Planned Development: Retrospect and Prospect || Development Perspective: Towards the year 2000 || Objectives, Strategies and Pattern of Growth in Seventh Plan || Financing the Plan || Balance of Payments || Framework of Economic Policy

FRAMEWORK OF ECONOMIC POLICY

6.1 In a mixed economy such as ours, the programmes of investment embodying the pattern of allocation laid down in the Plan are to be implemented both through direct public sector outlays and through influencing and regulating the flow of resources to the private sector, consisting of household and business enterprises in agriculture, industry and trade. Thus, in addition to the programme of public sector investment, the Plan must contain a set of policies designed to bring about the desired pattern of investment in the private sector. Other policies supportive of the plan will be those which lead to efficiency and economy in resource use in both the public and the private sectors. Thus, the success of the Plan would depend, among others, on the choice of the correct policy framework.

6.2 In designing the policy framework, both the choice of instruments and the nature of use need to be considered. The Government has at its disposal two types of instruments: direct or physical controls such as licensing and indirect or financial controls involving the use of fiscal, monetary and credit policies. The mix of these instruments and the extent of intervention would have to be determined from time to time depending upon the experience of the past, the stage of development and circumstances prevailing at a given time. In addition to policies for influencing the broad pattern of allocation in the private sector, the Plan also contains policies in regard to promoting development in particular areas such as agriculture, energy, protection of the environment, family planning and so on. The policies required for particular sectors are discussed in the respective Chapters in Volume II. The broad policy framework discussed in this Chapter relates mainly to fiscal policy in the broad sense (public sector management as well as budgetary policy to influence the private sector), monetary policy and credit management, foreign trade policy and physical controls on economic activities.

Fiscal Management

6.3 The budget is among the most potent instruments of economic policy. Through it the Government creates and sustains the public economy consisting of the provision for public services and public investment;'at the same time, it is an instrument for re-allocation of resources according to national priorities, re-distribution, promotion of private savings and investments, and the maintenance of stability. Thus, the budget must be geared simultaneously to the sustenance and growth of the public economy and to the pursuit of the broader objectives of fiscal policy. This implies that the methods of raising resources for the public sector should be such as to influence the rest of the economy in beneficial ways and, within the public economy itself, resources must be used in the most efficient way.

6.4 In the long run, the ability of the Government to provide for the needed public services and to undertake public investment on an increasing scale would depend on the soundness and buoyancy of the tax structure on the one hand and public expenditure policies that would contribute to the maintenance of budget balance on the other. An unsustainable budget deficit not only leads to general instability in the economy but also forces the Government to resort increasingly to methods of raising resources that cause distortions and produce other undersirable effects on the economy. In other words, the ability of the Government to pursue a meaningful fiscal policy gets eroded. In India, the size of the public economy¹, measured in terms of revenue expenditure share, has grown from 10.9 per cent of GDP in 1960-61 to 15.7 per cent in 1975-76 and further to 19.9 per cent in 1984-85. Alongwith this increase in expenditure, there was a more or less commensurate increase in the tax ratio up to the middle of the seventies; it rose from 9.0 per cent in 1960-61 to 15.1 per cent in 1975-76. Since then however, the tax ratio has not kept pace with the expenditure ratio. These tendencies have gradually eroded the capacity of the Governement sector to • generate the necessary surplus to expand essential public services and to contribute to the financing of public investment. The process of erosion seems to have accelerated during the Sixth Plan period.

6.5 The balance from current revenues at 1984-85 tax rates during the Seventh Plan period is estimated at (-) Rs. 5,249 crores. In the past this figure has almost always been positive. If the target of additional resource mobilisation through budgetary measures to the extent envisaged is achieved, the current account balance will become positive at Rs. 16,001 crores. However, since the Plan provides for current outlay of Rs. 25,782 crores, the ¹. Including only the Central and State Governments. net savings on Government account would become negative at (-) Rs. 9,781 crores. This would mean that even if the sizeable mobilisation effort involved in raising the tax ratio by two percentage points is put through, the Government sector would be borrowing to the extent of nearly Rs. 10,000 crores to finance current outlay, indicating the existence of a long-term disequilibrium in the budget.

6.6 This situation has arisen because of several causes. The current outlays outside the Plan have been increasing at a rate faster than current revenues. This is partly due to inflation. It would seem that expenditures are more responsive to inflation than tax revenues. Apart from the fact of inflation, certain large items of current outlay such as defence, interest payments and subsidies have been growing fairly fast at the level of the Central Government. Some States have been increasing their commitments unrelated to their Plans and these commitments, taken together with the committed expenditures arising out of completed Plan schemes including interest payments have been rising out of pace with the rate of increase in revenues.

