(coping with internal and external exogenous …documents.worldbank.org/curated/en/...coping with...

DRAFTFOR STAFF USE ONLY.

(COPING WITH INTERNAL AND EXTERNAL EXOGENOUS SHOCKS;INDIA, 1973-74 TO 1933-834

Pradeep K. MitraSuresh D. Tendulkar (Consultant)

CPO Discussion Paper No. 1986-21April 1986

CPD Discussion Papers report on work in progress and are cirCulated for Bankstaff use to stimulate discussion and comment. The views and interpretationsare those of the authors.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

First Draft

Comments Welcome

COPING WITH INTERNAL AND EXTERNAL EXOGENOUS SHOCKS:INDIA, 1973-74 to 1983-84

Pradeep K. Mitra -

and

Suresh D. Tendulkar 2/

April 1986

This paper has been done for World Bank Research Project No. 672-74,Adjustment in Oil Importing Countries. We are much indebted to Hector Sierrafor numerically implementing the model used in this paper with extraordinaryspeed, and to him, Shyamalendu Pal and Derek McGreal for setting up andrunning the simulations. Thanks are also due to them and to Shanta Devarajanfor many useful conversations and to T. N. Srinivasan for discussions on thedistributional aspects of the model. We also owe a special debt to AlexMeeraus and Arne Drud for advice on implementing the model in the GeneralAlgebraic Modelling System (GAMS), on the use of the algorithm CONOPT, and oncomputational aspects generally. The usual disclaimer applies.

The World Bank does not accept responsibility for the views expressed hereinwhich are those of the authors and should not be attributed to the World Bankor to its affiliated organizations. The findings, interpretations, andconclusions are the results of research supported by the Bank; they do notnecessarily represent official policy of the Bank. The designations employed,the presentation of material and any maps used in this document are solely forthe convenience of the reader and do not imply the expression of any opinionwhatsoever on the part of the World Bank or its affiliates concerning thelegal status of any country, territory, city, area, or of its authorities, orconcerning the delimitation of its boundaries, or national affiliation.

1/ Senior Economist, Country Policy Department, The World Bank, 1818 HStreet, N.W., Washington, D.C. 20433, U.S.A.

2/ Professor of Economics, Delhi School of Economics, rJniversity of Delhi,Delhi - 110007, India

Coping with Internal and External Exogenous Shocks: India1973-74 to 1983-84

by

Pradeep K. Mitra -/ and Suresh D. Tendulkar -/

Abstract

This paper (1) analyzes and interprets the adjustment of theIndian economy to the twin exogenous shocks of oil price increases andharvest failure during the period 1973-74 to 1983-84; (2) implements asix-sector economywide general equilibrium model to a consistent dataset for 1973-74; (3) uses the model to approximate the principaldevelopments in the Indian economy during 1973-74 to 1983-84; and (4)explores the consequences for the macroeconomic aggregates,intersectoral resource allocation and income distribution of differentpolicy packages for adjusting to various kinds of shocks.

Counterfactual policy experiments with the model allow thefollowing conclusions to be drawn. First, workers' remittances,borrowing from oil facilities and concessional aid more than offset theadverse impact of terms of trade losses following the two oil shocks,making possible higher consumption and investment and lending to higherexternal debt. Second, a more 'expansionarv" investment strategy in1974-75, comparable to that of 1979-80, combined with selective importsof essential consumer goods to maintain domestic per capitaavailability, would have led to higher GDP and private consumption andincreased domestic production of capital goods at the expense ofconsumer goods. As before, it would also have left the economy withmore external debt. Third, a less cautious policy of reserveaccumujlation between 1976-77 and 1979-80 would have led to similareffects but with a lower external debt burden because the hiaherinvestment would have been financed in part by reserve decumulationrather than inflows of foreign capital. Fourth, the cumulative effectsof weather-related agricultural peaks dominated those of the troughsover the 1973-74 to 1983-84 period, resulting in greater availability ofwage goods and higher savings, investment and terminal capital stock.

(Continued)

1/ Senior Economist, Country Policy Department, The World Bank, 1.818 HStreet, N.W., Washington, D. C. 20433, U.S.A.

2/ Professor of Economics, Delhi .7chool. of Economics, University ofDelhi, Delhi - 110007, India

-2-

Finally, the paper begins to explore the question of how investment isbest reallocated among sectors in response to exogenous shocks. Aseemingly plausible but myopic rule of reallocating investment acrosssectors in response to differences in short-run profitability would haveraised GDP and private consumption, while pulling resources out ofnontradeables and towards the tradeable sectors of the economy.However, it would have worsened the current account position and led toa higher external debt burden.

A disaggregated treatment of rural and urban households allowsattention to be focused on the consequences of different policies Lorthe size and functional distribution of income. The impact of thealternative policies described above on the size distribution of incomeand consumption in rural and urban areas was not significant.

COPING WITH INTERNAL AND ETERNAL EXOGENOUS SHOCKS:INDIA, 1973-74 to 1983-84

Table of Contents

Page

SUMMARY AND CONCLUSIONS ............................................. i

I. SHOCKS AND ADJUSTMENTBackground ............................................ iThe First Oil Shock ................................... iThe Intervening Years ................................ iiThe Second Oil Shock ................................. ii.

II. CONCLUSIONS ...............................................iii

Chapter 1: OVERVIEW ................................................

I. INTRODUCTION................................................1

II. ADJUSTMENT TO SHOCKS: GENERAL CONSIDERATIONS .............. 2

III. INDIAN ECONOMY BEFORE 1973-74: A PERSPECTIVE .............. 4

IV. ADJUSTMENT TO THE FIRST OIL SHOCK OF 1973/74 ............... 8

V. ADJUSTMENT TO THE SECOND OIL SHOCK:1979/80 TO 1983/84........................................ 21

VI. OVERALL ASSESSMENT ........................................ 31

Chapter 2: THE MODEL ...................................... 42

Production ........................................... 42Income Generation .................................... 45Final Demands ........................................ 46

Trade ................................................ 46Market Clearance (Goods) ............................. 47Factors .............................................. 47Investment and Savings ............................... 48Government...........................................48Dynamics............................................. 49Debt.................................................. 49

Table of Contents (Continued)

Page

Chapter 3 THE MODEL A! WORK................................... 50

I. INTRODUCTION .............................................. 50

II. COMPARATIVE STATICS

Changing Internal Variables...................... 51Agricultural Harvest Failure ......................... 51Consumer Goods Sector ........................ .... 53Capital Goods and Intermediates............ 53Infrastructure and Services .,...............e......... 54Decreasing the Savings Propensity of Households...... 55A 10 Percent Increase in Real Wages..................56Changing External Variables .e..@... .o.... 57A 30 Percent Increase in Export Prices...............57A 50 Percent Rise in Import Prices ...................58A 10 Percent Increase in Export Volume ............... 59A 100 Percent Increase in Foreign Savings ............ 60

III. TRACKING HISTORY........................... ............... 6

Methodology..................................... 62Input Data ........................................... 63Discussion of Tracking ............................... 65Features of the Historical Run ....................... 73

Chapter 4e SIMULATIONS WITH THE MODEL ........... .......... .... 85

I. INTRODUCTION .................. ............ 85

Experiment 1: No External Shock-Cum-AccommodatingBorrowing..................... . 86

Experiment 2: Alternative Adjtustment Strategy.......90Experiment 3: No Agricultural Shocks ................ 93

Experiment 4: Reserve Decumulation Between1976-77 and 1979-80................... 94

Experiment 5: Investment Reallocation ............... 097Adjustment and Income Distribution .................. 100


Page

Chapter 5: CONCLUSIONS ...................................... 116

I. INTRODUCTION ............................... 116

II. RESULTS OF THE POLICY SIMULATIONS ........................... 116

No External Shock-Cum-Accommodating Borrowing..........116Alternative Adjustment Strategy ........................ 117No Agricultural Fluctuations ........................... 118Reserve Decumulation ................................... 118Investment Reallocation ................................ 1l9

Adjustment to Exogenous Shocks and IncomeDistribution ........................................... 120

III. CONCLUDING REMARKS........................................... 121

Appendix 1: Equations of the Model .................................. 124Notation: ........................................................ 150Appendix 2: The Debt Module ......................................... 159Appendix 3: The Bivariate Lognormal Distribution .................... 163Appendix 4: Data Base ............................................... 172

iv -

Table of Contents

Page

List of Tables

Chapter 1 Tables

Table 1.1 Trend Rate of Growth Per Annum for Selected Periodsand Items ................................................ 10

Table 1.2 Surplus (+)/Deficit (-) on Current Account ............... 13

Table 1.3 Terms of Trade Effect .................................... 14

Table 1.4 Export and Import Outlays .................................15

Table 1.5 Indices of Imports and Exports ........................... 16

Table 1.6 Crude Oil: Import-Bill, Net Import-AvailabilityRatios and Production-Consumption Ratios ................. 17

Table 1.7 Selected Items on Invisibles in Current Account .......... 18

Table 1.8 Gross Domestic Fixed Capital Formation ................... 24

Table 1.9 Rates of Gross Domestic Capital Formation ................ 25

Table 1.10 Growth Rates of Index of Industrial Production ........... 26

Table 1.11 Trend Rates of Appreciation (+)/Depreciation (-)of Exchange Rates ........................................ 34

Table 1.12 Trend Rates of Appreciation (+)/Depreciation (-)of Exchange Rates.................................... 35

Table 1.13 Trend Growth Rates of Export-Earnings from Goods at

Current Prices ............................................ 36

Table 1.14 Trend Growth Rates in Exports and Imports ................ 37

Table 1.15 Trend Growth Rates in Exports & Imports: Volumeand Unit Values ........................................... 38

Table 1.16 Trend Growth Rates of Crude Oil: Domestic Outputand Net Imports (in million tonnes) ...................... 39

Table 1.17 Trend Growth Rates in Real GDP & Gross FixedCapital Formation ........................................ 40

Table 1.18 Trend Rates of Growth of W.holesale Prices ................ 41


PLage

List of Tables (Continued)

Chapter 3 Tbles

Table 3.1 INDIA: Selected Features of the Economy, 1973-74........75

Table 3.2 INDIA: Selected Features of the Economy, 1973-74Share of Consumption by Sector and Group(Constant prices)............................... 76

Table 3.3 INDIA: Comparative Statics Experiments on "Internal"Variables, 1973-74 (Percentage deviation frombase period).. ....................... . ............ 77

Table 3.4 INDIA: Comparative Statics Experiments on "External"Variables, 1973-74 (Percentage deviation frombase period) ............................................. 78

Table 3.5 INDIA: Input Data for Tracking. ...................... 79/80

Table 3.6 INDIA: Tracking Indicators............................81

Table 3.7 INDIA: Selected Features of the Historical Run(N4odel-generated) ......................................... 82

Table 3.8 INDIA: Debt Profile: Historical Run (tens ofmillions of 1973-74 rupees)........................... 83

Table 3.9 INDIA: Total Debt Service: Historical Run (tens ofmillions of 1973-74 rupees).............. ........ 84

Chapter 4 Tables

Table 4.1 INDIA: No External Shock-Cum-Accommodating BorrowingExperiment: Selected Features (tens of millions ofrupees) ..................................................101

Table 4.2 INDIA: No External Shock-Cum-Accommodating BorrowingExperiment: (Percentage deviation from historical run)..102

Table 4.3 INDIA: No External Shock-Cum-Accommodating BorrowingExperiment: Distributional Characteristics (Percentagedeviation from historical run) ...........................103

- vi -


Page

List of Tables (Continued)

Chapter 4 Tables (Continued)

Table 4.4 INDIA: Makeup of Sector 5 from 115 Sector Input-Output Table, 1973-74 ...................... 104

Table 4.5 INDIA: Alternative Adjustment Strategy (Percentagedeviation from historical run).......................... 105

Table 4.6 INDIA: Alternative Adjustment StrategyDistributional Characteristics (Percentage deviationfrom historical run) .................................... 106

Table 4.7 INDIA: No Agricultural Shock Experiment(Percentage deviation from historical run) .............. 107

Table 4.8 INDIA: No Agricultural Shock ExperimentDistributional Characteristics (Based onhistorical run) ......................................... 108

