between desired imports and available financing is greater and more durable i n India than has been the case in most other countries. The re la t ive ly simple expedient of rationing imports of finished goods i s not suf f ic ient , the imports of current production goods a l so have t o be rationed, and the establishment of rat ional c r i t e r i a f o r th is i s extremely d i f f icu l t . Horeoever, a large proportion of the funds available a re t i e d t o purchases i n specif ic countries, and often f o r specif ic purposes. Their amount i s a l so subject t o important variation a t the discretion of aid- givers. I n the l i g h t of these d i f f i cu l t i e s , it i s not surprising that the Foreign Ekchange Budget has not successfully established a pat tern of alloca- t ions optimal i n any sense. This does not mean t h a t the existing inadequacies cannot be i n some measure corrected; it does mean t h a t these inadequacies can be eliminated only i f the extreme disequilibrium of demand and supply is i t s e l f tackled.

Par t II - THE mCHANISPI OF THE COIJTROLS

Chapter 4 - Controls on the Public Sector

68. Investment by the public sector, including Central and State Government agencies, departmental enterprises and autonomous public sector companies, i s controlled through the annual Government budget and the annual Plan exercises. Imports by the public sector a re controlled by these instruments plus the foreign exchange budget and import control procedures described in t h i s chapter.

69. Public sector agencies submit t h e i r requests for imports t o the Ministry to which they are related. For instance, a public sector mine (other than coal mine) would submit i t s request t o the Department of Mines and Metals. Requests of State Governments a re channeled through the appropriate c e n t r d authority, for instance requests of State Departments of Agriculture through the central Department of Agriculture. These agencies send on requests re la t ive t o s t e e l through the Iron and Steel Controller, t o the Department of Iron and Stee l and, f o r imports, t o the Ministry of Finance. Other import requests a re sent on d i rec t ly by the responsible Ministries t o the Ministry of Finance.

70. The import and other foreign exchange requirements of each agency a r e detailed i n one or several chapters, each subdivided in to two sections, corresponding t o the subdivision of the Foreign Exchange Budget, one fo r maintenance requirements and one for additions. Additions include both investment needs and also new programs; requests fo r them have t o be jus t i f ied i n terms of t h e i r legitimacy, tha t is, of the i r f a l l i n g within the programs approved by the Plan. Increases re la t ive t o past periods i n the requirements of spec i f ic ongoing programs have t o be s imilar ly just i f ied. The right of ongoing programs to a s table l eve l of allocations i s i n general accepted without detailed questioning although 'n principle they do have t o be jus t i f ied i n terms of the i r legitimacy. 3 71. In times of very acute foreign exchange scarcity, the IJlinistry of Finance tends t o re-examine ongoing programs with greater severi ty and applies pressure on the various Departments t o reduce the i r requirements fo r foreign exchange. In principle, each authority along the chain checks whether the requests are rea l ly essent ia l t o the projects and programs approved by the Plan. Some authori t ies , i n par t icular certain S ta te Governments, a re notoriously l a x in t h i s respect and i n the i r case the

1/ During the acute foreign exchange c r i s i s of l a t e 1965, even public sector requests had t o be cut substantially. These cuts appear to have been made on the basis of ad hoc considerations.*

verif icat ion done by the Ministry of Finance is part icular ly s t r i c t . Despite the detailed nature of the requests submitted t o it, the Ministry of Finance cannot eas i ly evaluate the actual need for all the allocations requested, However, a s it can apply pressure by ins is t ing on requests fo r expenditure being jus t i f ied in as great d e t a i l as it chooses, i t s bargaining strength is considerable, It mostly uses t h i s strength in times of par t icu lar ly acute scarci ty of foreign exchange. Nevertheless, despite its discretionary powers, the Ministry of Finance does not normally r e j ec t requests said to be genuinely indispensable fo r carrying out important Plan projects.

72 . The allocations a re very detailed, For instance, it is specified what funds a re available for each category of imports such a s spares for machinery, s tee l , non-ferrous metals, raw materials, etc., for each of the public sector enterprises functioning under the responsibil i ty of each Ministry, A variable, but generally low, proportion of the t o t a l granted t o each agency can be f r ee ly used by it for purposes approved in t h e Budget. In turn, high l e v e l agencies make p a r t of the i r f ree ceil ings available to subordinated agencies. Outside t h i s f r ee ceiling, specific disburs- ment requests have t o be submitted t o the Ministry of Finance. The disbursement authorization is subject t o the verif icat ion tha t the disbursement oes indeed corresponds precisely t o an item inscribed i n the budget. 9 73- These procedures a re complicated and time-consuming. They ref lec t t he conflict between the desire to save foreign exchange and the strong preference of a l l agencies fo r imports. A s long as re la t ive pr ices continue t o provide inducement for importing i n excess of the available supply of foreign exchange, there is no obvious way of rendering these procedures radical ly f a s t e r and more eff ic ient .

74 . The repeated statement tha t the public sector - including some very large-scale, heavily capital-intensive segments of the pr ivate sector such as the s t e e l plants - obtains all the allocations it needs t o cover i ts legitimate requirements is i n discord with the widespread occurrence of targets unfulf i l led because of the unavailabili ty of scarce imported materials. The procedures themselves, even when administered with competence and celer i ty , a re necessarily time-consuming; obstacles t o the regular flow of paper can easi ly a r i s e and disrupt the regular counter- flow of supplies. Moreover, competence and ce ler i ty a re not always the dominant feature of administrations overburdened with work administered by badly paid personnel cramped i n insuff ic ient quarters and disposing of l i t t l e competent c l e r i ca l help and no data processing equipment.

75 The worst s i tuat ion in the past characterized the allocation of indigenous s tee l . The Iron and Steel Con t ro l l e r~s office, with i t s

1/ The f r ee ceil ings available t o ivIinistries were suspended i n March - 1965 because of the foreign exchange shortage,

multiple functions, i s the most overburdened of the great administrations, and it combined the slowest action with the greatest insistence on conformity t o prescribed rules and procedures. Furthermore, as shown i n Appendix 11, the actions of the producers often did not r e f l ec t the allocations and p r i o r i t i e s established by the Iron and Stee l Controller. 1' 76. Appendix V i l l u s t r a t e s the type of delays tha t have occurred. The statement reproduced in tha t appendix was prepared by the management of the Neyveli Lignite Corporation. No allocation was refused t o t h a t project and yet, because of the f a i l u r e of indigenous s t e e l del iver ies t o be made i n time, the project was delayed by more than 2 years, and ultimately the s t e e l had t o be imported. The case i l l u s t r a t e s the fac t tha t , although needed allocations a re in principle not refused t o public sector projects, the flow of the required resources is often f a r from smooth.

Chapter 5 - Controls on the Establishment of Productive Capacity in the Private Sector

77. A l l aspects of investment of large-scale enterprises a re subject t o the control of the Central Government. For a l l investments which would bring the fixed assets of an indu t r ia l firm above Rs. 2.5 million, an Industr ia l License is required. Once t h i s l eve l of asse ts is reached, any substant ial expansion in ac t iv i ty , the manufacture of new a r t i c l e s , and s h i f t s in location a r e also subject t o indus t r ia l licensing.

78. The most important function of indus t r ia l l icensing is i n principle to ensure the conformity of private investment t o the objectives of the Plan re la t ive to the volume, composition, and geographic pat tern of investment and the prevention of monopolies. A s seen in Chapter 1, t h i s i s not achieved i n any precise quant i ta t ive sense. Licensing also aims a t verifying the technical soundness of projects.

79. Large-scale indus t r ia l firms a re placed under the d i r ec t supervision of a technical Sponsoring Authority. The most important of these a re the Directorate General of Technical Development, in charge of engineering and chemicals, the Iron and Stee l Controller, i n charge

1/ Much of the special inefficiency which characterized s t e e l control - seems t o have been removed recently. *

2/ Until ear ly 1961r, t h i s requirement applied t o a l l large-scale enter- - prises, t h a t is t o all firms with a fixed capi ta l of more than Rs . 500,000. A l l such firms a re s t i l l required t o reg is te r with the competent central department. A t present i n some seven industries, there i s no lower l i m i t a t all. Small-scale industry with fixed capi tal below Rs. 500,000 normally belongs t o the f i e l d of respon- s i b i l i t y of S ta te Governments with which firms with any need for imported or controlled domestic materials a re required t o register.

of iron and s t e e l production, and the Textile and Jute Commissioners. They have primary responsibili ty for examining investment projects. The f i r s t s tep i s to examine the place of a project within the Plan. Once it is sa t i s f ied tha t the contemplated project has its place within the planned framework, the technical Sponsoring Authority proceeds t o examine technical aspects, though not in any great d e t a i l Only rather broad points are examined, notably with regard t o repercussions on import needs and exports. One purpose of t h i s examination i s to indicate the technical conditions subject t o which the l icense i s t o be granted. The aspect of location, re la t ive t o the regional dis tr ibut ion of investment, and problems concerning the proposed s i ze of the firm are examined d i rec t ly by the Ministries concerned, with l i t t l e or no consultation with technical organizations. There is no evidence tha t a t t ha t leve l there exis t any clear-cut c r i t e r i a fo r weighing the costs and benefits resulting from size- wise or locational decisions. It seems tha t concern over the socio- po l i t i ca l aspect of location and s ize was somewhat relaxed i n the recent past i n favor of technical and economic efficiency.

80. Import requirements of the projects a re examined i n the l i g h t of the existing import substitution policy. Import requirements normally should not be higher than those of similar firms. However, i f foreign exchange of the l e s s scarce types is required, rich as imports from Eastern Europe, available under b i l a t e ra l t rade agreements, some allot~ance i s made for this .

81. On the whole, the usefulness of the s c r c t h y is limlfed. Detailed examination of the technical and economic souli-hess of the project i s r ight ly considered t o be be t te r performed by tne wouid-be iiivestors themselves. Not much more can be done than to check the rough confornity of the project t o cer tain non-quantified preferences of the Government. However, t h i s i s done in such a manner, involving the consultation of so many organizations a t each s tep tha t the whole operation is extremely time-consuming. Under the accelerated procedures ins t i tu ted i n January 1964, recommendations for issuance of a Letter of Intent are t o be prepared within one month. The Letter of Intent is a preliminary document which indicates the conditions subject to which Government is prepared t o consider the grant of an indus t r ia l license. Separate f i n a l approval i s required. Final approvals are in principle t o be given within a period of three months a f t e r the receipt of applications. Under the special procedure for so-called key industries, whose rapid growth is considered essent ial (there are a t present twenty-two such industries), the procedure i s somewhat fas ter but s t i l l takes a great deal of time.

82. The recommendations of the technical sponsor a re submitted through the relevant Ministry t o the Licensing Committe composed of very high level c i v i l servants representing the Ministry of Industry, the Ministry of Finance, the Planning Commission, the Central Adninis- t r a t ive Department and the State Government concerned. A separate l icense has t o be obtained for authorizing the importation of capi tal goods. A source of import financing a lso has t o be indicated, for the use of f ree foreign exchange to import capi ta l goods i s normally not authorized. For applications above Rs. 2 million fo r capi ta l goods imports from Eastern Europe, above Rs . 500,000 for imports from the

United States, and above Rs. 200,000 for imports from other areas, the decision i s taken by the Capital Goods Committee which has the same high leve l composition as the Licensing Committee, with the addition of the Chief Controller of Imports and Exports. The Capital Goods Committee does not work within precise ceil ings valid for given periods. The Sub-committee dealing with smaller requests fo r capi ta l goods imports r e l i e s more heavily on funds available under b i l a t e ra l trade agreements and commercial credits. In both cases, the varying des i rab i l i ty of specific types of funds permits many gradations between approval and refusal of an application.

83- Foreign collaboration agreements a re considered by the technical sponsor which submits advice t o a Foreign Collaboration Agreements Committee, s imilar i n composition t o the Industr ia l Licensing Committee. The agreements a re scrutinized from the point of view of the technical competence of the foreign collaborator, but mainly from the financial angle; the cost of the agreement in terms of royalties, p ro f i t repatriation, etc., i s compared with previous experience in similar f i e lds and viewed i n the l i g h t of cer tain pre-established ground rules.

Chapter 6 - Controls on the Allocation of Current Inputs - t o the Private Sector

81r. A s pointed out i n Chapter 1, the shor t - fa l l of the Plan as a guideline is most serious fo r controls on current inputs. Indeed, these controls a re fundamentally v i t i a t ed by the f ac t t h a t more i s being controlled than i s planned. The controllers a re l e f t without guidelines for rat ional decision-making and are therefore bound t o follow simple rules of thumb. Administrative delays involved i n the process a re numerous. The public sector example of Appendix V has many private sector counterparts. These a re a nuisance and involve a heavy economic cost not only i n terms of production foregone and of machinery s i t t i n g i d l e fo r lack of inexpensive spare parts, but in terms of the scarce manpower kept immobilized on both sides, the permanent ambassadors kept in Delhi by large firms fo r I1pushing1l applications, and the Government personnel dealing with them.

85- This aspect of the control problem has often been i l l u s t r a t e d and w i l l not be considered here a t greater length. The complete lack of a mechanism within the control system capable of maximizing the returns - i n any sense, under any s e t of preferences - derived from the use of scarce resources is i ts most important fa i lure . The s i tuat ion i s so confusing tha t no one from the top controllers down could say whether the extensive uncontrolled pa ra l l e l black and gray markets a re a blessing or a plague.

86. The foreign exchange l e f t for use by the pr ivate sector has t o be dis t r ibuted among Sponsoring Authorities, indus t r ia l sectors, and ultimately individual firms. The location of scarce current inputs i s one of the most inportant factors determining the leve l of production. But even i f the controllers all along the l i n e r ea l ly knew the relationship between the amount of scarce resource allocation to a given sector and the resul t ing output, they would have no way of deciding whether any

given change i n the output of one sector was preferable t o a change i n the output of another sector. The controllers have no c r i t e r i a , such as a detailed and corrected plan,on which t o base t h e i r decisions. The Five- Year Plan does not provide a consistent s e t of annual production targets . The market value of the marginal product achieved through a given allocation decision - even i f it were known t o the controllers, which it is not - would not be a suf f ic ien t c r i te r ion fo r choosing between al ternat ive allocation patterns i f one of the purposes of the control system i s i n fac t t o a l t e r the allocations which would be made by the market.

87. If the questionnaires most firms f i l l out periodically were correctly answered and adequately processed, the controlling agencies would know the output e f fec ts of given allocation of foreign exchange or s teel . In fact , no serious e f fo r t is made t o process the information and to evaluate these effects, perhaps largely because even i f they were known, they could not be used as guidelines t o allocation decisions, as the desirable l eve l of output has not been defined.

88. In fact , two simple c r i t e r i a a re the main guides t o allocation decisions a l l along the control l i ne , and are only s l ight ly tempered by other relevant considerations. These are h i s to r i ca l shares and licensed (or registered) capacity. In the f i r s t sharing out of foreign exchange, it i s attempted t o give t o each sector roughly the same re la t ive share as i n the recent past.

89. Such a system is clear ly inadequate i n a growing eccnomy. It i s corrected by lower leve l controllers, those d i r ec t l a i n contact with films, by taking in to account changes i n licensed o r registered capacities. In most industries large-scale enterprises must obtain an indus t r ia l l icense before undertaking investment, o r a t l e a s t must regis ter with a technical Sponsoring Authority. The applications for industr ia l l icenses specify the additional foreign exchange and raw material requirements due t o the contemplated investmen-t. It i s always s tated tha t the granting of an industr ia l l icense does not imply any obligation on the pa r t of Government t o make available the required imports. In fact , however, an obligation is f e l t t o ex is t both by the controllers and the controlled firms. There can generally be no question of sat isfying all the licensed requirements; no firm has all the foreign exchange it desires. However, the control lers tend t o t r e a t equally a l l the licensed capacity, and t r y t o al locate b a l l firms within the i r control the same proportion of the i r full capacity requirenients. For smaller firms, which require regis t rat ion with a central technical sponsor but no licensing, regis t rat ion normally must precede actual investment i f the f i r m requires imports. Registration can be refused by the Sponsoring Authority; when it i s not refused it tends t o be considered a s giving the firm the same r ights as an Industr ia l License.

90. Small-scale firms requiring imports must regis ter with the S ta t e Director of Industry. In many States there tends t o be some discrimination against new firms which a re granted a lower proportion of t h e i r f u l l capacity requirements than old firms. After two t o three years, however, new firms a r e considered t o have turned into old firms.

91. The two cr i te r ia , h is tor ica l shares and licensed capacity, are not real ly contradictory. The dominant consideration is tha t some scarce resources must be distributed "fair lyt1. In the f i r s t instance, fairness means dis tr ibut ing the scarci ty equally: every firmqs allocation has t o be reduced or increased in the same proportion. This cr i ter ion cannot be maintained f o r long when industry i s growing. Therefore, the second equity consideration i s to al locate to every firm the same portion of i t s assessed needs.

92. Corrections for new capacity do not seem to be systematically transmitted from the bottom towards the top of the control chain; there i s no attempt t o maintain capacity u t i l i za t ion a t the same l eve l within all sectors. However, if a given industry got an outstandingly low proportion of i t s licensed requirements, the controller in charge of it would probably appeal f o r increased allocations, and the very low leve l of the r a t io of allocations t o licensed requirements would be s point i n favor of h i s getting them.

93. There are additional corrective factors. Sectors which i n some very obvious way deserve privileged treatment do get it. For instance, the importation of goods needed mainly fo r export - say cashew nuts - i s never limited. Firms working d i rec t ly on..-defense contracts also receive privileged treatment. When the scarci ty of a given product creates a part icular ly acute bottleneck, the level of allocations t o the sector producing tha t product i s generally increased a f t e r some time. Generally spealcing, obvious p r io r i t i e s are taken into account t o some extent. However, despite these correctives it would only be a s l igh t over- simplification t o s t a t e tha t allocations are made t o each sector propor- t ionately t o i ts share in the past, and t o each firm within algector proportionately t o i ts licensed or assessed "capacity need". -

The Uncontrolled Flows

94. Superimposed upon the system of controlled allocations of imported and scarce domestic items, there i s a ser ies of para l le l flows. Some of these resul t from completely i l l e g a l transactions, for example overstatement of cement requirements of approved projects and sale of the excess cement on the black market. Again, non-existing firms s e l l all the i r allocations on the black market. However, the majority of cases are not so clear-cut. There are those transactions which are contrary t o the s p i r i t of the control system, but not t o i t s l e t t e r ; others which confl ict with i t s l e t t e r but not with i ts s p i r i t ; and all those i n between.

1/ - This i s supported by the I1Report of the Study Team on Directorate General of Technical Developmentu, PEnistry of Industry, June 11, 1965: The statements quoted i n Appendix 5 clearly show that foreign exchange sub-allocations are very largely made on the basis of past shares although some special e f for t i s devoted t o making good use of aid funds. *

95 Few prices a re controlled in India. Among indus t r ia l products, there i s s tatutory control on prices of virgin copper, certain s t e e l products and certain grades of coal, cement, some categories of t ex t i l e s and a limited number of other products. So-called informal, but i n f a c t qui te firm, control i s exercised over the prices of trucks and motor cars. Firms which receive import licenses as t tactual userst1, and these are the major recipients, may not re -se l l the i r imports without processing. On the other hand, re-sales by commercial importers a re normally not subject to price control. In cases where they are, there is no mechanism for enforcing control. In fac t , a s there is no mechanism for allocating these scarce goods t o f i n a l users, i n practice, the traders cannot help rais ing the i r prices. Then again, processing by actual users is not necessarily a complex operation. Thus, only copper smelters a re allowed to import virgin copper. There is s tatutory control forbidding them to re-sell virgin copper; however, once they have transformed it in to sheets and s t r ips , there i s no s tatutory price control nor any formal mechanism obligating them to s e l l to specif ic users.

96. Presumably, i f a well-documented complaint of profiteering were made against one of the smelters, it could be deprived for fur ther licenses. This may ac t as an inducement t o make some sales to old customers a t less than f r ee market prices. However, copper sheets were often traded a t a price two to two-and-a-half times higher than the landed cost of equivalent imports before the t r ip l ing of the duty on copper i n February 1965. The new duty w i l l probably sponge up part only of the p r o f i t of smelters and traders. There i s nothing i l l e g a l i n this prof i t ; a f t e r a l l , small volumes of copper a re f ree ly traded a t the Bombay commodity exchange where there are open quotations for electrolyt ic coi ls , wire bars, ingots and scrap a t f ree prices. Similarly, t i n plates and s t e e l sheets can be processed by cutting them down t o smaller s izes or by punching holes i n them, bars by being cut, etc. After such so-called processing the goods are often sold legal ly a t f ree market prices.

97. Furthermore, there are long delays between requests and allocations. Often, there i s also a big difference, both qual i ta t ive and quantita- t ive, between what has been requested, what i s needed, and what is allocated. Allocations which are not needed immediately are often traded against other needed goods, or against promises of deliveries a t a l a t e r time. Such transactions, though clearly i l l ega l , are nevertheless often f ac i l i t a t ed by some controllers i n the in teres ts of production within industries under the i r control. For instance, indigenous s t e e l allocations are not infrequently received a f t e r a period of up to three years a f t e r they have been applied for. They are often no longer needed then. The Iron and Steel Controller, who controls s t e e l allocations, sometimes t r i e s to f a c i l i t a t e the disposal of allocated s t e e l which i s not needed, and the procurement of s t e e l outside allocations, provided he i s sa t i s f ied that both buyer and s e l l e r are primari- l y genuine producers. When such transactions have the expl ic i t or t a c i t permission of the controller, they can eas i ly involve up to several train- loads. Similarly, Directorate General of Technical Development off icers sometimes help i n effecting unofficial purchases of urgently needed spare parts and materials.

98. Export promotion l i censes , t h a t is, import en t i t l e aen t s f o r spec i f i ed goods given t o exporters i n addit ion t o t h e i r normal import a l loca t ions , a r e l e g a l l y tradeable within spec i f i ed i n d u s t r i a l groups. There a r e very ac t i ve markets in these import enti t lements, some of which ~$11 at p r i c e s upwards of 250% of t he nominal values inscr ibed on them. - Similarly, under the so-called ba r t e r deals , for ins tance exporters of manganese o res a r e allowed t o import ce r ta in types of s t e e l o r exporters of low qua l i t y tobacco t o France a r e allowed t o import t r a c t o r s from the United Kingdom. There i s no e x p l i c i t permission to make more than a normal p r o f i t on t he re-sale of these imports. For s t e e l imports, t he r e i s i n f a c t e x p l i c i t i n t e rd i c t i on t o do so, because o f the s t a t u to ry p r i c e control on ce r t a i n s t e e l items, Yet it is wel l known t h a t a I1normaltt t r ad ing p r o f i t on the imported items would no t cover the l o s se s made on the export p a r t of the t ransact ion. It is i n f a c t t o l e r a t ed t h a t a l a rge p r o f i t be made on these s a l e s , d i r e c t l y o r i nd i r ec t l y , by s e l l i n g at the nominal import pr ice , and being paid separate ly f o r choosing t h e pa r t i cu l a r buyer.

99 Again in a d i f f e r en t category we have the purchases of quotas, say of control led domestic s t e e l items, This i s a d i f f i c u l t operation, but it can be arranged with t he s t e e l p lan t t h a t t h e shipments be re- d i rected as needed. There a r e a l so i n t e r n a l b a r t e r deals , whereby a shipment of unneeded or de fec t ive s t e e l items i s purchased, i n re tu rn fo r which some scarce items a r e a l s o sen t without t h e normal waiting period; the p r o f i t s on t he s a l e s o r u t i l i z a t i o n of one group compensate t h e losses on the others.