6.7 Since Government savings have become negative, the entire investment in the Government sector has to be financed through borrowing. In addition, the Government is required through the budget to contribute substantially to the investment plans of public enterprises because of the fialure of the enterprises in general to generate the resources needed for their own growth. There is further erosion of budgetary resources owing to the need to make subsidy payment for loss-making enterprises including a large number of sick units taken over from the private sector. All of these required the Government to undertake a large borrowing programme which on the one hand increases the burden of indebtedness for the future budgets and on the other hand leads to the pre-emption of a large proportion of the resources of the financial institutions and the capital market. In this context, a long-term strategy has to be evolved to restore balance between budgetary revenue and expenditures so as to enable the public sector to finance developmental outlay without inflation and at the same time to pursue a sound fiscal policy in relation to the private sector.

6.8 The first component in the long-term strategy is to reform and strengthen the tax structure and its enforcement so as to make it buoyant and responsive to growth in income. The second element in the strategy lies in the formulation of an adequate expenditure policy. The third element is the maintenance of fiscal discipline which could be aided by the requirement to pursue a non-inflationary fiscal policy. Fourth, an equally important element in the strategy is to formulate policies for the public sector enterprises to improve their performance and generate surpluses on an adequate scale.

Current Revenues

6.9 On the revenue side, attention has to be paid to both tax and non-tax sources of revenue. In respect of taxation, the basic task is to make the tax structure more income-elastic as well as price-elastic while retaining the necessary degree of equity. For the tax system to become more income-elastic, first, it must cover adequately all sectors of the growing economy. Particular attention has to be paid in this context to the unincorporated industrial sector and the agricultural sector. Second, a major effort has to be undertaken to improve administration and enforcement so as to reduce evasion. The scope for substantial increases in the elasticity and yield of the tax systems of the Central and State Governments has been brought out by several studies.

6.10 The non-revenue-earning development activities of the Government are wide-ranging. The major components are social services like education and health, scientific research and technical extension and the provision of some items of social infrastructure like water supply and roads. The provision of these services on a virtually free supply basis with little contribution from the beneficiaries rests essentially on considerations of general social benefit arising from these services and of equity. This case is valid and, at the present stage of social development demanding substantial payment for these services will hurt poor households, backward regions and, most importantly, future generations. However, a part of the expenditure on these services benefits households who can afford to pay. They should be made to do so for these services in greater measure in future through appropriate changes in fees, cesses and municipal taxes.

Finances of Local Authorities

6.11 The tax and expenditure policies discussed so far relate to the Central and. State Governments. Reliable figures of revenue and expenditure relating to the local authorities are not available on a comprehensive basis. However, from whatever data that are available and from studies of selected municipal bodies conducted by various agencies, it can be stated that the finances of urban local bodies are in a sorry state and these bodies are unable to provide even the basic municipal services which are obligatory for them to provide, let alone undertake schemes of investment. While there can be more generous schemes of assistance by the State Governments and there is need to give the local authorities greater access to institutional finance, the major part of the resources needed for their functioning would have to be raised by themselves. But the tax systems of most of the local bodies are poorly structured and poorly enforced. A major effort would have to be undertaken to improve the productivity and equity of the local tax systems and also to train the staff of the local authorities in methods of sound financial management.

Control of Public Expenditure

6.12 The Seventh Plan has been drawn up on the assumption that non-plan expenditures of the Central and State Governments will grow at around 5 per cent in real terms i.e., at a rate equal to the growth rate of GDP. This, on past evidence, will require a strenuous effort at expenditure control. More specifically, existing procedures for the scrutiny of non-development expenditure proposals will have to be strengthened and subjected to the discipline of cost-effectiveness analysis. Administrative reforms which eliminate unnecessary work, reduce overlap and simplify procedures will have to be hastened. In fact, in many areas, such reforms can lead not merely to a reduction in expenditure but also to an improvement in relations with the public.

6.13 The efficient management of facilities needed for providing public services like schools, roads, waterworks and so on will require more systematic attention to maintenance, fuller utilisation and cost-effectiveness. It will be necessary in many of these sectors to institute changes in management structures and procedures which will allow these facilities to be run as performance-oriented enterprises rather than as Government departments. Planning and budgetary procedures should be re-examined so that an integrated view is taken of development outlays, regardless of whether they are on new schemes of the current plan or on the maintenance of schemes started in earlier plans.

6.14 Subsidies meant for poor household are justified on grounds of equity and long-term needs and cannot be eliminated. However, many of the subsidies tend to benefit also the not so poor, and are open-ended. This often means a loss of control over the total burden on the exchequer. For example, the sale prices of fertiliser are fixed at some point in time, and hence, all increases in production costs brought about by inflation or other factors have to be covered by increases in the subsidy. If the adjustments in the fixed sale prices are infrequent or inadequate, the subsidy burden grows over the years. Ways of avoiding this open-endedness must be seriously considered and the subsidy burden must be kept down to a reasonable level. It is also necessary that the rationale for subsidy proposals, particularly in plan schemes, is examined more thoroughly taking into account the possibility of leakages, the economic status of beneficiary groups and the cost-benefit case for the subsidy. A time-bound programme to eliminate subsidies¹ to particular loss-making public sector units must also be drawn up. ¹ In practice, only loans are given to cover cash losses, but if loans are never repaid, they will turn into subsidies. Besides, non-reciept of an adequate return on investment means an implicit subsidy from the budget.