Table 4.9 INDIA: Reserves Experiments (Basic Data) ............... 109

Table 4.10 INDIA: Reserves Experiment (Bold)(Percentage deviation from historical run) .............. 110

Table 4.11 INDIA: Reserves Experiment (Bold)Distributional Characteristics (Percentage deviationfrom historical run) .................... ................ 111

Table 4.12 INDIA: Reserves Experiment (Conservative)(Percentage deviation from historical run) .............. 112

Table 4.13 INDIA: Reserves Experiment (Conservative)Distributional Characteristics (Percentagedeviation from historical run) ........................... 113

Table 4.14 INDIA: Investment Reallocation Experiment(Percentage deviation from historical run).............. 114

Table 4.15 INDIA: Investment Reallocation ExperimentDistributional Characteristics (Percentagedeviation from historical run) ................... 115

- vii -


Page

Appendix 4 Tables

Table 1. Mapping Scheme for Sectoral Aggregatione............177

Table 2. Domestic Input Output Table (tens of millions of

rupees) ................................................. 178

Table 3. Derived Aggregated Use-Pattern of CSO-NAS IOTT-Based Sectoral Imports (Rs. lakhs) ................... 179

Table 4. Sector-specific Estimates of Depreciation and of Net and

Gross Value Added ....................................... 181

Table 5. Assumptions Made Regarding the Services Sub-sectors for

Pre-tax Factor Incomes ............................. .183

Table 6. Factor Income Matrix ..................... 186

Table 7. Per Capita and Aggregate Pre-tax Incomes for Rural andUrban Populations...........e.........................187

Table 8. Derivation of Rural and Urban Factor Incomes ............ 188

Table 9. Distribution of Work-Force by Sectors.................... 90

Table 10. Estimates of Sectoral Capital Stock, Gross Pre-tax Rates ofReturn and the Ratio of Capital Stock to ValueAdded............. ............ ............. ........... 92,

Table 11. Estimates of Trade and Transport Margins in FinalConsumption Expenditure.................................. 194

Table 12. Sector-specific Margins Plus Indirect Taxes asPercentages of Final Consumer Expenditure at ProducerPrices ................................................. 195

Table 13. Price Indices used for Converting LES Parametersto 1973-74 Market Prices Matrix (6x9)....................196

Table 14. Transformation Matrix for Mapping L" Commodity Groupsinto I-0 Sectoral Classification ......................... 197

Table 15. Sector-specific Rates of Indirect Taxes by Types ofTaxes .................................................. 200

Table 16. Sector-specific Rates of Indirect Taxes on Domestically

Produced and Imported Intermediate Inputs and FinalDemand .................................................. 201


Page

List of Charts

Chart 1 INDIA: Tracking 1973-74 to 1983-84

GDP at Market Prices (Growth Rates) . ..................... 66


GDP at Market Prices (1973=1) ............................ 66


Private Consumption (Growth Rate) ........................ 67


Private Consumption (1973=1) ........................... 67

Chart 5 INDIA: Tracking 1973-74 to 1983-84Total Investments (Growth Rate) ........................... 68


Total Investments (1973=1) .............................. 68


Exports (Growth Rate) ...................... ............69


Exports (1973=1) ........................... ............. 69


Imports (Growth Rates) ................................... 70


Imports (1973=1)................................70

SUMIMARY AND CONCLUSIONS

I. SHOCKS AND ADJUSTMENT

Background

The two kinds of exogenous shocks to which the Indian economy

had been subjected in the 1960s were: (1) harvest failure and (2) abrupt

cessation of foreign assistance. Adjustment to the first took the form

of foodgrains imports under PL480 and moves towards self-sufficiency via

extension of irrigation and adoption of chemical-biological

technology. Adjustment to the second was effected through cutting

public investment.

The First Oil Shock

The early seventies witnessed a peak harvest in 1970-71, a

severe drought in 1972-73 and a sequence of indifferent harvests which

was not to be reversed till 1975-76. A steep rise in defense

expenditure during the creation of Bangladesh led to accelerating

inflation. The quadrupling of oil prices in 1973-74 against this

background was probably perceived as temporary and responding to it

deemed less important than arresting inflation. The policy response to

these shocks was (1) to reduce private disposable inccme through a

series of fiscal and other measures; (2) to import wage goods in years

of domestic shortfalls; (3) to encourage export expansion which was made

possible by underutilized capacity in manufacturing and real exchange

rate depreciation; and (4) to resort to foreign assistance, to a large

extent from the IMF. The balance of payments was further helped by a

slowdown in the imports of intermediate and capital goods and a

continuous rise in workers' remittances. By these means, a record

current account deficit in 1974-75 was converted into a surplus in 1975-

76 and remained so before turning into a small deficit on the eve of the

second oil shock of 1979-80. However, wnen view-ed in the historical

perspective of 1950-51 to 1965-66, there was a deceleration in the rate

of growth of investment and virtually no change in the rate of growth of

GDP. In summary, it appears as if the balance-of-payments adjustment

and curtailment of inflationary pressures were achieved at the expense

of growth in investment.

The Intervening Years

Two bumper harvests in 1977-78 and 1978-79 and the.

unanticipated growth of private remittances led to the accumulation of

food and foreign exchange reserves. However, the experience with

inflation in 1972-73 and 1974-75 and some uncertainty regarding how long

reserves would continue to accumulate inhibited policy makers from

stepping up industrial investment and imports of capital goods.

The Second Oil Shock

The combination of a more than doubling of oil prices and a

severe drought in 1979-80 potentially fuelled inflationary pressures as

well as adding very substantially to the POL (petroleum, oil and

lubricants) import bill. However, the background against which this

occurred was very different from that of the first oIl shock, since

India had comfortable reserves of food and foreign exchange. It was

partly because cf this, as well as a growing realization that the oil

- ii -

price increase was a relatively secular phenomenon, that the policy

response was different. Adjustment comprised (1) import liberalization

to promote doxnestic efficiency via international competition; (2)

domestic oil exploration; (3) measures to switch eneray use away from

POL and towards domestically available coal and electricity; (4)

increased public investment and a concomitant rise in imports of capital

goods and intermediates (especially iron and steel); and, (5) imports of

food, edible oil and fibre to contain inflationary pressures. The

increased current account deficit arising from these policies was

financed through a variety of short- and medium-term facilities of the

IMF as well as workers' remittances.

These policies, and other developments, left the economy with

(a) more effective control over the rate of inflation; (b) some

deceleration in industrial growth in 1979-83, due to a combination of

import competition and infrastructural bottlenecks; (c) a decline in the

rate of real gross investment, due partly to lack of buoyancy in private

investment; (d) halting progress towards a more internationally

competitive industrial structure; and, (e) a much faster increase in

imports compared to export earnings. Overall, the economy has not

reaained the growth momentum attained prior to 1964-65; furthermore

recent growth has been dominated by the tertiary sector alone.

II. CONCLUSIONS

The above narrative suggests a number of hypotheses which have

been examined in our study of adjustment to shocks during this period.

- iii -

First, what net impact did external shocks and the policy

response to them have on investment and growth? This is answered by

examining the consequences of removing external shocks and particular

accomodating policies deemed to be pursued in response to those shocks,

while keeping remittances unchanged at their 1973-74 level. It is seen

that accommodating borrowing from the IMF and various oil-related

development institutions after the first oil shock and the Extended Fund

Facility with the IMF after the second oil shock more than offset the

deleterious impact of terms of trade movements. GDP, private

consumption and investment would have been lower in the no external

shock-cum-accommodating borrowing scenario: indeed the capital stock in

1984-85 and would have been 8 percent lower. Domestic production of

consumer good, and infrastructure would have gone up at the expense of

capital goods. This would to some extent have intensified rather than

allayed concerns that have been expressed about the stagnation of

investment compared to the pre-1964-65 years. However, as expected, the

debt burden would also have been lower - by nearly 48 percent at the

beginning of 1983-84.

Second, what would have been the consequences of stepping up

investment in response to the first oil shock and containing potentially

inflationary pressures through imports of essential consumer goods? The

higher investment would have led to a capital stock in 1984-85 which was

nearly 2 percent higher than in the historical run. GDP and private

consumption were also higher. Domestic production of capital goods

would have gone up at the expense of infrastructure and consumer

goods. In the absence of any other measures, however, the economy would

- iv -

have been left with a 27 percent higher stock of debt by the beginning

of 1983-84.

Third, how would the economy have developed in the absence of

exogenous agricultural shocks? The peaks and troughs in GDP,

consumption, and investment in this policy experiment mirrored those in

the exogenous variable which proxied weather-related fluctuations.

Thus, the above macroeconomic variables would have been higher if

weather-related dips had not occurred; their behavior would have been

the opposite in the absence of weather-related peaks. The 1984-85

capital stock would also have been lower - by 6.5 percent - under the no

agricultural shock scenario. The assumed connection between

agricultural shocks and the preceived need to effect deflationary

adjustment makes it instructive to ask what a "no agricultural shock-

cum-deflationary adjustment" would have implied for the economy. This,

however, simply involves adding the present experiment to the previous

one. It is an obvious counterpart to the "no external shock-cum-

borrowing" experiment, described above.

Reference has already 'cen made to the stagnation of investment

in the 1970s in historical perspective. The first experiment reported

above shows that investment would have been lower than in the historical

run in that case. This indicates that external shocks and accommodating

borrowing were not directly responsible for the deceleration in

investment: indeed the opposite is true. Furthermore, the no-

agricultural shock scenario, when run from 1973-74 to 1983-84, would

also have resulted in lower investment and terminal capital stock.

- v -

However, in as much as the demand-deflationary measures of 1974-75 and

1975-76 were prompted by agricultural shocks and their potential for

generating inflation, it is possible that investment would have been

higher than in the historical run on a "no agricultural shock-cum-

deflationary adjustment" counterfactual. This line of argument suggests

that the stabilization program designed to curb inflation contributed to

the stagnation of investment in the 1970s.

Fourth, what would have been the economywide impact of

following a less cautious policy on reserve accumulation, i.e.9 using

".excess" reserves to finance higher investment and imports during 1976-

77 to 1979-80? Specifically, reserves are decumulated in the years

1976-77 to 1979-80 to four months' level of imports in a "bold" scenario

and at six months' level of imports in a "conservative" scenario; the

resulting differences with actual reserves are added to foreign

savings. This generates a substantially higher profile of GDP, private

consumption and investment, leading to a nearly 3 percent increase in

the capital stock by 1980-81, an increase in produetion of capital goods

and infrastructure at the expense of consumer goods and some widening in

urban-to-rural per capita income levels. Since "excess" reserves were

available in those years, they would have allowed the economy to sustain

a less deflationary adjustment strategy of the kind formulated in the

last experiment. However, since the extra foreign savings would have

come out of reserves rather than fresh borrowing, the debt burden would

have been lower than in the previous experiment. The question could be

answered by combining the themes of those two policy experiments.

- vi -

Fifth, would adjustment based on a different sectoral

allocation of investment have led to markedly superior outcomes in terms

of arowth and the balance of payments? A seemingly plausible but myopic

policy of allowing investment allocation to take advantage of sectoral

differences in current profitability is implemented. This leads to

higher GDP and private consumption and a capital stock which is 1.7

percent higher in 1984-85 compared to the historical run, while pulling

resources out of nontradeables and towards the tradeable sectors of the

economy. But it also leaves the economy with a stock of debt which is

27 percent higher at the beginning of 1983-84. This is the result both

of higher import intensity of sectors towards which investment is

redirected, as well as an increase in domestic demand pressure and a

consequent bidding up of domestic vis-a-vis international prices. This

experiment, however, is only a start towards examining the question of

how investment is best reallocated among sectors in response to

exogenous shocks.

Finally, an interesting feature of all the policy simulations

is the virtually uniform impact on all groups of households. Indeed,

there is hardly any movement in the Gini coefficient of income or

consumption inequality. The cost of living indices do not move

significantly differently for the ten aroups of households separately

identified by the model. Nor is there any movement in the share of the

bottom 40 percent in income and consumption. Thus, the impact of the

alternative policies described above on the size distribution of income

and consumption is not significant. These remarks, however, do not

necessarily apply to the regional or functional distribution of

income.