100 The extent of these uncontrolled flows i s d i f f i c u l t t o evaluate, They a r e undoubtedly large , and may well be of c ruc ia l importance even t o large-scale industry by allowing it t o avoid paral j js is due t o the f a i l i n g s and delays of t he control system. However, they probably do no t account f o r a major p a r t of the t ransact ions of l a rge sca le industry. Uncontrolled t ransact ions a r e the normal way f o r small-scale i n d u s t r i a l f irms t o ge t t h e i r requirements. Controlled a l loca t ions only r a r e ly coincide with t he needs of these firms, and a r e a t l e a s t as much a means of earning income through re-sa les a s a way of obtaining physical requirements. A s i s shown is Appendix 3, t h i s i s more o r l e s s unavoidable, f o r the spec i f i c requirements of individual small-scale f irms a r e p r a c t i c a l l y not taken i n t o account i n determining t h e i r a l locat ions .

1/ Reportedly, up t o 70C$ f o r art s i l k l icenses . -

101 . The para l le l markets are actual markets. The Bombay metal 1/ exchange and the trading i n import entitlements a re exceptional cases.-

Nevertheless, the markets are large and traders a re well informed. Most controlled commodities have well established free market prices, those quoted do not show large variations even i n widely separate par t s of the country. The premiums over controlled prices generally range between 50-1~0%, though there are more extreme cases. In l a t e 1964, the premium on chromium salts was quoted t o be 400%~ about 250% for s ta in less s tee l , 150% for gener purpose indigenous s t e e l sheets and about the sane for zinc and t in .

162. There can be l i t t l e doubt tha t the uncon-trolled flows are useful i n I1oiling the wheels1' of the controlled allocation mechanism, whose delays and deficiencies would otherwise probably resul t in a complete breakdown of many industr ial production processes. Yet, a t the same time these flows pervert the controls; not only do the controllers not know what the desirable pattern of production should be or the precise relationships between allocation of controlled resources and production, they also do not actually know whic sector and which firms are ultimately get t ing the controlled resources, 9

A new source of f r e e market has been created by the National Defence Remittance scheme of October 1965. The beneficiaries of foreign exchange remittances received under the scheme prior t o the end of Nay 1966 get a transferable ce r t i f i ca te which e n t i t l e s i ts bearer t o an import l icense fo r 6@2 of the nominal value of the remittance. These licenses a re granted for a la rge variety of production goods. About Rs . 300 million had been remitted under the scheme up to March 10, 1966; thus, the NDRS introduces a new, very significant and perfectly lega l and open element of f l e x i b i l i t y k t o the import control system. *

2/ In January 1966, the pr ice quoted on NDRS cer t i f ica tes indicated - tha t each US$-worth of imports under the scheme must have an internal market value of Rs . 16.5-17.5, tha t is, a premium of about 200% a b o v e landed price, and about 250-270% above CIF price. *

3/ Incidentally, the pa ra l l e l flows are also a major source of "black - money1', t h e i r counterpart f inancial transactions. Even i f it were desired, p r o f i t s from transactionswherethe black market was involved a t some stage are d i f f i c u l t t o bring back t o l ight . They normally have t o continue t o circulate in the dark and be re-employed i n unofficial transactions which, of course, are also tax-free. One main cause for the depression of the stock market has been said t o be, only half facetiously, the Ifshortage of white moneyH.

Evaluation of Controls over the Allocation of Current Tnputs

103. In summary, the control system over current inputs aims a t determining prec i se ly and completely the l eve l s of scarce inputs used by a l l sectors , and ult imately by every firm. This i n tu rn determines the leve ls of most economic a c t i v i t i e s . For most of t he sectors a f fec ted by the controls t h i s is done i n the absence of any production targets . Decisions a r e taken which, i f f u l l y implemented, ~ ~ o u l d precisely determine most levels of economic ac t i v i t y , y e t only fo r a few a c t i v i t i e s has it ever been decided what the desi red l e v e l of a c t i v i t y was, and even f o r these the decision was taken severa l years ago i n t he context of a Plan which by now appears outdated and unrea l i s t i c .

104. Only the simplest c r i t e r i a a r e t h e r e f o r e applicable and applied. A p r ac t i ca l l y absolute p r i o r i t y i s given t o t he fu l f i l lment of those few production t a rge t s t h a t do e x i s t - mainly i n the publ ic sector and a few of the most capital- intensive pr iva te i ndus t r i a l sectors, which a r e considered t o form an e s sen t i a l p a r t of development s t ra tegy and, moreover, a r e those where the under-uti l ization of capacity would involve t he heaviest c ap i t a l cost. There i s no c r i t e r i on f o r governing the d i s t r ibu t ion of t he residual; and it is i n f a c t considered t o be of secondary importance.

Chapter 7 - General Assessment of t he Control %stem

Controls a s a Protect ive Device

105. The controls obviously pro tec t domestic f irms from a l l foreign competition. A s seen i n Chapter 2, this protect ion is the same fo r a l l producers, whatever the excess of t h e i r costs over t he cost of imports. There i s no se l ec t i ve encouragement t o those with greater comparative advantage. A s a l l inpor t subs t i tu t ion is offered equzl protection, some import subs t i tu t ion operations a r e necessar i ly by-passed i n favor of l e s s worthwhile ones. Moreover, controls a l so o f f e r protection against i n t e rna l competition. In most sectors output is r e s t r i c t e d more by the s ca rc i t y of current inputs than by the exhaustion of avai lable productive capacity. Each firm is e n t i t l e d to a "fairl l a l loca t ion of scarce inputs a t controlled pr ices . This is more o r l e s s equivalent t o a subsidy which can be turned i n t o cash e i t he r by re-sel l ing t he controlled a l loca t ion on the p a r a l l e l markets o r , more normally, by incorporating the a l located resources i n t o a product so ld a t uncontrolled pr ices o r a t controlled pr ices which ensure a llreasonablell prof it even t o t he l e a s t e f f i c i e n t producers.

106. Leaving as ide f o r t he moment t h e uncontrolled flows, one can say t h a t t h e quant i ty of controlled inputs a l located to a given f i r m determines i t s l e v e l of production and thereby i ts share of t h e market. There is l i t t l e competition f o r none can increase its share of the market by reducing pr ices or improving qual i ty . A s the controlled a l locat ions allow a generally low l e v e l of operations r e l a t i v e t o capacity, average costs contain a high over- head element and the p r i ce l e v e l r e f l e c t s a generally high gross p r o f i t markup, which may r e f l e c t a high l e v e l of n e t p r o f i t f o r t he most e f f i c i e n t producers.

107. If the firms had to compete for the allocations (or the markets) some of them would be squeezed out of business; the most e f f i c i en t and dynamic firm would acquire a la rger share of the market.The automobile industry provides a good i l lus t ra t ion . Passenger car manufacturing uni ts work well below capacity for lack of current inputs. Ex-factory f i n a l prices are de facto controlled by the Government. Demand i s rationed by waiting lists. The o f f i c i a l price of an ~tAmbassador~~ car was R s . 17,000 i n December 1964, the waiting period f o r the car was three years. Black market pr ice f o r immediate delivery was said to be about R s . 19,000. A t the same time, the o f f i c i a l price for an Indian tlFiatlt was R s . 15,000, the waiting period eight years and black market pr ice for immediate delivery R s . 25,000. Clearly, i f instead of each firm being allocated i t s share of the market they had t o compete with each other fo r it, the M a t factory would have taken over as much of the market a s i t could have served when using i ts f u l l productive capacity. The essent ia l element i n th i s picture i s not the control over f i n a l product price, but the f a c t tha t physical l imitations on the inputs a given firm can purchase limit i ts capacity t o s a t i s f y demand and therefore reserve a share of the market to the l eas t e f f ic ient firms . 108. A par t icu lar ly dynamic and e f f i c i en t firm could expand i t s produc- t ion by relying substant ial ly on black market purchases. This would push i ts marginal costs up very high and only firms with abysmally low efficiency would be prevented from s t i l l making a p ro f i t by u t i l iz ing only the i r con- t ro l led allocations. 1/ These could supplement the i r revenues through black market sales of their-allocations. So even then, the controll-ed allocations would tend t o ac t as forced market sharing arrangements.

109. The more an industry uses scarce imported and controlled domestic materials, the more urgent it would seem to stimulate efficiency within it, but the more it i s sheltered from any competitive pressure. However, many existing firms have a stake i n the maintenance of the present system and a r e opposed to i ts fundamental modification. The understandable, almost instinc- t ive, reluctance to abandon the shel ter of controls, i s compounded by some understanding tha t i f firms had to compete among themselves, l e t alone with imports, gross p r o f i t markups would f a l l ; the inef f ic ient may well be forced out of business. Few firms are r ea l ly desirous to t r y out whether, by increasing the i r share of the market through active price competition, they can increase the i r total prof i t s .

The Incentive to Invest and Under-utilization of Capital

110. It is commonly observed that, because of the acute scarci ty of imports of current production materials, productive capacity i n industry is

1/ The average cost graph contains a kink corresponding to a gap i n the - marginal cost chart a t the point of general reliance on black market purchases. Most firms would tend to operate a t the point nearest to tha t gap and only a few of the most e f f ic ient firms would go beyond it and re ly on the black market as heavy net purchasers of a l l the mate- r i a l s they require (most firms do part ic ipate i n the black market both as se l l e r s and buyers to improve the balance of the i r input mix).

grossly under-utilized. l h i l e there exis t s no comprehensive quantitative measure of this phenomenon, there i s widespread evidence also supported by the findings of other Bank missions. The control system shel ters ineff icient firms and i s highly tolerant towards a l l inefficiencies; however, it is paradoxically more tolerant towards inef f ic ient use of capi ta l than towards that of otiner factors, for instance labor. Tax incentives are par t ly responsible for this; because of the "development rebate" the cost of an additional piece of equipment is, rupee for rupee, much l igh te r to the firm than the cost of an addition to i ts wage b i l l . The overvaluation of the rupee a lso lightens the cost of imported equipment. Fears tha t imports w i l l be banned because of the development of high cost loca l production also induce indus t r i a l i s t s t o import as much machinery a s they are allowed. Industr ial licensing, which should i n principle check excessive investment, does so only pa r t i a l ly and ineffectively.

111. The absence of study of excess capacity referred to i n paragraph 110 i s evidence tha t this factor is not taken seriously in to account i n indus t r ia l licensing. l/ Investment permits may be refused i f investment has already reached or-is on i ts way to reaching the Plan targets, and also i f it is quite evident t h a t enough capacity i s generated to sa t i s fy future demand. However, the existence of more capacity than can be u t i l ized w i t h the present supply of scarce inputs is not considered to be a suf f ic ient reason for refusing an indus5rial license. The controllers have l i t t l e usable evidence on the s t a t e of excess capacity; i n fact , they are not prepared to use such evidence (which may well be why it has not been collected). Accord- ing t o higher personnel i n the Directorate General of Technical Development evidence of large excess capacity in a given industry would not be a suf f ic ient reason for refusing an indus t r ia l license, for one cannot know what foreign exchange w i l l be available fo r the industry in future.

112. The system of allocation of current inputs positively encourages the formation of excess capacity. Almost the only way i n which a firm can make a successful plea fo r increased allocations i s by increasing i ts licensed capacity. Upon completion of a licensed investment the licensee i s considered t o be morally en t i t l ed t o a larger current allocation. I f the expansion within the sector was general, actual allocations may well remain stable, but each firm is s t i l l r i g h t to consider that, but fo r the timely expansion, i ts allocations would have been cut. Investment yields an increasing allocation; the pa ra l l e l market offers very high premia for iLnports, and these are ref lected i n prices of f i n a l products. The marginal return t o investing even i n an i d l e machine can therefore be very high. The re l a t ive r a r i t y of multiple s h i f t working i s a facet of the excess capacity problem.

1/ Several studies have i n f a c t been carried out recently, within and - outside the Government; they bear out both the existence of substan- t i a l unutilized capacity and the f a c t that the technical Sponsoring Authorities do not have val id information on this. +e

113. Factors other than the control system (and tax incentives) also contribute t o building up excess capc i ty . Rapid investment i n discreet units, the organizational problem involved i n multiple s h i f t working, the des i rabi l i ty of having standby units when sk i l led maintenance and repair s t a f f is not always available and par ts and replacements have to be imported from f a r away, a l l play a role. However, Indian policy, i n part icular the allocation system, has had a major role i n encouraging the building up of productive capacity i n excess of the actual means of providing the necessary current inputs both by fostering inefficiency i n general and by being specif ical ly biased towards u t i l i za t ion of excessive capital .

P n t I11 - CONCLUSIOEJS AYD RECOI@iE:J'DATIOIJS

lI-4. A t present i n India more i s controlled than is planned. Orders a r e issued which purport t o determine precise courses i n many f i e l d s i n which it has never been decided what t he precise course should be. One can propose the following f i r s t approximation t o a bas ic r u l e f o r the control system: physical controls should be exercised only where f ea s ib l e and de ta i l ed aims capable of being implemented through such controls e d s t .

chapter 8 - Controls on Investment

115 . &ny Indian economists would accept the need f o r d r a s t i c simplif ica- t i o n of controls on current inputs, bu t would nevertheless i n s i s t t h a t investment l i cens ing i s necessary. This argument cannot be re jec ted off-hand. The planner has an ove ra l l view of the economy and i s sometimes a b e t t e r judge of the fu tu r e than t he p r iva t e entrepreneur. More importantly, the preferences of the p r iva te entrepreneur and of the ffmarketll may well d i f f e r from those of the planner. Idhen, as i n India, the Plan aims a t achieving a profound transformation of socie ty , it would be too opt imis t ic to expect t h a t present soc ie ty contains i n i t s e l f , and ac t i va t e s through automatic market forces , the germs of t he desi red transformation.

116. It can be argued t h a t the market can be s t be changed by act ions working through it; f o r instance, t h a t it is ea s i e r and more e f f i c i e n t t o change income d i s t r ibu t ion , i f so desired, by appropriate taxat ion than t o i n h i b i t its e f f ec t s through controls, o r t h a t investment may be adequately di rected by t a x incentives. However, general tax measures may no t be selec- t i v e enough, and the speed and f l e x i b i l i t y of the p r iva t e sec tor i n responding t o them may not be suf f ic ien t .

I ndus t r i a l Licensing

117. I ndus t r i a l l icensing as functioning today i s a very pecul iar type of guidance. It i s no t r e l a t ed to feas ib le , de ta i l ed and up-to-date investment t a rge t s . Moreover, l icensing permits only t o prevent undesirable investments, no t t o st imulate desired ones. Even i n the past , when possession of a l i cense , and no t eff ic iency, was the key t o p r o f i t s , avai lable l i c ense s were no t always taken up or, more frequently, l icensed investment p ro jec t s were not ca r r ied out.

118. This purpose and r o l e of i n d u s t r i a l l i cens ing could be performed by taking and publishing from time t o time general decisions banning durably o r temporarily spec i f i c types of a c t i v i t i e s and investments. A case by case, de t a i l ed examination i s no t necessary.

119. Another function of i n d u s t r i a l l icensing i s t o prevent undesirable regional o r firm-wise concentration of income or economic power. For the f i r s t of these purposes a general ban on new investment and expansion i n ce r t a in regions may be a l l that i s needed as far a s purely negative too l s a r e concerned (of course, pos i t i ve t oo l s o r e required t o s t imulate investment i n the lagging regions; seebelow, paragraphs 122-126). It is somewhat more d i f f i c u l t t o conceive of general r u l e s t o prevent the formation of

monopolies; nevertheless, antimonopoly rules enforced through quasi-judicial and judicial action have proved to be f a i r l y effective on occasion. It may well be desirable t o create a permanent committee charged solely with the prevention of monopoly and undue re s t r a in t of competition.

120. The present detailed case-by-case examination of a l l investment plans by the licensing authority goes much beyond these points. Although the controllers a re i n general dedicated and competent, t he i r work i s based on second-hand documents, sometimes poorly prepared; they are f a r from the locs- t ion of investment; and they have no specialized knowledge of the f i e l d concerned. A s they themselves recognize, they are not i n a good position fo r technical judgments. Technical examinations sometimes ident ify cases where soc ia l preferences fo r cer tain techniques obviously d i f f e r from those indicated by prevailing price ra t ios . Concretely, the pr ice of imports i s low, and entrepreneurs have a natural incl inat ion to re ly on them; the controllers tend to counter t h i s and i n s i s t on high indigenous content. A s seen i n Chapter 2, the r e su l t of t h i s confl ict is a highly i r r a t iona l s t ructure of import substitution, i n which India's comparative advantages are not exploited. I f the r a t i o of foreign to domestic prices - which i s the effective exchange r a t e - correctly ref lected the r e a l scarc i ty of foreign exchange, entrepreneurs would take technical decisions i n function of this r e a l scarcity, and there would be no need to supervise and examine such decisions.

121. The exchange reform and re la ted measures should also reduce the ease with which p ro f i t s can be made i n industry; thus, indus t r ia l licensing should no longer be needed to keep i n check a generally excessive inducement to invest. Yet, i n addition t o general bans and tax measures, more select ive intervention w i l l a lso be needed a t times, t o slow down expansion i n well- defined sectors and regions where there are no durable reasons fo r banning it, and to stimulate investment i n specif ic sectors or regions. The present procedures involve unduly cumbersome centralized supervision of each individual investment project. Moreover, they provide no means of fulf i l . l ing the second, and more important, aim.

Selective Credit Controls

122. A t present, only the licensing authori t ies a re responsible for verifying the essent ia l i ty of an investment. Financing ins t i tu t ions r e ly ent i re ly on them fo r this . Negotiations for financing can seriously s t a r t only a f t e r the Industr ial License (or Letter of 1ntent) is issued. License holders are seldom refused financing. The financing ins t i tu t ions also tend to r e ly on the controllers for the verif icat ion of the technical, f inancial and economic soundness of projects. Possession of the necessary licenses a l l but ensures the success of a project and thereby rel ieves the financing ins t i tu t ions from most responsibili ty.

123. I f there were no indus t r ia l licensing, f inancial ins t i tu t ions would have to ver i fy carefully the social usefulness of projects submitted to them, because these a re i n general preconditions for the projects being reasonably assured of f inancia l success. After a l l , the cases where private p ro f i t s and soc ia l in t e res t diverge are not very wide-spread. &st aims sought to be

enforced through licensing are not autonomous; most production and investment targets are no more than estimates of what wi l l be necessary i n order t o f a c i l i t a t e the fuLfillmentof few imperative targets and of the projected general growth r a t e of the economy. Financial inst i tut ions have an in te res t i n ensuring tha t investment i s indeed forthcoming a t the planned rate , unless the i r forecasts d i f fer from those of the planners. Naturally, they would also verify the technical and financial soundness of projects.

124. Of course, i n some cases social in te res t does differ from private prof i t , and the Government has to ensure that i t is not neglected. From its vantage point, the Government may also judge tha t i n certain branches investment decisions are being made on the basis of wrong estimates of the global evolution of the econov. Such divergences as pe r s i s t despite the use of appropriate f i s c a l measures, and broad bans, could be corrected by issuing rules and regulations to financial ins t i tu t ions (including commercial banks) and revising them from time to time. The firm-wise distribution of credi ts should be l e f t t o be decided by the inst i tut ions themselves. Government directives should bear only on credi t ceilings to be s e t on or special credi t f a c i l i t i e s to be given to certain sectors of act ivi ty. I f , fo r instance, investment i n t ractor production appears grossly inadequate, the Government could provide special refinancing f a c i l i t i e s f o r credits made to t rac tor manufacturers; the choice of the manufacturer, and the precise amount of credits t o each would s t i l l be determined by the financial ins t i tu t ions themselves. Conversely, i f investment o r production in a branch i s too high, a ceiling can be s e t t o new or outstanding credits to the particular branch; but the individual inst i tut ions would themselves decide how to dis tr ibute credits within the ceiling.

125. Selective credi t con+zols are very l i t t l e used i n India. Apart f r m some ru les governing advances against inventories of specific, agricul- tura l comtnodities introduced i n 196b, credit management is almost purely global; no distinction is made among aims and sectors (except for the specially favorable conditions for loans to agricul tural cooperatives). Selectivity i s f e l t to be the province of physical controls. Whatever is authorized by these, i s legitimate from the point of view of the monetary authorities. &/ There is a strong relationship between medium and long-term finance ins t i tu t ions and the licensing authorities; but it is one of complete subordination of the former to the l a t t e r . Foreign exchange loans are the crucial matter; none can be granted without the specific authorization of the Government; very seldom a re they refused outright to firms which have this authorization. An altogether different relationship is being proposed here; the Government should issue a p r i o r i directives concerning specific sectors, but l e t the financial ins t i tu t ions examine the actual investment projects and make the i r lending decisions within the framework of tha t policy.

126. Selective credi t controls work most easi ly when money i s generally tight; then selective untightening i n favor of privileged sectors has the desired effect. On the contrary, investment can be oriented through selective

1/ Some sector-wise select ivi ty was included i n the credi t control package announced i n November 1965. *

interdict ions by licensing only i f the moneL&ry si tuat ion i s generally easy. In the past, the monetary s i tuat ion i n India has been on the whole rather easy. Frequently firms resorted t o I C I C I or IFC solely because they desired foreign exchange, and had no r e a l need t o borrow. Monetary policy has progressively been tightened during the pas t months, thus giving a much greater scope to select ivi ty. The necessary ins t i tu t iona l arrangements already exist ; for instance, instructions could eas i ly be channeled through the Industr ial Development Bank and other public sector banks and f inancial ins t i tu t ions . Summary Recommendations for Controls on Investment

127. A four-tiered system of increasing speci f ic i ty should orient pr ivate investment. Various elements of such n system a l read j ex is t , but are not rea l ly integrated wit:? each other because thejr zl-e d i f f i cu l t t o use i n conjunction r.rith thc present i n d u s t r i ~ l licensing mechanism. 1/ Impera- t ive targets for hrge-scale investments should be implemsnted b? d i rec t agreencnt, n t high levels, between Government a d the rs ln t ive ly few private firms involved i n such projects. Steel, f e r t i l i z e r production, petroleum ref ining and exploration m e the examples tna t come to mind. A t the other ofireme, absolute prohibitions against cer tain types of developments - manufacturing of some luxury items, f o r instance - can be enforced.

128. A t the lowest leve l of specif ici ty , the Government1 s preferences should be made to bear through t ax incentives. The present types of tax concessions seem to be an adequate tool. In order to permit private investors to make ra t ional calculations, it is essent ial tha t taxation be f a i r l y stable; brusque and frequent variations i n the tax r a t e applicable to given investments should be avoided. Therefore, tax incentives should implement broad preferences, e p e c t e d to be durable. Two or three ra tes can be used, for instance to penalize industries catering t o luxury demands ( i n addition t o more different iated excise taxes), and to favor industries producing indus t r ia l machinery. But t a x measures are ill sui ied for the implementation of plans aiming a t a specif ic industry or a specific location.

129. Therefore, a t the intermediate level of specif ici ty , selective controls on credi t should be re l ied on and managed by means of periodic directives to the Reserve Bank, commercial banks and financial inst i tut ions. There is no prac t ica l obstacle to these measures being as f ine ly shaded and different iated as the Plan i t s e l f requires and permits, and varied as frequently as appears desirable.

Chapter 9 - Controls on Imports and Scarce Domestic Materials

The Ra,j Committee Report

130. The only comprehensive study of the controls on one current input - as distinguished from the numerous studies on certain administrative

1/ For administrative convenience, the legal requirement for indus t r ia l licens- - ing can be retained, with the understanding tha t licenses w i l l be automatic- a l l y granted except for industries inscribed on a published list.

aspects of controls - is the Report on Steel Control dated October 1963, prepared by a committee headed by Professor K. N. Raj, Chairman of the Economics Department of Delhi University. Although s t e e l controls have the i r own special aspects (including controls on production), on the s ide of the allocation of scarce s t e e l products they work i n a way very similar to controls on imports. The Report considered that the following important social objectives may not be f u l f i l l e d by completely unregulated market a110 ca tions :

(1) The avai labi l i ty on a p r io r i ty basis of s t e e l for I l e s ~ e n t i a l ~ ~ capi tal projects and f o r the current production requirements of Nessentialll units.