6.15 As one of the means of achieving the objectives mentioned above, the principle of zero-based budgeting which requires the expenditure on even on-going activities to be justified needs to be introduced. It is to be applied not only to items of non-development expenditure but also to those'of development expenditure. This would make possible redeployment of personnel, thereby cutting down new recruitment. The rate of growth of expenditure on goods and services could also be reduced in this way.

6.16 In the longer term, there is a need for the formulation of an adequate expenditure policy. While details of the policy cannot be dealt with here, two major principles may be mentioned. First, since there are competing claims on resources, priorities have to be laid down and it should be stipulated that as the economy grows, certain items of expenditure should be maintained as a constant percentage of GDP, other items with higher priority should be allowed to increase relatively to GDP at postulated rates, and yet others should gradually decline, if not absolutely, at least as a proportion of GDP. For this scheme to be operationalised, various expenditure items should be aggregated into well-defined groups and targets should be laid down for each group in terms of ratio of GDP which should be maintained during a five-year period. For example, it could be stipulated that the aim should be to keep budgetary subsidies'as a constant proportion of GDP unless extraordinary circumstances warrant otherwise, whereas expenditure on education and health can be planned to increase as a proportion of GDP. Second, in undertaking schemes of investment particularly in relation to projects which are not directly revenue yielding, the scale of investment undertaken during a plan period should be conditioned by the anticipated increase in revenues accruing to the budget so that the rate of increase in maintenance expenditure in the future would not outstrip the rate of increase in revenue.

6.17 Another important element in the long-term strategy is to pursue a fiscal policy leading to non-inflationary growth. Experience has shown that inflation, far from increasing the real resources at the disposal of the public sector tends to erode them, partly because of the higher inflation elasticity of budgetary expenditure and partly because of the diminution in the surpluses in the public enterprises through cost increases. This can be corrected to a certain extent by making taxes more responsive to inflation (e.g., by shifting to 'ad valorem' duties) and by timely adjustement of public enterprises' prices. However, a non-inflationary fiscal policy calls for fiscal discipline, the avoidance of overdrafts at the level of the States and excessive deficits at the Central level. If the principle of avoiding excessive deficit in the Government sector as a whole is strictly adhered to, an additional beneficial consequence would be the automatic enforcemerit of greater control of expenditure and maintenance of fiscal dsicipline. Keeping this objective in view,, the Seventh Plan provides for only a moderate volume of deficit financing at the Centre.

6.18 Wnile public enterprises m several cases are expected to serve certain social purposes rather than to maximise profits, the major public enterprises which are in the core sector and in public utilities have been established in order that social ownership could ensure fast development of these vital sectors and at the same time prevent concentration of wealth and monopolistic practices. In all the industrialised countries, major industries such as steel, aluminium, coal, power and railways grow largely on the basis of surpluses generated by themselves, and to the extent equity finance was raised, an adequate rate of return had to be maintained. In India, too, these industries, though in the public sector, must generate surpluses through proper pricing and efficient operations. The needed resources are so large that they cannot be raised through market borrowings by the Government or through taxation. At present, the burden on the budgets for subsidising and funding public enterprises is too large for the health of the public economy. The reform of the public enterprises system, with a view to making them efficient and capable of generating surpluses commensurate with the scale of capital invested in them, must rank high in the agenda of fiscal reform. The aim should be to make the public enterprises financially viable and productive of surpluses. This financial autonomy must be matched by a corresponding managerial autonomy, with secretariat intervention being limited to policy guidelines and the direction of major investment programmes. An arms-length relationship between the commercial enterprises in the public sector and the government will also require major changes in the mode of organisation of departmentally-run activities. Several government committees have made recommendations oriented towards these ends. During the Seventh Plan period, the action that is needed to be taken on these recommendations must be completed.

Fiscal Policy for Growth

6.19 As stated earlier, fiscal policy involves more than raising resources for the Government sector. It comprises powerful instruments for influencing macro variables such as savings, investment, the price level and costs as well as the allocation of resources. And these must be employed to the best advantage. Indeed, a proper fiscal policy would stimulate growth and savings and these in turn would lead to a faster rate of growth of Government revenues. For example, a major part of the tax revenue of the Central Government is derived from taxes levied on the industrial sector (excises) and on imports (customs). Therefore, a fiscal policy that leads to a higher rate of growth of industry and of exports would automatically lead to an acceleration in the rate of growth of revenues, increase in revenue from Union excise duty and in revenue from duties on higher imports made possible through higher exports.