- vii -

Chapter 1: OVERVIEW

I. T1TRODUCTION

This paper

(1) analyses and interprets the adjustment of the Indian

economy to the twin exogenous shocks of oil price

increases and harvest failure during the period 1973-74

to 1983-84 (chapter 1);

(2) implements a six-sector economywide general equilibrium

model to a consistent data set for 1973-74 (Chapter 2 and

Appendices 1 to 4);

(3) uses the model to approximate the principal developments

in the Indian economy during 1973-74 to 1983-84 (Chapter

3);

(4) explores the consequences for the macroeconomic

aggregates, intersectoral resource allocation and income

distribution of different policy packages for adjusting

to various kinds of shocks (Chapter 4); and

(5) summarizes the main conclusions (Chapter 5).

Chap-I(India Shocks):4-11-86:pp

-2-

TI. ADJUSTMENT TO SHOCKS. GENERAL CONSIDERATIONS

Every erzonomy is subject to certain exogenous shocks which

disturb the growth process or accentuate the constraints operating upon

that process. Weather-induced failure of the agricultural harvest in

predominantly agrarian economies is an example of an internal exogenous

shock. Sudden emergence of war abroad which interrupts the supplies of

certain essential commodities in an open economy is an example of an

external exogenous shock. By contrast, an example of a policy-induced

(and hence not exogenous) shock is provided by profligate government

spending or, in some cases, excessively tight demand management.

Furthermore, within these two categories of shocks, i.e., exogenous and

policy-induced, it is possible to distinguish between temporary and

permanent shocks.

The mode of adjustment to an exogenous shock depends on the

perception of the policy-makers regarding its nature. A shock which is

perceived to be transient in nature may call for borrowing (as with a

temporary shortfall in export earnings) a change in the monetary-fiscal

policy mix (if priority attaches to containing inflationary pressures

arising from a poor harvest, but without deleterious effects on

investment) or a temporary reallocation of available supply outside tha

market mechanism. On the other hand, longer-term adjustment is deemed

necessary if the shock is perceived to be persistent in nature (for

example, increased oil price or a secular slowdown in productivity

growth in the industrial countries).

Chap-l(India Shocks):4-11-86:pp

-3-

The ability of an economy to respond to exogenous shocks

without seriously compromising its growth prospects depends on (1)

initial conditions, e.g., its agrarian or non-agrarian character, the

extent of its dependence on international trade and the facility with

which resources can be shifted across uses; (2) the appropriateness of

the economy's perception of the nature of shocks; and (3) the policies

adopted and the relative weight of those affected by such policies.

This chapter analyzes and interprets the adjustment of the

Indian economy to exogenous external shocks in the form of two steep oil

price increases in the seventies and their repercussions. In the Indian

context, both the external shocks coincided with the internal exogenous

shock of harvest failure and the policy response was aimed at adjusting

to both the shocks simultaneously. In the review of actual adjustment,

therefore, it is not always possible to separate out policies aimed at

the two shocks. Furthermore, in as much as end-results in the form of

certain performance indicators are shaped by policies as well as

exogenous forces, an assessment of their relative roles requires the

exercise of some judgement.

With these general considerations, the next section (Section

III) reviews the developments in the Indian economy prior to the

Chap-l(India Shocks):4-11-86:pp

-4-

external shocks. This provides a perspective against which the

developments in the adjustment period can be placed. Section IV is

devoted to the discussion of the first oil shock of 1973 and the

adjustment to it during the period from 1973-74 to 1978-79. Section V

examines the period of the second oil shock of 1979, from 1979/80 to

1983/84. An overall assessment is presented in Section VI. -

Ut. TnDAt ECONOMY BEFORE 1973-74: A PERSPECTIVE

The Indian economy can be characterized as a densely

populated, low income, large and predominantly agrarian economy.

GenerrLly, relatively limited reliance on international trade marks the

large economies - defined in terms of population and diversified

natural resources - from the average of all developing countries. 1/

In the context of the Indian economy, this limited reliance on foreign

trade had been further restricted by the strategy of import-

substitution-led industrialisation that was adopted possibly in the

light of 'export-pessimism' prevailing in the nineteen-fifties.

Recurrent foreign exchange crises -- arising partly out of the adopted

policy package itself - further strengthened the import and foreign

exchange restrictions of various kinds. These restrictions, combined

with an overvalued exchange rate provided protection to domestic

producers of import-competing products and, notwithstanding certain ad

/ See Chenerv, H. B. (1982), "Industrialization and Growth: the Experience

of Large Countries," World Bank Staff Working Paper, Number 539.

-5.

hoc concessions, discriminated against exports.-L During this period,

foreign assistance substituted for export expansion as a source of

foreign exchange. While import restrictions protected domestic

producers from international competition, industrial licencing

restricted entry of other domestic producers and prevented the emergence

of internal competition. This constellation of policies gave rise

to a diversified yet a highly protected industrial structure and an

economy that was effectively instulated from the international

environment. In this situation, the exogenous shocks interrupting the

growth process were of two kinds: the weather-induced failure of

agricultural harvests and unexpected cuts in foreign assistance. The

former could trigger an inflationary price spiral in a virtually closed

and predominantly agrarian economy whereas the latter could lead to

significant cuts in public investment.

The growth process that was initiated in the early-fifties was

broken by two successive droughts in the agricultural years (July-June)

1965/66 and 1966/67, together with a cessation of American foreign aid

following the war with Pakistan in 1965. A comparison of the trend

/ For a discussion of the policies and their consequences, seeJ. N, Bhagwati and P. Desai: India: Planning for Industrialisation,Oxford University Press, London, (1970).

J. N. Bhagwati and T. N. Srinivasan: Foreign Trade Regimes and EconomicDevelopment: India, National Bureau of Economic Research, New York (1975)

I. Little, T. Scitovsky and M. Scott: Industry and Trade in SomeDeveloping Countries: A ComDarative Study, Oxford UTniversity Press,London (1970)

- 6 -

growth rates over the period from 1950/51 to 1964/65 (period I) with

those over the period from 1964/65 to the onset of the first oil crisis

in 1973-74 (period II) is presented in Table 1.1 for a number of macro-

variables. This comparison indicates that period II covering a decade

prior to the first oil crisis is marked by a deceleration in the trend

rate of growth of almost all the macro-variables. The only sectors

which register a higher growth rate in period II than in period I are

(a) GDP in Agriculture (line 3); (b) the primary sector of which

agriculture is a dominant component (line 6); (c) finance and real

estate (line 10); and (d) public administration and defence (line 12).

Among the remaining macrovariables there was a virtual stagnation in

period II in gross fixed capital formation in the public sector as also

gross investment going into registered manufacturing (for which trend

growth is not given in Table 1.1). A sharp deceleration in the trend

growth rate is experienced by the following: gross investment in total

(registered plus unregistered) manufacturing (line 16), gross domestic

as well as fixed capital formation-L (lines 13 and 14), and GDP

originating in registered as well as total manufacturing (lines 4 and

5). It should thus be obvious that period II was generally marked by a

much lower trend growth rate than period I.

/ Trend growth rates are not indicated for these items for period II becausethe levels were virtually stagnant during the period.

-7-

The recurrent harvest failures and their adverse implications

for wage-good availability and the resulting constraint on the growth

process had indeed been perceived in the late fifties. Conseqtuently,

self-sufficiency in foodgrains featured for the first time as one of the

major objectives of the Third Five Year Plan formulated in 1960. The

programs for intensive development of crop output by concentrating on

selected favorably placed regions were initiated in the early sixties.

The immediate response to the two successive droughts of the mid-sixties

consisted of foodgrains imports under PL480. Simultaneously, certain

steps were also initiated towards stabilising and stepping up of

domestic output of grains through the extension of irrigation and the

incentives for the adoption of chemical-biologicaL technology.

Consequently, the trend growth rate of GDP originating in agriculture

could be marginally stepped up from 2.40 percent in period I to 2.79

percent in period II. Despite greater variability around a higher trend

growth rate, the achievement can be regarded as remarkable as it

occurred in the face of deceleration in the growth of net sown area.

Adjustment to the abrupt cessation of foreign assistance took

the form of a cut in public investment in particular and a decline in

the rate of gross domestic investment in general.

The net result of both the shocks is reflected in a slow-down

in the trend growth rate of aggregate GDP from 3.85 percent to 3.32

percent and of per capita GDP from 1.86 percent to 1.08 percent, with a

much hiaher variability around the trend growth rate in period II than

in period T,

IV. ADJUSTMENT TO THE FIRST OIL SHOCK OF 1973/74

Before the onset of the first oil shock in 1973, the peak

agricultural harvest of 1970-71 was followed by a slight reduction in

1971-72 and a severe drought in 1972-73 when real income originating in

agriculture declined by 6.36 percent compared to the previous

indifferent harvest. The influx of refugees from what was then East

Pakistan, resulting in the creation of Bangladesh, in 1971 led to a

steep rise in defence expenditure. Consequently, the annual rate of

inflation -/ as measured by the wholesale price index accelerated

progressively from 2 percent around April 1971 to about 17 percent by

September 1973 the beginning of the oil price hike.

The oil price more than auadrupled from ITSS2.70 per barrel in

September 1973 to UJSS11.20 per barrel in March 1974. Simultaneously,

the agricuiltural harvest of 1973-74 managed only to restore the real

income in agriculture to the peak of 1970-71 only to dip marginally

again in 1974-75. The internal and external shocks together accentuated

the inflationary tendencies which had been accumulating since '972. The

annual inflation rate increased further from 17 percent in September

1973 to the highest ever rate of nearly 34 percent by September 1974.

Reading through the Economic Surveys of this period from the tinistry of

/The estimates of annual rates of inflation auoted here, and subsequently,

are based on the chart of annual rates of inflation from April 1971 toOctober 1983 appearing between pages 36 and 37 in the Economic Survey1983-84 published by the Government of India.

Finance, one gets the impression that the policy-makers perceived the

internal shock resulting from downward variations in agricultural

harvest, and not the oil price increase, to be the primary cause of the

inflationary pressures. In fact, the oil price increase was perceived

to be a mere aberration that was unlikely to persist and hence treated

as a purely transient phenemenon requiring only short-term adjustment.

As a consequence of the oil price increase, import outlays on

POL (petroleum, oil, lubricants) shot up from Rs 207 crores in 1973/74

to Rs 541 crores in 1973/74 and more than doubled in 1974/75 to reach Rs

1246 crores - an increase of 132 percent per annum over two years.

Relative to this high base, the growth rate over the next three years

1975/76 to 1978/79 was reduced to less than 11 percent per annum. It is

worth noting that imports of crude, as well as petroleum products, in

physical terms increased at the rate of 10 to 11 percent per annum

between 1975/76 and 1978/79 -- more or less in line with import

outlays. In contrast, between 1972/73 and 1974/75, import outlays more

than quadrupled although in physical units, the growth rate of crude

imports was 7.7 percent per annum whereas imports of petroleum products

declined at the rate of 13.33 percent per annum. -/

1/ The statements in this paragraph are based on figures available in variousEconomic Surveys published by the Ministrv of Finance, Government ofIndia.