(2) The avai labi l i ty of intermediate products, e. g., pig iron and b i l l e t s , t o processors other than the producers of these products (who are l ike ly to prefer processing the whole or most of the available supply i n the i r own plants ) .

(3) The avai labi l i ty of a " fa i r sharen of the supply to the llsmall man".

(4) The " fa i rH regional dis tr ibut ion of scarce supplies.

131. The Report proceeded t o note tha t the f i r s t step must be the determination of essent ia l demands. It proposed tha t a l l s t e e l demands should be divided into: "A. Overriding pr ior i ty demands; B. Pr ior i ty demands; and C. Non-priority demands. d Class demands should consist only of defense needs, B Class demands should cover Lhe demands of basic industries, e.g., coal, s t ee l , o i l , heavy machinery and heavy e lec t r i ca l equipment, f e r t i l i ze r s , agricul tural equipment and machinery, shipbuilding and road transport equipment; and of v i t a l soc ia l overheads... A l l other demands should be treated as C Class demands. - 1/ Prices allowed t o producers should fu l ly cover the i r long-term costs. llWhen f ree market prices are such as to jus t i fy an increase i n f i r s t sa le prices ... but the l a t t e r a re already high enough t o more than cover producerst costs and requirements of replacement and expansion, action may be taken by the Government t o adjust the sa le price realized by producers through imposition of excise duties or other f i s c a l devices ... A f r ee market i n s t e e l i n respect of sales subsequent to the f i r s t s a l e by the main producers should be ... legal ly recognized. Free market prices would r e f l e c t from time t o time the degree of scarc i ty or abundance, i n the market, of different categories of s t e e l and have the normal e f fec t of adjusting - non- p r io r i ty demands to the available non-priority supplies ... 132. "As a general principle, the assignment of p r io r i ty to part icular consumers should not carry with it the implication tha t they w i l l get any kind of price preference. The price charged i n each case w i l l be governed by the same considerations as for others. However, for those users of s t e e l

1/ Report on Steel Control, October 1963, Government of India, Ministry of - Stee l and Heavy Industries, Department of Iron and Steel, page 19.

who, it i s f e l t , should be given a price advantage as well, there should be a system of drawbacks allowed by the Government i n respect of s t e e l direct ly purchased fron the producers or from Government stockyards. The consumers who are to be given the privilege should be carefully determined and on very s t r i c t considerations; the drawbacks should also be allowed only when the actual use of the s t e e l for the purpose asked for has been duly cer t i f ied by an appropriate agency of the Government. Even subsidized s t e e l should not be sold a t prices which are below costs of production; drawbaclts should be permitted only i n regard to the excess of the sa le pr ices charged to consumers over actual costs. I t 1/

133- Although the recommendations of the Raj Committee have been carried out i n pa r t only, the Report was widely discussed i n India and received generally favorable comments. Careful additional consideration should be given to carrying out those recommendations of the Raj Committee which have not yet been implemented. 2/ Many of the recommendations of t h i s Report concerning import control Lave, mutatis mutandis, been inspired by those of the Raj Committee.

The Decontrol of Imports

134. In the f i e l d of s t e e l there was reason t o make a dis t inct ion between p r io r i ty treatment as regards the physical ava i lab i l i ty of the product and favored treatment as regards price. This is because, due to technical considerations on the reset t ing of r o l l s , etc., it i s desirable to provide for a p r io r i ty which ensures the physical ava i lab i l i ty of the needed s t ee l , but does not shield the purchaser from whatever pr ices a re reached on the market. For foreign exchange there can be no problem of physical ava i lab i l i ty d i s t inc t from price problems, but there is some danger tha t unregulated market allocation, were it suddenly reintroduced, would re su l t i n a price too high for ttessentialfl capi tal projects or for current production requirements of t lessentialt t units.

135. The combination of the control system with an a r t i f i c i a l l y appreciated nominal exchange ra t e yields an effective exchange r a t e which, according to the nature of the transaction and whether or not an import l icense can be obtained, varies from b.76 to an i n f i n i t e number of rupees per U.S . dollar. - 3/ Rational calculation is rendered excessively d i f f i c u l t

1/ Report on Steel Control, October 1963, GOI, Ministry of Steel and Heayy - Industries, Department of Iron and Steel, page 26.

2/ The recommendations of the Raj Committee and subsequent action by the - Government a re summarily described i n Appendix 11.

3/ Transactions were actually performed a t ra tes var-ying from R s . 4.76 (e.g. - for food impor-ts, emor ts of spices, and p r o f i t remittances) to about Rs . 17.60 (e. g. for imports of components under the NDRS) per U.S. dollar i n January 1966. Imports of some materials such as s ta in less s t e e l allowed only under a few export promotion schemes, involve an even more unfavorable rate. Most exports get r a t e s varying from R s . 4. 95 - 6.19 (exports benefiting from tax credi t schemes, l i k e tea and jute) to Rs. 7.50 - 10.00 (exports benefiting from import entitlements). *

by t h i s va r i ab i l i t y , but whatever calculations a r e made by large-scale industry (which i s assured of ge t t ing a t l e a s t p a r t of i ts requirements through o f f i c i a l channels) a r e based on the nominal r a t e (corrected only f o r customs dut ies ). 1/ Therefore, the technology b u i l t i n to pas t c ap i t a l forma- t ion, while it is-excessively import-saving i n some instances, i s on the whole excessively import-using. Some aspects of technology can no doubt be adjusted instantaneously when the p r i ce r a t i o changes; bu t not most. I n other terms, i f the e f fec t ive r a t e of exchange is depreciated some demands fo r imports would be given up immediately and replaced by demand f o r domestic materials , but i n most cases immediate adaptation is not possible. Similarly, exports too would adapt only gradually to the stimulus provided by the new ra t e . A t the same time, i f the depreciation i s accompanied by a lowering of the control ba r r i e r , some demands h i ther to excluded from the market would reenter it immediately.

136. By f a r the bes t solut ion would be t o accomodate t h i s addi t ional import demand. This could be done only i f foreign a i d were subs tan t ia l ly increased during the adaptation period. Such an increase i n a i d would absorb much excess i ndus t r i a l capacity and allow f o r a jump i n production; it would f a c i l i t a t e and accelerate the process of adaptation t o the new pol ic ies . Unfortunately, it i s qu i te possible t h a t a su f f i c i en t increase i n a i d w i l l not become available. The path t o be followed, i f such i s the case, w i l l be more arduous. Mainly f o r t h i s reason, more space i s devoted to it i n t h i s report .

137. If the increase i n a i d is not suf f ic ien t , t o t a l imports must be kept down i n the sho r t run. This would probably require a much steeper depreciation of the exchange r a t e than needed in the long run, when import subs t i tu t ion and exports have had time t o r eac t t o the stimulus of the new ra t e . This may take long; what i s required i s not merely time fo r entrepreneurs t o study the new s i t ua t i on and r e a c t t o it, but ult imately a l so an adaptation of the cap i t a l stock t o modified p r i ce r a t i o s . In the meantime, unless a i d makes up f o r the difference, the p r i ce of foreign exchange w i l l have t o remain above the l e v e l su i t ab l e f o r long-term equilibrium.

138. The exchange ra te , which (together with protect ive customs du t i e s ) would equi l ib ra te demand and supply of foreign exchange immediately a f t e r decontrol, may be so depreciated as t o render f inanc ia l ly unat t ract ive and d i f f i c u l t ce r ta in e s sen t i a l investment and production a c t i v i t i e s . I f these a r e j u s t i f i ed by long-term economic considerations they should nevertheless be performed. It i s therefore necessary to reserve t o those sec tors whose rapid development along spec i f i c l i n e s the Government considers 30 form an es sen t i a l p a r t of development s t ra tegy, the foreign exchange (and other scarce resources) they require to f u l f i l l the t a rge t s s e t f o r them. Further- more the resources and the resource-mix used by these sectors should not be determined i n the l i g h t of immediate market p r o f i t a b i l i t y considerations only, bu t ra ther i n the l i g h t of overa l l long-term development s t ra tegy. These two considerations suggest an exchange sys t en under which : (a) foreign exchange required by the p r i o r i t y sec tors i s a l loca ted to tnem on a p r i o r i t y basis and a t an exchange r a t e judged t o be a long-term equilibrium ra t e ; (b) a l l other exchange i s ava i lab le i n a f r e e market a t a f luc tua t ing r a t e determined by short-term market equilibrium.

1/ The acute c r i s i s of l a t e 1965 may have brought about some change i n t h i s . * -

The Determination of the Long-term Equilibrium Exchange Rate

139- The determination of the long-term equilibrium exchange r a t e involves an estimation of future costs and competitive advantages i n India as compared to the r e s t of the world. It is not easy to say how t h i s may be done with any assurance. However, a few points may be noted. Positively a l l effects of decontrol may have worked themselves out only a f t e r several - decades, b u t t h e r e is no need to look so far . After a much shorter time, say about f ive years, the new equilibrium should already have been approached f a i r l y closely so tha t further apprcach to equilibrium w i l l . be marginal.

&G. The concept of equilibrium used i n the expression I1equilibrium exchange r a t e 1 should not be taken to mean equilibrium of the current balance of payments. We assume that i f India is t o develop a t a l l , foreign a id or capital inflow is needed and w i l l be needed fo r a long time to fill the short-fall of realizable domestic savings re la t ive to desirable domestic investment. However, with present prices, exchange rates , and technolow, the short-fal l of India's own foreign exchange earnings from the level of desired imports i s much larger than what is made up by foreign aid. The equality is a t present re-established by means of physical controls. The equilibrium r a t e of exchange would re-establish the equality without such controls, but not without the maintenance of foreign aid.

The Short-term Equilibrium Exchange Rate

l-41. India disposes of several types of heterogeneous foreign exchange. Bilateral loans and credi t l ines are t i ed to purchases i n the creditor country and frequently also to specif ic categories of goods. Some of these funds are scarcer than others. F'ree foreign exchange usable anywhere, and foreign exchange usable i n most Western European countries and i n Japan, i s considered to be the scarcest. Mainly because of the s ize of United States aid, and the accustomed sources of supply, funds t i e d to purchases i n the United States are, a t the margin, generally l e s s desirable. - 1/ Funds usable for purchases i n &stern Europe are the l e a s t sought af ter . A t the o f f i c i a l cross r a t es of exchange the desire for purchases i n each country does not match exactly the avai labi l i ty of t i ed funds. Because of th is heterogeneity and inconvertibili- t y of foreign exchange resources, a uniform exchange rate , whether fixed or fluctuating, would not be completely suitable to the Indian situation. A t present, the controls ensure roughly the u t i l iza t ion of each category of available funds. I f the controls were greatly eased and a single depreciated ra te , respecting the o f f i c i a l cross ra tes of exchange, were introduced, then f ree foreign exchange would tend to disappear while funds t i ed to purc;.rases i n the United States and Eastern Europe were s t i l l available.

l.42. The combination of an absence of controls and a single s table exchange ra te is a mechanism designed to deal with generalized convertibili ty of foreign exchange resources, and i s unsuitable to widespread inconvertibil-

1/ One ef fec t of the temporary suspension of U.S. a id i n l a t e 1965 was - that, for a time, funds t i ed to purchases i n the United States became as scarce as f r ee foreign exchange. .#.

i ty . A s long as country-tied a id and b i l a t e ra l trade provide a substantial portion of India's foreign exchange, some form of allocation m u s t be maintained or some system of multiple exchange ra tes must be used.

a30 It would be possible to limit decontrol to transactions in the most abundant currencies, i.e., allow freely imports from Eastern Europe and perhaps from the United States and maintain licensing for imports from Western Europe and Japan. This i s similar to the practice of intra-European trade l iberal izat ion followed a f t e r the w a r . This may well reduce the wastes involved i n the present system.

L!h . A th i rd solution would consist i n allowing f ree markets to be established i n each of the separate types of funds with varying scarci t ies . A mult ipl ici ty of cross r a t es might, hot~ever, not be considered favorably by creditors, trade partners and international monetary inst i tut ions. 1/ Licenses for categories of transactions - including country-tied imports - dzscribed as broadly as possible, could be sold by the Exchange Control Authority without affecting the nominal cross ra tes of exchange. The licenses could be sold i n a free market, fo r instance the stock exchange (as i n ~ a k i s t a n ) , and equilib- r i u m prices could be f ree ly determined fo r each category of licenses. The t o t a l foreign exchange value of licenses to be sold during each period could be determined from time to time i n an exercise similar to the Foreign Exchange Budget. It would of course be desirable to improve on the present procedures fo r elaborating the Foreign Exchange Budget, so tha t it could estimate with greater accuracy the quantit ies of each type of foreign exchange l ike ly to be available during future periods.

1115 I f so desired, the system could be introduced gradually, a f t e r the devaluation of the general effective r a t e of the rupee which would be a l l tha t is required a s f a r as the "strategicu sectors of the economy are concerned. This devaluation could take the form of a general uniform import surcharge o r licensing fee, or of a change i n the registered par value. Quantitative controls rcrould be maintained temporarily, but controlled allocations would be cut, and licenses for the amounts thus rendered available sold i n the f ree market. In addition, import entitlements would also be given to exporters and sold by them. By gradually enlarging the area of the f r e e market, the most violent type of fluctuations could be avoided and serious misallocations could be corrected. It i s essent ial tha t the operation should fcllow a predetermined published schedule, i n order to avoid generating the wrong kind of expectations and speculations . Capital Goods Imports: A Specj-a1 Case

llr6. A t present foreign exchange usable f o r capital goods purchases is less scarce than completely f ree foreign exchange. Consequently capital-tied

1/ One may note, however, that, e.g. i n Afghanistan most importers have to - purchase foreign exchange on a f r ee market where the r a t e i n recent months was about Afs. 75 per dollar equivalent for convertible currencies and Afs. 55 per dol lar equivalent for b i l a t e r a l currencies, as against the o f f i c i a l r a t e of Afs. 45 per dollar.

funds are allocated through special schemes and l e s s stringent controls. I f imports are decontrolled, the difference i n !;he scarci ty of the two types of foreign exchange funds should be ref lected i n a difference i n the exchange r a t e s applicable to the two types of transactions.

l47. However, applying different r a t e s to capi tal goods imports and current imports would perpetuate serious s t ruc tura l distortions, part icular ly a bias against manufacturing capi tal goods and i n favor of importing them, created by the easier avai labi l i ty of project a id f c r capitdl goods i w o r t s . This dis tor t ion could be removed i f aid-givers made a larger proportion of the i r credits usable fo r whatever purpose they are required. lrlhile the country-tying of credi ts may be considered to be, i n some sense, i n the in te res t of the aid-givers by protecting them against balance of payments d i f f icu l t ies , the tying 02 a i d to purchases of capi ta l goods (and to projects) does not seem t o provide to aid-giver any advantage, potent ial or actual.

l48. Project-tying of a id is largely a reaction against the practice of the 1920's and ea r l i e r periods, when loans were f ree ly usable but were often wasted. It may well be more useful to t r y and ensure good u t i l iza t ion of foreign a id by seeking agreement with regard to the overall development program. But even i f it is desired to continue to finance part icular projects, it should be possible also to finance the domestic costs of such projects, or a t l e a s t the i r indirect import costs, and thereby to provide f ree foreign exchange. The World Bank group has already proceeded to some extent i n this direction. If b i l a t e r a l aid-givers desire to continue country- tying, reimbursements for costs incurred on a specif ic project might be credited to a special b i l a t e r a l account, usable to finance a specif ic percentage of a l l imports from the creditor country.

Jh9. There is also some belief tha t i f loans a re t o provide capi tal , i n some sense, they have t o finance the importation of capi tal goods. T h i s lacks any foundation. The net d e f i c i t of the balance of payments, financed by foreign a id and credits, i s equal to the shor t f a l l of realized domestic savings from domestic investment. But th i s shor t f a l l need not correspond to a shor t fa l l of the domestic capi tal goods producing industries from the requirements of the investment program; i f the country has a comparative advantage i n machinery production, it may even be a large net exporter of machinery, and its savings gap may be translated into a d e f i c i t of, say, foodgrains o r indus t r ia l raw materials.

150. Although there is necessary ex post equality between the balance of payments gap and the savings gap, a different ex ante explanation may be more relevant to India's problems i n the short run. Depending on a country's resource endowments, the stage of development it has reached and the exchange ra te , each product has a cer tain import content. A t present, the desired t o t a l import content of India's national product i s much greater than the savings gap; the e x post equilibrium i s re-es tablished by means of d i rec t controls. It may well be argued by a id givers that, however annoying it is to India tha t it cannot furnish a l l the import content required by, say, refr igerator manufactures, t h i s is unlikely to hinder greatly i t s development effort . However, the same argument cannot be validly made against import of copper fo r manufacture of e l ec t r i c power equipment. A s long a s the argument

for a id is made along physical import-con%snt l ines, it i s indeed necessary to ensure tha t pr ior i ty i s given t o the ac t iv i t i e s considered indispensable for development. Beyond that, a l l imports contributing t o national product should be treated equally, except for discrimination against imports for luxury purposes. What constitutes luxury for a given country needs t o be defined with some care jointly by the donors and receivers of aid.

151. I f the creditors remove the need f o r a special treatment of capi tal goods imports, the same exchange r a t e should be applicable to capi tal goods purchases and other imports. The sharp dist inct ion between investment w i t h imported capi tal goods, and investment with indigenous goods with perhaps the same net import content would then disappear.

Direct Private Investment

152. Most private foreign investment i n India involves the direct importation of foreign goods financed by the investor; there is a transfer of goods but no transfer of money. Direct investment gives r i s e t o subsequent repatr iat ion of profi ts . The ra te a t which p ro f i t s are converted into foreign exchange must be the same as the one measuring the original contribution of d i rec t investment t o the econony. If i n India the price of a dol lar 's worth of goods imported by an investor i s 10 rupees and i f direct foreign investment yields a p ro f i t r a t e of, say, 25%, a dollar d i rec t investment yields an annual p ro f i t of 2.5 rupees. I f this p ro f i t were repatriated a t the o f f i c i a l exchange r a t e of R s . 4.76 per U.S. dollar, th i s would be more than 5% annually. Converting foreign exchange into rupees a t the present scarci ty exchange r a t e by importing goods into India and reconverting the gains a t the o f f i c i a l exchange rate , yields an exorbitant prof i t . The Indian controllers a re conscious of this , and th i s is one reason why they i n s i s t on submitting d i rec t foreign investment t o a ser ies of checks, examinations and supervisions which are so r ight ly exasperating foreign investors.

153. The r a t e fixed for conversion of rupees earned i n India into foreign exchange should consequently 5e the short-term market-determined equilibrium r a t e which measures the immediate scarci ty value of new foreign investments t o the econon2y. I f the short-term equilibrium r a t e is expected to improve i n the future, t h i s w i l l provide an inducement for reinvestment of profi ts . There needs to be no exception from th i s rate , except i n favor of the "strategicn sectors, where foreign investment, l i k e other important ac t iv i t i e s , will remain subject to more d i rec t Government supervision. In general, with such a rate, imports of capi tal goods direct ly financed by foreign collaborators need not be subject t o direct controls a t a l l .

Invisibles

154. There can be no doubt that some di rec t control on invisible movements must be maintained. The expatriation o f capi tal must certainly be

1/ According to some estimates i n 1963/64 d i rec t private investment taking - the form of the d i rec t importation of goods financed by the investor, amounted to about Rs. 23 crores. Indials balance of payments accounts do not normally re f l ec t t h i s type of foreign investment nor the imports financed by i t .

forbidden a s a general rule , and t h i s involves the naintenance of exchange controls on a l l inv is ib les , and indeed even on v i s ib l e trade, inasmuch a s the repa t r ia t ion of export proceeds and the conformity of import payments to the ac tua l value of imports a r e to be ver i f ied. Some inv is ib les may be severely r e s t r i c t e d fo r reasons s imilar t o the banning of luxury imports. Thus, pleasure t r i p s abroad may wel l continue to be forbidden f o r a long time t o come. It may even be a l so desirable t o ban the payment of cer ta in types of royal t ies . Nevertheless, it i s important t o decide a t what p r ice the authorized transactions a r e t o be se t t l ed . In general, there seems t o be no reason t o d i f f e r en t i a t e between authorized inv is ib le payments, such as royal- t y payments, p r o f i t remittances, debt service, etc., and v i s i b l e trade. Consequently the short-term market-determined equilibrium r a t e should apply.

155- Inv is ib le inflows of funds should s imi la r ly be converted a t the short-term equilibrium ra te . This i s not to be done so much i n order t o encourage such inflows a s t o discourage black market transactions. It seems prima f a c i e unlikely tha t , f o r instance, tourism would be grea t ly encouraged by a more favorable exchange rate. However, a be t t e r o f f i c i a l r a t e would reduce the t o u r i s t s ' temptation t o y i e ld t o s t r e e t vendors of rupees. If a depreciation of the effect ive exchange r a t e s is expected t o reduce the t o t a l in take from some transactions because of t h e i r low p r i ce e l a s t i c i t y , t h i s s h o r t f a l l can be compensated, f o r instance, by t a ~ g some of the f a c i l i t i e s used by tou r i s t s so t h a t t h e i r p r i ce should remain constant i n terms of foreign exchange.

Multip?-e Exchange Rates and Possible Distort ions

156. The recommendation of multiple exchange r a t e s aims a t avoiding the most harmful d i s tor t ions , and a t shel ter ing the core of the development plan from disorderly short-term f luctuat ions which -my follow decontrol. However, multiple exchange r a t e s give r i s e t o other dis tor t ions , notably those due t o transactions between sectors or i n goods not having the same exchange ra tes . The main po ten t ia l sources of d i s tor t ions l i e in:

a . A bias within the "s t ra tegic" sectors i n favor of purchases from abroad a s compared to purchases from domestic producers;

b. The possible bias against import subs t i tu t ion i n the cap i t a l goods producing domestic industry, due t o the l e s s depreciated exchange r a t e which may apply t o imports of c a p i t a l goods, i f aid-givers continue unduly to confine the use of a i d to such goods.

157. For a var ie ty of reasons domestic industry may be producing materials needed by the f f s t ra teg ic l l sectors a t pr ices higher than imported equivalents. The excess of the pr ice of such purchases over imports can be compensated by a spec ia l subsidy.

158. A d i f f e ren t type of d i s tor t ion may be due t o the spec i f i c way i n which the composition of the f?s t ra teg icu sectors is defined. There w i l l be a sharp difference between the exchange rate payable by sectors within the scope of the def in i t ion and those outside it, some of which can a l so be, i n

some ways, essent ia l to development. Ifihile some such Sistor t ion i s unavoidable, one has to seek to minimize it. This can be done ei ther by extending the scope of the definition so as t o be quite sure of including a l l sectors i n some sense useful to development, or by re s t r i c t ing it so as t o be cer tain t o include only essent ial sectors. The second solution is favored here.

Customs Duties

159. A t present the average r a t e of customs duties in India i s high. Weighted by a l l imports except those financed by PL &80, it amounted to about 32 percent i n 1963/6&. After the r i s e s i n specif ic duties and the 10 percent regulatory duty imposed in February and April 1965, the present r a t e of duties is probably somewhat above 45 percent (excluding foodgrains), fo r an import b i l l from which inessent ial imports, including most consumer goods, a re eliminated by administrative measures. 1/ A t present, indigenous industry r e l i e s on quantitative r e s t r i c t i o n s and indigenous clearance more than on the t a r i f f t o protect it from foreign competition. The procedure whereby protective duties a re imposed upon advice of the Tariff Commission has been prac t ica l ly i n disuse for the pas t two or three years. Some of the highest duties a re on imports where prac t ica l ly no indigenous production exists , such a s s ta in less s t e e l (120 percent); and copper (about 100 percent). There are, however, industries where indigenous production and imports ex is t side by s ide and i n some cases such imports are subject to very high customs duties.