6.20 As regards industry the major tasks of the fiscal policy would be (a) to enable industry to raise a much greater part of the resources needed for its expansion from internal resources and the capital market than hitherto; and (b) to rationalise and simplify the tax structure so as to make enforcement and compliance easier, reduce the scope for litigation and disputes and minimise distortions. The recent changes in the direct tax system are basically designed to achieve these objectives. With the reduction in the burden of personal income taxation and the favourable treatment given to savings in specified financial assets, more of household savings may be expected to be channelised into the capital market.

6.21 Another objective of fiscal policy in the present context must be to induce a higher rate of savings in the household sector and to reduce significantly the volume of blacl{; income generation. Maintenance of price stability is important from the point of view of stimulating private savings. Positive real rates of return on financial assets net of taxes need to be ensured. The recent reduction in the rates of personal income and wealth taxes combined with strict enforcement is designed to reduce black income generation.

6.22 With a sizeable proportion of income and wealth evading taxation, the redistributive impact of progressive taxation had been severely blunted. A reduction in the scale of black income generation would improve distribution of income and wealth after taxation. Besides, if the magnitude of tax evasion is significantly reduced, there would be a greater volume of tax revenue, and a greater volume of public expenditure benefiting the. poorer section of the population would become possible.

6.23 Indirect taxes affect costs and prices. While the impact on the prices of final goods is unavoidable and is meant to reduce consumption, the aim should be to minimise the impact on costs of inputs and to avoid distortion in costs by unwarranted changes in relative prices. A rationalisation of the indirect tax structure would lead to reduction in costs and it is essential for improving international competitiveness. The rationalisation would have to be initiated in such a way that the reform wold not only produce beneficial effects on the private economy but also lead to buoyancy in revenues.

Money and Credit

6.24 Monetary policy relates to the regulation of the volume, cost and allocation of credit. But monetary and fiscal policies are inter-related, because fiscal policy almost always brings about changes in money supply through the budget deficit. A fiscal policy that keeps the budget deficit down would give greater scope for autonomy to monetary policy. An excessive budget deficit on the other hand would shift the burden of control of inflation to monetary policy. This would generally necessitate a restrictive credit policy which may lead to insufficient supply of credit to industry and trade. In the Seventh Plan the amount of deficit financing (net Reserve Bank credit to the Government) has been fixed at a level considered just sufficient to generate the additional money supply needed to meet expected increase in the demand for money. That is, a non-inflationary fiscal policy is postulated.

6.25 Since the Indian economy is vulnerable to inflationary impulses arising from a sudden fall in agricultural output and rise in import prices and since cost-push factors are at least as important as demand-pull factors, an anti-inflationary policy must consist of the following elements, besides the avoidance of excess money creation:

(i) bufferstocking and public distribution of foodgrains in order to moderate the impact of weather induced fall in production; and

(ii) maintaining exchange reserves at a level that provides adequate margin for precautionary imports of other essential items like edible oil and fertilisers to counteract the effects of domestic shortages.

6.26 A very large part of the total credit available is diverted to the public sector through statutory requirements and other means. This ensures that the essenital programme of investment in the public sector would be assured of funds. Similarly, selective credit control and the differential rate of interest scheme ensure that priority sectors and weaker section obtain a certain minimum of credit at concessional rates of interest. In addition, public financial institutions are enabled to raise resources at lower than the market rate in order to finance investment by private industries. This pattern of credit allocation has helped in securing allocation of capital funds in accordance with Plan priorities. However, it has meant that the role of the capital market would remain limited and that the allocation of credit would not be crucially dependent on the efficiency and profitability of the enterprises demanding funds. A reference has already been made to the undue dependence of public enterprises on budgetary support for securing investible resources. While the basic arrangements for the allocation of credit to priority sectors and to the Government will need to be retained, a stage has come to enlarge the role of the capital market and for enterprises to bid for resources on the basis of their capacity and credit-worthiness. Private industries should be encouraged to seek a much larger volume of support from the capital market and on a selective basis public enterprises may also be encouraged to resort to the capital market.

6.27 The beginnings of a change in this direction are already noticeable. In recent years there has been a growing tendency to mobilise finance directly through the capital market. This tendency has been strenghened by changes in policy in regard to interest rates and other terms of offer. The amount of resources mobilised by the private sector through the capital market has greatly increased. A good secondary market in financial instruments is being built up which is attracting savers who value liquidity. Further, reform of the stock market and improvement in its functioning would accelerate the development of the primary and the secondary markets, The capital market could also be deepened by the creation of new financial instruments and new financial institutions.

6.28 The organised part of the capital market has left out some sectors of activities, the most notable being housing. In the past the commercial banks, which in several countries finance housing activity, have been permitted to lend to a only very limited extent to the housing sector. So far only a small proportion of housing investment has been institutionally financed, the bulk of it being financed through own savings, sale of assets and borrowing from the unorganised market. Some promising developments have taken place recently in this area, but far more remains to be done. Financial intermediaries specialising in housing finance will be able to tap new sources of savings and help to bring housing investment within the framework of the organised credit systenrf. The Seventh Plan envisages a major effort in this direction.