Table 1.1

Trenid Rate of Growth Per Annum for Selected Periods and Items

Period I Period II1950-51 1964-65 gighest ROG Observed Over

to to 1964-65 to 1.98'-82

1964-65 1973-14 2

Item ROG (5%) 2 ROG (%) r ROG M r Period(2) (3) (4) (5) (6) (7) (8) (9)

1. Aggregate CDP 3.85 O9891 3.32 0.9003 3.59 0.9777 1964-65 to 1983-84

2. Per Capita CDP 1.86 0.9614 1.08 0.4836 1.34 0.7811 1964-65 to 1978-791.34 0.8505 1964-65 to 1983-84

3. GDP ivx Agriculture 2.40 0.9208 2.79 0.6120 2.84 0.8163 1964-65 to 1978-79

4. CDP in MIfg. (Total) 6.75 0.9884 3.47 0.9294 4.08 0.9642 1964-65 to 1979-804.08 0.9745 1964-65 to 1981-82

5. GDP in Mfg. (1Reg t d.) 7.98 0.9806 3.78 0.8839 4.27 0.9652 1964-65 to 1981-82

C 6. CG)P in Primary sector 2.50 0.9370 2.78 0.6509 2.82 0.8383 1964-65 to 1978-79

H 7. GDP in Secondary secror 6.67 0.9794 3.53 0.9732 3.92 0.9646 1964-65 to 1978-790.9707 1964-65 to 1979-80

8. CDP in Tertiary sector 4.87 0.9897 4.01 0.9951 4.72 0.9890 1964-65 to 1981-82

9. CDP in Trade & Communicatilons 5.78 0.9877 3.94 0.9901 4.76 0.9863 1974-65 to 1981-82

10. GDP in Fi:nance & Real Estate 3.94 0.9898 4.58 0.9928 4.57 0.9845 1964-65 to 1979-90

11. CDP in Community and 4.06 0.9900 3.79 0.9867 4.75 0.9733 1964-65 to 1981-82

Personial Services12 GDP in Public Administration 6.26 0.9602 6.50 0.9885 7.13 0.9863 1964-65 to 1981-82

13. Cr Fixed Cap. Formation (GFCF) 6.68 0.8795 4.12 0.9389 1964-65 to 1978-79

14. Cr. Dom. Cap. Formation (GDCF) 7.16 0.8026 4.87 0.9625 1964-65 to 1978-79

15. Public Sector GFCF 11.40 0.9762 4.20 0.7880 1964-65 to 1981-82

16. Gr. Inv. Mfg. (destination) 10.52 0.6149 3.40 0.2899 5.25 0.7465 1964-65 to 1981-82

17. Gr.Iniv.Regd.Mlfg.(destiinatiotn) 10.55 0.5260 -0.30 0.0024 6.83 0.1475 1964-65 to 1977-78

Note: 1. Cross fixed capital format:ion and gross domestic capit:al formatiotn (rows 13 anid 14) are measulred at

1960-61 prices. All ot:her Itlems are at 1970-71 prices2. R05 (%) = tretnd rate of growth ini percent. pet annutim.

r=squared correlation. coefficienit between time and the logarithmic tranisform of the variablelisted in columni (2).

3. Trentd rate of growth is given by thie coefficietit oF the tinme variable when logarithmic transformv ofa givent variable (columni (2)) is regressed agailnst time.

In relation to export earnings, POL imports amounted to 10.35

percent in 1972/73. This share more than doubled in 1973/74 to 22¢20

percent and rose further to nearly 35 percent in 1974/75. In the

subsequent four years - 1975/76 to 1978/79, the share fluctuated

between 28 and 31 percent (see Table 1.6).

The oil price increase in 1973/74 was accompanied by a rise in

the unit values of imports and exports which continued in subsequent

years despite the oil price remaining stable. As a result of the

changes in the commodity composition as well as in the composition of

partner countries, the net barter terms of trade (1970/71 = 100)

deteriorated from 116.98 in 1972/73 to 66.04 in 1975/76, improved

somewhat to 89.62 in 1977/78 only to dip again to 84.91 in 1978/79

(Table 15). The resulting terms of trade effect transformed itself

from 0.30 percent gain during 1970/71 and 1973/74 to a loss amounting to

1.45 percent in 1974-75 and 1.9 percent in the subsequent two years

(Table 1.3).

The heavy import bill on account of POL combined with a

deterioration in n'et barter terms of trade transformed a small surplus

of Rs 176 crores on account of goods and non-factor services in 1972/73

into a deficit of Rs 346 crores in 1973/74, a record deficit of Rs 944

crores in 1974/75 and a slightly lower one at Rs 852 crores in

1975/76. Combined with other invisible items which were in deficit till

1974-75, the current account deficit of Rs 327 crores in 1972/73 rose to

Rs 425 crores in 1973/74 and a record level of Rs 748 crores in

- 12 -

1974/75. The magnitude of the current account deficit was 1.18 percent

of GDP in 1974/75 compared to an average of 0.20 percent over the four

years prior to 1974/75 (Table 1.2). While the relative magnitude of the

current account deficit was significant in the Indian context, it could

not be regarded as significant when compared to other oil-importing

developing countries.

Formally, the record current account deficit of 1974/75 was

converted into a current account surplus in 1975/76 and remained so for

the next two years before turning into a small deficit on the eve of the

second oil shock of 1979/80 (see Table 1.2). W;hat were the factors

behind this remarkably rapid turn around in the current account?

First, at the policy level, the government initiated certain

post-budget measures in 1974/75 to reduce private disposable income,

especially to curb the long accumulating inflationary pressures

indicated earlier. These consisted of: (i) freezing all wage increases

and half of additional cost of living increases in the public sector;

(ii) limitations on dividend distributions by companies; (iii) a new

scheme of compulsory (frozen) deposits on the basis of a graduated slab

for all income taxpayers; (iv) raising excise duties and railway freight

rates and; (v) taxing interest income o.7 commercial banks. This strong

dose of demand management occurred in the face of bumper agricultural

harvests in 1975/76, 1977/78 and 197 8/7P and selective imports of

certain key consumer goods in temporary short supply such as foodgrains,

edible oils and fibres. This constellation of policies and circum-

Table 1.2

Surplus (+)/Deficlt (-) on Current Account

Rs Crores Columns (2) to (6)

Surplus on Surplus on Surplus on Surplus on GDP @On A/C of Current tMerchandise Merclhandtse Current % % % %

Goods & N.F. A/C (NAS) A/C (NAS) A/C (Eco. Mkt Prices (2) (3) (4) (5)Year Services Survey) (6) (6) (6) (6)(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

1970-71 -45 -424 -99 -99 36736 -0.12 -1.15 -0.26 -0.261971-72 -212 -519 N.A. -216 39263 -0.54 -1.32 N.A. -0.551972-73 +176 -327 -104 -103 43241 +0.41 -0.76 -0.24 -0.241973-74 -346 -425 -432 -432 53772 -0.64 -0.79 -0.80 -0.8(1974-75 -944 -748 -1190 -1190 63263 -1.49 -1.18 -1.88 -1.881975-76 -852 +77 -1222 -1222 66370 -1.28 +0.12 -1.84 -1.841976-77 +525 +1275 +72 +69 71464 +0.73 +1.78 +0.10 +0.101977-78 +84 +1417 -621 -616 80666 +0.10 +1.76 -0.78 -0.761978-79 -311 -180 -1088 -1085 87046 -0.36 -0.21 -1.25 -1.251979-80 -1478 -627 -2449 -2724 94978 -1.56 -0.66 -2.58 -2.871980-81 -4550 -2151 -5813 -5839. 113584 -4.01 -1.89 -5.12 -5.141981-82 -4626 -2665 -5868 -5802 130583 -3.54 -2.04 -4.49 -4.411982-83 N.A. N.A. N.A. -5448 144393 N.A. N.A. N.A. -3.771983-84 N.A. N.A. N.A. -5897 173420 N.A. N.A. N.A. -3.40

Sources:Columns (2) to (4) and (6) are based on National Accounts.

Column (5) is based on data In the Economic Survey.

t I

*Table 1.3

Terms of Trade Effect

[Rs. crores for Cols. (2) to (4)]

Terms of Trade GDP Gross Disp.Effect (Rs. Crores (at 1970-71 Income (2) (4)

Year At 1970-71 Prices Mkt Prices) [(2) + (3)] %(1) (2) (3) (4) (5)

1970-71 0 40623 40623 0.001971-72 168 41196 41364 0.411972-73 328 40901 41229 0.801973-74 0 42370 42370 0.001974-75 -608 42437 41829 -1.451975-76 -879 46574 45695 -1.921976-77 -877 47124 46247 -1.901977-78 -309 51017 50708 -0.611978-79 -486 54407 53921 -0.901979-80 -1421 51598 50177 -2.831980-81 -1102 55098 53996 -2.041981-82 -743 58292 57549 -1.29

1970-71 to 1973-74 496 165,586 0.301974-75 to 1978-79 -3159 238,400 -1.331979-80 to 1981-82 -3266 161,722 -2.021974-75 to 1981-82 -6425 400,122 -1.61

Note: Terms of trade effect indicates a surplus (+) or deficit (-) of import capacity in relation to volume ofexports, or

- x

m x

wlhere X = value of exportsPm = unit value index for imports

Px = unit value index for exports

Table 1.4

Export and Import Outlays

Export of Goods Imports of Goods Total Export of AdjustedYear & Services at & Services at Goods at as % of

Current 1970-71 Current 1970-71 Current Prices UJnadjustedPrices Prices Prices Prices Unadjusted Adjusted (7) * (6)

(1) (2) (3) (4) (5) (6) (7) (8)

1970-71 1771 1771 1816 1816 1535.36 1510.59 1.601971-72 1794 1760 2006 2157 1608.20 1558.41 3.101972-73 2225 1965 2049 2112 1970.80 1829.73 7.161973-74 2830 2055 3176 2301 2523.40 2441.08 3.261974-75 3835 2221 4779 2000 3328.80 2914.28 12.451975-76 4812 2589 5664 2023 4042.25 3384.18 16.28

r4 1976-77 6139 3099 5614 2019 5143.20 4962.60 3.511977-78 6636 2981 6552 2631 5404.26 5073.59 6.121978-79 7115 3223 7426 2856 5726.26 5260.21 8.141979-80 8381 3764 9859 2739 6458.76 6111.40 5.381980-81 9029 3753 13579 4017 6683.17 6266.42 6.241981-82 10253 3748 14879 4338 7805.90 7408.52 5.091982-83 N.A. N.A. N.A. N.A. 8829.80 7129.10 19.26

Sources: Column (2) and (4) from the National Accounts Statistics- Column (2) deflated by unit value indexfor exports (1970-71 = 100) is given in column (3). Column (4) deflated by unit value index forimports. (1970-71 = 100) is given in Column (5). Coilumns (6) and (7) are from S. K. Verghese, partII, Table 10, p. 1152.

- 16 -

Table 1.5

Indices of Imoort8 and Exports

Volume Indices Unit Value Indices Net Barter

Export Import Export Import terms of trade

1970-71 100.00 100.00 100.00 100.00 100.001971-72 100.94 120.69 101.89 93.00 109.431972-73 113.21 113.79 113.21 97.00 116.981973-74 117.92 131.03 137.74 138.00 100.001974-75 125.47 114.94 172.64 239.00 72.641975-76 138.68 127.59 185.85 280.00 66.041976-77 164.15 111.49 198.11 278.00 71.701977-78 158.49 149.42 222.64 249.00 89.621978-79 169.81 160.92 220.75 260.00 84.911979-80 187.74 155.17 222.64 360.00 62.261980-81 183.02 228e74 240.57 338.00 70.751981-82 186.79 244.83 273.58 343.00 80.19

1973-74 to 198>182

Mean 159.12 158.24 208.28 276.11 77.57s.d. 26.3236 47.8314 39.8862 67.8296 12.1535c.v. % 16.54 30.23 19.15 24.57 15.67

1970-71 to 1981-82

Mean 145.52 146.55 182,47 231.25 85.38s.d. 33.4545 46.1626 57.8510 99.6732 17.8927c.v. % 22.99 31.50 31.70 43.10 20.96

Notes: s.d.: standard deviationc.v.: coefficient of variation

- 17 -

Table 1.6

Crude Oil: Import-Bill, Net Import-AvailabilityRatios and Production-Consumption Ratios

Import Bill on Petroleum Domestic Crude Oil Ratio of Net ImportOil & Lubricants as X of Production as x to Availability

Year Total Merch- Total Merch- of Domestic Cons- both in millionandise Imports andise Exports umption in Crude tons for crude

Equivalent(1) (2) (3) (4) (5)

1970-71 8.34 8.88 35.45 63.141971-72 10.64 12.07 33.83 63.951972-73 10.92 10.35 31.09 62.271973-74 18.96 22.20 29.93 65.861974-75 25.61 34e76 32.28 64.611975-76 23.86 31.12 35.19 61.711976-77 27.86 27.49 34.41 61.221977-78 25.78 28.70 39.29 57.421978-79 24.69 29.36 38.36 55.761979-80 35.77 50.95 36.98 57.801980-81 41.97 78.48 31.75 60.721981-82 38.14 66.48 46.53 45.691982-83 39.04 62.92 56.93 28.151983-84 30.64 48.9% 68.18 18.71

Sources: (1) Columns (2) and (3) based on value of merchandise imports andexports given in the Economic Survey.

