Deficit Financing

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

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

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

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

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

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

     Inflation that now prevails in India began in 1955-56. Budget deficits rose from 97 crores in 1954-55 to 225 crores in 1955-56. In 1957-58, the Plan outlay was so great that, with additional defence expenditure, the budget deficit that year reached a peak of 495 crores. These yearly deficits have a cumulative action.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

     We know that deficit financing to the extent of Rs.367 crores during the five years ending 1959-60 led to a price rise of 32 per cent. The deficit financing inherent in the Third Plan will certainly involve ‘runaway inflation’, like the one that swept over Germany after the first World War. During the five months ending August 1960, prices have been rising at a rate computed at 14.2 per cent per annum. This is an indication to take note of that deficit financing has already gone too far. Foreign aid and drafts on currency reserves cannot go on indefinitely. Holding the price line, which is continually promised, would be just King Canute’s command to the waves of the sea.

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

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

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