Framework of Controls

6.29 In the Indian economy the allocation of resources, broadly according to plan priorities and targets, has been sought to be achieved through (a) direct public investment, (b) fiscal and monetary policies and (c) regulation of the private sector and public enterprises through physical controls such as investment and import licensing, exchange control, price control and quantitative allocation of materials through Government agencies. Of these, in the earlier phase of development, public investment and physical control were greatly more important. The apparatus of control originated during the Second World War and was adapted to fulfil the needs of a planned economy. Importance was given to physical controls in the early stages of development because it was felt that financial instruments would not be able to achieve the kind of results that could be obtained through detailed industrial licensing, which could limit capacities to the expected demand for goods and thus conserve scarce resources. In view of the shortage of resources then prevailing and the undeveloped state of the economy, it was necessary to resort to physical controls. But as the economy developed and the industrial structure became more and more diversified and complicated, the licensing mechanism and other physical controls became more difficult to operate. With the fast growth in the number and variety of products, determining proper capacities became increasingly unsatisfactory. At the same time, the manner of operation of industrial licensing created undue delays and led to wastage of opportunities. Often small and uneconomic sizes of plants were licensed leading to high costs. Similarly, quantitative import controls led to a high wall of protection and the creation of high cost industries. Rigid price controls in many cases led to stagnation of output and perpetuation of shortages. In view of these developments and more particularly in view of the enlargement of the resources base and the degree of sophistication attained by the Indian economy, it was considered necessary to reduce the rigour and range of physical controls and place greater reliance on fiancial controls which would give signals but would not involve inefficiency and delays. The Sixth Five Year Plan noted: "The framework of rules and regulations relevant to the nascent stage of development are not necessarily appropriate to the complex industrial structure which has since been built up. Without sacrificing the basic principles of a planned eonomy, sufficient flexibility would need to be built into the system to impart a sense of dynamism to take advantage of the considerable technological and managerial capabilities that have been developed over the years."

6.30 During the Sixth Plan period considerable liberalisation was introduced in the rules and operations relating to industrial and import licensing. The level of investment below which licensing was not required was raised to Rs. 5 crores. A sizeable number of commodities were placed on the open general licence (O.G.L). In the light of the experience gained during the Sixth Plan, more recently, substantial changes in licensing policy have been introduced. Several important industries have been delicensed and broad-banding has been introduced to impart flexibility in regard to choice of product by the entrepreneurs. The steps that have been taken, while removing the delays and complications caused by licensing procedures, are expected to lead to faster growth and greater competitiveness in a wide range of industries. Of course, investments in important industries, particularly those requiring large volume of investment, would need to be more closely regulated.

6.31 In a planned economy, the broad allocation of resources would necessarily have to be under Government control. Besides, through direct public investment and the pre-emption of investible resources of the required magnitude, the Government could ensure that the sectors producing essential goods would be provided with the funds needed for their growth. In other words, growth in these sectors would be regulated according to the needs of the economy. For the rest of the economy the allocation of resources could be left to be determined by the demand in the market which, however, could be influenced by financial means such as indirect taxation.

6.32 The Seventh Plan lays greater stress on improvements in productivity and cost-reduction in industry and other sectors. This may require in the first instance better utilisation of capacity already available. It would also require in some cases the establishment of large plants and the expansion of existing plants to an economical scale. These scale requirements are particularly important in technology-intensive industries where a -substantial research and development effort is required. Hence fragmentation of capacities has to be avoided. This would mean acceptance of a measure of dominance which, however, could be controlled through other means. Also, some of the provisions for the reservation of item for small scale industries need to be re-examined.

Price Controls

6.33 Over the years, price control has been removed in respect of most commodities. In respect of two important commodities, namely, sugar and cement, the dual price system has been introduced which has served to take the pressure off the controlled market. In these cases only the levy prices are controlled. Apart from these, price control now exists only for bulk drugs and certain varities of paper. In addition, there is a regime of administered prices in regard to a number of commodities produced mainly in the public sector, such as steel, fertiliser and petroleum products. Also, the charges and tariff of public utilities like Railways and State Electricity Boards are fixed by Government.

6.34 A general principle that has gradually found acceptance is that, except in the case of monopolies and public utilities (which are natural monopolies), no commodity should be subjected to price control on a permanent basis, while temporary price controls may be called for to deal with certain shortage situations. Also, if rationed supply of a commodity like sugar and rice is considered necessary, a dual market system should be adopted so that a black market may not be created and the profitability of the concerned industry may be sustained through free market sales. The dual market system should, however, be restricted to the most essential goods, because a lower price than cost in the controlled market would inflate demand and ultimately lead to mis-allocation of resources.

6.35 Commodities subject to administed prices, though few in number, play a critical role in the economy. They account for about 30 per cent of the weights in the wholesale price index, 18 per cent of private consumption expenditure and 30 per cent of intermediate consumption. Hence any increase in these prices generates cost-push pressures in a large number of sectors. A policy framework for these administered prices has to take account of this and also the need to ensure that the production of these commodities remains remunerative.