160. If import controls were l i f t e d the importance of customs duties would greatly increase. The average r a t e of customs duties enters into the effective exchange rate; the present average effective exchange r a t e for imports i s about &S percent 2/ more depreciated than the effective exchange r a t e fo r exports, not taking-into account export subsidies. This excess of import ove? export pr ices enters in to domestic prices, d i rec t ly through the cost of imported materials, and indirect ly, through the prices of domestic materials, which except a s prevented by in terna l competition, can grow to be as high a s the landed price of competitive imports. Production fo r exports is thus both discouraged and rendered d i f f i cu l t . It is t rue tha t exporters are allowed drawbacks of customs duties actually paid. But these give them no compensation for high-priced domestic inputs. In fac t , i f the customs duties are a way of compensating fo r an over-valued currency, the drawbacks of customs duties operate t o induce and subsidize exporters to use imported rather than domestic inputs. I f the present average r a t e of customs duties

1/ Written before the supplementary budget of August 1945. The basic ra tes - of duty, including the regulatory surcharge of 10 percent ad valorem, now stand a t 45 percent for capi ta l goods, 50 percent f o r indus t r ia l raw ma- t e r i a l s , and 70 percent for most processed industr ial materials. The duty on consumer goods i s 110 percent, although most foodstuffs are exempt. The average r a t e of non-food imports may well be i n the neighborhood of 55 percent. The rernarks of th i s section are s t i l l valid. *

2/ Now 55 percent. * -

is retained a f t e r whatever other measures have been taken to come back to equilibrium, the present bias i n the Indian economy against production for exports w i l l pers i s t . L/

161. A dras t ic reduction of customs duties is extremely desirable. 2/ Ideally, a l l duties a t present e e s t i n g should be suppressed and duties Fe- imposed only f o r specif ic reasons, Protective duties may serve to protect industr ies against temporarily higher costs due ei ther t o the re la t ive infancy of the industry i t s e l f or to t h a t of i ts suppliers. Protection may also be given t o industr ies which have grown up behind the present barr iers and cannot adapt instantaneously to the new conditions.

162. It is impossible to d i f ferent ia te a p r io r i between the infants and the misfits; the same r a t e of temporary protection should therefore be given to the two types of industries. This r a t e of protection should be re la t ive ly low, especially as, for some time to come, the short-term equilibrium exchange ra t e w i l l be qui te depreciated and therefore w i l l of i t s e l f discourage imports for which reasonable domestic subst i tutes can be obtained. There is of course another group of duties, basically similar to excise taxes, imposed to penalize the demand for certain luxury or social ly undesirable goods. These can be as high and as permanent as desired.

The Exchange Rate for Exports

163. The problems connected with exports a re consideredin Volume V I I of th i s Report. For reasons analogous to those considered i n paragraph 160, it i s important t o allow decisions concerning production, import substitution, imports and exports to be made i n the l igh t of correct price rat ios . The effective price of foreign exchange paid to exporters must therefore be i n general the same as the effective pr ice of foreign exchange paid by importers. J/

Alternative Solutions

164. It i s qui te clear tha t the control system i s not conducive to ef f ic ient u t i l i za t ion of India's scarce foreign exchange resources. The complex system described above is one possible t ransi t ional means of depar- ture from the existing control system, within the l imitat ion imposed by inadequate and inconvertible a id (or export receipts). Alternatives have been proposed. They a re described below i n a summzry way which does not do then f u l l justice.

1/ Following devaluation, customs duties were lowered to 27.5 percent on raw - materials and capi ta l goods and 50 percent on processed materials. *

2/ E q u a l subsidies to exports, and similar measures f o r invisibles , would - be equivalent to th is .

3/ Special a t tent ion has to be paid to the f a c t that , other things being - equal, measures tending to equilibrate the demand and supply of imports would generally reduce the value of import entitlements, and therefore the effective pr ice of foreign exchange earned by some exporters.

165. One can make different assumptions about the amount of additional a id which will become available, and i t s convertibil i ty. Clearly, i f during the short-run adaptation period such a large volume of untied a id were given t o India tha t it eliminated the special short-run scarcity, the necessity fo r f l u c t ~ ~ a t i n g rates , special crossrates and a sheltered r a t e for the s t ra tegic sectors would be removed.

166. The other major difference concerns the method whereby f l e x i b i l i t y is introduced into the system. Flexibi l i ty , it has been suggested above, may be introduced through a fluctuating effect ive exchange rate. The proposal tha t some sectors be shielded from the f l e x i b i l i t y assumes tha t it is possible to i so la t e a limited number of sectors essent ial to development strategy, and tha t the other sectors can provide the required f l e x i b i l i t y without impeding the progress of the essent ial sectors. I f it is not thought possible to i so la t e essent ia l sectors, or i f it is thought t h a t there are very many of them, no special r a t e should be recommended. F lexib i l i ty may also be introduced through foreign aid. This would, i n any case, be the most desirable solution, i f only one could be certain tha t a suff icient volume of a id would be available. The l a s t element of f l e x i b i l i t y i s provided by the s ize of the development program.

Complete Decontrol and Stable Unitary Rate

167. One al ternat ive proposal would involve v i r t u a l w complete removal of administrative controls over imports and a single depreciated rate. Excise taxes and possibly some import bans would be applied t o res t ra in import (and domestic) demand for non-essentials . Some allocation devices might be retained to deal with the inconvertibil i ty of cer tain funds, but no special rate-wise protection would be given to any sector, however favored it may be from other points of view. A l l would pay the same import prices (and receive the same export prices). The r a t e would be so s e t as to correct the present over-valuation of the rupee and give appropriate and adequate stimulus to export and import substitution. Preferably additional aid i n the near future years would be obtained so tha t imports and a lso national output and expenditure could be expanded.

Depreciated Stable Unitary Rate and Decontrol Limited to Production Materials

168. This proposal is similar to the preceding one but envisages tha t during a t ransi t ional period, demand for consumer and capi tal goods iniports may s t i l l require d i rec t r e s t r a i n t as an al ternat ive to f i s c a l and monetary res t ra in ts . It obviously perpetuates during the t rans i t ional period some consequences of the control system.

Depreciated Stable Unitary Rate and Ihintenance of Controls

169. The basic assumption behind t h i s proposal i s tha t the control mechanism is rendered inoperative only by the large excess demand placed on it by the extremely over-appreciated chzracter of the present exchange rate . Therefore, i f the effective exchange r a t e were to be depreciated considerably, the control mechanism would be rendered capable of operating with an acceptable efficiency. T h i s solution i s similar to the preceding proposal, i n

assuming t h a t the pers is tence of the control mechanism w i l l not prevent the emergence of a r a t i ona l pa t te rn of demand f o r current production materials and the development of eff ic iency i n production.

170. These a l te rna t ives d i f f e r markedly from each other and from the one described i n greater d e t a i l over the previous pages. Each - except the l a s t one described in paragraph 169 - would probably represent a subs tan t ia l s tep forward. Yet, they place a great burden on obtaining the r i g h t amount of a id , and on f inding the r i g h t measure of devaluation. A subs tan t ia l short- f a l l on e i t he r account could lead t o a forced choice between an in to le rab le cut i n investment and re-imposition of administrat ive controls. They a l so assume t h a t controls maintained fo r the purpose of dealing with the incon- v e r t i b i l i t y of a i d funds have fewer ill e f f ec t s than f l oa t i ng cross-rates. The combination described i n detail in the preceding sect ions a l so involves r i sks ; bu t if an adequate volume of a i d were i n f a c t forthcoming, and i f it had a su f f i c i en t conver t ib i l i ty t o allow the equilibrium of permissible imports and desired imports a t the new bas ic exchange ra te , there would be no premium for import entitlements; the f r e e l y f l oa t i ng multiple rate would i n f a c t be equivalent t o a s t ab l e uniform ra te .

Objections t o Decontrol

171. To some, decontrol i t s e l f appears objectionable because of a dis- t r u s t of the market mechanism f o r achieving a l locat ions corresponding to s o c i a l p r i o r i t i e s . The market does indeed s e t p r i o r i t i e s which i n some i n s t a m e s may d i f f e r sharply from those of the Government and the planners. This has no t been contested here. ldhat has been argued is t h a t the adminis- t r a t i v e control mechanism a t l e a s t equally f a i l s to implement the p r i o r i t i e s s e t by the Government, and, i n addition, has serious negative e f f e c t s on output and e f f ic iency which would be avoided i f the system were abandoned. Administrative inef f ic ienc ies , the cont ro l le r s ' very inadequate knowledge of the economy and black rnarket flows a r e a l l p a r t l y responsible f o r this. How- ever, no conceivable administrative improvements could transform the f u l l physical a l loca t ion of production materials i n to an e f fec t ive way of implementing the soc i a l p r i o r i t i e s s e t f o r the development of the economy o r of fos ter- ing the increased and more e f f i c i e n t production so desperately needed. A s was of ten s t ressed i n this report , physical controls a r e a su i t ab l e instrument only f o r implementing feasible , precise, quant i t a t ive targets . By the nature of things, there can not be very many such ta rge t s even i n economies planned i n much greater d e t a i l than t h a t of India. Beyond the implementation of p rec i se t a rge t s , physical controls a c t u a w i n h i b i t the use of the more general measures which alone a r e su i t ab l e to the furtherance of the more general types of aims.

172. Another s e t of objections is addressed not t o decontrol bu t t o the r i s e in the e f fec t ive rupee pr ice of impor* which is i ts corollary. It i s feared that this would r e s u l t i n widespread r i s e s i n the p r i ce s of final products, and a rise i n the general p r ice level .

17 3. A r i s e i n the pr ice of ce r ta in f i n a l products proportional to t h e i r import content should not be unwelcome. Such a change in r e l a t i v e pr ices i s important and desi rable t o r a t i ona l i ze the composition of imports and the

assuming tha t the persistence of the control mechanism p s i 1 1 not prevent the emergence of a ra t ional pattern of demand for current production materials and the development of efficiency i n production.

170. These al ternat ives d i f f e r markedly from each other and from the one described in greater d e t a i l over the previous pages. Each - except the last one described in paragraph 169 - would probably represent a substantial step forward. Yet, they place a great burden on obtaining the r i g h t amount of aid, and on finding the r i g h t measure of devaluation. A substantial short- f a l l on ei ther account could lead to a forced choice between an intolerable cut i n investment and re-imposition of administrative controls. They also assume tha t controls maintained for the purpose of dealing with the incon- v e r t i b i l i t y of a id funds have fewer ill effects than f loat ing cross-rates. The combination described i n d e t a i l i n the preceding sections also involves r isks; but i f an adequate volume of a i d were i n f a c t forthcoming, and i f it had a suff icient convert ibi l i ty to allow the equilibrium of permissible imports and desired imports a t the new basic exchange rate , there would be no premium for import entitlements; +he f r ee ly f loat ing multiple r a t e would i n f a c t be equivalent t o a s table uniform rate .

Objections to Decontrol

171. To some, decontrol i t s e l f appears objectionable because of a dis- t r u s t of the market mechanism for achieving allocations corresponding to socia l pr ior i t ies . The market does indeed s e t p r io r i t i e s which i n some instances may d i f f e r sharply from those of the Government and the planners. This has not been contested here. 'What has been argued is tha t the adminis- t r a t ive control mechanism a t l e a s t equally f a i l s to implement the p r io r i t i e s s e t by the Government, and, i n addition, has serious negative ef fec ts on output and efficiency which would be avoided i f the system were abandoned. Administrative inefficiencies, the controllers1 very inadequate knowledge of the economy and black market flows are a l l par t ly responsible for this . How- ever, no conceivable administrative improvements could transform the f u l l physical allocation of production materials into an effective way of implementing the soc ia l p r i o r i t i e s s e t fo r the development of the economy or of fostering the increased and more ef f ic ient production so desperately needed. A s was often stressed i n th i s report, physical controls a re a sui table instrument only for implementing feasible, precise, quantitative targets. By the nature of things, there can not be very many such targets even in economies planned i n much greater d e t a i l than tha t of India. Beyond the implementation of precise targets, physical controls actual ly inh ib i t the use of the more general measures which alone are sui table to the furtherance of the more general types of aims.

172. Another s e t of objections is addressed not to decontrol but to the r i s e in the effective rupee price of imports which is its corollary. It i s feared t h a t this would re su l t i n widespread r i s e s in the prices of f i n a l products, and a r i s e i n the general price level.

173. A r i s e i n the price of cer tain f i n a l products proportional to the i r import content should not be unwelcome. Such a change in r e l a t ive prices is important and desirable to rat ional ize the composition of imports and the

structure of production. But i n the case of India, there is no reason to believe tha t widespread price r i s e s need follow decontrol.

174. In those few branches where product-prices are effect ively con- t ro l led a t present and supply is short of demand, decontrol would be followed by a r i s e i n prices. Yet the actual prices charged fo r such products i n present transactions are often closer to ref lect ing the i r scarci ty values than the i r o f f i c i a l prices. Even when t h i s i s not the case, the purchase of a controlled-price item often represents an unjus3ifiable p r o f i t accruing t o privileged consumers - as when motorcars a re purchased a t controlled prices and e i ther resold immediately a t a huge prof i t , or resold a f t e r several years a t the purchase price. Independently from decantrol elsewhere, equilibrium should be re-established i n these branches by excise taxes, or select ive duties on scarce inputs. The method adopted for disposing of foreign cars sold i n India through periodic auctions of the State Trading Corporation seems in f in i t e ly more sensible than the controls on domestic car prices and the accompanying long queues, flourishing black markets, and accusations of favoritism and profiteering against those ent i t led to by-pass the queues.

175 Neglecting these branches, and also neglecting black market flows, i n a l l other sectors supply is largely determined by the level of foreign exchange allocated to each sector, and the r e l a t ive efficiency of each firm i n u t i l i z ing the foreign exchange suballocated to it. A t present, there is i n general equilibrium i n the product markets, where the prices r e f l ec t t h i s level of supply. A s has been stressed ear l ie r , the difference between controlled input pr ice and equilibrium product pr ice is ref lected by very high gross p r o f i t margins, accompanied by high average costs due t o the low level of operations and other inefficiencies. Assuming no change i n the intra-sectoral and inter-sectoral allocation of foreign exchange a f t e r decontrol, t o t a l supply and i ts composition w i l l remain unchanged too and product prices w i l l have no reason to r i se . In fac t , however, intra-sectoral allocation w i l l change to the benefit of the more ef f ic ient firms; t h i s w i l l increase t o t a l supply and exercise a downtiard pressure on prices. Inter- sec tora l allocation i s l ike ly to change too, i n response to marketpressures. This w i l l r e s u l t i n an increase i n allocations to some sectors and i n supply by them, and the converse elsewhere. Prices w i l l tend to reac t accordingly. Relative prices w i l l change, but there is no reason t o expect t h i s to lead to an increase i n the absolute pr ice level. Of course, efficiency w i l l improve, both i n the physical sense of a lower foreign exchange input/physical output r a t io , and i n the sense of a l is t of f i n a l products corresponding more closely to the pat tern of f i n a l demand.

176. The above analysis was conducted i n p a r t i a l equilibrium t e r m s . General equilibrium analysis w i l l have to take in to account the Reserve Bank's higher rupee intake from importers, and higher rupee payments to exporters. I f a l l exporters ge t the same r a t e as importers, t h i s would have a s l igh t ly inf lat ionary impact, fo r Government imports account for more than the t o t a l trade def ic i t . However, a l e s s favorable r a t e is l ike ly to be granted to the eAxporters of a few staple agricul tural goods. - 1/ 1/ It is t o be noted tha t pr ices have been r i s ing qui te rapidly before de- -

valuation i n June 1966. Devaluation, by i t s e l f , cannot be expected to a r res t t h i s trend. *

177 iLn objection which i s r a r e ly made exp l i c i t l y r e l a t e s t o the very desired e f f ec t s of decontrol. Increase i n ove ra l l eff ic iency may mean grea t economic hardship t o the l e a s t e f f i c i e n t producers. When these a r e small a r t i sans , o r when they a r e important employers of unskil led labor, this means grea t soc i a l hardship. The re-employment of unskil led labor of ten creates g rea t s o c i a l problems i n r i c h countries, too; i n India, where employed workers earn the equivalent of $20 per month ( a t t he present exchange r a t e ) , unemploy- ment can quickly lead t o quasi-starvation. The f a c t t h a t eff ic iency elsewhere i n the econow has increased, has l i t t l e bearing on such extreme misery. Special open subsidies should be provided t o a t tenuate ce r ta in hardships; t h e i r cost t o soc ie ty would be smaller than t he gain from the more e f f i c i e n t u t i l i z a t i o n of foreign exchange. Adaptation would a l so be grea t ly f a c i l i t a t e d - and therefore res is tance t o the reforms more ea s i l y overcome - i f a i d t o India were increased, a t l e a s t temporarily, thereby allowing an immediate step-up i n the r a t e of economic ac t iv i ty .

178. A more ser ious var ian t to t h i s objection says t h a t excess capacity i s only temporary, and there w i l l be need f o r t h i s cap i t a l in the future. Controls a r e a way of preventing competition due t o excess capacity from leading t o the wasteful scrapping of physical capi ta l . Tkis argument over- looks the waste of scarce resources involved i n t h i s procedure; it assumes t h a t t h e existence and modus operandi of the control mechanism do not con- t r i b u t e t o the s ca rc i t y of foreign exchange. This is wrong. The argument a l so assumes that fu ture c a p i t a l needs correspond t o the present s t ruc ture of the cap i t a l stock. This i s not necessar i ly so, because present cap i ta l has been created p a r t l y i n response to the d i s to r t ions of the control system. In par t i cu la r , the building up of excess capacity w a s not due so le ly to a once-and f o r a l l miscalculation; the control system great ly contributed, and continues to contribute, t o it. The physical preservation of cap i t a l i n temporary surplus can, and should, be ensured, bu t this can be done a t a lover cost and with greater precision through other means, notably se lec t ive c r ed i t controls.

Concluding Remarks

179. The diagnosis of the i l ls of the present control system as presented i n t h i s Report is generally admitted t o be f a i r l y accurate. There a r e disagreements about the proposed solut ions which go from the advocacy, by many i n India, of mere administrat ive improvements on the working of the control system, t o proposals of a prodigious auto-da-fe of a l l controls and unorthodox measures. Host of these solut ions have t h e i r advantages; a l l of them, including the one out l ined i n some d e t a i l above, have t h e i r drawbacks. I n an economy which i s not per fec t ly f l ex ib l e - and while none is, India i s probably fur ther from per fec t f l e l d b i l i t y than many others - there is no per fec t and easy way leading from extreme disequilibrium t o the desired equilibrium path.

1 -. ?hc primary respons ib i l i ty f o r conpiling Ind ia s Balance af P a p e n t s r e s t s with t h e Rescrve Bank of India . For t h e f i r s t t i n e i n 1905 t ~ o other types of Balance oZ i3ay:aents t ab l e s were published. However, t h e primary data on which the7 a r e based a r e i n both cases plainly compiled by t he Reserve fianl:.

2. Inpor t f i gu re s i n t he Balance of Payments a r e based on exchange control data . I n the f irst a?proxii.~lation imports a r c recorded o n v a s and w!m~ pa;rment,s f o r then a r e made. Thus, goods financed by suppl ie r s r c r e d i t s a r e recoraec~ only a s and when the several i n s t a l l i ~ e n t s on this debt a r e s e t t l ed . The dzbt i t s e l f i s not recorded a t a l l . Ici2orts of" cap i t a l goods financed by d i r ec t investment by foreign f i n a s a r e not recorded e i ther . An exception i s made t o this r u l e i n favor of iinports financed by o f f i c i a l fore ign a id , recorded by t h e Reserve Bank on t he bas i s af periodic repor ts by t he rec ip ien t agencies. There seems t o be very considerable delay i n recording these i t e n s ; this r e s u l t s i n an understatenext both o.f imports and foreign a id u t i l i z a t i o n . l / Exports a r e recorded on t h e basis of exchange control data on a c t u a l ~ ~ ~ ? n e n t s , not on t h e ba s i s of pay~rients.

3 . I n t he i r p o r t c01ui:in no d i s t i nc t i on i s ;;lade between PL 480 imports and other inlports. PL 480 i;.iports a r e recorded together with other inpor t s . The corresponding pa~ i~ i en t of rupees t o the spec ia l account of t he United S ta tes Goverrilen-t held with t h e Reserve Bank of India i s recorded i n t he Balance oi' Fa:jmlent s a s an inflow of i~miscellaneous cap i ta l s1 . ?!hen, l a t e r , azreeixents a r e reached alith t h e United S t a t e s on the use t o be made or" these counterpart Tunds, they are , a s and when used, debited .to miscellaneous c a p i t a l and credi ted t o "1oai-l~" ( c a p i t a l account ) or Lo '!Governrfient donationstt ( current account i n v i s i b l e s j a s t he zase may be. Inasmuch a s t he funds a r e used t o cover Local expenditures of t he Unite3 Stz-tes Zii:bassy t h i s i s rendered Qr creti l- t l i~z t h e account "Govern1;lent not lnclitded else~p~here". DLF rupee loans a r e t rea ted i n a s imilar way. 3ervi ce of the nonconvertible loans i s s i i i ~ i l a r l ~ , ~ recorijed a s i n v i s i b l e paj-ents or investnent incoce and a s o f f i c i a l debt a:nortization, balanced by c red i t s on ::;i~cellaneous c a p i t a l account.

4. The records a r e fu r the r conipllcat;~c; by di f ferences i n tillling and t h e eccen t r i c i t i e s of various accounting procedures. Thus, when the inpor t i s phjrsically rmde India paurs t he ac tua l to1;al I'reidht cost o ~ t of her own foreign cxchan;e rese=es. This operation i s recorded by :he Reserve Bznk a s a debit t o t h e CIF cost of iniports and an equivalent c r ed i t t o "foreign exchange reserv?sIz. Hall the t o t a l t o mi...;c has t o be transported i n American

1/ ,Thus, i n tile Balance of Payments f o r the year ended i n idarch 31, 1964, - published i n February 1965 i n tha Zconcmic Survey, 1964-65, contains an a id figure about 400 biillLon R s . l m e r than t he External Assistance stateillents i n Appendix 7 of the sarne publ icat ioc .

bottorns which have a b n o r ~ a l u high f r e i g h t r a t e s ; the f r e i ~ h t d i f f e r e n t i a l i s subsequently r e i ~ ~ ~ b u r s e d by the United S t a t e s a s a s t r a i g l ~ t grant. This reimburse,.lent i s recorded by the Reserve Bank a s a debit t o "foreign excllarlge reserves" and a corresponding c r ed i t t o t he current account item llGovernment not included elsewhere". F i f t y percent of the remainder of the t o t a l f r e i g h t cost i s t o be borne f u l l y by India. The do l la r cost of the other 53 percent i s reiribursed ,to her b,; t he United S t a t e s upon payment by India of an equivalent amount i n rupees i n t o the United S t a t e s counterpart account with t he Reserve Bank. This operation i s recorded a s a debi t t o t h e t rade account, i .e., an addit ion t o t he CIF cos t of inports, compensated by a c r ed i t t o ~lrniscellaneous capital1 ' , and a c red i t t o IIGovernment not included elseip~herel~, balanced by a debi t t o "foreign exchange reservesI1. A s a r e s u l t of these operations, t h e p a r t of f r e i g h t on PL 480 imports which i s reimbursed by t h e United S ta tes against a counterpart payment i n inconvertible rupees i s included twice i n t he import account. This i s not a small item;' it anocnted t o R s . 263 r k l l i o n in 1~63/64.