(2) Column (4) is from Table 13 from M. S. Ahluwalia, "Balance ofPayments Adjustment in India, 1970-71 to 1983-84" UNCTAD.

(3) Column (5) based on the Economic Survey.

Table 1.7

Selected Items on Invisibles in Current Account

Net get Gross Private TransferYear Foreign Private Transfer Receipts

Travel Payments(1) (2) (3) (4) (5)

1970-71 10.1 67.3 136 80.51971-72 12.0 99.5 175 111.81972-73 18.6 92.8 165 104.11973-74 39.5 130.4 204 142.41974-75 78.9 214.0 280 220.21975-76 167.6 410.3 541 423.71976-77 246.3 616.9 746 623.71977-78 485.6 910.8 1029 917.31978-79 500.1 927.0 1059 943.81979-80 831.2 1464.4 1632 1472.11980-81 1075.3 2118.1 2269 2129.71981-82 918.9 2066.4 2237 2082.91982-83 945.5 2416.7 N.A. 2430.8

Sources: Columns (2), (3) and (5) from Economic SurveyColumn (4) from National Accounts Statistics

Notes: Differences between columns (4) and (5) for the same item persist.The reason are not clear. Since the National Accounts figures areinvariably higher than those in Economic Survey, we can take thelatter figures (available till 1982-83) as lower bounds.

- 19 -

stances managed to curb the rate of domestic inflation. The annual rate

of inflation started to decline from a peak level of 34 percent per

annum in September 1974 and reached less thant 10 percent by May 1975 and

negative levels by September 1975. After reaching the lowest rate of

arounO, 6.5 percent per annum by March 1975, it started rising but

barring a brief period February to June 1977, during the indifferent

agricultural harvest of 1976/77, it never crossed a double-di,git rate

until June 1979.

Secondly, this period of adjustment is also marked by a

persistent deceleration in rate of growth of real gross domestic (total

as well as fixed) capital formation (Table 1.1, lines 13 and 14), public

sector gross fixed capital formation (line 15) as well as gross

investment in registered and total manufacturing. The same is true for

real GDP originating in total as registered manufacturing (lines 4 and 5

in Table 1.1, columns [7] to [9]). In fact, the real gross domestic

capital formation in relation to real GDP at market prices reached a

peak of 20.9 percent (in 1966/67) over the period from 1950/51 to

1966/67. This peak could be restored only by 1973/74 (21.4 percent)

(since 1966/67), to fall again and to be regained by 1978/79 (21.4

percent). In other words, there was a slowdown in the rate of real

gross domestic capital formation during the adjustment period (See

Table 1.9).

Finally, on the external front, adjustment was facilitated by

the following factors:

- 20

(a) Almost half of the current account deficit in 1974/75 could be

finianced from unconditional or low conditionality facilities of

the IMF. I/

(b) There was a rise in the rate of growth of export earnings

exceeding 25 percent starting from a pre-oil-shock year of

1972/73 to 1976/77. Out of these five years, the first three

were marked by rising unit values rather than volume, whereas

in the last two years, the situation was reversed (see Table

1.5). This export expansion was made possible by the existence

of underutilised capacity in the manufacturing sector and

appeared to be due to effective exchange rate depreciation over

the period aided, especially in the later years, by domestic

price stability noted earlier. The rate of growth of export

earnings slowed down considerably in 1977/78 and 1978/79.

(c) The adjustment period was also marked by a slowdown in imports

especially of intermediate and capital goods. Their combined

share in total import outlays declined from 52 percent during

1970/71 and 1973/74 to 39 percent during 1974/75 and 1978/79.

In constant 1970/71 prices, the peak level imports of capital

goods in 1973/74 was not restored even by 1979-80.

(d) Finally, there was an unanticipated yet continuous rise in

current private transfers from abroad which more than

compensated for a slowdown in export-earnings in 1977/78 and

See M.S. Ahluwalia, "'Balance of Payments Adjustment in India: 1970/71 to

1 1983/84" UNCTAD, (no date), pp. 5-6.

- 21 -

1978/79 noted above, thereby helping keep the current account

balance in surplus.

Thus, adjua>tment to the first oil shock was marked partially

by internal demand management prompted by internal inflationary

pressure, a slowdown in the rate of real gross domestic investment, some

short term external financing, acceleration in export earnings combined

with a slowqdown in imports and finally current private transfers,

especially remittances from migrants to the oil-exporting countries. As

mentioned earlier, the accent on short-run adjustment policies with

reference tc the balance of payments perhaps reflected policv-makers'

judgment that the oil price increase was unlikely to persist and hence

required no major supply side adjustments. Although year-to-year growth

rates of real GDP showed some increase, the last three columns of Table

1.1 indicate that they did not make much difference to the trend growth

rate of real aggregate or per capita GDP.

V. ADJtJSTMENT TO THE SECOND OIL SHOCKz 1979180 TO 1983/84

The second major increase in the price of oil was from IJS$13

per barrel in late 1979 to USS30 per barrel in early 1980. This shock

also coincided with a severe drought in 1979-80 when real income

originating in agriculture dropped by over 13 percent from the record

level of the previous year. The combined consequence of these two

shocks was to generate inflationary pressures. The annual rate of

inflation rose from around 5 percent in April 1979 to a peak of 25

percent by January 1980.

As a consequence of the oil price increase, the import bill

for POL doubled from Rs 1681 crores in 1978/79 to R.s 3270 crores in

- 22 -

1979/80 and further to Rs 5267 crores in 1980/81. The POL import-bill

formed 51 percent of export earnings in 1979/80 and 78 percent in

1980/81. The corresponding average share of POL imports in export

earnings was only 29 percent during the first oil shock period from

1974/75 to 1978/79 (see Table 1.6).

The trade deficit on merchandise account also rose from 1.25

percent of GDP at market prices in 1978/79 to 2.87 percent in 1979/80

and a new record level of 5.14 percent in 1980/81. Although it declined

gradually to 3.4 percent by 1983/84, its level was twice as high as the

record level of 1.9 percent during the period of the earlier oil price

increase. Because of continuing remittances, the deficit on current

account could be contained to around 2 percent of GDP in 1979/80 and

1980/81 although this itself was a steep rise compared to 0.66 percent

recorded in 1979/80 (Table 1.2).

The deterioration in the barter terms of trade resul-ted in a

terms of trade loss (in real terms) of 0.90 percent in 1978/79, rising

to 2.83 percent in 1979/80. The relative rmtagnitude of the loss was

higher than the highest level of 1.92 percent in 1975/76 experienced

during the first oil shock (Table 1.3).

As of 1983/84 -- [the latest year for which data are

available] - the trade deficit on the merchandise account continued to

be over Rs 5800 crores, or nearly 3.5 percent of GDP. The deficit in

the current account showed no signs of being converted into a surplus as

it did by 1975/76 after the first oil shock.

- 23 -

It is important to note that the initial conditions facing the

Indian economy were more favorable at the time of the second oil shock

compared to the first one.

(a) India had continuously accumulated foreign exchange reserves -

the result of unanticipated private remittances between 1974/75

and 1978/79.

(b) Following the two bumper harvests of 1977/78 and 1978/79, the

foodgrains stocks with the government had .-eached a record

level of 21.5 million by the end of July 1979.

(c) As mentioned already, the annual rate of inflation had come

down to less than 10 percent per annum on the eve of the second

oil shock.

The first two initial conditions (a) and (b) implied that the

two major perceived constraints of the growth process since the mid-

fifties, namely, the acute scarcity of wage goods and that of foreign

exchange, appeared to have been relaxed. It is important to note,

however , that the accumulation of food and foreign exchange reserves had

taken place in the face of the followi-ng circumstances. First, capital

goods imports had remained virtually stagnant in real terms.-/ Second,

the rate of gross domestic investment kept fluctuating around 20 percent

(Table 1.9); so did real private gross investment, especially in the

registered

/ See Ahluwalia, op. cit. Table 6. Notice there has been no trend in

capital goods imports in real terms especially from 1970-71 to 1979-80

(Table 1.14, line 11).

Table 1.8

Gross Domestic Fixed Capital Formation

(Rs Crores)

At Current Prices At 1970-71 PricesPublic Private Total Public Private Total

1970-71 2394 3911 6305 2394 3911 63051971-72 2802 4272 7074 2648 4038 66861972-73 3619 4447 8066 3166 3893 70591973-74 4009 5020 9029 3134 3926 70601974-75 4272 6658 10930 2680 4176 68561975-76 5600 7648 13248 3176 4338 75141976-77 7048 8219 15267 3918 4567 84851977-78 7697 9449 17146 4181 5134 93151978-79 8376 10449 18825 4186 5223 94091979-80 9974 10928 20902 4312 4726 90381980-81 11629 13588 25217 4486 5242 97281981-82 14563 14910 29473 4880 4997 98771982-83 18233 1.5428 33661 5569 4712 102811983-84 20517 20150 40667 5506 5408 10914

Source: Central Statistical Organisation: National Accounts Statistics, variousissues.

- 25 -

Table 1.9

Rates of Gross Domestic Capital Formation

At 1970-71 PricesGross Domestic GDP at Rate of Gross

Capital Formation Market Prices Capital Formation

1970-71 7344 40263 18.241971-72 7959 41196 19.32

1972-73 7479 40901 180291973-74 8739 42370 20.631974-75 8947 42437 21.081975-76 9388 46574 20.161976-77 9847 47124 20.901977-78 10096 51017 19.79

1978-79 11633 54407 21.381979-80 11489 51598 22.27

1980-81 12192 55098 22.131981-82 12218 58292 20.961982-83 12230 59953 20.401983-84 12998 64543 20.14

Source: Central Statistical Organisation: National Accounts Statisticsvarious issues.

- 26 -

Table 1.10

Growth Rates of Index of Industrial Production

Ser. Description 1970-74 1974-79 1979-82 1979-83No.(1) (2) (3) (4) (5) (6)

1. General index of industrial production 4.49 5.58 4.78 4.71

2. Manufacturing subgroup 2.85 5.26 4.03 3.82Selected components of mfg. group:(a) Chemical & chemical products 4.88 8.77 5.03 4.61(b) Petroleum products 3.10 6.30 4.45 5.20(c) Basic metals industries 1.03 6.30 4.43 3.32(d) Metal products except machinery 5.10 5.93 -1001 0.65(e) Non-electrical machinery 11.20 6.03 5.29 5.15(f) Electrical machinery 3.13 7.62 3.34 2.08(g) Transport equipment 2.18 2.86 4.30 4.10(h) Miscellaneous 3.15 5.58 8.18 na

3. Use-based classification

(a) Basic industries 3.38 7.87 7.00 6.62(b) Capital goods 6.68 4.37 3.94 4.04(c) Intermediate goods 2.94 4.43 2.13 3.54(d) Consumer goods 2.34 4.28 4.75 3.64

(i) Durable 4.60 4.60 2.33 1.79(ii) Non-durable 1.90 4.24 5.09 3.91

4. Input-based classification

(a) Agro-based 1.10 3.99 4.23 4.24(b) Metal-based 5.97 4.57 3.03 3.14(c) Chemical-based 5.31 8.28 5.27 4.67

5. Sectoral Indicators

(a) Transport equip. & allied industries 4.31 2.58 4.55 5.16(b) Electricity & allied industries 6.24 7.42 5.77 5.05(c) Energy output 4.51 7.54 8.22 7.96

Note: These are point-to-point growth rates per annum because continuous time-series were not available to compute trend growth rates.

- 27 -

manufacturing sector. - Third, the acceleration in the industrial

growth rate from 2.85 percent during 1970-74 to 5.26 percent during

1974-79 was achieved more by better capacity utilization than by new

capacity creation. Fourth, the accelerated industrial growth rate of

5.26 percent was lower than the 8 to 10 percent growth rate achieved

during the 10 years preceding 1965. From these circumstances, it

follows that the accumulation of food and foreign exchange reserves

occurred precisely because of the economy's inability to utilize them

for stepping up industrial investment. Part of tne reason for this

phenomenon may be attributed to policy-makers' perceptions. Reserves

were not used to step up productive investment because of the perceived

uncertainty regarding the continuation of both food and foreign exchange

reserves. It was apparently felt that a bold industrial investment

program would lead to uncontrollable inflationary pressures in the event

of rapid exhaustion of food stocks. And depletion of foreign exchange

rest -' would make it difficult to relieve this situation via food

imports. Being extremely sensitive to the inflationary pressures

especially after the experience during 1972/73 and 1974/75, the policy

makers opted for a conservative approach of maintaining price stability

with stagnation in industrial investment, rather than take the risk of

inflation with a step-up in industrial investment. This is admittedly a

speculative ex-post rationalization of events.

