Foreign Aid and Economic Development, 1948-1966

In this article we will discuss about the impact of foreign aid on economic development, 1948-66 in India.

While the volume of private foreign investment and technical collaboration was relatively small, the greater part of foreign capital came on official account either as grants but mostly as government to government loans.

These foreign loans, also called ‘foreign aid’ increased from Rs. 380.34 crores in the First Plan to Rs. 2552.62 crores in the Second and Rs. 2939.79 crores in the Third Plan Foreign aid authorised up to the end of the Third Plan thus totaled Rs. 5873.64 crores. Of this, aid actually utilised amounted to Rs. 4515.11 crores or 76.8% of the total authorised aid.

Although the total magnitude of foreign aid was large, yet seen in terms of per capital availability, India was one of the under-aided countries of the world. This may be seen from the fact that the average of aid received by India per head of population during 1962-63 came to 1.8 dollars as compared with 4.4 dollars by Pakistan, 5.9 by Kenya, 9.2 by South Korea, 13.3 by South Vietnam, and 7.1 dollars by Egypt.

The bulk of this aid was received in the form of loans. Grants formed a substantial more than 1/3 part of the total aid utilised during the First plan. Com­modity—Assistance, which came almost entirely from the U.S.A. under PL 480 and 665, constituted 38% and 29.7% of the aid utilised in the Second and Third Plans.

Perhaps, no single developing country has received aid from sources so varied and under terms and conditions so diffuse as India.

The development efforts and more particularly the strains imposed by the deteriorating balance of payments resulted in the tapping of aid sources of such a wide variety that in a single activity such as steel making, the Russians, the Germans, and the British each contributed to an aid-financed steel plant in the public sector.

Primarily, out-side the communist bloc, India has had her aid channeled in through the Aid —India consortium. Among the consortium members, the U.S. was the major donor to India; its share in the total aid utilised by India was over 70% in the First, over 55% in the second and over 58% in the Third Plan.

Other countries including the U.K., West Germany, Canada, Japan, France, Italy and international organisa­tions such as the World Bank and the I.D.A. also contributed their share.

A significant development was the spectacular increase in Soviet aid. The proportion of Soviet Bloc aid to India grew from practically zero in the First Plan to just under 6% during the Second and 2% in the Third. The bulk of the aid from socialist countries came from there union which supplied over 90% of the total aid from this source.

The conditions attached to loans varied according to creditor country or organisation. The I.B.R.D. Loans were costly, the interest rate generally being 5.75% and repayable within 20 years and at times, even ten.

The I.D.A. lent on the much more favourable 0.75% rate of interest and repayable in 50 years with a permissible delay of 10 years. These compared favorably with the Soviet bloc credits which carried an interest rate of 2½ per annum with the principal repayable over a period of 12 years.

Furthermore, the Soviet loans, being part of trade cum aid agreements, were repayable in kind. This definitely eased the burden of repayment in so far as such provision led to net additions to Indian exports. The U.S. lent on very strict condition; the export-import Bank demanded an interest rate of 5.75% with a 15 year term-and permissible delay of 5 years although some American loans were granted on 3.5% interest.

During the Third Plan, America agreed to give I.D.A. loans of Rs. 900 crores at an interest rate of 0.75% repayable in 40 years with a delay of 10 years. These were obviously better conditions but the repayment in dollars was difficult The West German, British and Japanese credits had 10-25 years terms and carried 3.6% interest rates.

Purpose-Wise Utilization:

Apart from commodity assistance, the over whelming proportion of aid to India went to industrial development including Iron and steel projects, 71% of the aid utilised being accounted for by this sector. A substantial portion 24% went directly into overheads including harbours, power transport and communica­tion development.

This was in keeping with the general Indian strategy of develop­ment and also the economic philosophy of the time which under-emphasised the productive significance of expenditure on education and other social services and also agriculture which accounted for only 1% of the aid utilised.

While the bulk of the aid was utilised for industrial or over-head development some of the credits were used to pay for raw-materials, semi-products and spare parts that is for meeting the current needs of the economy and not for development.

Broadly, American and the I.B.R.D. Loans went to the private sector or for transport, irrigation and hydroelectric projects in the public sector. The policies of other capitalist countries were similar but only slightly more flexible.

The U.K., for instance, financed some projects in the public sector such as the Durgapur Steel works and the Bhopal Heavy Electrical Equipment plant while West Germany financed the steel works and fertiliser factories at Rourkela and Neyvelie.

Credits from socialist countries were mainly directed towards the construction of basic industries in the public sector where the ideological desire of the Soviet Union to support the public sector matched the Indian government’s preference for having heavy industrial projects such as steel, drugs, oil-relining, coal and heavy engineering.

Impact of Foreign Aid:

Foreign aid proved in expedient which, apart from filling the foreign exchange gap in the early stages of growth, also stepped up the rate of capital formation by supplementing domestic resources. It, in fact, formed a crucial ingredient in India’s resource mobilisation endeavour for planned development.

This may be seen from the fact that net capital inflow from abroad financed 5.8% of net capital formation in 1954-55 and 19.2% in 1963-64. During the First Plan, external assistance accounted for nearly 10% of the public sector outlay, 22% in the Second and 23% in the Third Plan.

Impact on Agriculture:

Foreign aid made a useful contribution in increasing the productive capacity of agriculture through its participation in River-valley and irrigation projects, dairy and fishery department schemes, production and supply of inputs like fer­tilisers.

Besides, the import of food grains, the bulk of them under PL 480 programme, not only helped in feeding the population but also played an important part in stabilising food grains prices.