5 4 ' he treatment ~f PL 480 i s soine~~hat revealing of t he Reserve Sank's

conception of tile r o l e 02 the Balance of Payments. The formal s ide of operations - f o r ins tance the f a c t t ha t the United S ta tes Government i s the nominal owner of t he counterpart funds - i s considered more important than t he f a c t t h a t these swis a r e not convertible i n t o foreign exchange and theref ore do not cons t i tu te a short-tern foreign l i a b i l i t y colilparable with debts t o foreign banks or with t he clearin2 debts incurred on account of t rade under b i l a t e r a l payment agreei,lents. The treatment of PL 480 very largely obscures t he significance of movelnents witlrin the c a p i t a l accounts . The treatrrlent of tcansport costs i s even nore aberrant. An iten1 of t ransport cost ,which i s i n f a c t f u l l y borne by t h e United S t a t e s Governrcent,figures twice i n t he t o t a l of Indian imports. The only explanat'ion t he Iiission got frokl t h e Reserve Bank f o r this curious procedure was t h a t it resu l ted from !!administrative arrangements1! between the Government of India and the United S ta tes Gcvelniient which were beyond the scope of t he Reserve Bank t o control . The handbook on ':Iildia s Balance of Fayment s, 1948/49 t o 1961/62 compiled by t h e Reserve Bank of India i n 1963, a f t e r explaining the procedure ac tua l ly followed s t a t e s t h a t t h i s procedure i s incorrect but "for want of adequate de t a i l s , ho~~nver , the present procedure has been continued, e s p e c i a l b a s tlie net e f fec t I s t h e same i r respec t ive of how the t ransact ions a r e enteredar!l / O f course, whatever items a r e debited i n whatever manner the "net e f fec t Ts the same1! provided tha t the sorresponding c r ed i t s a r e a l so made. - 2/

6. The PL 486 acsounts thus t r a n s i t through a number of cap i t a l and current accounts i n varying and somet~hat qyster ious quant i t i es and render t he reading of these accounts extremely d i f f i c u l t . kn addi t ional d i f f i cu l ty r e s u l t s from t h e inclusion of t h s movements i n Ind i a ' s b i l a t e r a l clearing balances under ~lr iscel laneous capital1! and not under I1f oreign exchange reserves" For this reason, and i n t h e absence of a deta i led icnot~ledge of trade, inv is i -

1/ Indials Balnncc of Paymcnts 191r8/b9 t o 1961/62, Bombay 1963, page 16. - 2/ This doublc counting setms t o havt bccn stopped ear ly i n 1966. Also thc -

United S ta tes no longer accepts paynent i n rupees f o r half of the cost of f r c igh t on PL LBO. i+

bles, and capital movements, including a id and the amor5ization of credits, between India and h ~ r b i b t e r z l trade partners, it is impossible t o arr ive a t a rcconciliation of the detailed published figures with the changes in foreign exchange reserves. Thus, while one can see tha t factors included i n "errors and omissionsll, i n ~lmiscellaneous capital", and i n l t invisiblesll have contributed strongly to the pas t year's foreign exchange losses, one can only d w v suspect tha t there is more to the s tory than short-term se l f - reversing capi ta l movements and lags i n repatr iat ion of export receipts.

7. In early 1965 the Ministry of Finance published two somewhat different but more meaningful Balance of Payments statements, respectively i n the text of the Economic Survey for 1964/65 and i n the Memorandum for the India Consortium 1965.

8. The Survey presentation of the Balance of Payments d i f fers from the Reserve Bank tables mainly by i ts more reasonable treatment of PL 480 imports. The transactions re la t ive to PL 480 a id have been regrouped under the heading PL 480, respectively on the current and on the capi tal side. Amortization and in te res t payments on loans repayable i n non-convertible rupees have been eliminated from the Balance of Payments altogether. The double counting of PL 480 freight has been avoided by subtracting the corresponding element from the import figure as shown by the Reserve Bank, and of course also subtracting the equivalent credi t item from the current invisible item llGovernment not included elsewheret1.

9. In the Memorandum to the India Consortium the PL 480 accounts proper have been kept grouped, and rupee debt service was similarly kept out. However, the double counting of a pa r t of f re ight charges on PL 480 imports persis ts ; the total CIF value of PL 480 imports (including the freight d i f ferent ia l due to the higher cost of shipping half the wheat i n American bottoms) i s included under "PL 480" both on the current and the capi ta l side of the table. In addition, the amount reimbursed by the United States against payment of counterpart rupees - about $60 million i n 1963/64, is also included under the item llcornrnercial importsv1. However, t h i s double entry is not balanced by a credi t t o "current invisiblesIr a s i n the Reserve Bank's Balance of Payments tables, but by a credit to "other capi tal trans- actionsl1, which includes I1errors and omission^^^. h o ther conceptual difference between both the Reserve Bank and Survey accounts on the one hand and the accounts presented by the IJIemorandum on the other, i s the inclusion by the Memorandum of an estimate of imports financed by d i rec t private foreign investment under commercial imports" and "private foreign investmentf1 respectively. These estimates are based on sampling studies of foreign collaboration agreements. No ef for t has been made t o corroborate them by confronting the exchange control data thus collected w i t h customs estimates. It i s t rue tha t Indian Balance of Payments data cannot, i n any case, be reconciled with the customs estimates.

10. The only other difference termed conceptual by the Ministry of Finance between the Balance of Paynents i n the Memorandum and tha t prepared by the Reserve Bank, is the treatment of the amortization of the debt owed to Kuwait with respect to the currency re t i red i n 1961. This i s entered i n the Memorandum under item 6(d) "repayment of other foreign

loans t t and i n both t h e Econonic Survey and t h e Reserre Rank's Balance of Payments under t h e i tem "other c a p i t a l t ransact ions ."

11. Correction having been made f o r tilese "conceptual" d i f ferences the re i s s t i l l a considerable discrepancy between t h e d i f f e r e n t Balances o f P a y ~ e n t s . These discrepancies a r e saic! t o be due t o t h e very g rea t delay wj.ti.1 which in fo rna t ion r e l a t i v e t o items such a s debt amortizat ion, a i d disbursements, PL 480 shipments, e tc . , i s incorporated by t h e Reserve Banlc i n t o i t s accounts. For these items t h e Survey a l s o r e l i e s on t h e Reserve Bank, while t h e Memorandum does not. The d i f fe rence i n t h e value o f PL 480 imports, f o r ins tance , amounted t o about 1 0 pe r cent i n 1963/64. There i s a l s o a d i f ference of about 5 p e r cent i n disbursements o f o t h e r fore ign ass i s t ance . The Reserve Bank seems t o record t h e various movexents on t h e b a s i s of prel iminary information and rev i ses these prel iminary accounts only when t h e t r ansac t ions have Seen f i n a l i z e d i n an acco-mting sense. Thus, PL 480 t r ansac t ions i n 1963/64 a r e recorded i n t h e Balance o f Payments t a b l e of t h e Economic Survey on t h e b a s i s of data furnished by t h e Reserve Bank a s having amounted t o Rs.1672 mil l ion , even though t h e same document contains a t a b l e based on data furnished by Government departments i ~ h i c h gives t h e f i g r e of R s ,1851.9 mi l l ion f o r t h e same period.

12. Despite t h e recent e f f o r t s by t h e i5 in is t ry o f Finance t o present a more meaningful Ralance of Payments statement,, t h e e x i s t i n g published accounts do not p ~ r m i t a meaningful ana lys i s of t h e evolution of t h e a c t u a l payments s i t u a t i o n . Some unpublished data conc~rn ing , i n p a r t i c u l a r , payments r s l z t c d t o b i l a t e r a l t r ade agrcemcnts a r e no doubt a v a i l a b l e t o t h e h ighes t policy-makers; y e t even they do probably no t have the da ta required f o r a meaningful ana lys i s of c a p i t a l movements, i n v i s i b l e s , and lcads and lags . This explains why t h e a c t u a l evolution of fo re ign exchange reserves appear s o ~ e t i m e s t o t ake policy-makers by su rpr i se , and why commentary upon t h e s i t u a t i o n i s reduced t o q u a l i t a t i v e statements such a s "the worsening i n t h e reserves pos i t ion was, i n t e r a l i a , due t o l a r g e r exports t o East European countr ies under b i l a t e r a l t r a d e arrangements than t o o t h e r ccun t r i e s , a slight de te r io ra ion i n current i n v i s i b l e s and increased debt servic ing charges . "d It i s t o be noted t h a t t h e f i g u r e s i n c l ~ d e d i n t n e EdIemorandum t o t h e Consortium, o r indeed i n any o the r published Balance of Pa-yments docllrnent do not permit v e r i f i c a t i o n of t h i s statement. I n f a c t , o t h e r dia,goses were 2 1 ~ 0 made publ ic ly , which placed heavy emyhasis on shor t - tern se l f - revers ing fac to r s , such as temporary l a g s i n r e p a t r i a t i o n of export earnings and short-term c a p i t a l nioven~ents i n react ion t o t h e modification of t h e discount r a t e d i f f e r e n t i a l between London and Bombay. These nov appear t o have been a t l e a s t p a r t l y mistaken.

13. I n I n d i a ' s precarious Balance of Paynents s i t u a t i o n no amount of energy d i rec ted toward. t h e preparat ion of more mesninzf-dl, more d e t a i l e d and more up-to-date Balance of Paynents statements, can be too l a rge . Following l a s t y e a r ' s important improvenients, t h e next inost urgent s t e p seems t o be tile prepamtion o f d e t a i l e d i n v i s i b l e and c a p i t a l accounts i n

1' ilenorandum f o r t h e India Consortium 1965, page 57.

which the movements o f PL 480 funds a r e s u i t a b l y segregated, and t h e inclus ion i n a Balance of Payments conceptually s im i l a r t o t h a t presented i n t h e Economic Survey, of t h e est imates o f d i r e c t p r iva te investiient and of t h e more up-to-date information on a i d u t i l i z a t i o n included i n t he Balance of Payments presented i n t h e Memorandum f o r the India Consortium 1965. It i s a l s o des i rab le t h a t information r e l a t i v e t o changes i n t he c lea r ing accounts under b i l a t e r a l t r ade agreements be no longer in tegra ted i n a s ing le account toge ther with c a p i t a l movements of a very d i f fe ren t nature. If reasons of secrecy - which a r e very d i f f i c u l t t o understand&'- prevent t he presenta t ion of these accounts even a s an in tegrz ted s ing le item which ~rou ld hide movements i n t he balances of any s ing le fore ign countzy, some thought should be given t o t h e p o s s i b i l i t y of including these b i l a t e r a l balances together with foreign exchanse reserves i n a s ing le itern ca l l ed , f o r ins tance , "short-term ne t fore ign a s s e t s o f t he banking system." Final ly , it i s important t o prepare, notably a s a check an leads and lags , comparable balance o f payments and customs statements f o r imports and exports.

- -

1' It i s t o be noted t h a t severa l o ther counti,es sometimes re ly ing on b i l a t e r a l arrangements a s heavi ly a s India , do publish t he amount of t h e i r b i l a t e r a l balance.

ILLUSTRATIVE RECONCILIATION OF TRE DIFlrERENT EXISTING FENTATIONS OF INDIA'S BhWNCE OF PAPWENTS IN 1963/6hL

Imports Commercial m-b8o

Presentation of:

I I I I11 Memorandum for the

Reserve Bank of India Consortium India Economic Survey 1965

&ports 801.7 801.7 801.7 Trade balance -m -m f / -m

- 16.5 + 7.L- Invisibles, excluding official lh .8 - 31.3- - 9.1 donations

Errors .and omissions

Private capital (net) - 11.6 of which: gross investments

other

Banking capital (net) - 3.1 - 3.1 - 3.1

Amortization payments (gross) - 58.h + 9.8A1 - 48.6 - 2.05~ - 50.6

1/ Other capital transactions (net) b6.8 - L5.1- a/ 1.7 - 5.1- - 3.b

Official assistance (gross ) 521.7 560.0 599.3 of which: loans - 66.111 7 7 3 +25.d -mz7

donat ions 78.9 - 6 2 . 8 ~ ~ 16.1 - h.3d n.8 n-480 +167.2 167.2 +18.a1 185.2

Transactions vfth MF - 23.8 - 23.8 - 23.8

Change in reserves 10.8 10.8 10.8

a/ Freight on PZ-LBO reimbursed by the United States.

!/ Total of c and d below. C/ i) 28.3 - Freight on PZ-LBO reimbursed by the United States. -

ii) 22.8 - Imports financed by private investment. iii) 21.3 - Counterpart of more accurate aid esthtes by Government departments than

by Reserve Bank (excluding PL-LBO). iv) 1.5 - Imports financed by BOC loan for oil pipeline, not included in Reserve

BPnk estimates. d/ -18.0 - more accurate PL-h80 aid estlnmte by Qovernment departments than by Reserve -

Bank. e/ i) -28.3 - counterpart of item a. -

ii) - 3.0 - net Govement receipts in rupees. f/ i) + 8.3 - India's contribution to Indus fund considered current item by Reserve

Bank, Itother capital11 by Survey tut. ii) - 0.9 - higher payments of interert to WSR. Counterpart of item a. f +22.8 - counterpart of item c(ii).

/ + 1.0 - draual of BOC loan - payment to BOC. I/ + 9.8 - amortization payments on rupee loans. k/ i) - 3.2 - amortization on debt to Kunit Wren out of other capital. -

ii) + 1.2 - difference on other amortization payments. 1/ i) + 3.0 - counterpart of item e(ii). -

ii) - 9.8 - counterpart of item j. iii) + 66.1 - counterpart of item n. iv) + 62.8 -.counterpart of item p. v) -167.2 - counterpart of nsw PL-LBO aid.

?/ Counterpart of f (i) and k(i). j Loans out of rupee funds.

o/ & g/ More accurate estimate of aid disbursement by Oovement departments than by Reserve - Bank.

p/ Grants out of rupee funds. r/ Counterpart of d. -

1_/ Last complete year available.

2/ Figures in Memorandum converted into rupees at the rate of $ 1 million = Rs. .h76 crores. -

S t e e l Control a s seen by t h e Raj Committee

1. Before t h e g a r t i a l iniplernentation of the recommendations of t he Raj Coinmittee, s t e e l con t ro l operated nainly a t 4 points:

( i ) Hegulation of der,iand f o r cliff erent categories of s t e e l .

( l i j Framing of t he production programs of t he main producers and r e r o l l e r s of s t e e l .

(iii) Determination of p r i ce s f o r the d i f f e r en t categor ies of s t e e l .

1/ ( i v ) Nomination of wholesale and r e t a i l azencies f o r d i s t r i b u t i o w . 2 . Several agencies intervened i n t he administrat ion of s t e e l control . The so-called retentiori p r i ce s allawed t o producers f o r each category of s t e e l were f ixed by the ~.iinistyjr of S t e e l and Heavy Indus t r i es on t h e recommendations of the Tariff Commission. The ce i l i ngs on imports of s t e e l were s e t by t h e 1.Iinistr.p af Finance through fore ign exchan~e a l loca t ions and t he 1"linistry of S t e e l Ldistributed quotas f o r " ~ n r e l a x e d : ~ categor ies of indizenous s t e e l t o the various t echn ica l sponsorin2 au tho r i t i e s . A l l other control operations were normally administered by t h e Office of the I ron and S t e e l Controller i n Calcutta. "Essential ly the funct ion of t h e I ron and S t e e l Cvntroller i s t o ensure t h a t the r o l l i n g Frograms o.f the producers achieve t h e maximtun u t i l i z a - t i on of p lan t capacity, and a t t he szizne time conform a s c losely a s possible, given t he t echn ica l const ra ints , t o t h e pa t t e rn of deinand f o r s t e e l ; and mora pa r t i cu l a r l y t h a t t h e producers give due p r i o r i t y t o the r e q ~ i r e ~ ~ i e n t s considered important fro;;? the na t iona l point of view. To prevent accumulation of backlobs on t he order books of t he producers and t h e resu l t ing delays i n delivery of s t e e l , t h e Controller i s a l s o expected t o cut deinands t o t h e extent required by su i t ab l e a d ~ i n i s t r a t i v e measures. Further, t he Controller i s expected t o enforce the s ta tu tory p ~ i c e control ." - 2/

3 A l l orders f o r s t e e l vere routed through t h e Office of t he I ron and S t e e l Controll.er who "plannedtt them on t h e various producers, taking i n t o account technical const ra ints on t he i r r o l l i n g programs. Control on some categories of s t e e l ha2 been relaxed i n 1960, i n the sense t h a t quotas f o r these c a t e ~ o r i e s were not t:lereailter a t t r i bu t ed t o consumers. This does not mean t h a t a l l Itrelaxedlt ca tegor ies were i n easy supply. %ne I ron and S t e e l Controller remained responsible f o r indicat ing the degree of p r i o r i t y t o be given t o each order (o r "indenti1, i n t he administrat ive terminolow) both f o r

1/ Report on S t e e l Control, Government of India, .:iinistry or* S t e e l and Heavy - Indus t r i es (Department of I ron and S t ee l ) , October 1363, page 8.

2/ Report on S t e e l Control, op. c i t . , page 9. -

relaxed and unreiaxed items. For t he wwelaxed categories t he quota stern was supposed t o ensure roughly t ha t , over time, t h e t o t a l of incents eq17.al t o t he t o t a l of production. For inany of t h e relaxed categories, there was a su i t ab l e balance of demand and s u p p l ~ . Other relaxed categories were i n f a c t considered t o be i n short supgly and t h e I ron and S t e e l Controller "screened1' t h e indents b;r applying inore or l e s s a rb i t r a ry cu t s on them.

4. Zven with t he rough equali ty of demand and supply supposed t o be ensured by t h e quota system and t h e screening of indents by t he I ron and S t ee l Controller , queues of various lengths were formed f o r t h e various categories of s t e e l . It was t h e responsibi l i ty of the I ron and S t e e l Conkroller t o sub- divide each of these queues by giving p r i o r i t y ra t ings t o indents. The producers were supposed t o I"ormu1ate thei? ro l l i ng pro>;rams on the bas i s of the orders directed t o them and t h e p r i o r i t i e s attached t o these orders. To ~ a k e sure t h a t they did so, they were required t o get t h e f i n a l approval of t he I ron and S t ee l Controller f o r each rol l in=; prograr~l. &There were a nurnber

1 G bliroug': "just, ordinary of categories a o r i o r i t y going fro:? "no p r io r ' ' jr" 'L

prior it;,^^ "overl-idin ; p r i o r i t y , 'I "top p r io r i t y " and evcn "red ha.: p r io r i t y , " based p a r t l y f'on an i d sn t i f i ca t i on of what has been ca l led t h e 'core projects t i n the Five-Pear Plans and defense requirements, and pa r t l y on a var ie ty of ad hoc ~ o n s i d e r a t i o n s ~ ~ .l/ - 5 13e I ron and S t e e l Controller did not have any data r e l a t i ng t o outstanding orders c lass i f ied according t o p i o r i t y groups. The standing orders of the producers wers t h a t each ro l l i ng program should include a proportion cf each p r i o r i t y ra t ing, i n c l u d i n ~ sorxe non-priority orders. The accordagce of i:riority did not carry with it any assurance a s t o tihe period within which t h e supply asked f o r was t o become avai lable . "The allotment of t he p r i o r i t y by t h e I ron and S t ee l Controller seeras t o have only l i ~ 5 t e d p rac t i ca l significance unless the indentor i s i n a posi t ion t o apply pressure and persuasior? a t a n ~ i b e r of points within thz chain of agencies associated ~ ~ i t l i t he production and d i s t r ibu t ion of st;cel."2/ - 6. I n f a c t , i n t h e absence of any propoer i n fona t ion with t he I ron and S t ee l Controller and a s orders of varying t,lrpes 02 s t e e l were accumulating, t he producers were l e f t qu i t e f r e e t o pick and choose the orders t h a t su i ted them Tor each r o l l i n s program. "Th",clloice of actions by t h e producers f o r each ro l l i ng program does not, however, seem t o be s ign i f ican t ly a l t e r e d by tha indentwise 'planningt done b:~ the I ron and S t e e l Controller; sle a l s o doubt whether p r i o r i t y ra t ings are observcd i n a l l ccses and indents placed on t h e order books taken up s t r i c t l y on ' f i r s t cone, f i r s t servedt bas i s f o r each category of prior it,^. "3/ - ? Gne main objective of routing t h e indents through the I ron and S t ee l Control lers 'off ice was s t a t ed t o be t h e need t o ensure that a reasonable proportion of a l l s i ze s and sect ions be ac tua l ly produced. The r e l a t i v e costs

- -- - -- -

1/ Report on S t ee l Control, Government of India , : l inistry of S t e e l and Heavy - 1:ldustries (3epartment of I ron ond S t ee l ) , October 1463, pa:;e 11.

2/ Report on S t e e l Coritrol, op. c i t ., page 12. - 3/ Report on S t e e l Control, op. c i t . , page 12. -

of producing various sect ions was not rdlected by t he re tent ion pr ices f o r s t e a l f ixed by the Governnlcnt afiter re~omrr~endations of t he Tariff Commission, nor even by the flexbras" - i . e . , premia - f ixed by the I ron and S t ee l Controller f o r cer ta in specific sect ions . The primary consideration f o r determining the re tent ion p r i ce s was t o make t h e average p r i ce of a l l items produced equal t o t he average cost of each p r o d u c e r m e a s o n a b l e p r o f i t . Overheads were prorated over t he vzrious categories of s t e e l on t he bas i s c~f so-called standard ro l l ing programs. The Raj Committee quotes with disapproval an ex t rac t frci i the 1956 Report of t h e Tariff Cortmission which tfrecognized t h a t if the ?at tern of production were deter~l ined by purely commercial considerations, a s t ruc ture of pr ices based on a uniform average pr ice nlight c rea te t h e pos s ib i l i t y of ce r ta in undesirable s h i f t s i n production between . . . categories . . . Vith t he cooperation of t he producers, and where necessary by using the power vested in Government t o regulate production, it shoulci be possible t o avoid any undesirable shifts. I l l / - U. I n f a c t , such shifts i n production were not avoided, pa r t l y because the e f f e c t s of t he unsatisfactory f ixa t ion af r e l a t i ve pr ices were heightened by a tendefic:~ t o judge the performance af producers, especially i n t h e public sector plants , i n t e r n s of the ac tua l tonnage ro l led i n r e l a t i on t o t he rated capac i t j of t he p lan t . Of course, t he ease with which a given tormase i s produced depends strongly on t h e type of sect ions rol led.

9. A r e l a t ed aspect of t h e question was t h a t a great nw.ber of s izes and specif icat ions were ro l l ed by the main producers, necess i ta t ing frequent r e se t t i ng of r o l l s . ' n ~ e p r i ce s t ruc ture of t h e various s izes gave no incent ive t o the consumers f o r ra t iona l iz ing t h e i r demand, nor t o t h e r e ro l l i ng mills t o concentrate on the ro l l i ng of small quant i t i es of specia l s i ze s f o r which they would technical ly have been more su i ted than t h e main producers.

10. The d i s t r ibu t ion of s t e e l was channeled through so-called controlled s tock is t s , wholesalers of whon there were only 213 i n a l l India and through regis tered s tockis ts , of wholli t he re were about 2,000. Pr ices and p r o f i t margins were essen t ia l ly determined by t h e Government and published i n a chart , t h e format of which caused producers' p r ices t o be general11 ref erred t o a s "column 1 pr ices f f , bhosz of tllc controlled s t o c k i s l ; ~ a s ' : c o l w ~ ~ 2 p r i c ~ s ~ ~ and those of t h e res i s te red s tock i s t s a s 'fcolunn 3 prices." 'The existence of a black mark9t i s re f lec ted by t h e unof f ic ia l appellat ion lfcolumn 4 pricesf1.