1/ This statement is based on the time-series of real gross investment by

industry of use, given in variouis issues of the National Accounts

Statistics released by the Central Statistical Organization.

- 28

Although the food and foreign exchange reserves were not being

uitilised at the time of their build-up during 1974-78 period, they

provided favourable initial conditions when the second oil shock took

place. Possibly because of these favourable initial conditions, the

policy response to the second oil shock was bolder than that to the

first shock. The policy response consisted of the following

ingredients.

(1) Liberalization of imports was undertaken in the interest of

promoting efficiency bv exposing domestic producers to

international competition.

(2) Domestic oil exploration efforts were stepped up to reduce the

dependence on imported crude.

(3) Measures were undertaken to switch energy use away from POL and

towards domestically available coal and electricity.

(4) Efforts were made not only to maintain public sector fixed

capital formation but to raise its level in real terms.

(5) The policy of importing food, edible oil and fibre in case of

shortages was continued in order to curb inflationary

pressures.

These measures were indicative of the acceptance of the oil

crisis as a persistent feature to which policies had to be directed with

the objective of making medium-term adjustments. Even the

liberalization of imports was promnpted mainly by the need to ensure

international competitiveness in order to bring about an expansion of

exports. There appears to have been a realisation that the Indian

economy could not, unlike in the years before 1973/74, remain semi-

- 29 -

closed and insulated from external shocks. This perception could have

been shaped by the persistent nature of the high and intermittently

rising oil prices, continuing and progressively rising terms of trade

losses (see Table 3), and the rising share of imports and exports in GNP

during the post-1973 period in comparison with the pre-1973 period.

The end-results of these policies have been mixed.

First, the rate of domestic inflation was brought down from

the peak level of 25 percent in January 1980 to near 2 percent by May

1982. The recovery in foodgrain output from tRe drouight level of 109.7

million in 1979/80 to 129.6 million in 1980/81 and a new record level of

133.3 million in 1981/82, combined with imports, was a major factor in

this connection. Following another drought in 1982/83, the rate of

inflation rose to near 10 percent by May-June 1983 and fluctuated around

10 percent despite another bumper harvest of 151.5 million in 1983/84

before showing a downward trend. Tn other words, the inflationary

pressures have been checked more effectively and more quickly after the

second oil shock.

Secondly, the rate of industrial growth showed some

deceleration during 1979-83 compared to the 1974-79 period. The

deceleration was experienced by most groups of industries (Table

1.10). Liberalisation of imports -- in the then prevailing environment

of falling international prices in the face of recession in the

developed industrial countries -- provided a partial explanation of

deceleration, especially in certain high-cost import-competing

industries. With exports being relatively unimportant in relation to

- 30 -

the domestic market, fluctuations in agricultural harvests brought about

corresponding fluctuations in the market for industrial goods. The two

droughts of 1979-80 and 1982-83 adversely affected hydel power

generation. They accentuated the infrastructural bottlenecks

originating in the coal-railway-power complex during the 1979-83

period. The combination of supply and domestic demand constraints

worked in the same direction of adversely affecting industrial output.

Thirdly, the rate of real gross investment declined from 22

percent during 1979-81 to 20 percent by 1983/84 (Table 1.9). The real

fixed investment of the private sector also did not show any buoyancy

(Table 1.8).

Fourthly, the growth rate of export-earnings slowed down

pafitly due to the rccession in industrial countries. Fifth, the import-

substitution in oil brought down the net import-availability ratio from

61 percent in 1980 to nearly 19 percent in 1983/84 (Table 1.6,

Column 5). -/ This also brought down import outlays on POL in relation

to merchandise export earnings from the record level of 78.50 percent in

1980/81 to nearly 49 percent in 1983/84. But even this level of 49

percent was considerably higher than the previous peak level of nearly

35 percent recorded in 1974/75. In other words, the import- bill of POL

rose faster than export-earnings since 1979/80 (Table 1.6).

1/ Table 1.16 presents the trend growth rates of domestic output and netimports of crude. Notice a virtual absence of any trend in the netimports of crude (lines 7 and 8) up to 1983-84 and the correspondingstrong positive trend growth rate in domestic output (lines 3 and 4).

- 31 -

Sixth, the import liberalisation measures, heavy import-bill

of POL and imports in the interest of controlling inflation, combined

with a step-up in the imports of capital goods and intermediates

(especially iron and steel) led to imports rising much faster than

export-earnings. Consequently, the trade deficit widened considerably

during the 1979/80 to 1983/84 period (Table 1.2).

The adjustment on the current account in the face of a

widening trade deficit was facilitated by two factors. First, India

negotiated a variety of short and medium term facilities with the

International Monetary Fund. In the four year period 1980/81 to

1983/84 "India obtained a total of about Rs 4700 crores from IMF

sources which is about 55 percent of the cumulative deficit in those

years." I The second factor was a continued increase in private

remittances (Table 1.7). Nevertheless, the the current account deficit

persisted as late as 1983/84 and showed no signs of decline.

VI. OVERALL ASSESSMENT

How do we assess the adjustment of the Indian economy to the

two oil shocks over the period from 1973-74 to 1983-84?

The differences in the two situations have already been

discussed. To recapitulate brieflv, the first shock was not perceived

to be permanent and hence the response was in terms of certain short-run

adjustments. The continuation of the high price of oil and the second

major increase in 1979/80 served to change that perception. This

- Ahluwalia, op. cit, p. 79.

- 32 -

brought about not only import substitution efforts in oil L/ but also

efforts to alter certain other policies, especially because of the

favourable initial conditions on the eve of the second shock in 1979.

The need for achieving an internationally competitive industrial

structure has been recognised and certain policy initiatives have been

taken in that direction. The process of transition from the existing

industrial structure to the internationally competitive one has been

proceeding slowly and with hesitation. What is the end result of these

efforts?

We have already seen from Table 1.1 that compared to the

period prior to 1964/65, the economy has not managed to regain the

growth momentum since 1964/65. Even if we confine ourselves to the

period 1973/74 to 1983/84, we find that while the real gross fixed

capital formation in public sector grew around 6.8 percent per annum,

the growth rate of the private sector GFCF (in real terms) was hardly

around 2.5 percent per annum. Overall GDP in real terms showed a trend

growth rate of 3.97 percent per annum. However, the character of that

growth was dominated by the tertiary sector alone (Table 1.17, lines 4,

18 and 19).

The major achievements of this period may be listed as

follows:

1/ The Union Budget for 1985/86 (presented on March 15, 1985) mentions thatdomestic crude output has reached a plateau and underlines the need forexport expansion in order to finance oil imports which are anticipated torise progressively.

- 33 -

(i) The trend rate of growth of wholesale prices (all commodities)

was around 7.66 percent per annum despite a significant rise in

energy prices (Table 1.18).

(ii) While the net barter terms of trade for India, vis-a-vis the

rest of the world, deteriorated at around 1.5 percent per annum

during 1973/74 to 1981/82, the income terms of trade actually

improved at the trend rate of 4.5 percent per annum because of

the volume expansion of exports (Table 1.15). The phenomenal

export expansion - that has taken place especially since 1972-

73 can be mainly attributed to a continuous depreciation in

real exchange rates in general (Table 1.11) and with reference

to its US dollar and pound sterling in particular (Table

1.12). This is not to deny the possible role played by a

variety of other export incentives. However, the fortuitous

factors in the expansion of exports is a cause for concern

(Table 1.4, columns (6) to (8)). Adjustment for these elements

not only brings down the trend growth rate of export-earnings

but also increases variability around the lower trend growth

rate (see Table 1.13, compare first three lines with the next

three lines).

See Table 14 for trend growth rates of nominal and real exports andimports of goods and services. Notice that exports increased at the rateof 15 percent per annum in nominal terms and 8 percent per annum in realterms in the post 1973-74 period.

- 34 -

Table 1.11

Trend Rates of Appreciation (+)/Depreciation (-) of Exchange Rates

Ser. Description of Period Type Trend Growth 2 SourceNo. Exchange Rate Rate % pea. r(1) (2) (3) (4) (5) (6) (7)

1. Export wted. 1970-83 Nominal -2.49 0.9335 Ahluwalia(4 currencies) Table 7

2. Export wted. 1975-83 Nominal -1.82 0.9110 Ahluwalia(4 currencies) Table 7

3. Export wted. 1970-83 Real -2.22 0.7302 Ahluwalia(4 currencies) Table 7

4% Export wted. 1975-83 Real -0.86 0.1758 Ahluwalia(4 currencies) Table 7

5. Export wted. 1975-83 Nominal 0.47 0.6956 Verghese(15 currencies) Pt.I, Table 6

6. Export wted. 1975-83 Real -0.99 0.1768 Verghese(15 currencies) Pt. I, Table 6

7. Import wted. 1975-83 Nlominal -0.43 0.3306 Verghese(15 currencies) Pt. I, Table 6

8. Import wted. 1975-83 Real -1.59 0.4535 Verghese(15 currencies) Pt. I, Table 6

9. Total-traded wted. 1975-83 Nominal -0.42 0.4593 Verghese(15 currencies) Pt. I, Table 6

10. Total-traded wted. 1975-83 Real -1.32 0.3289 Verghese(15 currencies Pt. I, Table 6

Sources: Lines 1 to 4 based on Table 7 in M. S. Ahluwalia "Balance of Payments inIndia, 1970-71 to 1983" (mimeographed, no date).

Lines 5 to 10 based on Table 6, p. 1099 in S. K. Verghese, 'Managementof Exchange Rate of Rupee Since its Basket Link," Part I, Economic &Political Weekly, Vol. XIX, No. 28, July 14, 1984, pp. 1096-1102.

- 35 -

'Table 1.12

Trend Rate of Appreciation (+)/Depreciation (-) of Exchange Rates

Ser. Description of Period Type Trend Growth r 2

No. Exchange Rate Rate % p.a.(1) (2) (3) (4) (5) (6)

1. US $ per Rs 100 1971-83 Nominal -1.66 0.57142. US $ per Rs 100 1975-83 Nominal -1.37 0.23563. US $ per Rs 100 1971-83 Real -2.32 0.54474. US $ per Rs 100 1975-83 Real -2.72 0.52885. dS per Rs 100 1971-83 Nominal 1.29 0.36326. £ per Rs 100 1975-83 Nominal 0.39 0.02147. £ per Rs 100 1971-73 Real -4.19 0.71148. £ per Rs 100 1975-83 Real -4.46 0.58649. DM per Rs 100 1971-83 Nominal -4.88 0.7371

10. DM per Rs 100 1975-83 Nominal -1.77 0.323111. DM per Rs 100 1971-73 Real -2.14 0.313012. DM per Rs 100 1975-83 Real 0.71 0.029813. Yen per Rs 100 1971-83 Nominal -4.54 0.829014. Yen per Rs 100 1975-83 Nominal -3.67 0.596215. Yen per Rs 100 1971-83 Real -4.82 0.642716. Yen per Rs 100 1975-83 Real -1.93 0.1290

Source: Based on data in Table 8 p. 1100 in S. K. Verghese, "Management of ExchangeRate of Rupee since its Basket Link," Part I, Economic z.nd Political Weekly,vol. xix, no. 28, July 14, 1984, pp. 1096-1102.

39 -

Table 1. 13

Trend Growth Rates of Export-Earnings fromi Goods at Current Prices

2Ser Description Period Trend Growth r

No. Rate (% p.a.)