6.36 Agricultural prices, particularly foodgrain prices, play a critical role in determining the distribution of income and the rate of inflation. At present the Government announces support prices on the basis of advice tendered by the Commission on Agricultural Costs and Prices whose terms of reference have recently been expanded. The Commission takes into account the cost of production of different crops and the need for incentives to encourage production. This basic framework for determining support prices has worked well and needs to be strengthened. One distortion that has crept in is the announcement of substantially higher minimum prices by State Governments on the basis of limited considerations which do not take into account the inter-se-parity between different crops and different areas. Another difficulty is the notional nature of the support prices when there is no organised system of official procurement. The example of rice and wheat shows that a system based on rationally determined support prices and backed by arrangement for procurement can reduce fluctuations, maintain profitability and stimulate steady growth. An effort must be made to establish such systems for other crops like coarse grains, pulses and oilseeds so that rationally determined support prices are made effective through public purchase and, of course, public distribution. Agricultural price policy should be increasingly concerned with the determination of appropriate relative prices of different crops with a view to ensuring efficient use of resources.

6.37 The policy framework for determining the prices of industrial products is not as fully articulated. In certain cases prices are fixed separately for each producer, as in the case of fertilisers, and in others prices are product specific and may vary by region, as in the case of levy cement and sugar. The general approach is to fix prices on a cost-plus basis but the details of the procedure vary. Sometimes prices are fixed on the basis of actual costs, as in the case of coal; but generally certain standards of efficiency and capacity utilisation are taken into account in fixing standard costs. The basis on which a return to capital is allowed also varies. For some commodities a specified return on net worth is allowed and is some an overall return on capital employed. It is necessary that this diversity of procedures is rationalised and a common approach established for price fixation. Prices must always be set on the basis of reasonable norms of efficiency and, at the same time, enterprises should be allowed to retain the benefits of productivity raising and cost reducing innovations. The return on capital should be determined on the basis of the level required to generate and attract investment funds. Most important, the lag between cost increases and price adjustments should be drastically reduced. Small and frequent price adjustments should be preferred to large and infrequent ones.

6.38 The prices of industrial products are often fixed without paying due regard to the impact on the demand for related products and their consistency with development strategy. The energy sector is an important case where, because of substitution possibilities, a measure of consistency is required in the pricing of related products like kerosene, soft coke, electricity and LPG. Moreover, the impact of conventional energy prices on the promotion of non-conventional energy also needs to be taken into account. Similarly, the pricing of different metals and other materials must take into account the substitution possibilities which need to be encouraged or discouraged. Existing procedures for price fixation must be modified to take into account these wider considerations.

6.39 The prices of most industrial products are set in a manner where an explicit subsidy is not required, though there may be a measure of cross subsidisation amongst products. However, fertilisers are an important exception. Here the final price paid by the farmer is very much below the average cost of production and a large and growing budgetary provision for a fertiliser subsidy has become necessary. Fertiliser sale prices cannot be raised to cover the entire gap without dislocating and jeopardising agricultural growth. Alternative schemes which limit the quantum of the subsidy will have to be worked out as otherwise the burden of subsidy under the present system will rise very rapidly with the growth in domestic production.

Trade Policy

6.40 The trade deficit, though declining over the Sixth Plan period, still constitutes a structural weakness of the balance of payments. In fact, except for brief periods, a relatively large merchandise deficit has been a persistent feature of India's foreign trade. The main factors underlying it become directly relevant for policy prescription. This does not imply, however, that policy concerns be confined to merchandise trade. Invisibles, particularly tourism and expatriate remittances, which have emerged as important elements of the balance of payments on current account, too deserve attention.

6.41 India's foreign trade sector and balance of payments have to contend periodically with unforeseen internal and external shocks, such as sudden and sharp deterioration of the terms of trade or droughts and other internal supply problems of varying intensity. Apart from developments which cannot be easily foreseen, or which cannot be easily influenced through national policies, the pull of domestic demand and high production costs have been persistent obstacles to the rapid growth of exports.

6.42 Considering the nature of internal constrainsts to be overcome, the lack of clear indication so far of an enduring improvement in the international economic environment, and uncertain prospects for expatriate remittances, a whole array of policy instruments, ranging from general and aggregative to selective and commodity specific will need to be deployed to attain Seventh Plan balance of payments objectives. These would include, among others, measures to extend the same treatment to exports and efficient import substitution.

6.43 Import licensing has been a major instrument for according protection and keeping down the level of imports. Quantitative import restrictions, though no doubt effective, have also fostered a chronic disregard for productive efficiency by creating a protected domestic market. And in the absence of equally secure and commensurate incentives for sales abroad, they have discriminated against exports in the same way as a generalised export duty. As a consequence, a large number of import products are replaced at a much higher domestic resource cost than would have been involved in acquiring equivalent foreign exchange through exports. In line with Sixth Plan policy concerns, deliberate efforts were mounted to minimise this bias against exports; and the policy packge for exporters from the domestic tariff area (DTA), consisting essentially of import replenishment, duty drawbacks, cash compensatory support or CCS, concessional credit and provision or domestic intermediates, was streamlined and liberalised. The residual discrimination against exports, however, remains significant, as export incentives generally still do not compare favourably with those extended to production for the home market.