11. The sinaller s ized consumers !lad t o submit t h e i r requests f o r s t e e l through t h e regis tered and controlled s tockis ts , who i n f a c t performed no useful work other than grouping these requests and transmitt ing then t o the I ron and S t e e l Controller . A s soon a s shipinents arrived they were iminediately l i f t e d bjr t h e f i n a l users or by an unregistered s tock is t operating an t he black market. i!;oreover, it was t he i:#lpression of t h e Raj Comission thzt flthrough various channels established by the trade, .the pr ices actual ly charged from t h e f i n a l users by a l a rge number of s t ock i s t s a r e , i n the case of scarcer

1/ duotea? on t h e Report on S t e e l Control, Governinent of India, I5inistry of - Stee l and Heavy Indus t r ies (Department of I ron and S tee l ) , October 1963, page 4.

cate;ories and sections, nearer t o those prevail in2 ir, the black Illarlri?t.t:l/ ihis uas rendersd ;,ossible bjr t he absence of con t ro l on tile stoci.ists e n s z i n g t h a t orders placed with thern were s a t i s f i ed on a T i r s t come, first served bas i s . A perverse e f fec t of these controls was t h a t "generally most of t h e small consuners a r e ab le t o get on1;r about one-quarter or l e s s of t h e i r supplies a t t he controlled pr ices , while ,rlany ~f the la rger consuners manage t o get a s much a s two-thirds or thee- four ths of these pr5ces and r e ly only f i ~ a r ~ i n a l P ~ on the f r e e market. It2/ - 12. It was a l s o t he opinion of the Raj Comnittee t h a t the average re tent ion p r i ce was not high enough, notably because it did not su f f i c i en t ly r e f l e c t t h e cost of replacing p lan t and equipment.

S t ee l Control a t Present

13 The recommendations of t he 2 a j Committee have ~;lrea&f been part137 described i n t he illain t ex t . The main e f fec t s would have been substantial1;r t o f r e e t he s-t(;el t r a h , re ta in in2 ~ h y s i c ? l ; l loca t ions only t o s a t i s f y the requirements of a r e s t r i c t i v e l , ~ defhed group of p r i o r i t y consumers, and e l i n ina t i n s possible excessive scarc i ty p r o f i t s mainly through the use of cxcisz ta::es. The renaining ra t ional ized controls were t o be adrllinistered through the creat ion of two neu cormit.teas. A S t ee l P r io r i t y ComLttee was t o be s e t up i n the ; I ln i s t iy of S t e e l i n order t o deterrene t he bulk a l locat ions of d i f fe ren t catezor ies 02 s t e e l -to p r i o r i t y demands. A l l indiv'idual orders of s t e e l , both p r i o r i t y and non-priority, l a rge enouzh t o be >laced d i rec t ly with the main prociucers shoul.ci be sent throueh a newl:~ set-up Jo in t Plant Cocmittee which reiould Itplanf1 t h e ~ l on the producer best suited from a technical point of vie:$ Zor producing the spec i f ic iiem. T h i s Conmittee was t o be made up oi" a i l m i n ,producers and vas t o meet p e r i ~ d i c a l l ~ ~ under the chairmanship 02 the I ron and S t e e l Controller . Iiis r o l e i n the Cornrittee Idas t o consist i n hel2ing t o resolve possiblc differences betwen plants , and a l s o i n seeing t h a t the p r i o r i t i e s granted bjr t he S tee l p r io r i t y Comi t tee were i n f a c t respected. Beyond the s a l e by the m i n jrroducers, tile s t e e l t rade was t o be decontrolled completel~r and a l l p r ices and t ransact ions freed. The p r i ce s of t he m i n producers were t o be s e t by the Jo in t Plant Conunittee; any excessive diff'erences between produzers p r ices and f r e e ~ a r l t e t p r ices were from time t o t i n e t o be nlo~2ed up through excise duties.

4. It 1-]as a l so recomtcended t h a t conplete freedom should be le f t t o the r e r o l l e r s t o respond t o the pr ices prevai l ing on t h e f r e e market f o r various sect ions . The Cormittee f e l t that this would ensure t h a t r e r o l l e r s and ,-in producers would concentrate on tilose types 02 products f o r which t h e i r respective s i ze s gave thein technical advantade. Final ly , the abol i t ion of the f r e i g h t eljualization s;ste.!i f o r s t e e l was a l so reconlmended .

1/ Report on S t e e l Control, Government of India, i i i n i s t r ~ of S t ee l and Heavy - Indus t r ies (Department of I ron and s t e e l ) , October 1963, page 17 .

2/ Report Oi l S t e e l Control, op. c i t . , page 70. -

1.5 . , ;afi,r of $he f o~- ; , a l arrafi2el~ent.s p r q ~ o s e d by t h e 225 Corx:it-tee have been carr izd out, bxt mucil of t he s p i r i t o:F the reforl~l has been l o s t on the pray. 'fi~(: S t ee l F r ~ o r i t y Comait-Lee was indeed s e t up i n the Departnent of I ron and S t e e l i n order t o a t tach p r i o r i t i e s t o t he various demands presented by the sponsoring au thor i~ t ies . However, the d i s t inc t ion between relaxed and unrelaxed categories of s t e e l was i n f a c t maintained althougn these a r e now ca l l s6 "con-kr~l led~ ' sn< "c l econ t ro l l~d~~ c ~ . t o ~ o r i c s ; i n tlie f i r s t roun-?, t h e Departmen-t of I ron and S t ee l act ing on i t s own al located quotas of controlled s t e e l Ite;:,s t o the various sponsoring au tho r i t i e s which sub-allocate then; by issuing quota c e r t i f i c a t e s t o f i r m s under t h e i r sponsorship. The - to ta l of these quo32s i s higher than t h e t o t a l expected production. Qui te separately frcrr; the quotas, a Stee l P r io r i t y C o i ~ L t t e e nlade up of representatives of t he 1.inistr;;r oi" Steel , tile iUnisi;r:: of Industr,r, t he ?-;inistry of Finance and -the ? laming Co~;imission assign p r i o r i t i e s f o r -the co!;ing period. The assignment of the pr ior i t ; r e n t i t l e s i t s b e n e f i c i a r ~ t o be inscribed by t h e Jo in t Plant Cor,lmittee on a sepzrata ; presu~ilably shorter, waiting l is t f o r delivery. Although the S t e e l Priorit;r Cornit tee i s e n t i t l e d t o i s suz p r i o r i t i e s f o r a l l categories 02 s t e e l , it has i n f a c t done so u n t i l now only f o r t he controlled categories. P r i o r i t i e s a re sa id t o be assigned t o 755 of the quota-holders. The pr ices of controlled items continue t o be f ixed d i r ec t l y by the Government.

16 ,, Decorltrolled i-teriis a r e given a p r i o r i t y raking d i rec t ly by t he I ron and S i ce l ControlLer according t o t he nature of the indentor. F i r s t p r io r i t y i s ~ i v e n t o c?e.fense needs, second p r i o r i t y t o tile railways and the "core projects i t or;' the plan, t h i r d priori-tjr t o o.iost s t e e l processing indus t r ies and the r e s t 02 Governnent denlands. S tock is t s and some investment needs other than those af the of t he plan get 110 p r i o r i t y . For c ~ f i t r o l l e d items there a r e a l s o four c a ~ e ~ o r i e s 03 p r io r i t y including non-priority. The waiting i3eriod f o r &livery l o r controlled items i s said t o be p rac t i ca l l y nFl Tor t he f irst p r i o r i t y i.terfls. For second and th i rd p r i o r i t y items the r ~ a i t i n g period goes 2ro1ii s i x inontiis t o a .year, and ,nay take two t o three years

,a; periods f o r ~ o s t decontrolled itei-IS vary f o r r im-priori ty orders. i:'ait4 I'ra:: p rac t i ca l l y n i l I'or f i r s t p r i o r i t y iter:,s t o about one gear f o r some non- priori t . / deaands. Of course, specif ic items diverse f ron this pa t te rn from time t o t m e . According t o t he I ron and S t e e l Controller , b e t t e r t r ack i s k e i ~ t on t h e length of t he xrarious queues a t present and indentors can be illformed car>;r oP t he expected r ~ a i t i n g tirne before delivery. I n f a c t , t he considerable i~!~provernent t h a i does indeed seem 'to have occurred on t b i s score seenis largel;. due t o t h e easing of tlie supply s i tua t ion . For items i n pa~1;icularly shor-t supple:;, t he waltin;;: period i s s t i l l both Long and fa i rLy uncertzin unless d i r ec t paths can be fourid t o t he producers.

1 7 . I n t h e decontrolled categories producers1 pr ices a r e decided by t h e Joint Plant Co~,rxittee. 'The Government i s represented on t h a t Cormittee ind i rec t ly tllrough the Railway Zoarci snd d i r ec t l y by t h e I ron and S t ee l Controller . 'The producers have s t a t ed t h a t i n f a s t they have no freedoin a-t a l l i n determininz pr ices and t h a t t h e prlces both of the controlled and of the so-called decontrolled ca-Legories of s t e e l cont,inue t o r e f l e c t nei ther t h e i r r e l a t i v e narglnal costs nor the average t o t a l cost . It has,hot~ever, been reported recent17 t h a t with t h e acquiescence of the representative of t he Railways and of the I ron and S t ae l Controller, the producers a t present have considerable freedom i n nlani~ula.i;ing t he pi-enia over t h e basic pr ices ,

the so-called llext,i-as", charzed f o r cer-Lain s ~ e c i a l s t e z l i-i;c;t~s, and i n f a c t do so. ' ~ f course, t h s prices so deterndned do not r e f l e c t the ac tua l costs of producing these ite.is but r a the r the producers1 discriminating monop01;~ power t o increase t h e i r ravenues when thejr a r e not faced with strong, institution all?^ 1i;rotected ccnsuaers such a s the Railways.

18. Tile rou.t.iilg ,:of i n d e ~ i t s througli the Joint Plant Conmi-ttee %:,stead of only the of f ice oT the Iror, and Steel Controller see:;is t o have speeded somewhat t h e i r processins. Iloreovcr , the ac tua l decontrol of t he resale of tha so-calied decontrolled iteiils has reduced t h e non no pol is tic posi t ion of the control?.ed and registered s tockis t s and, i n i t s e l f seems t o have i:3igroved the ?lor-J of s t e e l and has produced, according t o inernbers of the trade, a sigriificani fal:! i n pr ices and soae re t iona l iza t ion of denland.

19. Iio~jever, ~ r o d u c e r s pr ices generally continue not t o r e f l e c t e i ther rela-hive costs or the strength of demnd and production plans continue t o be deterained 729- ati:.jLilistrative decisions ra ther than cost and demand considerat ions. Rarollers i.ahose production program a r e no longer subject t o adminis- t r a t i v e control, continue t o con2entrate on the eas ie r and, more widely deizanded sections, leatr'lng the r;~ajor producers 'i;o .t 'uUil.l the demand f o r the more s ~ e s i a l tyges of which s:naller quanti7;ies a r e needed. The super positi011 of quotas aild separately de'ter;:r.ined p r i o r i t i e s seeiqs perfect ly liieaningless. It i s hard t o f ind an;. significance f o r t h e a!;t~*ihuticn of a s t e e l quota LC this i n f a c t does not ensurz delivery of s t e e l wiklzin a reasonable period. l ;oreover, contrai-,~ t o the Ra j Cor,u,~it,tee s i-ecor~-mendations, s t e e l i!;lpcrt quo-cas a r e not rout22 throush the St e e l Pr ior i t - j Cc. .x~it tee. They a rc de.L?nxLned joill.tljr by the 3epartment of Iron and S tee l and the i l in is t ry of Finance without apparently being coordlna+,ad idith the a t t r i bu t ion of p r i o r i t i e s . Thus, a sponsoring authority, say E T D , a t 2 i r s t receives, upon the bas i s of a request subnitted t o the Departnent of I ron and Steel , a global quota of indisenous s t e e l whlcn it i s f a i r l y f r e e t o sub-allocate between the f ir:ns under i t s spolisorshiij , Alter the si&-allocati on has Seen achieved, it subn1i.t~ recoix.iendations t o the S tee l 2 r i o r i ty Comxittee f o r a t t r i bu t ion of p r i o r i t i e s t o sm!e af the fir;-;s t o which .it has a l located quota ce r t i f i ca t e s . P r io r i t y r a t i nzs a re distri'ou-Led d i rec t ly b;l tile S t ee l P r io r i t y Committee. Separately f r o ~ l this procedure, E'Td i.s a l so glven by the i i in is t ry of Finance, through the 2,inistry 0: Steel ,a t o t a l ce i l i ng of foreign exchange usable f o r imports of i ron and s t e e l i t e a s . 1l;e product breakdoxn of this t o t a l i s not specified, al . thou~h, of course, indizenous angle clearance has t o be obtained froal t he I rcn anti S t e e l Controller f o r each individual inport l icense. Neither i s there any s ign i f ican t coordinatiori between the a l locat ion of s t e e l - indigenoils or i i : i~~orted - and the a l locat ion of loreign exchange f o r other purposes.

23. T h i s lack of coorLi13tion and thc 10112 delays which, especially f o r the scarcer controlled categories, have t o be incurred before del iver ies can be obtal-ned, :lean t1ia.L there i s cften no correspondence be-k~een the scheduled del iver ies ani! ttiie needs of the consumers. 'Elis provides a s-trong incentive f o r black merket transactions i n the c o l ~ t ~ o l l e d cstegorles . Such transactions iilvolve not only various r e a l and f i c t i t i o u s consumers; a l l f i v e na jor plants a l so seem t o play an i r~por tan t p a r t i n them. !.!?ien proper re la t ionships a r e

established with .the p l an t s the; car, ensure prompt deli-"-erjj independerrtly f ron p r i o r i t y ra t ings . One wag of t h e i r doing this seems t o consist of t h e i r informing the Jo in t Plant Connittae t h a t the pa r t i cu l a r items scheduled f o r shipr,ient a r e ir: easy supply. The f a c t t h a t some quota holders can arrange f o r delivery nuch f a s t e r than c t h e ~ s means tha t they a t tach higher value t o L : ~ . ~ L L possession of a quota. Transfers of quotas - of course azainst f i nanc i a l ca.ipensation - a r e said t o be quite current and the deliver:? of the s t e e l i s said t o pose no ;~roblern provided thas the agreexent of the p lan ts i s obtained. - I t i s a l s o sa id t h a t the pronpt delivery of scarce iteins can often be arranged with t he ?:ants independently from the possession of p r i o r i t y entitlements, pr.ov5ded thak a$ the same -tine some categories i n very low demand otherwise uirenunerative should a l s o be bought.

study I n most Sta tes . I n a second s tzsc , Tor i r o n and s t e e l i t e i . 1 ~ ~ both inporteti and c:oclestii:, cu t s a r e nade on -the applications, generally on a pro rats bas i s so a s t o br ing t he t o t a l c e r t i f i ed requirements i n l i n e with -. - t he a v a i l a l ~ l l i t i e s oT ir,~ported an6 dornestic s t e e l a s not i f ied t o t he Director of Indus t r i es by tha GfL'ice of the I ron and Skeel Controller . Then, essentialit-! c e r t i f i c a t e s a r e Lssued t o each firm Tor the anount 'to rdhich it i s e n t i t l e d accordin2 t o t h e calcula t ions described above. The I ron and S t e e l Controller nornally authorizes t he irnport or domestic a l loca t ion o i s t s e l equivalent to t h e quan t i t i es contained i n the e s sen t i a l i t y c e r t r f i c a t e , subJect on1::y t o clearance from the indigenous angle.

5 Jus t a s f o r large-scale industry t he d i s t r ibu t ion of these e s s e n t i a l i t y c e r t i f i c a t e s seens t o be based largely on h i s t o r i c c r i t e r i a . Even ii the Director of Indus t r i es goes through the motions of evaluating i n some sense the ac tuz l requirements of f irms, this evaluation i s necessari ly based on the iilachinei-y i n s t a l l ed . Rccept i n some of t he l e a s t industria7Azed S ta tes , ner~l.7 i n s t a l l e d n~achir~eqr i s cliscrinlinated against i n t h i s evaluation, i n the sense t h a t I ts needs a r e mult iplied a f r a c t i o n a l coef f ic ien t , say one-third. However, only machinery i n s t a l l ed l e s s than two or th ree years ago i s generally consiciered t o be neta.

6 . 2-valuati.oi? of the needs of f i rm f o r the purposes of imports other than i ron and s teel . I.s f a i r t i s i r i l a r t o t he procedure described above. However, once the "objective" needs of thc f i rms have been assessed t he proceaure i s completed. i'he Director of Indus t r i es c e r t i f i e s the e s sen t i a l i t y of t h e q u a n t i t ~ of iinporis wilicii, a c c o r d l n ~ t o hi.171, a r e ob j e c t i v e l j needed by each f i i ~ i i on t h e ba s i s af i n s t a l l e d capaci't:?, rr~ithout taliin2 i n t o account t h e availability of fo re igx exchange. The e s sen t i a l i t y c e r t i f i c a t e s thus esta.blished are transi . l i t ted tcs the oT'"fic of t he l o c a l Controller of Imports and w o r t s . The l a t t e r , however, receives frori~ the Chief Control ler ' s ofr"icc i n Netj Dz2L di rec t ives , worked out on t h e ba s i s 0;' the fo re ign exchange quo.i;z a l located t o a l l snal l -scale indus t r i es , which incLca-Le t hechan~es t o be made ix t h e al l_:~cation cf each i n d ~ s t ~ i a l groqi r e l a t i v e t o t h e preceding pc r iod r s nllocatLr~ns. I:.gor.ts a r e then a l located on the ba s i s 01 Lliese d i rec t ives . !Bt:hin each i n d u s t r i a l group thc share of each f iriii i s ;3roportional t o kheir cert:ii"ied e s s e n t i a l weds .

7 It i s no;; c lear on what bas i s the d i rec t ives given t o t h e Jo in t Chief Controllers of In,ports and ExporGs aye elaborated, except f o r t he f a c t th.t when given i ndus t r i e s Tori:: a bottleneck of a verlr e t iden t type they a r e probably soneho~d favored. 'These d i rec t ives a r e no-t known t o the S t a t e Director of Ir idustries. The il-lport requireriients cert if iec! t o be essent ia l vary from roughljr t en times tile ai110unt ac tua l l y authorized i n the end i n some States , t o about -tiiflee t i n e s the anrount ac tua l ly authorized i n t h e S t a t e s where the c e r t i f i s d r e q u i r e n e ~ t s a r e ixost c losely r e l a t ed t o what could technical ly be actuall tf used. The a l l o c a t i o r ~ s of i r on and s t e e l , both Inported and indigenous, a r e made oil Lhe bas l s of q u i t e d i f fe ren t c r i t e r i a and ii? f a c t without any knowledge of tile crl ' teria governing geileral imports. ,Tllere i s sane technical re la t ionshig between the quan t i t i e s of s t e e l items and of other imports required by a ziven firs?; a s t h e decisions .zoverning the a l loca t ions a r e made by d i f fe ren t ageists on -the bas i s of d i f f e r en t c r i t e r i a and without any lu~owledge

of t he o t l l~_r a_<ent 1 s cjecisiori, t i lere i s T i 0 rcecllanisi:! f o r resgect inz these proport ions. Cnl$ a f.ew of t h e Directors or" Indust ry deny t h a t the re i s here a ser ious probleii~. I n Pact , it i s zeneralljr recognized b.y those who dea l wi th a l loca t ions t o s i#~a l l - sca le indus t r ;~ , t h a t t h e a l l oca t i on mechanism does not even aim a t achieving an input mix technica1l:y su i t ab l e t o t h e requirements of t he f i n s . Alloca-tions correspond t o t h e needs only nore or l e s s by chance, and a c t u a l requirements a r e nomnaLl,y s a t i s f i e d through ;>urchases and s a l e s on t he uncoi~trol led markets.

8 . I n t h e l i g h t of this, of course, t he preoccupation of t he Directors of Indus t r i es wi th f a i r n e s s i n t h e a l loca t ions seems q u i t e j u s t i f i ed . Allocations t o diven f i rms do not deternine output; they a r e simply t he equivalent of a pure s tbs idy d i s t r ibu ted t o t h e f irnis of t h e S t a t e . Fairness liiust indeed be a dominant considerat ion i n t h e d i s t r i bu t i on of a subsi.dy.

9 Tlie Stuci,~ Team on Export and Ixport Trade Control Crsanizations (iiathur Committee) reconunended t h a t "d i rec to rs of i ndus t r i e s and other sponsoring au tho r i t i e s i n the case of small-scale i ndus t r i e s shou3.d be placed a t par with t he sponsorin2 author i t ies i n t i i ~ large-scale sec to r ( e .g . i3GTD)l; and thajr should not only c e r t i f y essen t ia l i t ; but a l s o rec~rnmend a c t u a l a l loca t ion on a un i t ba s i s . For t h i s puraose tihe-;r should 'be infornled o," t h e ce i l i ngs within which thejr can fit i n t h e i r unitwlss a l loca t ions . This would make t h e recol.i.nendations oi" t he sponsoring a u t h o r i t i e s Tilore e f f ec t i ve and would inc iden ta l ly !ilake them ziore responsible i n pa r t i c i pa t i ng i n t he import con t ro l s so f a r a s i-t a f f e c t s t h e small-scale sect.3r .I1 :/

10. 'TI-Lis recoiimendation has been accepted ' u ; ~ t h e Government. Its impleaentation w i l l reduce t h e ccn?lete a i r oC unrea l i ty which a t present surrounds con t ro l s over small-scale indust ry . It i s indeed d i f f i c u l t t o see wh;y i t has talcen so long f o r such an extr2ii1ely simple reform t o be implemented. Tha-t the re should be no g r ea t d i f f i c u l t y i n carrying it out i s i l l u s t r a t e d not only by tne f a c t -i;hat such a q r s t ~ i i l has elready been functioning f o r a l loca t ions of s t e e l , but a l s o t h a t t h e i i ission linoi~s of one S t a t e where, i n f a c t , .through an inforcia1 understaading between the Director of 1ndus.tries and t h e Local Jo-int Cl~Aef Control ler of' I ~ ~ i i ~ o r L s and w o r t s , t h e Director of I ndus t r i e s wzs already t a i l o r i n g h i s e s s e n t i a l i t y recommendations t o the a c t u a l avai labi l l i ty of' fo re ign exci~mge f o r i i i o r t s by indus. tr izs under his sponsorshii; The controls on small-scale indilstry were universal1,;r knot-~n t o be functioning large1,y a s a pure subsidy device. Tile f a c t t h a t it has taken such a long t i n e and t k e formal racorimendati.ons 02 a high l eve l Committee t o introduce 2 very obvious and very s i r .p le ref oriii, seems -to r e f l e c t a c e r t a i n cynlsisl;: i n viewing iniport controls i n ;enera1 .

1/ See Chapter 3, Section 1, paragraph 5. -

APPENDIX I V

A. Controls 3e la t i -n~ t o Investnent Act ivi t ies -- - - 1. The Letter of In t en t and %ne 1ndwtr ia l .L icense . -- 1. Any i ndus t r i a l investment project requires roughly the follotring three types of sanctions:

( a ) Approval of the project in terms of the l i s t of goods t o be produced, capacity, location, etc., by the issue of an Indus t r ia l License under the Industr ies (Development and ~ e g u l a t i o n ) Act; - 1/

( b) Approval of foreign exchange expenditure f o r cap i ta l equipment;

( c) Approval of the terms of foreign collaboration, if any, required f o r the project; and

(d) Approval of domestic cap i t a l issue.