(1) (2) (3) (5) (6)

1. Export-earnings: unadjusted 1970-71 to 1976-77 21.41 0.9822

2. Export-earnings: unadjusted - 1976-77 to 1982-83 8.97 0.9668

3. Export-earnings: unadjusted 1970-71 to 1982-83 15.10 0.9552

4. Export-earnings: adjusted 1970-71 to 1976-77 19.95 0.9633

5. Export-earnings: adjusted 1976-77 to 1982-83 7.21 0.9237

6. Export earnings adjusted 1970-71 to 1982-83 14.48 0.9470

Source: Based on Table 10, p. 1152 in S. K. Verghese, Part II.

Note: Exports earnings in lines 4 to 6 are adjusted for fortuitous factors such as

grant financed exports to Bangladesh, administrative decisions such as

lifting of ban on silver exports, unprecedented rise in the international

price of sugar, and ad hoc increases in exports due to acute scartd.ty

conditions abroad and exports of crude petroleum for processing abroad. (See

Verghese, Part II, p. 1152 for details).

- 37 -

Table 1.14

Trend Growth Rates in Exports and Imports

Price Trend growth 2

Ser Description Base Period rate rNo. (% p.a.)(1) (2) (3) (4) (5) (6)

1. Exports of goods & services] current 1970-71 to 1981-82 17235 0.96582. Exports of goods & services] prices 1973-74 to 1981-82 14.96 0.9477

3. Exports of goods & services] 1970-71 1970-71 to 1981-82 8.02 0.96044. Exports of goods & services] prices 1973-74 to 1981-82 7.94 0.9179

5. Imports of goods & services] current 1970-71 to 1981-82 19.77 0.96996. Imports of goods & services] prices 1973-74 to 1981-82 17.83 0.9566

7. Imports of goods & services] 1970-71 1970-71 to 1981-82 6.60 0.72888. Imports of goods & services] prices 1973-74 to 1981-82 9.30 0.77679. Imports of goods & services] 1970-71 to 1979-80 3.87 0.5904

10. Imports of Capital Goods] 1970-71 1970-71 to 1982-83 5.76 0.489011. Imports of Capital Goods] prices 1970-71 to 1979-80 -0.20 0.0035

Source: Lines 1-9 based on National Accounts Data and Unit Value Indices of Importsand Exports from S. K. Verghese, Part II.

Lines 10-11 based on M. S. Ahluwalia, Table 6.

- 38 -

Table 1.15

Trend Growth Rates in ExDorts & Imports: Volume and Unit Values

Ser. Description Period Trend growth r2No. rate (% p.a.)(1) (2) (3) (4) (5)

1. Exports: Volume 1970-71 to 1981-82 6.46 0.9553

2. Exports: Volume 1973-74 to 1981-82 6.02 0.9006

3. Imports: Volume 1970-71 to 1981-82 6.80 0.7614

4. Imports: Volume 1973-74 to 1981-82 8.87 0.7557

5. Exports: Unit Value 1970-71 to 1981-82 9.34 0.9307

6 Exports: Unit Value 1973-74 to 1981-82 7.02 0.9050

7. Imports: Unit Value 1970-71 to 1981-82 13.16 0.8267

8. Imports: Unit Value 1973-74 to 1981-82 8.53 0.6564

Source: Based on Table 11, p. 1154 (with updating) in S. K. Verghese: "Managementof Exchange Rate of Rupee since its Basket Link," Part II, Economic &Political Weeklv, vol. xix, no. 2, July 21, 1985, pp. 1151-58.

- 39 -

Table 1.6

Tr-nd Growth Rates of Crude Oil:Domestic Output and Net Imports (in million tonnes)

Ser. Description Period Trend Growth r

No. Rate (% p.a.)

(1) (2) (3) (4) (5)

1. Crude Oil: Domestic 1973-74 to 1981-82 8.53 0.8562

production


production


production


production

5. Net Imports of Crude 1973-74 to 1981-82 1.66 0.5213


7. Net Imports of Crude 1973-74 to 1983-84 -1.18 0.1066


Source: Based on the data available in the various issues of the Economic Survey

published by the Ministry of Finance.

- 40 -

Table 1.17

Trend Growth Rates in Real GDP & Gross Fixed Capital Formation

Ser. Description Period Trend Growth r2No. Rate (% p.a.)

(1) (2) (3) (4) (5)

1. Agrregate GDP 1970-71 to 1981-82 3.59 0.9446

2. Aggregate GDP 1973-74 to 1981-82 3.98 0.9300

3. Aggregate GDP 1970-71 to 1983-84 3.68 0.9635

4. Aggregate GDP 1973-74 to 1983-84 3.97 0.95785. GFCF, public sector 1970-71 to 1981-82 6.20 0.89106. GFCF, public sector 1973-74 to 1981-82 6.66 0.8401

7. GFCF, public sector 1970-71 to 1983-84 6.30 0.92768. GFCF, public sector 1973-74 to 1983-64 6.67 0.90109. GFCF, private sector 1970-71 to 1981-82 2.97 0.8185

10. GFCF, private sector 1973-74 to 1981-82 3.25 0.721411. GFCF, private sector 1970-71 to 1983-84 2.52 0.770712. GFCF, privrate sector 1973-74 to 1983-84 2.46 0.6206

13. GFCF public & private 1970-71 to 1981-82 4.37 0.918414. GFCF public & private 1973-74 to 1981-82 4.78 0.860415. GFC'? public & private 1970-71 to 1983-84 4.24 0.9417

16. GFCF public & private 1973-74 to 1983-84 4.42 0.899217. GFCF in primary sector 1973-74 to 1983-84 2.24 0.699218. GDP in secondary sector 1973-74 to 1983-84 4.15 0.937619. GDP in tertiary sector 1973-74 to 1983-84 5.95 0. 9968

Source: Based on the data available in the various issues of National AccountsStatistics published by the Central Statistical Organisation.

- 41 -

Table 1.18

Trend Rates of Growth of W4holesale Prices

2Ser. Wholesale Price Index Period Trend Growth rNo. Specification Rate (% p.a.)(1) (2) 3)

(4) (5)

1. All Commodities 1970-71 to 1981-82 8.89 0.94542. All Commodities 1973-74 to 1981-82 7.45 0.88713. All Commodities 1973-74 to 1983-84 7.66 0.93764. All Commodities 1970-71 to 1983-84 8.69 0.96265. All Commodities 1970-71 to 1981-82 13.34 0.95066. Administered Prices 1970-71 to 1981-82 11.72 0.90277. Administered Prices 1973-74 to 1981-82 11.36 0.93768. Administered Prices 1973-74 to 1983-84 12.75 0.96099. Crude Petroleum & 1970-71 to 1981-82 27.79 0.9208

Natural Gas10. Crude Petroleum & 1973-74 to 1981-82 20.56 0.8769

Natural Gas11. Crude Petroleum & 1973-74 to 1983-84 17.06 0.8517

Natural Gas12. Crude Petroleum & 1970-71 to 1983-84 23.89 0.890913. Petroleum Products 1970-71 to 1981-82 14.16 0.919114. Petroleum Products 1973-74 to 1981-82 11.75 0.829815. Petroleum Products 1973-74 to 1983-84 11.59 0.895016. Petroleum Products 1970-71 to 1983-84 13.52 0.938517. Electricity 1970-71 to 1981-82 9.55 0.999818. Electricity 1973-74 to 1981-82 10.45 0.977519. Electricity 1973-74 to 1983-84 10.69 0.987220. Electricity 1970-71 to 1983-84 10.21 0.987021. Coal & Lignite 1970-71 to 1981-82 12.95 0.964422. Coal & Lignite 1973-74 to 1981-82 14.13 0.947823. Coal & Lignite 1973-74 to 1983-84 14.67 0.970824. Coal & Lignite 1970-71 to 1983-84 13.59 0.9755

Source: Based on the data compiled from official sources by the Centre for theMonitoring of Indian Economy, Bombay.

- 42 -

Chapter 2: TIE MODEL

This chapter contains a heuristic description of the model

used to study questions of adjustment to external and internal shocks in

India. A formal statement appears in Appendix 1.

Production

The production side of the model distinguishes six sectors:

(1) Agriculture, (2) Consumer goods, (3) Capital goods (including

construction), (4) Intermediates, (5) Public Infrastructure, and (6)

Services. The sectoring follows agriculture-industry-services lines.

Industry is disaggregated into use-based categories (2), (3) and (4), to

capture the differential impact of policies on different parts of the

industrial sector. Infrastructure is singled out to help focus on

possible bottlenecks to expansion of traded goods sectors necessary for

adjustment. The number of sectors is large enough to pose the questions

of interest to the study and yet small enough to keep the exercise

manageable. The precise details of the aggregation from the underlying

input output table to the six sectors appears below in Appendix 4 (see

Table 1 of that appendix).

In sector 1 (agriculture), the production structure is

represented by a nested CES tree as follows:

Chap-2/Disc-26(India Shocks:4/11/86:pp

43 -

Z G

Is Lw "D

Output, X is a function of H (land), Ls (self-employed labor), LW (hired

labor), ND (domestically produced intermediate goods from all sectors

ot'-r than 5 into the sector in question), NM (imported intermediate

goods from all sectors other than 5 into the sector in question), and G

(the flow of infrastructure, i.e., output of sector 5 going into the

sector in question). The particular tree structure chosen imposes some

separability on the production function. Much, although not all land,

is owner-cultivated to some extent: the resulting sub-aggregate S is

combined with hired labor (Lw) to produce value added (V) 11 ND is a

fixed-proportions bundle of domestically produced intermediates

excluding sector 5; similarly, N14 is a fixed-proportions bundle of

imported intermediates, again excluding sector 5. Some substitution is

allowed between ND and NM; their aggregate, N combines with value added

to produce Z. Infrastructural services, G, which are publicly provided

in most countries, are identified separately and combined with Z to

produce output, X. Since G is an integral part of the tree structure,

1/ In empirical implementation, H includes both land and capital inagriculture.


- 44 -

the formulation captures the contribution of infrastructure to the

production process.

In sectors 2 to 6, the portion of the CES tree below value

added is as follows:

V

K Ls Lw

Capital and the two categories of labour continue directly to

produce value added in these sectors.

In sectors with significant auantities of almost-finished

imports, there is an extra layer at the top of the tree as follows:

cx

Thus imported final goods (M) are less than perfect substitutes for the

domestically produced variety (X); final output (CX) is considered to be

a CES aggregate of the two. This formulation holds in sector 3.

The choice of a nested CES function is made on a priori

grounds. It is however intuitively easy to understand and encompasses a

wide range of substitution possibilities at every level. The

sensitivity of some of the model results to changes in the degree of

substitution will also be explored.


- 45 -

Income Generation

In an effort to capture the impact of adjustment policies on

income distribution in as much detail as available data will allow, we

model the distributional aspects of the economy in the elaborate way.

The production svstem distinguishes four categories of income, viz., (1)

income from self-employment, (2) wage income, (3) land/capital income,

and (4) income from implicit government subsidies on publicly provided

infrastructure. To this must be added nonproduction-related income,

comprising such items as (a) interest on national debt, (b) domestic

current transfers, (c) net factor income from abroad and (d) net current

transfers from the rest of the world. The model maps those incomes

according to fixed rules into fifteen asset owning classes each in rural

and urban areas. In parallel with the treatment in Narayana, Parikh and

Srinivasan, income per capita and expenditure per capita are assumed to

be jointly lognormally distributed. -L/ This distribution, when

empirically implemented, makes it possible to calculate the shares of

total population, consumption and income accruing to households with per

capita expenditures at different segments of the distribution and

standard measures ot consumption and income inequality such as the Gini

coefficient. /

1/ Cf. N. S. Narayana, K. S. Parikh and T. N. Srinivasan, "An IndianAgricultural, Policy Model: Preliminary Results of an Analysis of SomeRedistributive Policies," (ISI Discussion paper, Bangalore, 1984).

2/ The technical details are provided in Appendix 1.


- 46 -

Final Demands

Final demands comprise private consumption, public

consumption, exports and investment. Household incomes are mapped into

private consumption via a savings function. Private consumption demand

for the output of the six production sectors is generated by a linear

expenditure system for each of the rural and urban households identified

in the section on income generation; these are functions of prices and

incomes. Public consumption of each sectu's output is exogenous.

Export demand is a function of income in the rest of the world as well

as the ratio of export prices to those of substitutes in international

markets. Investment demand is almost entirely directed at sector 3

(capital goods, including construction).

