Reference: Our letter No.587 of July 10, 1958.

In recent weeks it has become increasingly evident that last winter's hopes for an alleviation of the Foreign Exchange Crisis have proved false. Since April 1, 1958, the reserves have declined at an average rate of approximately $10million a week, and with the sterling balance now totalling a scant $400million, the Reserve Bank's treasury of foreign assets promises to be well nigh empty before the year is out. It is now officially estimated that the over-all foreign exchange deficit for the Second Plan period will be approximately $3400million as compared with the $2200million deficit originally anticipated and, therefore, that additional foreign exchange resources totalling at least $1000million (over and above foreign assistance already agreed to) must be obtained by 1961. In the longer term, say for the next decade, the shortage of foreign exchange promises to be almost equally serious. With the completion of the steel projects in 1960 a considerable saving will be effected, but some of the other heavy industrial projects now under way will not be earning or conserving foreign exchange until well into the Third Plan period. Furthermore, it is probable that heavy industrial and transportation projects with a high import content will again be emphasized in the Third Five Year Plan and that an effort will be made to increase overall investment by at least 24 percent. In addition to these factors, repayments due during the Third Plan period on loans and credits already extended now exceed $600million.

2. In these circumstances it is not surprising that the Government is concerned lest there be a general loss of confidence in the country's financial stability and broad economic prospects, and official spokesmen are losing no opportunity to emphasize that the level of foreign exchange reserves is but one aspect of a country's economic health, that the present decline in reserves has long been foreseen, and that the situation, however disturbing, need not prove critical if all concerned will buckle down to their allotted tasks. The crisis is, after all, one of development rather than stagnation, they assert. No doubt it is proper that these facts should be emphasized, especially in view of the national tendency towards what the Governor of the Reserve Bank recently described as unwarranted oscillations ... between optimism and apprehension, though there is an abundant evidence that the immediate crisis is more severe and has developed at an earlier date than the Government anticipated, and a disinterested observer might perhaps speak less confidently of ultimate success than Government spokesmen.

3. The broad explanation of India's foreign exchange shortage that the Government has embarked upon an ambitious programme of economic development which it would be most difficult to finance through domestic savings or exports is of course well known to you and we need not discuss it here. As to the factors which have contributed to the immediate crisis there is substantial agreement among observers, despite differences of emphasis and occasional barbs from critics who explain the crisis principally in terms of Government bungling and ineptitude. Imports, it is clear, have been considerably greater in cost and volume than was anticipated by planners. The import costs of the Plan's industrial projects, for instance, were greatly underestimated and food imports exceeded two million tons in 1956-57 and 3½ million tons in 1957-58 in contrast with the Plan estimate of an annual importation of 400,000 tons. While the issuance of licences during the past fifteen months for even essential imports has been controlled with increasing strictness, the actual flow of imports and of course corresponding decline of exchange reserves has continued with little abatement owing in part to vast import commitments entered into prior to the tightening of the regulations. (Outstanding import commitments were officially estimated to have totalled $2,000million last October, and Lokanathan of the National Council of Applied Economic Research recently estimated that commitments totalled $1,500million in June 1958.) Declining exports, too, are known to have contributed in no small measure to the shortage. Foreign exchange receipts from this source in 1957-58 appear to have fallen $50million short of the relatively modest Plan estimates, while receipts are believed to have declined yet more seriously during the first quarter of 1958. The tying of foreign loans and credits, especially from the United States, has been a further factor in the continued decline of exchange reserves for such funds have perforce been utilized in projects which, while valuable in themselves, frequently constituted an addition to the Plan's core. As a Finance Ministry official recently expressed it when writing to us concerning Colombo Plan aid for the current year:
   
   Our situation now is that we must find from current earnings exchange required to pay for the capital goods we have already ordered. It is causing an extreme shortage of exchange to finance imports required to maintain the economy. Any current imports we get under aid programmes help in releasing an equivalent amount of exchange for the payment of capital goods already ordered. Aid tied to the purchase of capital goods only enlarges our development programme but does not relieve our exchange shortage.

4. A variety of suggestions have been advanced as to how the exchange crisis is to be alleviated. Government spokesmen and most private observers are agreed that every effort must be made to reduce the flow of imports further, but there is less agreement as to how this is to be achieved. Non-essential imports have already been reduced to a trickle and any further exclusion will seriously affect the economy unless great care is exercised. While it may be possible to cancel or postpone plans for the importation of some capital goods, in most instances projects have reached a stage where it would be highly uneconomic to postpone completion. Furthermore, many of the Plan's industrial and transportation projects are closely interrelated and failure to complete any of them would tend to create bottlenecks making the completion of other projects difficult. Quite apart from such considerations, the Government is of course aware that any appreciable curtailment of the Plan's core would seriously affect their political standing in the country, and they have hitherto firmly rejected such measures.