2. Under revised procedures introduced in January 1964, following the recommendations of the l ' Industr ia l Development Procedures C~rmnit tee ,~~ when an investment i s contemplated, i f it i s of a type f o r which an indus t r i a l l icense is required, a t f i r s t an application f o r a Let ter of In ten t must be suSmitted with ten spare copies t o the Coordination and Licensing Progress Section of the Union Department of Industry. This Section was s e t up with the sole aiin of expeditiously dispatching applications t o the au thor i t i es concerned. This is in principle t o be done within three days of the receipt of the applications. The t tprinciplell is not expected t o be always respected, as is i l l u s t r a t e d by the fact t ha t it is recommended t o the applicants t h a t they speed up the consideration of t h e i r applications by also submitting separately and d i r e c t l y a copy of t h e i r application t o the technical Sponsoring Authority of tineir industry, such as the Directorate General of Technical Development, the off ice of the Textile 2ommissioner, e tc . The form of the application i s reproduced in Table 1 of t h i s Appendix.

1/ Firms whose t o t a l f ixed assets do not exceed Rs. 2% million in value - are exempt from t h i s requirement, except in the following industr ies : coal, vanaspati ( i. e., vegetable shortening), r o l l e r f l ou r milling, oilseed crushing, leather , matches, and power loomed t ex t i l e s . Firms with a f ixed cap i t a l between R s . 500,000 anci Rs. 2& million a re required t o r eg i s t e r with the relevant Central ISnis t ry o r Department. Except in the industr ies l i s t e d above, firms with fixed cap i ta l s of l e s s than Rs. 500,000 a re of the r e so r t of S ta te Governments. Licensing procedures concerning these a re t rea ted in Appendix 111.

3- In principle within a period of three days a f t e r t h e i r receipt the copies of the application are transmitted t o the Adrr~inistrative Ministries concerned, the S ta t e Director of Industries, and the technical Sponsoring Authority. The application is scrutinized mainly by the l a t t e r , which submit t he i r recommendations through the Administrative Department concerned t o a sub-committee of the Licensing Committee. This sub- committee consists of the Secretary of the I t inis t ry of Industry a s Chariman, and the Secretary of the Department of Economic Affairs, the Director of Technical Development, and representatives of the Company Law Division of the Ninistry of Finance and of the Planning Commission. This membership is in f a c t the same as tha t of the full Committee, with tine only exception being t h a t the relevant S ta te Government concerned is t o be represented i n the f u l l Licensing Cornittee, The Licensing Sub-comittee considers information submitted by the applicants and the recommendations of the technical Sponsoring Authority, and on the basis of these grants the Let ter of ~ntent .E/

4. The Letter of Intent , the form of which i s reproduced in Table 2, broadly indicates the conditions subject t o which the Government i s prepared t o grant an Indus t r ia l License, It specif ies the period within which def in i t ive proposals have t o be made regarding the terms of foreign collaboration, the im3or.i; of cap i ta l equipment and issue of capital , if anl7 i s required. This period normally varies from s i x months t o a year, and if tne applicants do not f u l f i l l some of the conditions of the Let ter of In ten t within this perio.d, it automatically la?ses.

5 . I n the general case, separate applications have t o be submitted f o r the approval of cap i ta l goods import reqdests, of collaboration agreements concluded with foreign firms, and of cap i t a l issue on the domestic f inancial market. These requests are considered by the appro- pr ia te committees. When a l l the separate requests have been approved, the technical Sponsoring Authority makes z f i n a l ver i f ica t ion of the conformity of the f i n a l plans t o those described in the Let ter of Intent; i f it i s s a t i s f i e d on t h i s account, the Ministry or Department responsible f o r the industry concerned transforms the Letter of In ten t i n to a f i n a l Indus t r ia l License. I f doubts a r i s e as t o whether the conditions stipu- la ted i n the Let ter of Intent have been f u l f i l l e d , the f u l l Licensing Comettee may be appealed to.

1/ Formally the Licensing Committee and i t s Sub-committee only make - recommendations t o the Government; in fac t , these recommendations are always accepted.

6. For so-called "key ind.us t r i e s ll&/ a l l applications f o r the subsequent clearances, such a s import of cap i t a l goods, approval of foreign collaboration proposals,etco,areto besubmitted as and when plans reach a su f f i c i en t ly advanced stage, and the recommendations of the technical sponsor have t o be prepared immediately. l~hen a l l applications have been submitted and recommendations r e l a t i ve t o them prepared, the ac tua l approval of the proposals i s consicered simultaneously i n one meeting of the Sub- committee of the Licensing Committee,which may coopt the Chief Controller of Imports and Exports f o r considering the cap i t a l goods import request and the Controller of Capital Issues f o r considering the cap i t a l i ssue request . 2. Capital Goods Inport Licensing.

7 . A spec ia l scheme cal led the Capital Goods Scheme applies t o i m ~ o r t s of cap i t a l goods by ac tua l users, when the "aggregate value of any s ing le mit so t o be imported is not less tha t Rs . 100,000 F.O.B."I/ The value l imi ta t ion does not apply t o replacement, modernization, o r addit ions t o plant anc! machinery when the or ig ina l l icenses were issued under the cap i t a l goods scheme, nor t o patent t e x t i l e machinery, plant, and components and par ts thereof. Applications are t o be submitted only by possessors of an Indus t r ia l License o r Let ter of Intent. In the case of firms not subject t o i ndus t r i a l l icensing, only firms regis tered with a cen t ra l technical Sponsoring Authority (large-scale industry) or with a S t a t e Directorate of Industr ies (small-scale industry) can submit applications. Applications a r e t o be sen t to the following l icensing authori t ies , together with copies of the list of goods proposed t o be imported:

( a ) For a l l cotton t e x t i l e machinery and rela ted a r t i c l e s t o the Jo in t Chief Controller of Imports and export,^ i n Bombay.

(b) For ju?;e and hemp nachinery and spares, and fo r machinery connected with coal-mining and the t ea industry, t o the Jo in t Chief Controller of Imports and Exports in Calcutta.

(c) For a l l other machinery and plants t o the Chief Controller of Imports and Exports, Capital Goods Division, i n New Delhi.

1/ The or ig ina l l i s t of key industr ies a s published on January 13, 1964 - i s the following: (1) Pig iron, (2) a l loy s t ee l , (3) ferrochromium and other ferroalloys, except ferrornanganese and ferrosi l icon, (I;) malleable i ron castings, ( 5 ) s t e e l castings, (6) s t e e l forgings, (7 ) s t ruc tura l s (heavy), ( 8) indus t r i a l machinery, (9) cranes, (10) inachine tools, including small tools, dies, j igs and f ix tures , (11) automobile anc i l la r ies , (12) abrasives, ( 13) e l e c t r i c winding wires, (14) f e r t i l i z e r s , (15) su l fur ic acid, (16) caust ic soda and soda ash, (17) rubber chemicals, (18) petro-chemicals, including synthetic rubber, (19) pesticides, (20) paper and paper board, (21) cement, (22) pulp (ce l lu los ic ) .

2/ Import Trade Control, Handbook of Rules and Procedure, 1964, paragraph 92.

8. However, fo r applications in excess of Rs. 2 inillion fo r imports from b i l a t e ra l trade partners, i n excess of 9s. !%l,OOO fo r imports from the USA and in excess of Rs. 200,000 fo r imports from a l l other countries, applications are t o be submitted t o the Directorate General of Technical Development.

9 . Correspondingly, applications i n excess of these values are examined by the f u l l Capital Goods Committee, composed, l i k e the Licensing Cormnittee, of o f f i c i a l s of secre tar ia l rank and chaired by the Secretary t o the Ministry of Industry, while the Sub-committee meets under the chairmanship of the Chief Controller of Imports and Exports and i ts membership is mainly composed of Development Officers of the Directorate General of Technical Development. Key industries follow s t i l l another procedure. They send the i r capi tal goods import requests to the Coordination and Licensing Progress Section of the ltinistry of Industry which distr ibutes them according to the procedure explained in the sub-section dealing with industr ial licensing. The purpose of th i s special procedure i s to allow the Licensing Sub-committee to keep track more eas i ly of the completion of preliminary clearances by key industries.

10 . Applicants f o r imnort licenses f o r capi tal goods have to specify clearly the nature of the goods to be imported and the country from which the imports are to be made. They also have t o specify the f o ~ e i g n financing source against which the import is requested. A s a general rule, only those applications are even considered which can be financed by direct foreign investment, foreign exchange loans by I C I C I and the IFC, India, long-term foreign exchange loans by foreign or international f inancial inst i tut ions such as the U.S. A I D or the IFC, Washington, or by b i l a t e ra l trade and payment arrangenents. Exceptions to these rules are considered only in the case of export industries. Importers do not always have a very good knowledge of the type of resources available. However, especially i f the applicant i s a large enough industry for maintaining direct and more or l e s s permanent contact with i ts technical Sponsoring Authority, an indication of tliis may be given a t an early stage so that a new and appro- priately modified application may be submitted. This, however, i s not always the case; moreover, the country from which financing would be available may not be suitable from the point of view of the applicant. Oiscussions about sources of financing, sometimes even f o r minor items, are often very time-consuming and not only delay the s tar t ing of projects but often greatly retard the u t i l iza t ion of already imported capi tal goods.

11 Even if the import of capi tal goods is actually expected to be undertaken accordjng to a program phased out over a long period, i n i t i a l "clearance in principle" fo r the whole of the import program must be obtained.

1 2 . The procedures t o be followed f o r imports of heavy e lec t r i ca l plant by industr ial establishments are very similar to those described above. The relevant technical Sponsoring Authority i n th i s case i s the Central Water and Power Commission ( Power Iding) through which import applications are to be submitted.

13 • Vhatever the procedure f o r submitting applications, and whichever is the authori ty which ac tua l ly approves the applications, the authori ty which ac tua l ly issues the l icense i s in each of these cases the Chief Controller of Imports and Exports in New Delhi. However, f o r machine too ls not f a l l i n g within -the compass of the cap i t a l goods scheme, applications are t o be submitted t o and approved and l icensed by the Development Officer ( t oo l s ) , Tools Directorate, i n the Directorate General of Technical Jevelopment in New Delhi.

1h. Even i n such cases when applications a re now submitted d i r e c t l y through the technical Sponsorkg Authority of an industry, say i? the case of key industries, o r in the casp of applications submitted d i r e c t l y t o the Chief Controller of Imports and Exports, o r the Development Officer ( t oo l s ) , the e s sen t i a l i t y of the requested import i s t o be c e r t i f i e d by the technical Sponsoring Authority of the applicant.

B. Licensing Procedures f o r Imports of Current Production Haterials

15. There are tr,ro categories of importers: ac tua l users and established importers. The l a t t e r are inaividuals or firms established in the import t rade during a "basic period" which, a s a general ru le , is the year ending >larch 31, 1952, although it has been extended t o other years up t o 1960 f o r a large nuiiber of items.

1. Established I n ~ o r t e r s

16. Each established importer possesses a "quota ce r t i f i ca t e " which describes the nature and the value of the commodities he had imported during the basic period. A t the beginning of each l icensing period ( a t present, each f i s c a l year)' the Government publishes a statement on 'IImport Trade Control Policy," known as the Red Book, which indicates f o r each commodity the percentage of basic quota which established importers w i l l be allowed t o import during the given period. Each such percentage re fe rs t o a given commodity specified i n great de t a i l : the 196L/65 Red Book has more than 500 pages. These quotas are determined by the Economic Adviser i n the mistrjz of Industry, who of course has t o work within the constraint of the t o t a l funds allocated f o r commercial imports, out of which he has Lo reserve a large p a r t t o ac5ual users, For various reasons a large proportion of imports has been reserved t o ac tua l users. This i s immedi- a t e l y apparent upon reading the Red Book where the quotas f o r most items are zero, and are of ten below 20 percent f o r other items.

2. Actual Users.

17- Actual users a r e those who require raw materials, accessories, machinery and spare par t s f c r t h e i r own use in an indus t r i a l manufacturing process. The present Appendix i s concerned only with ac tua l users belong- ing t o large-scale industry; a separate appendix i s devoted t o the problems of l icensing in small-scale industry.

18. Actual users of large-scale industry a l l have the i r t,echnical Sponsoring Authorities, the most i m 0rtan.t of which is the Directorate General of Technical Development.~J) The authority respmsible fo r actually issuing licenses is the Iron and Steel Controller f o r a l l imports of unmanufactured iron and s t e e l items, and the Chief Controller of Imports and Exports fo r a l l other i t e m . However, a U technical Sponsoring Authorities (except State Directors of ~ n d u s t r i e s ) recommend the acceptance o r rejection of the import applications submitted by firms under the i r sponsorship. They know the amount up to which they can recommend import applications within each category of funds during each period; the i r recommendations are always accepted. In f a c t tinerefore it i s the tech- n ica l Sponsoring Authority and not the licensing authority proper that is responsible f o r authorizing imports.

19 Technical sponsors are given two different ceilings, one for iron and s t e e l items and the other fo r a l l other items. I n ihe case, say of a t rac tor manufacturing unit, two separate import appiicaLions would be submitted through the Directorate General of Technical Development, one addressed t o the Iron and Stee l Controller f o r items of unmanufactured iron and steel ; the other, also through the Directorate General of Technicai Development, addressed to the Chief Controller of Imports and Exports (CCIE). The Automotive Directorate of the Directorate General of Technical Development would a t f i r s t scrutinize the applications and make such cuts and changes in it as appear appropriate in view of the ceilings fo r s t e e l and fo r other inports that had been sub-allocated to the Directorate. Then, copies of the list of goods appended t o the applica- t ion addressed to the C C I E would be transmitted to the appropriate Development Officers within the Directorate General of Technical Development

1/ The following i s the complete l i s t of Technical Sponsors: Textile - Commissioner for t ex t i l e and engineering industry and t ex t i l e industry other than jute, hemp =d s i lk ; Tea Eoard f o r tea industry; Indian Coffee Board f o r coffee industry; Director (Sugar ~echn ica l ) , Director- a te of Sugar and Vanaspati, Ninister of Food and Agriculture, f o r sugar industry; Indian Rubber Board f o r rubber estates; Elinistry of Petroleum and Chemicals f o r petroleum industry; Iron and Stee l Controller f o r producers of iron and s tee l , and rerol l ing mills; Coal Controller fo r col l ier ies; Central Water and POI-rer Commission (Power Wing), Government of India f o r e l e c t r i c i t y undertakings; Central S i lk Board fo r s i l k industry; State Directors of Hand Looms fo r hand loom industry; Chief Direc3orate of Sugar and Vanaspati, blinistry of Food and Agri- culture fo r vanaspati industry; Coir Board f o r coir industry; Director General of Shipping fo r shipping industry, and Shipping Companies i n respect of seagoing vessels; Directorate of ji~hrketing and Inspection, IEnistry of Food and Agriculture fo r f r u i t and vegetable preservation industr,r; Jute Commissioner f o r jute and rope industry; Director, Indian Bureau of Mines fo r mines other than colleries; State Directors of Fisheries f o r canning, freezing and other fishery industries; State Drugs Control Authorities fo r pharmaceutical industries; Sa l t Commis- sioner, Jai-our, for s a l t industry in the private sector; and the In- dustriesCommissioners or State Director of Industries, as the case may be, of the State where the factory i s located, f o r a l l other industries.

f o r indigenous angle clearance. The app2.ication addressed t o the I ron and S t e e l Controller is transmitted t o him together with a c e r t i f i c a t e a t t e s t - ing the e s s e n t i a l i t y of Lhe requested items, The I ron and S t ee l Controller i s responsible both f o r indigenous angle clearance and f o r the issue of the ac tua l l icense. I f indigenous angle clearance i s refused f o r some of the i t e m , the application i s s e n t b a c k with appropriate remarks t o the Develop- ment Officer in charge of the automotive industry, The Development Officer then generally modifies the r e s t of h i s recommendation so as t o bring the t o t a l recornended f o r l icensing up t o the " f a i r share" of the firm. After completion of the indigenous clearance procedures, the applications a r e f i n a l l y transmitted t o the I ron and S t e e l Controller f o r l icensing of i r on and s t e e l inpor-ts, and a l so transmitted f o r t h e f i r s t time t o the Chief Controller of Imports and Exports who w i l l i ssue the l icense f o r a l l other imports.

20. The I ron and S t e e l Controller ac t s in multiple capacities. He i s technical sponsor of t he i ron and s t e e l industry, and i n t h a t capacity a l so gives indigenous angle clearance f o r imports of i ron and s t e e l items, and i s roug3ly the equivalent of the Directorate General of T e h ~ i c a l Developmnt vis-a-vis, say, the e n g i n r c r l l ~ , ~ industr ies . He i s a l so l icensing author i ty f o r the i m ~ o r t of i ron and s t e e l items, being in tinat capacity roughly equivalent t o the Chief Controller of Imports and Exports. He screens and transmits a l l public sec tor applications f o r s t e e l imports. I n audition, the Iron and S t e e l Controller i s a l so concerned with producticn of domestic i ron and s t e e l and the operation of controls on i t s allocation. The personnel of h i s o f f i ce i s in su f f l c i en t f o r these numerous tasks. Morecver, the o f f i ce of the I ron and S t e e l Controller is physically located in Calcutta, lrhile the Directorate Goneral of Technical Developnlent and the Chief Controller of Impsrts and 3xports a re both located in New Delhi. The f a i r l y easy infornial communica-cion channels established between the Directorata Cenerzl of Techlical Jevelopment and the CCIE a re lacking i n the r e l a ~ i o n s of the Directorate General of Technical Development with the I ron and S t e e l Controller. 'his may wel l be the most important cause of the slowness with which applications submitted t o the I ron and S t e e l Con- t r o l l e r a re processed, r e l a t i ve t o the time taken f o r approving applications f o r other imports. Under the f i r s t i ndus t r i a l imports c r ed i t of IDA, no d i s t i nc t i on was made f o r imports of i ron and s t e e l and other items. The procedure adopted does no^ seem t o have had any s ign i f ican t drawback, a l - though presumably the ver i f ica t ion from the indigenous angle was l e s s thorough than it i s i n general.

21. The l icenses specify in great d e t a i l the value and nature of each type of goods t o be imported. However, the l icensee may import more o r l e s s of any items of raw materials or components covered by h i s l icense, subject t o the condition t ha t the excess in respect of any individual item should not exceed 25 percent of t he limit, in quanti ty and value, indicated in the l icense. He may a l so import permissible spare par t s and small too ls required f o r the purposes of h i s fac tory up t o a limit not exceeding 25 percent of the t o t a l value of the l icense, even i f they are not mentioned on h i s l icense, provided t h a t such spare par t s and too ls have not been banned f o r import. These provisions a re va l i d only f o r ac tua l user l icenses f o r

raw materials and comonents; moreover, the importation of too ls and spares which under the current Red Book can be imported by established importers i s not authorized under these provisions.

22. Small amounts are made available t o the jo in t Chief Controllers in the ports f o r authorizing the emergency import of spare par ts f o r values l e s s than Rs. 1,000. Other spare par ts a r e t o be imported under ac tua l user l icenses, although in the case of emergency requests f o r imports can be submitted through the normal channels outside the regular l icensing periods.

23 • A t present the l icensing period nominally covers twelve months corresponding t o the Indian f i s c a l year April-1"larch. However, during the first six months of the period of va l id i ty of the l icense, orders amounting t o only 50 percent of the t o t a l l icense value can be placed. The balance of the SO percent can be u t i l i zed only within the second par t of the year a f t e r endorsement by the l icensing authority. The SO percent l imita t ion applies not only t o the t o t a l value of the l icense but t o each of the items separately inscribed i n it. The Government reserves fo r i t s e l f the r i g h t to reduce the value of the l icense usable d i~r inz the second period. Thus i n the second half of the f i s c a l year 1961r//65 the value of l icenses was reduced by 10 percent f o r most industries.

24. Import trade policy concerning established importers i s i n pr inciple t o be announced before the beginning of the f i s c a l year. While there is no public announcement of import trade policy concerning ac tua l users, the decision concerning t h e i r imports i s a l so i n principle taken a t the beginning of the f i s c a l year. However, the recurrent foreign exchange d i f f i c u l t i e s have repeatedly forced the postponement of the decision. For the current f i s c a l year import trade policy has been announced only in July. This does not mean t h a t imports a re held up i n the meanwhile; they continue t o a r r ive on the basis of l icenses issued in the past. The delay is par t ly genuinely due t o the d i f f i c u l t y of determining the policy and par t ly it i s a conven- i e n t wag f o r strongly reducing allocations by s i w l y making no al locat ion a t a l l f o r the first three months, f o r instance, of the year.

Table 1: FOX< OF PRELIHiNARS APPLICATION FOR IDUSTRIAL LICENCE

To be addressed with 10 spare copies to the Coordination & Licensing Progress Section, I i I i n i s t ~ j of Industry &

Supply, Udyog Bhavan, New Delhi.

1. Name of the Scheduled Industry or Industries t o which the a r t i c l e s proposed to be manufactured relate.

2. Name and address of the applicant

3. Name and address of the indus t r ia l undertaking

4. I f possible a t t h i s stage, indicate - (a) whether it is proposed t o be undertaken by proprietors, partners,

private limited or public limited company

(b) Names of proprietors, partners, or Board of Eirectors and the i r addresses

( c ) Name and address of the Nanaging agents, i f any

(d) Obligations, r ights and privileges of Nanaging Agents in the constitution and worlcing of the Conpany

(e ) How i s it proposed t o finance the undertaking ?

( f ) Is m y foreign collaboration (whether in the form of royalty or consultancy agreement j or investment envisaged? I f so, the extent and nature of such collaboration. Is it proposed t o f ind foreign exchange fo r import of capi tal equipment in any other way?

5. Proposed location of the factory

Tehsil ................. Dist r ic t ............ Sta te ........... 6. Lines of manufacture proposed:

Kame of product andbye product.

Proposed* (Annual) ins ta l led capacity

w Basis of estimating ins ta l led capacity should be clear ly s tated v iz . whether the operation will be continuous o r by s h i f t s and the number of s h i f t days assessed fo r estimating t h e annual capacity.

1/ Table from Procedures f o r Industr ial Licensing, Federation of Indian - Chambers of Commerce and Industry, Federation House, New Delhi-1, Annexure I V (a) (Vide para. 6), pages 29-32.

7. Manufacturing Programme :

(a) Zxisting activities, if any:

Existing-capacity Current Annual Production -

S1. Items of production B a y Value Wan ti ty Value

( tonnage) ( tonnage)

etc.

(b) Final manufacturing programme for items in respeci; of which this awlication is made:

Annual capacity Estimated Annual Production CIF S1, Item of value oi No. manufacture Quantity Value Quantity Value unit

( tonnagej ( tonnage) product

1, 2, 3. etc.

(c) Forecast of time required for implementat,ion of the project

8, Fhased manufacturing programme for 7 (b) above, if any:

Year Item of production Annual Turnover Percentage by value of imported-content (i.e,, total of all imported

Quantity Value raw materials and com- ( tonnage) ponent s . )

1st Year (i) (ii)

( iii) ( iv)

2nd Year (i) (ii)

( iii) ( iv)

3rd Year etc, (Attach a sheet, if necessary)

9. Estimated requirements of main raw !rla%erials:

Name of raw Idhether indigenous or Quantity required Estimated value material imported; i f the l a t t e r , per year

the country of origin

10. Requirements of capital/equipment Total value of equipment required;

( i ) I q o r t e d : Please give name of the countries in order of preference

( ii ) Indigenous :

11. Indicate your requirements of r a i l transport fo r movement of raw materials and finished products i n the proforma attached

12. Water Supply:

(a) I d i l l i t be ample f o r requiremen5s of:

( i ) factory, and ( i i ) township or s ta f f quarters?