6.44 With the existing structure of import restrictions and tariffs, incentives for import substitution vary widely from product to product; and there is no simple or clearcut manner of computing the equivalent benefits to exports. Moreover, while incentives to import substitution are already included in the high cost of domestic products and do not involve direct budgetary subsidies, compensating incentives to exports, including even those (like the CSS) essentially refunding indirect taxes not rebatable though drawbacks, are a visible charge on budgetary resources. These problems, however, can be tackled. Greater reliance on tariffs than on import restrictions to restrain the demand for imports, as also lesser variability in the structure of tariffs would provide a better norm for setting export incentives extended in various forms including import replenishment, drawbacks, cash compensatory support, fiscal concessions and preferential access to bank credit and term finance. Considering that CCS is in the nature of a drawback, its coverage should be extended to all products barring only those which face rigid export supply constraints or inelastic demand abroad. Manifestly, the shift away from import licensing towards less differentiated tariffs, which is an essential element of this policy package, has to be accomplished step by step in a manner that avoids unnecessary drawal of foreign exchange reserves or other unwelcome side effects.

6.45 Discrimination against exports can be avoided as has been done through the establishment of Free Trade Zones (FTZ), or the more recent 100 per cent export oriented units (EOUs)—a foot loose version of the former. That a striking success has so far eluded them is largely due to their operations not always being more attractive than partial production for exports in the domestic tariff area (DTA). Duty free and open access to imports does ensure that prices of import substitutes used in the FTZs or EOUs cannot, as in the case of exports, exceed the border price. The resulting parity of treatment with import substitutes, however, does not necessarily make exports more profitable than those from the domestic tariff area (DTA). Conceivably, exports from the domestic tariff area could well have yielded a better return in some cases. For, until 25 per cent of output was allowed to be sold in the domestic market, the difference between the rather small fraction of import price representing the annual equivalent of import duty exemption on capital goods on the one hand, and the REP benefit, on the other, constituted broadly the incentive differential between FTZ type and DTA regimes*.

6.46 The favoured treatment of import substitution could, moreover, be offset by concentrating on the expansion of some 'thrust' industries with demonstrable and lasting comparative advantage in the export market. Among other things, enlarged and easier access to imported inputs and exemption from relevant provisions of industrial licensing would enable them to benefit from modern technology and economies of scale. The 'thrust' industries could then undertake to enter the export market in a very big way by expanding production well beyond domestic demand, the resulting supply shortfalls elsewhere in the economy being corrected through recourse to imports.

6.47 Measures to remove the discrimination against exports and to promote their growth must be accompanied by proper policies for containing domestic demand, as otherwise the gain in exports may be neutralised to a large extent by increase in imports. While this might still leave a favourable impact on income, not much contribution would be made to the reduction of the trade deficit. Trade and current account deficits, however, are not affected so much by excessive aggregate spending as by a pattern of demand with preferences for exportables and import substitutes. The demand for import substitutes could spill over into imports directly (as in the case of oils and fats) or indirectly through the use of imported inputs. 'Direct tax concessions are roughly comparable, with the higher net tax price of domestic inputs used by DTA exporters is partially offset by arrangements to provide some of them at international prices.

6.48 Clearly, balance of payments difficulties stemming from the structure of demand cannot be overcome simply by correcting the existing policy bias against exports; for, that would only shift resources from import substitution to exports whenever the latter are more competitive internationally. Thus, in additional other measures will be needed which are designed to restrain generally the growth of domestic requirements of import substitutes and export-ables (other than wage goods and essentials like food-stuffs) as well as to strengthen the production base for both. More important still, they will have to become progressively more competitive, price and quality wise, with their internationally traded counterparts. Otherwise, the demand for imported intermediates, components and equipment may not decline relative to GDP while it would become difficult to find outlets abroad for surpluses of exportables. International competitiveness, not just in some enclaves but in large segments of the economy, is indispensable for eventual self-reliance. Their competi-tivesness, moreover, would have to be protected from erosion through a domestic rate of inflation higher than inflation abroad.

6.49 General policy measures to lessen the impact of demand patterns on the external balance can be further strengthened by suitable action at the commodity level. Some examples will illustrate these possibilities which involve pricing, investment incentives, infrastructure support and counter-protective methods. A shift from the present practice of setting grower prices of coffee partly with reference to the fluctuating international price could, by providing a more stable real return, lead to steadier average and output growth trends in the future. Investment in tea bushes has been woefully inadequate over the past several years which, together with the fast growing domestic demand, has begun to impinge seriously on the availability for exports. Existing obstacles to more rapid and sustained expansion of cardamom production, a major export spice, could be removed through provision of better irrigation and a change from the practice of leasing land to growers by concerned State Governments for a 25-year period, which discourages investment. As regards import substitution, generally only marginal lands are allocated to the cultivation of edible oilseeds because of lack of high yielding genetic material, susceptibility to pests and insufficiently effective price support. More orderly marketing, expansion of irrigation with application of fertilisers to groundnuts and introduction of high oil content sunflower are the types of measures to improve the growth of oilseed production.