5. As to the possibility of further curtailing the entry of raw materials, there is already abundant evidence that this cannot easily be accomplished if the economy and employment levels are to be maintained. The Government has been seriously considering the cancellation or withholding of import licences for raw materials for the third quarter of 1958-59, but such a measure, while calculated to conserve foreign exchange in the short run, would inevitably cause much distress and havoc. As the Times of India recently expressed it, it will be a pity if in wielding the axe the Government damages the very sinews of industrial production on which the success of the Plan depends. The Government is apparently aware of this danger and press reports which have appeared within the past ten days indicate that they have now rejected the idea of a blanket cancellation of licences.

6. Similarly, it might well prove difficult to conserve any large amount of foreign exchange through the reduction of food imports. As you are aware, the volume of India's domestic food production is still primarily governed by the generosity of the monsoon, agricultural campaigns notwithstanding. If, as during the past two years, the monsoon is inadequate, extensive food imports are unavoidable. A considerable part of these food imports have been provided by the United States under Public Law 480 and have thus (apart from transportation costs) not involved expenditure of foreign exchange, but normal commercial suppliers would no doubt object strongly if this type of assistance were increased, or if overall food imports were decreased, at the expense of traditional cash purchases.

7. There remains, however, at least one type of import which could be considerably reduced without adversely affecting the Plan and the economy: defence equipment. The exact amount of defence imports has not been revealed by the Government, but it is widely assumed to be substantial. The Eastern Economist in a recent critical article maintained that total defence expenditure has inflated our import bill by about Rs.75 to Rs.80 crores over three years. The Government and much of the Press has hitherto taken the stand that however unfortunate such imports may be they are unavoidable in the present circumstances. There are, however, some signs of a growing realization that India must to some extent choose between economic development and such security as defence equipment can bring, a realization that she cannot have, in the words of the weekly Thought, both guns and butter. Since the introduction of the budget the Government is thought to have reduced defence expenditures somewhat, and there are known to be some, particularly amongst those responsible for the Plan, who are pressing for more drastic reductions.

8. Whereas for over a year now attention has been focussed on the need to reduce imports, it is only within the past few months that sustained consideration and determined Government action has been directed to the alleviation of the exchange shortage through the promotion of exports. A variety of appropriate measures have been suggested tax incentives, rebate of import duties on essential raw materials, reduction of excise duties, liberalization of export quotas, assisted transport, subsidization, compulsory export and in some instances the necessary Government action has already been taken. Export duties for certain edible oils, the sale of which has fallen ominously, have been abolished. While the rate of export duty on teas is to be unchanged, duty will henceforth be calculated on a lower price. The drawback of excise duties on sugar and margarine used in the preparation of certain exports is now to be granted. A Government ordinance during the latter part of June directed all sugar mills to deliver a part of their production for export, the target for the current year being fixed at 50,000 tons. Preliminary discussions with the Railway Board for decreased freight rates are said to have begun. Above all, there appears to be a new and long-overdue awareness in Government circles, and it is hoped among private exporters, that more vigorous selling tactics must be adopted in foreign markets and that the quality of exports must be improved. Since May the Press has repeatedly emphasized the importance of this new awareness, and like the Hindustan Times, has cautioned readers that gone are the days when India was in a position to have a trade surplus without much effort.

9. It remains to be seen how sustained this determination to increase exports will prove, and in the short run there are, we think, at least two major obstacles to the success of the campaign. The first of these is, of course, that world markets are depressed at this time and the terms of trade are unfavourable to many Indian products. Indeed, unless world markets recover quickly, it may prove difficult to prevent export earnings from declining further. The second obstacle is that many potentially exportable goods and materials are already in short supply in India and significant exports are likely to increase prices and inflationary pressures generally. Already there are ominous reports of prices rising in anticipation of shortages and while Press and Government have joined in denouncing such profiteering, mere exhortation promises to be ineffective if unaccompanied by determined restraints and controls.