( s t a t e approximate quantity)

(b) W i l l i t be drawn from public supply?

( c> Effluent problems, i f any

13. Power S~ppljr:

(a) Total requirements proposed t o be drawn from:

( i ) mrn generating s ta t ion (ii') public supply

(b) In case of own s ta t ion give brief particulars of plant in operation

14. I f possible indicate your requirenents of coal/coke i n the proforma attached.

15. If possible indicate the estimated requirements of fixed assets i.e. investment irl land, buildings and machinery:

Land - Building - Machinery - Note: Idhere the land and/or building i s rented, the capitalised value

of the same may be given.

16. Give a brief discription of the processes involved in the manufacture and factors favourable fo r the i r adoption

Place Date Signiture of Applicant

Table 2: FOE1 OF THE XETTER OF IIU'TENT L/

............. I am directed t o re fer t o your application dated the f o r the issue of an indus t r ia l licence f o r the establishment of an indus t r ia l undertaking fo r the manufacture of ......................................... and t o say tha t Govenunent are prepared t o issue an indus t r ia l licence t o you subject t o your f ina l i s ing arrangements in respect of the following, t o the sa t i s fac t ion of the Government:

etc.

................... 2. You are requested t o send within a period of from the date of issue of t h i s l e t t e r % (1) proposals regarding foreign collaboration ( 2 ) application f o r import of capi ta l goods (3) application f o r consent t o the issue of capital , with 10 spare copies of each of these applications, t o the Coordination and Licensing Progress Section of the Ministry of Inaustry.

3. This " l e t t e r of intent t t is valid f o r a period of ................ months and, in the event of your not submitting applications/proposals re la t ing t o the conditions mentioned above within the s t ipulated period, t h i s l e t t e r of in ten t w i l l automatically lapse.

Under Secretary t o the Government of India

Copy to:

1. 2. 3 4. C.L.P. Section

*Strike out whichever i s not applicable

1/ Table from Procedures f o r Indus t r ia l Licensing, Federation of Indian - Chambers of Commerce and Industry, Federation House, New Delhi-1, Annexure I V (b) (Vide para l l ) , page 33.

STATE3ENT SUBMITTED TO THE I ~ ~ I S m Y OF F I i W N C E

by the

O F F I a O F THE DY. GEhTEHAL P.TLN.AGZI-~ (~ginl), IEYVELI LIGNITZ CORPN. , LTD. , ; \ z r a L I - 1

Offloe of the Dy,Genl .b&ager(~&\~) , Neyvoli Lignite Corpn. Ltdo ,Nepeli-1.

Sub: Draft para 'Dolay i n o o ~ e i o n i n g of the Fer t i l imer Plantw r e l a t i n g t o the Lignite Corporation f o r i96i-82.

Pef: D.o.No.IAI/~o~/A.P~~~/~~ dt.9.6.64 from the D y . Chief Aooountm Off ioer t o the D y . General W a g e r (Teoh. 8 Works).

****+

With referenoe t o the above, the following

par t ioufara ray be furnished t o the Aooounte Brenoh,

1. Date on whioh proJeot repor t I fa r t iou laru-nut availabf tt 7 warn prepared . ~ - 5 " ~ ~ ~ ~ . C-7

2. Projeot approved by the Board- Approved by t l ~ o noard during i t n 6th meeting i n 10/57 (mub~eot t o v e r i f i - oat ion i n Chairman'e Offioe) ,

3. Tenderr inv i ted In May, 1958.

4 , Orders plaoed f o r equipment 27.10.1969

A s regards the proourement of mteel, a

lohronologioal statemsnt indioat ing the ao t ion taken

is enolouad.

The Neyveli Lignite Corporation Limited, l ntered i n t o two contracts on 27.10.1959, o m wi th M/sr PrB.L, of Wert Germany and other with M/s.Ansaldo of Itau, f o r the r e t t i n g up of a F e r t i l i z e r Plant. Under these cont rac ts , the Corporation agreed t o supply the s t e e l required i n respect of e quipment and machinory t o be manufactured by the cont rac tors i n India, and it was a l s o provided t h a t non-avai labi l i ty of s t e e l would cons t i tu te a force maJeure. It war rubsequently agreed t h a t the Corporation should supply the S t e e l wi th in s i x months from the date of r e c e i p t of requis i t ion8 from the cont rac tors r Before committing i t a e l f the Corporation d i d not a s c e r t a i n t h e s i z e s , sec t ions , q u a n t i t i e s e tc . , of the r t e e l involved and t h e i r a v a i l a b i l i t y indigenously.

Detai ls of s t e e l r e uired were furnished by M/s.P.B. L. B ( f o r 2796 tonnes) between 8. .1H0 t o 3.5.1860, and by l v s .Angaldo ( fo r 889 tonnes ) between 24.8.1960 t o 19.5.1961. The corpccation included the requirements of s t e e l i n i t s indents placed on tho Iron and a t e e l Control ler i n May, 60 and i n February, 1961. Between May 1960 and October 1960 the mattor was pursued by the Corporation only by i r s u e of reminders. In October 1960 i t became known t o the Corpaxition t h a t no a c t i o n had been taken on the indents and t h a t i n order t o enable f u r t h e r a c t i o n being taken, the indents had t o be revised t o conform t o the e x i s t i n g ins t ruc t ions of the Iron & S t e e l Controller. After some correspondence tho revised indents were furnished on 28.2.1961. In May 1961 the Iron and S tea l Control ler , intimated tho Corporation t h a t indents required f u r t h e r rev is ion , s ince the quan t i t i e s damanded i n respect of some items were belaw the minimum of 3/10 tons. The revised indents . were f i n a l l y given i n May 1961 t o the Iron and b tee l Control ler who then planned them on t h e various s t e e l works. Since the s t e e l works could not guarantee supply within a reasonable time, except i n the case of a small quant i ty of s t e e l , the matter was taken up by the Corporation wi th the Government of India and t h e i r orders were obtained fo r importing 3429 tonnes of s t e e l a t an expenditure of Rs. 27 l acs i n fore ign exchange. Orders were finally placed on 1703,1962 f o r the purchase of imported s t e e l .

In view of the considerable de lay i n s u p ly of s t e e l , R the existence of Foree Majeure was n o t i f i e d by t e Contractors. A s the s t a t e of Force Majeure continued f o r more than s i x months, and the contracts would become void unless a mutually s a t i s f h c t o r y agreement is ar r ived a t between the p a r t i e s t o the con t rac t s , the matter was negotiated wi th the contractors and supplamentary bgreernents have been entered i n t o f o r f u r t h e r continuance of the contracts. The supplementary agreement involve an e x t r a payment of R s . 72 lakhs (Rs. 42 lakhs i n fore ign exchange.) The comiss ioning of the Plant ha8 a l s o been delayed by 27 months, and it i s estimated t h a t the loss of production a t r i b u t a b l e t o t h i s delay would be of the order of 400,000 tons. of urea, which if imported would cos t about R s . 20 crores i n fore ign exchange.

Chronological Statement showing the action taken fo r procurement of s t e e l f o r the Fe r t i l i so r Plant.

The Contract f o r the supply and erection of the Fe r t i l i so r Plant was concluded on 27.10.59.

The requirements of s t e e l were tentat ively assessed by the Corpor- a t ion and a t o t a l quantity of about 6931 tonnes of s t e e l was included i n the Corporation's demand f o r s t e e l f o r the I1 half year 59-60 and I half year 60-61, t o meet the requirements of S tee l f o r the Fe r t i l i so r Plant.

I. P.B.L. Tortion

Details of s t e e l requirements (about 2796 tonnes) were received from P.B.L. between 8.2.60 and 3.5.60.

A s per the procedure f o r acquisit ion of s t e e l exis t ing then, no piecemeal indents would be entertained by the Iron and Stee l Controller. Hence the en t i r e requirements of the Project (including Fe r t i l i so r Plant) were consolidated and indents placed on Iron and S tee l Controller against the Quota a l lo t t ed to the Corporation f o r second half year 59-60 vide l e t t e r No. 141204/HVl(i) 59-20 dt.17.5.60.

Iron and Stee l Controller was reminded telegraphically on 18.7.60, 25.7.60, 18.8.60, 5.9.60, 19.9.60 and by D.O. on 24.9.60.

No reply was received inspi te of repeated reminder and hence the Progress Officer of the CorporatAon was deputed to Calcutta during 1st week of Oct,ober, '60 t o chase up the indent and it was learn t then tha t the indents were being returned as they were not i n accordance with the Iron and Stee l Controller s circular NO. 5 7 ( ~ ) .

Iron and Stee l Controller was addressed again demiofficially on 26.10.60 pointing out the d i f f i c u l t i e s in changing the specifications and t o arrange therefore supply of the materials as per the indents place. Neither the indents were received back nor was any reply received indicating the action taken.

Reminded Iron and Stee l Controller again on 10.11.60 by telegram.

The Managing Director had also addressed the Iron and Stee l Con- t r o l l e r demiofficially - vide D. O.TJO. 23256 DII/~O-1 dated 10.11.60. - requesting expeditious action.

The idanaging Director again addressed the Joint Secretary to the Government of India, Ministry of Steel, i m e s and Fuel - vide D.O. ~0.23256 D11/60-2 at.10.U. 60.

:2eply received from I ron and S t ee l Controller - vide l e t t e r No. P~~/1/7/34/72-73 dated 5/8.11.6~ - i n t i m t i n g t h a t indents f o r pla-Les and wires onPj had been planned with t h e Hindustan S t ee l and Indian S t ee l & ?lire Products Ltd., respectively. It was a l s o s t a t ed t h a t a s t h e specif icat ion e tc . ~ b e n i n t he body of the reinaining indents were not c lea r it was d i f f i c u l t t o p lan them on any source. He wanted t h e indents t o be prepared i n accordance with the "Tats Isco" Kand Book and a s per c i rcu la r N O . ~ ~ ( R ) .

Irrmediateljr t he contractors were addressed t o fu rn i sh t h e i r requiranezts oZ s t e e l i n the forr!; required by t h e I ron and S t ee l Controller . I n reply F.B.L. inticlated us t h a t i f any niodificatiorxi were t o be made i n the s ~ e c i i l c a t i o n s e tc . , it would involve an addi t ional cost of Dli1,5Q,000 and 6 aonths ti-qe.

;:eanwhile i n D.O. No.~?~(~)/1/7/34/72-73 d t . 18.11.60 fror~l I,r. C . F. Taneja of t he S t ee l Control t o t h e ltlanaging Director one of our representatives was asked t o be deputed f o r discussion and c l a r i f i ca t i on of t he indents.

A s t he exact polnts of c l a r i f i c a t i o n e tc . required by the Iron and S t ec l Controller xere nct furnished i n the above 0.0. it was considered desi rable t o ascer ta in the same before an of f ice r was deputed f o r discussion. The I ron and S t e e l Coiltroller rlas, therefore, again addressed - vide l e t t e r No. &12~4/iiVI ( i)/S9-59 dated 2L. 11.60 t o i n t h a t e the exact c l a r i f i ca t i ons r e q u i x d t o be ;!lade.

ReZundcd the I ron and S tee l Controller te legraphical ly on 13.12.60, 17.12.60, 7 .I- .51 and ly D.O. l e t t e r on 12.1.61.

I n '3.9. No. PA4/1/7/34/7-273 d t . 12.1.61 from t h e I ron and S t ee l Cor~t ro l le r t o t he ;:anaging Director the NLC was a;ah asked t o send one of our representatives :or drlscussion & ~ L a r ~ i c a t i o n of t he indents.

Thc Gxecut!.ve Sngineer ( C;lenlricals) w2s accordingly deputed t o Calcutta and the i a t t e r was discussed b~ h;ix wi t11 tile S t ee l Control au tho r i t i e s on 30.1.61.

A s per t h s above discussions revised indents f o r s t e e l s t ruc tura l s , Bars and 3.ods asd Sheets and Flails e tc . were forwarded t o t he I ron and S t ee l Controller on 28.2.61 - vide l e t t e r Mo. 14120L/~~1(1)/59-8LL d t .28.2.61.

1nl;iination was received on 28.2.61 from Endustan S t ee l t ha t t he p l a t e s planned on then; on 8.11.60 could not be supplied, s ince t he quant i ty involved i n each s ize was very l i t t l e . Tne I ron and S tee l Controller was, therer"ore addressed i n l e t t e r llo. '&i204/:~,~(1)/59-93 dated 20.3.61, t o arrange supp1;- f roni any othell source.

Reminded t h e I ron and S t e e l Controller on 20.3.61, 3.L.61, 7.4.61, 10.4.61, 12.4.61.

t~ianag3.n;;. Director has addressed Silri S. S. Khera, S e c r e t a q ~ t o Governinen-I; of India , denllofficially vide D.C. l e t t e r No. 23256 DIIj60-9 dated 15.k.61.

Rminded I ron and S t e e l Controller b:? belegrams 28.4.61, 9.5.61 ar:d 18.5.61.

I n l e t t e r Ro. ~ ~ ~ / 0 3 / ~ 5 / 9 2 - 9 3 / 7 2 - 7 3 da.ted 19.5.61 t h e I ron and S t e e l Controller intimated us t h a t t he revised indents placed on 28 -2.61 a l s o could be planned only p a r t t a l l y .

I n D.C. l e t t e r No. iS(6)/61-l ignite d t . 24.5.61 from t h e 3y. Secretar,. t o the Gover,ment of India, i- ini is try of S tee l , Pines & Fusl, New Delhi, it was suggested t h s t revisea indents on t h e l i ne s indicated by t h e I ron and S t ee l Controller mighc be placed. Accordingly indents were prepared increasin; t h e q u a ~ i t i t i e s t o -the minimum tonnade prescribed by t h e I ron and S t e e l Controller and Lhese revised indents were handed over i n person t o the Dy. I ron & S t e e l Controller , Calcutta by the Dy. ~ ~ p d t ./purchase on 27.5.61 and these were planned on 'Zroducers on 31.5.61 (I.!industan S-teel Liiilitsd, Rourkela t?; Bhila i , Tatas and IISC and Guest, lieen, l l i l l iams Ltd.)

The I ron & Stee l Controller iiad accorcled only 50% p r i o r i t y f o r t h e revised indents pi.anned an 31.5.61. However, t he matter was taken up wit:^ t h e Government of India f o r according 1COZ p r i o r i t y . But no orders were received f ron t h e Government i n t h i s regard.

An off icer of t he Corporation was deputed t o i3hilai and Rourkela during .the f irst weei: of August 61 t o chase u? t h e orders with t h e producers. But no f r u i t f u l purpose was served.

The producers were not able t o supply- a l l t h e sect ions even a s per t h e revised indent accepted by t he I ~ o ~ I and S t ee l Controller . They were a l so not able t o quote a de f in i t e delivery period f o r t h e sect ions offered bj tizem.

Since it was found d i f f i c u l t t o obtain t h e requirements ~f s t e e l indigenously t h e I r c n and S t e e l Controller was approached on 25.7.61, 18.5.61 f o r a clearance c e r t i f i c a t e f o r t h e iniport of t h e s t e e l .

11. knsaldot s Portion - The f i r s t l i s t indicaiiing t he d e t a i l s f o r 317,824 Xgs . ( subsequently

increased t o 40j,L45 Kgs. ) of xide f lange H Bcms e t c . was received on 25.7.60. I n order t o ascer ta in whether these beans could be procured i nd igenous l~ the i r o n and S t e e l Controller was addressed on 27.7.60. The ,La in producers of s t e e l i n the count r j were a l s o contacted. I n 3eceinber, 196'3 it was established t h a t these w;de f l ange beams i n question were not manufactured i n t h e ~ o - ~ t q f and accordingly il/s .Ansaldo themselves were authorised t o arrange f o r t h e i r i:<;port from abroad.

Detai ls Tor t h e supply of a f u r the r quant i ty of about 889 tonnes of stieel were received froi!; il/s. Ansaldo on 24.8.60, 16.12.60, 24.1.61, 24.3.61 and 19.5.61. The quanti ty involved i n each of t he items was l e s s than t he minlii!uii tonnages prescribed by the I ron and S t ee l Controller f o r planning on producers. Hence t he a v a i l a b i 1 i . t ~ of these mater ia ls with aqv of t he cofitrolleci stockholders had t o be ascertained. But t h e 1 )~a te r ia l s were not readi ly avai lable wi th ari;r of t he stoclcists. Hence lndents f o r t he supply of about 82.19 tonnes of s t e e l , t h e d e t a i l s of which were received on 24.8.60 were placed wi th t h e e controlled stockholders a t iiadras on 7.12.60 on forward delivery bas l s . Based on t h e d e t a i l s received on 16.12.60 and 24.1.61 another indent f o r t h e supply of about 21k.57 tonnes of s t e e l was a l s o placed on 29.3.61 on the coni;rolled s t ~ c k h o l d e r s a t iladras .

The indenbs were acceyted b j t he s t ock i s t s only p a r t i a l l y s ince they wzre not able t o supply a l l t he items i n t he specif icat ion required. Even f o r t h e items accepted by the s t ock i s t s t h e delivery period was i nde f in i t e .

Several items of the s t e e l required by Zi/s. hsaldo were s imilar t o t he s t e e l sect ions required by l;/'s. Pintscil &nag ( t h e other contractors of the F e r t i l i s e r P l an t ) . !,.!e had already placed an indent rfilith t he I ron and S t ee l Controller f o r t he acqe . s t t i on of t he s t e e l mater ia ls required -to be supplied t o ~; /s . Pintsch Eamag. A s the quan t i t i e s required by M / s . Pintsch Barnag i n various i t e n s of s t e e l were below t h e m i n i m tonnage prescribed f o r pl.anrung on producers we had t o increase t h e quan t i t i es i n each section, considerably- and It xas thought t h a t i;/s. Ansaldo s balance requirenents could a l s o be inet out of t h i s indent.

c ieanwhile a s t he s l l v p i ~ posi t ion of indents placed on producers and stockists was not sa t is ;sc tor j and a s t he requireirlent was urgent t h e I ron and S t ee l Col~ t ro l le r was requested t o autllorise us t o arrange f o r the i- port of t he e n t i r e quanti ty of s t e e l required f o r t he Fert i l iser Plant . Our rcqucst was conceded by the I ron and S t e e l Controller and a no- o b j e ~ t i o n c e r t i f i c a t e was issued by hin? vide l e t t e r No. PAA/3/05/90-93/72-73 dated 13.9.61 authcrisirig t o import a t o t a l q u a n t i t ~ of 3429 tonnes of s t e e l required f o r t h e F e r t i l i s e r Flant . 'Jllile authorising t he iinport t he I ron and S t ee l Controller siaZed t h a t the foreign exchange required f o r t h e import should not be debited t o t he ce i l ing allowed t o his organisation. S ~ n c t i o n cr' the G o ~ e r ~ f i e n t or" Ind ia f o r fo re ign exchanse f o r t he import of t he s t e e l i n question had therefore t o be obtained a ~ d accordingly t he Government were addressed on 23.9.61.

I n telezram No. 15(6) /6l / l igni te dt.28.10.61 of t he i i in i s t ry of Steel , ;Tines and Fuel, sanctior! of t h e Government of Ind ia re leas ing t he r equ i s i t e fo re ign exchange t i ed t o Trade plan t i i th East European countr ies was communicated. Immediately tenders were i nv i t ad by paper adverkisement and through the Indian Tracie Journal inviting c_uotatior,s f c r t he sllpply of t h e s t e e l inateriais i n question f r o n East Zuropean co-i;)%ries, the due date of the tendsr being 25.11.61.

A s t h e resFonse f o r s u p p l . ~ ~ oof s t e e l f roil1 d a s t Luropean cour,tries was not sa t i s fac to ry , f r e s h sanction of t h e Soverninent of I n d i a f o r f r e e f o r e i z n exchange f o r importing t h e s t e e l frorr? Fiest Germany, had, t o be obtained. Rle revised sanct ion of t h e Goverruaent of I n d i a re leas ing t h e r e q u i s i t e free f oreidn exchange f o r inlportin, the s t e e l from 5Jest Germanv w d s dccoraed i n l e t t e r No. 15(6)/61--1,ignite d t . 7.3.62 of t h e i.Ij.nlstr7 or" S tee l , . , ines and Fuel. Firm orders f o r t h e i!nport of t h e s t e e l ma-lerizls i n quest ion were a l s o placed on 17.3.1962.

fhe supply of s t e e l t o t h e contrac tors has already been completed and the f a b r i c a t i o n works a r e i n progress.

EXTRACT FROM THE 1rX3PORT OF THE STUDY TEAM ON

DIRXCTORATE GENERAL OF TECHNICAL DEVELOPiENTn FART I, APPENDIXIV. SECTION I1

I1 The procedure adopted in D,G.T.D. f o r i ts apportionment among various industries is broadly as follows:

( A ) CrnMICAL INDUSTRIES :

Final apportionment of the ceil ings among various chemical industries is made by the Deputy Director General with the pr ior approval of the Director General and the Secretary, Supply & Technical Development, a f t e r taking in to account the continuing and special requirements of the industries. The s t a r t i n g point would of course be the t o t a l amount of foreign exchange earmarked f o r the Chemical Directorates under the head "Free R e s o ~ r c e s , ~ ~ and credi ts from other countries, f o r instance f o r the period October, 1964 - Karch, 1965, the allocation of Free Foreign Ex- change to the Chemical Directorates as received from the Economic Adviser was Rs . 15 crores representing a cut of 19% over the allocation in the previous period. It was, however, not considered feasible t o apply the cut of 19% in all cases and process the applica.tions because cer tain special aspects had t o be taken in to consideration.

These were :

( i ) The p r io r i ty now attached t o t i e Cement industry necessitated a special allocation of Free Foreign Exchange to the industry f o r i t s special needs;

( i i ) The Alkali industry had t o be given a special allocation of Free Foreign Exchange in order to meet the raw material requirements of a new factory s e t up f o r the produc%ion of Borax and, in another case, f o r the production of an item by a par t icular process,

( i i i ) The Aromatic Chemicals Directorate had t o be given a special allocation of Free Foreign Exchmge on account of the f a c t that the DUTCH c redi t given to it e a r l i e r did not materialise,

The additional Free Foreign Exchange required f o r the above could come only from the t o t a l exchange of Rupees 15 crores made available, and, therefore, inevitably, a pro rat,. cut of 20% was made i n the alloca- t ion of Free Foreign Exchange t o each Chemical Directorate to mop up the notional saving in order t o neet the above special needs.

In the case of DUTCH aid of Rupees 125 Lakhs earmarked fo r the Ru:b'ber Directorate, i t was decided not to u t i l i z e more than Rupees 40 lakhs because the items f o r the import of which +his provision has been made had, meanwhile, registered increasing indigenous production and, therefore, it was decided t o u t i l i s e the amount of Rupees 85 lakhs thus saved f o r import of other materials tha t might be available from Nether- lands a f t e r consulting the Economic Adviser. Similarly, a sum of Rupees 15 lakhs earmarked under DUTCH credit f o r import of Aromatic chemicals was not considered f o r u t i l i sa t ion on account of the f a c t that not a single import license f o r the inport of t h i s item had been authorised by the DUTCH authorities in the past despite provision.

The allocation under XEST GERNAJJ aid was used t o supplement the allocation under Free Resources to Drugs & Fharmaceuticals, Insecticides, Dye s tuf fs , Paints and Varnishes and Plastic industries.

In the case of A I D provision for organic and petro-chemicals, plastics, asbestos, rayon and paper, it represented an approximate cut of 20% from t h i s source. A separate allocation f o r asbestos under the COL014J30 PLAI\J was made actually f o r the amount already released on annual basis.

· pdf filetable of contbjts page no. brief suidiary of findings and recol4piendations...

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