6.50 External imbalances may also build up, or be aggravated, by excess spending and the resulting scarcity of local currency finance. They will have t6 be rectified through better demand management and resource mobilisation. Fiscal discipline, emphasising expenditure control, and appropriate monetary and credit policies, are needed, as stressed earlier in the chapter, to prevent the emergence of excess demand.

6.51 The mutually reinforcing interaction between productivity and the balance of payments comes into sharp relief against the backdrop of the major means of improving the performance of the economy. First, a rapid growth of exports will reduce the need to rely on high cost and inefficient import substitution. Second, the containment of external dificit within manageable limits will permit better capacity utilisation through relatively flexible and liberal access to imports. Third, technological upgradation and modernisation as well as increasing technical sophistication of domestic products will win wider acceptance for them in export markets and increase their substitutability for imports.

6.52 Technological dynamism, however, requires, the stimulus of a competitive environment with both domestic and international pressures on firms to improve technology. A sustainable combination of import liberalisation and deregulation of manufacturing capacity would thus be a necessary spur to technological change without which liberal access to technology imports may not have the desired effect. Easier access to foreign technology will not only permit rapid absorption of innovations abroad but also encourage domestic development of new processes and products for the reason that innovation seldom takes place in isolation. All the same, discretionary regulation of technology inflows will still be necessary in order to ensure that high technology imports in the export sector carry an export obligation as well as to avoid acquisition of replicable or unduly high cost technologies. In fact, unnecessary imports or excessive costs can be even more effectively avoided through further progressive development of local technological capabilities which will (a) increase the bargaining power of domestic firms vis-a-vis foreign suppliers of technology and (b) make them more discerning about the import of different elements of a technology package.

6.53 Over the years service exports, particularly tourism, have emerged as an important element of current earnings comparable to major merchandise exports like engineering and chemicals. The potential for tourist earnings, which have a relatively large value added component, can be more fully exploited in various ways. First, greater attention should be paid to competitiveness relative to other destinations with regard to both price and non-price factors. Second, marketing effort abroad should be consolidated and strengthened. It should also be related to the mix of different types of tourism, categorized by tourist areas of interest and per capita expenditure, which is most likely to maximise earnings. Third, some further specialisation between private and public sectors in the future development of tourism may also become necessary. While the public sector would devote greater attention to general promotion, transportation and other basic infrastructure, the private sector would take up other¹' aspects of tourist development including hotel construction. Finally, in order to maximize foreign exchange earnings from new investment in high cost tourist facilities for foreign travellers—five star hotels, for instance-competing domestic demands should be discouraged through appropriate taxes.

6.54 To be fully effective, policy changes discussed above require adequate institutional and organisation back up. They must also evoke the desired response from firms in different sectors of activity. The relevant administrative rules, regulations and procedures in all their detail should faithfully reflect policy intentions. This does not, however, imply operational rigidity, but adaptability to changing situations and circumstances. In this context existing institutions, like the Export Promotion Councils and the Commodity Boards, have an important role to play. They should be providing periodically accurate market information and in-depth commodity knowledge to inform administrative decision making. Promotion and marketing is the other function which they need to emphasise, particularly the provision of such services to firms not sufficiently equipped to venture out, or further, into export markets on their own. For, export selling involves location of buyers and establishment of trading connections over an immensely large area; changes in tariffs or trade regulations in importing countries, intense competitions, and shifts in tastes or technology add to the complexities and risks selling in the world market. However, large well-established firms in manufacturing, owing to the experience accumulated and connections developed over decades, possess substantially the type of flexibility and resources required to operate abroad. The success of policy adjustments will therefore depend, among other things, on the responsiveness of large firms, and on their willingness to equip for, and invest in, a substantial expansion of export operations instead of continuing to rely mainly on the domestic market. Small firms do not have similar resources at their disposal. In their case an important role could be played by large merchandising houses which would mobilise finance, organise supplies and develop commercial contacts to establish viable export markets.

6.55 To conclude, the management of the balance of payments, in the Seventh Plan period and beyond, calls for' a pragmatic many-sided approach rather than a monolithic strategy. Policy, guidelines, instead of being selective, have to be pervasive. Improvements in productivity, vigorous resources mobilisation and strict demand management, and virtual freeing of exports from the adverse impact of import restrictions, other regulatory measures and indirect taxation, constitute the main structural features of an appropriate policy frame.

Annex
LIST OF ABBREVIATIONS USED IN THE SEVENTH PLAN  DOCUMENT