10. Yet another means of relieving the foreign exchange shortage has evoked growing interest within recent months: the mobilization of private gold and silver hoards. It has of course long been known that there were large amounts of these precious metals in India, apart from Government holdings, but it is only recently that an authoritative and relatively precise estimate of the amount has been generally available. This estimate, which appeared in the April edition of the Reserve Bank of India Bulletin, placed the international value of private gold stocks at $3500 million (the domestic value was placed at $6070million) and private silver stocks at $4150 million; it is hardly surprising that these figures should have aroused the interest of planners. Unfortunately, however, it will prove no easy task for the Government to mobilize more than a small amount of this treasure. A considerable part of it is known to be in the form of ornaments and personal jewellery which, as some have hastened to remind the Government, few would willingly part with. Much of it, too, is believed to be cached away as a hedge against inflation or in order to escape the taxation on wealth. Furthermore, millions of humble folk, and indeed many who are moderately well off, harbour a traditional and sometimes justified distrust of banks and other financial institutions and prefer to entrust whatever treasure they may have accumulated to a private hiding place. Despite considerable press speculation and occasional official reference to the desirability of surmounting these obstacles to the productive use of gold and silver, there is as yet no indication that the Government has decided upon specific measures.

11. During the past two or three months a few economists have suggested that the shortage of foreign exchange could be lessened through the devaluation of the Rupee. You will recall, however, that in our letter No.587 dated July 10, 1958, we informed you that these suggestions had aroused vigorous opposition in Government and Press circles, and we suggested that in the present circumstances devaluation was unlikely to prove beneficial.

12. Whatever the success of the Government's own measures to relieve the foreign exchange crisis there can be little doubt that extensive foreign aid will be required within the next few months if the economy is to be maintained and if the Plan is to have a reasonable prospect of success. Furthermore, even if the immediate crisis is surmounted, foreign aid will in our view be crucial to the success of economic development for at least the next ten years. There is we think a growing recognition of these facts and Government spokesmen appear determined to convince the public that it is neither undesirable nor abnormal for a country to facilitate industrialization through foreign investment and other forms of foreign assistance. There are, of course, still occasions when it is evident that the Government has not entirely mastered the art of accepting assistance graciously, but on the whole attitudes have improved markedly. Much of the responsible press, as you know, has generously recognized the contribution which foreign aid has made to the Plans, and at least one leading Socialist economist, Mr.Ashoke Mehta, has recently urged the Government to create a more favourable climate for foreign assistance.

13. Inevitably, many are looking to the United States in the hope of prompt and substantial assistance, the more so in view of the Senate's recent agreement that India's needs are of particular importance. Not all appreciate that it may prove difficult for the United States administration to provide extensive and united assistance from funds approved by Congress so far, and that whatever the ultimate prospects for a specific Aid to India bill it is most unlikely to be approved this year. Many are now looking to the United Kingdom in the hope that an overdraft can be promptly arranged for India's sterling account. The Press has been quick to note improvements in the United Kingdom's balance of payments, and some observers have concluded that she will be more ready to extend credits than she was a year ago. Within the last week reports have appeared in at least two leading newspapers that a sterling credit of £75 million may have been tentatively agreed to during Mr.B.K.Nehru's recent visit in London. Nor are other sources of foreign assistance being overlooked. Some are hopefully speculating that India's creditors in Germany and Japan will agree to accept payment in Rupees, for the time being at least. Others are hopeful that the forthcoming meetings of the Fund and the World Bank in NewDelhi may assist the free world, in the words of The Statesman, to recover the inspiration of the latter '40's, with their hope of joint international endeavour to maintain an expanding volume of both trade and investment. Within the last two or three days several newspapers have given prominence to reports that a high-level conference, with representatives from the World Bank, the Fund, the United States, the United Kingdom, West Germany and Canada, will be held in Washington next month to consider India's plight. As the Hindustan Times sees it if all goes well, a combined loan underwriting a major part of India's present outstandings as also a fair proportion of future requirements of the second plan. No doubt, too, India is prepared to accept any additional assistance which may be offered by the Soviet bloc, although it is perhaps significant that this possibility has received little attention since the widely publicized cancellation of Russia's programme of assistance in Yugoslavia.

14. It will, we trust, be apparent from the foregoing paragraphs that there is no easy solution for India's foreign exchange difficulties. It is, however, to be hoped that the exchange shortage can be reduced to manageable proportions through a combination of determined domestic measures and generous foreign assistance, for it is manifestly in the interests of neither India nor the West that the pace of economic development should be markedly slackened or that it should prove impossible for India to honour her foreign commitments.

C.A. RONNING