Industry:

Of the aid utilised, more than half was for industrial development where it helped in the development of the country’s infrastructure such as railways and ports; in the phenomenal increase in steel production with its ‘linkage-Effects,’ enlargement of the sources of funds for investment and utilizing capital for private sector enterprises in the form of foreign exchange for raw-materials, spares and components.

It also helped by providing the technical know-how, with as many as 3211 foreign technical experts having visited India during the three plans. As regards the “Demonstration Effect” of foreign technical personnel, it was less powerful than one might have anticipated.

In reality, it was less powerful than one might have anticipated. In reality, it was strictly limited to the technical fields in which they operated and did not extend beyond either socially for functionally.

The overall impact in the industrial sector was reflected in the changed spectrum of industrial expansion in India, in the modernisation and expansion of Tisco and I.I..S. Co., the three public sector steel plants, heavy Electricals at Bhopal, Heavy Engineering corporation at Ranchi and drug projects at Rishikesh, Munnar and Guindy which provided the base for further development of related industries.

Power Generation:

Almost all the major power projects developed during the plans received external assistance. U.S. assistance was received for the Rihand Power project; I.B.R.D. provided two loans for the Trombay Thermal power project and exchange needs of the Koyna hydroelectric project. The Kundah project was a joint Indo — Canadian Venture.

Foreign Trade:

The role of foreign trade in easing the foreign exchange constraint on India’s economic development was more substantial. During the Third Plan, external assistance formed nearly 75% of India’s exports and covered over 46% of her imports.

A more important change was brought about in the pattern and direction of the foreign trade. It diverted trade from West European countries to the Soviet bloc countries. The share of the U.K. in particular and the commonwealth in general declined while that of the East European socialist countries increased as a result of the Rupee Payment Agreements.

Foreign aid, however, did not prove an unmixed blessing. While it helped the country’s economic development in certain spheres and directions; in others, it led to serious consequences.

In the first instance, it involved a heavy repayment burden. Measured as a ratio of national income, the average annual repayment charges amounted to an insignificant 0.70% during the Third Plan. What was disturbing, however, was that the debt service and interest charges increased much faster at 10.4% a year than the rate of increase of the gross domestic product.

This transfer, on account of debt repayment and interest charges was therefore eating into our available investible resources. Because of this transfer, net aid as a percentage of gross aid was expected to go down from 80% during the Third Plan to 66% in the Fourth.

Repayment involved not only a reduction of our savings but also a transfer of foreign exchange resources. Debt service payment formed 22% of our exports in 1966. The utilisation of large-scale financial assistance thus weighed with increasing force on the balance of payments. This forced the country to seek new aid and thereby increase her debts.

The burden was all the greater since a substantial part of the aid was tied by source and by commodity. Having no option but to buy from the aid-giving suppliers, India was often made to pay 30-35% in excess of the market price. Tied-aid had the further effect of distorting the pattern of trade and influencing the production techniques in the aided projects.

Tied-aid was also instrumental in channeling imports of spare parts and equipment to the countries from which aid had been received for import of the initial equipment. An example of this kind of effect may be seen in the imports of spare parts from West Germany in connection with the repairs and efficient operation of the Steel Mill equipment in Rourkela.

Ordinarily, foreign aid helps in absorbing the inflationary pressure through the balance of payment deficits. In India, it failed even in this respect. In the First instance, foreign aid freed domestic resources for unproductive and wasteful application elsewhere.

Secondly, as Prof. Bhagwati has argued, foreign aid, in the form of project loan, produced certain ‘structural imbalances’ in the Indian economy in the form of excess capacity in many fields for utilisation of which requisite raw-materials and components were not available. Consequently, the anticipated flow of goods did not materialize and prices rose.

Foreign aid also had a retarding effect on the pursuit of determined policies of self-help and progressive reforms in agriculture. As Gadgil and Dandekar point out, the availability of PL 480 food aid was an important contributory cause of lack of concerted attention to such aspects as Land reforms and agricultural policies for raising agricultural production in the country.

Besides, PL 480 food artificially held down the price of food, especially wheat, in comparison with other crops whose prices went much higher, thus robbing the wheat growers of the much needed price incentive.

In the words of Prof. B.R. Shenoy, a part of the foreign aid “provided foreign exchange finance for illicit exports of capital, the smuggling in of gold and consumer goods, speculative inventory accumulations and the construction of less essential urban property and luxury living” all adversely affecting the development of the country.

Foreign aid was not without political implications. Dr. Rao rightly says that “no recipient Government which receives aid —can entirely escape some influencing by donor governments or agencies.” There were widespread fears that western pressures would be exercised to influence Indian policies once the Indian economy became aid — dependent.

And these fears were not entirely base­less as is proved by:

(a) The suspension of western aid during and immediately after the Indo- Pakistan war of 1965

(b) The apparent willingness of President Johnson to hold up PL 480 shipments during near-famine conditions in India in 1966 for political reasons. Mention may also be made of pressures brought to change economic policies including those relating to private foreign investments and the price-mechanism.

On the whole, foreign aid was vital both quantitatively and qualitatively in the task of modernisation and expansion of railways, development of power, es­tablishment of a public sector in Steel, machine tools, heavy electrical and en­gineering goods industry.

However, it failed in mobilising the underemployed rural productive forces, in creating the large-scale technical advance so indispen­sable for any improvement in the standard of living. Nor did it lay the basis of a self-sustained economic growth. If anything, it further increased India’s de­pendence on external assistance.