Trade

It is worth noting that the trade side incorporates price-

responsive export and import relationships. The derived demand for both

intermediate and final imports depends on the level of output and the

import price to the user relative to that of the domestically produced

variety, where appropriate. -1/ Similarly, exports depend on the state

of demand in the rest of the world (world income) and export prices

relative to that of substitutes. Import prices are given, so that the

country is small in the relevant market. By contrast, the country is

assumed to be able to vary its export sales by changing its export

1/ For imported goods which have no domestically produced substitute, importdemand depends only on the level of production of output.


- 47

prices. In any event, the model is equipped to simulate the effects of

tariffs and subsidy policies on the trade side.

Market Clearance

Goods

Gross output in each of the six sectors must equal the sum of

final demands, intermediate demands and changes in stocks, less

imports. Since each of these components is either exogenous or price-

responslve, the market clearance conditions determine prices.

The allocation of public infrastructural flows for

intermediate use in each of the production sectors is fixed by policy,

while production and final demand are price-responsive. Intermediate

users are typically not charged the market price for infrastructure.

This allows an exploration of the effects of changing the rates of cost

recovery on public infrastructure as well as of the policy-determined

allocations to intermediate users.

Factors

The operation of factor markets can be expected to have an

important bearing on the efficacy of alternative policies pursued in

response to shocks. The wage of hired labor in sectors 2 to 6 is

indexed to the consumer price index, hence determining the demand for

them. This leads to rationing of jobs: those who are unable to find

employment swell the ranks of the low productivity self-employed whose

returns must be depressed to clear the market. In this sense, there is

no open urban unemployment. In sector 1 (agriculture), wages of hired

labor are fixed as well. But since much self-employment is on own land,


- 48 -

the stock of self-employed is postulated to be fixed with returns

varying to clear the market. Those unable to find jobs at the fixed

agricultural wage become openly unemployed. On grounds of its

quantitative insignificance in India, there is no rural-urban migration,

so that rural and urban labor markets are not linked on the supply side.

The amount of land in sector 1 and the stock of capital in

each of sectors 2 to 6 is fixed within periods but augmented across

periods as investment takes place.

Investment and Savings

The relation between household incomes and consumption

determines household savings. Covernment savings are the difference

between government income and expenditure. In the so-called "savings-

driven" version of the model, foreign savings are exogenously

specified. The sum of these three sources of saving equals investment,

which is therefore residually determined. Alternatively, in the

"investment-driven" version, investment is exogenously specified, and

foreign savings must adjust residually to satisfy the savings investment

equality. The model is run in either mode depending on the question at

hand. But it needs to be stressed that these different specifications

can make a substantial difference to qualitative behavior, a feature

worth bearing in mind when interpreting the numerical results.

Government

The sum of tax and tariff revenue, the return on public

infrastructure net of subsidies and other income, less the value of

government consumption equals government saving. This is the


- 49 -

government's budget constraint but it does not need separate

formulation, since it may derived from the other equations of the

system.

Dynamics

The breakdown of investment by sector of origin is given by

base year input output data; it typically comes entirely from sector

3. Its breakdown by sector of destination is taken from national

accounts data, when available. Otherwise, it is chosen to rieproduce

base year proportions or to move In response to differences in sectoral

rates of return to capital, or a combination of both. A more explicit

modeling of private investment and credit market behavior would be

desirable, but is left for future work.

Debt

The model incorporates a debt module which keeps track of the

effect of foreign borrowing on the stock of debt and debt service

payments (amortization and interest) corresponding to medium- and long-

term (official and private) and short-term debt. Details are provided

in Appendix 2.


- 50 -

Chapter 3: TEE MODEL AT WORK

I. INTRODUCTtON

This chapter and the next explore the consequences of

different configurations of shocks and policy responses. However, since

different outcomes need to be compared against a benchmark, it is

necessary, as an intermediate step, to define a "historical run' between

1973-74 and 1983-84 which broadly replicates the principal developments

in the economy during this period. To understand how this is done, and

appreciate why the numerical policy simulations come out the way they

do, it is important, in the first instance, to understand how the model

responds to changes in exogenous. variables.

To this end, we begin by performing a number of comparative

statics exercises with the model. We next describe how the 1973-74 to

1983-84 base path (or "historical run") is constructed, a procedure

which may be seen as a sequence of comparative statics experiments, and

look at the main features of the historical run. Chapter 4 reports the

results of intertemporal policy simulations with the model. I/

II. COMPARATIVE STATICS

The comparative statics experiments are performed in the base

year, i.e., 1973-74. Tables 3.1 and 3.2 report selected features of the

base period which may be seen as the initial conditions describing the

1/ The reader who is interested only in the results of the policyexperiments may wish to look at the tables at the end of this

chapter as well as the charts before proceeding directly to Chapter4.

Chap-3disc-26:India Shocks:4-1L/86/:pp

e 51 -

Indian economy at the beginning of our analysis. In performing the

comparative statics experiments, the model is run in its "savings

driven" version.

Changing Internal Variables

The first set of experiments examines the consequences of an

exogenous productivity decline in each sector of the economy. -Y This

can be given various interpretations -- in Sector 1, harvest failure; in

Sector 5, decline in the efficiency of p'iblic management and so on.

Agricultural Harvest Failure

This is modeled via a 10 percent cutback in the efficiency

parameter of the agricultural production function. This moves the

supply curve of agricultural output backwards and, given that the price

elasticity of private consumption demand for food ranges across

different groups from -0.13 to -0.26, raises its price relatively more,

increasing the amount spent on food. Given that the share of food in

total consumption is never less than 40 percent and exceeds 70 percent

for the poorest urban and rural groups, the adverse income effect of the

rise in the price of food shifts the demand curve inward, further

reducing output, but moderating the rise in the food price., The value

of agricultural output rises by 29 percent.

Since the elasticity of substitution between value added and

other inputs Is nearly unity, the share of nominal value added to

nominal value of output must remain practically constant (at 76 percent)

1/ This is formally accomplished by scaling the production functiondownwards in Hicks-neutral fashion.

Chap-3disc-26:India Shocks:4-11/86/:pp

- 52 -

and income paid out as value added in agriculture must rise. Virtually

all of this is a rise in the price of value added, principally because

wages, which account for 19 percent of vralue added, increase on account

of indexation vis-a-vis the consumer price index.

Table 3.3 shows that the dip in agriculture leads to a fall in

demand for all other commodities in the economy. Sectors 2 and 6

account for 22 percent and 14 percent of the value of total consumption

respectively in the economy as a whole and hence suffer from output

contraction. But the sectors which are hardest hit by harvest failure

are capital goods and intermediates: their outputs fall by 60 percent

and 31 percent, respectively. This may be explained as follows. The

consumption deflator (in which food looms large) rises by 33 percent as

opposed to a 20 percent rise in the GDP deflator. This reduces

household savings by 70 percent and investment (since it is savings-

driven) by 66 percent. Since virtually all investment demand is

sazisfied by the capital goods sector, its output falls sharply. This,

in turn, hits intermediate goods particularly hard.

Turning to the macroeconomic agaregates, the harvest failure

has an adverse effect on GDP (-6 percent) and, as discussed above, on

consumption and investment. The adverse supply shock from agriculture

worsens the relative competitivreness of exports which fall by 26

percent. Since foreign savings are lixed, this is reflected in a drop

in imports -- by 14 percent.

The impact effect of an agricultural shortfall on the true

cost of living index is regressive; it rises by around 37 percent for

the poorest households and by roughly 30 percent for the richest

Chap-3disc-26:Tidia %ocks:4-11/86/ pp

- 53 -

households. - The Gini coefficient of consumption as well as income

inequality increases by between 2 to 3 percent in both rural and urban

areas and is accompanied by a decline in the share of the bottom 40

percent in consumption and income. 2/

Consumer Goods Sector

A decline in productivity in the consumer goods sector has

many similar effects. However, the fact that Sector 2 accounts for no

more than 25 percent of consumer budgets across different groups implies

that the adverse income effects are smaller. GDP falls by Just over one

percent, consumption by less than 1 percent, household savings by 21

percent and, hence investment by over 17 percent. Sector 2 accounts for

half of all exports in the base year; the experiment cuts total exports

by 12 percent.

Capital Goods and Intermediates

A fall in productivity in capital goods production may be

analyzed in the same way. The backward movement in the supply curve

raises the output price by 12 percent, with output falling by 7

percent. Since capital good items are unimportant in Einal consumption,

there is no reason to expect significant changes in wages and other

1/ The true cost of living index here and in Chapter 4 is the cost ofattaining "pre-experiment" utility levels at "post-experiment"prices, expressed as a ratio to the cost of attaining the sameutility level at "pre-experiment" prices.

2/ It should be understood that this example merely serves toillustrate the working of the model. A government, faced with asevere harvest failure, would presumably choose to increase food

imports rather than allow the impoverishment consequent upon a sharpincrease in the relative consumer price of food.

hap-3disc-26:India 9ocks:4-11/86/ .pp

- 54 -

factor prices, so that the price of value added changes little -- by

1.6 percent. Since the share of nominal value added in nominal output

must vemain virtually constant by the assumption of nearly unitary

elasticity of substitution, real value added rises by 2.5 percent. 1/

The principal macroeconomic impact is expectedly on investment, which

declines by over nine percent, almost matching the productivity decline.

Since intermediates have more pervasive linkages with the rest

of the economy, the effects of a fall in productivity in that sector are

stronger. There is a greater increase in the output price and, hence, a

larger divergence in the opposite movements of gross output

(-10 percent) and value added (6 percent). The cost-push effect of the

16 percent increase in the price of intermediates is reflected in the

macroeconomic aggregates: investment falls by 13 percent and exports by

3 percent.

Infrastructure and Services

A fall in productivity in public infrastructure has similar

consequences. It is noticeable that government income from import

duties rises significantly. This is because of profits made on

controlled imports in Sector 5. The government continues to import the

same quantity of M at the unchanged international price but is able

to resell it domestically at a price which, as a result of the decline

in productivity, is nearly 19 percent higher. There is, however, an

increase in the implicit subsidy to infrastructure for the same

/ This is a somewhat more approximate statement for Sector 3 than for

the other sectors, since the final imports of capital goods add anextra layer to the production trea (recall the description of themodel in Chapter 2). However, its share in gross output was lessthan five percent in 1973-74.

- 55 -

reason. The subsidy is calculated vis-a-vis the market price of

infrastructure which, as noted above, increases by 19 percent.

The corresponding experiment in the services sector does not

merit a separate discussion: the figures may be consulted in

Table 3.3. 1-

The next set of experiments alters certain behavioural

parameters of the system.

Decreasing the Savings Propensity of Households

The logarithm of mean per capita expenditure in either rural

or urban area, vc, is related to the logarithm of mean per capita

income in that same area, py, by the formula (see equation (6.10) in

Appendix 1):

lic = a + a 4c y

1/ All the productivity experiments reported above are characterised bya fall in Pz relative to PX (where it will be recalled from Chapter

2 that Z and G combine to produce output X). The reason is asfollows. P is a weighted average of PV and PN, while P reflectsthe impact ol the backward shift in the supply curve as wel as that

of the demand curve because of the income effect. Cost minimization

then leads to a rise in the (-g) ratio. We have seen that X fallsxin all sectors; whether Z will rise or fall is sector-specificdepending both on the share of Z in X in the base year and theelasticity of substitution between Z and G. It turns out that Z and

V move in the same direction in all sectors except intermediates.

As before the (v) ratio depends on the relative price ratiop z

pV

- 56 -

An exogenous decrease in $ may be interpreted as a rise in households'

savings propensity: this could be brought about by policies outside the

purview of the model, e.g., raising interest rates, instituting

compulsory deposit schemes and the like.

Table 3.3 reports the consecuences of two experiments raising

S in rural and urban areas separately by 5 percent. As is to be

expected, this raises private consumption at the expense of investment,

lowers GDP and makes exports less competitive. Changing the rural

has a more potent impact because of the disparity of population between

the two sectors; the numbers may be consulted in the table.

A 10 percent Increase in Real Wages

A 10 percent increase in the real wage of hired labour is

analogous to an adverse supply shock. Since sector 5 (respectively

sector 1) has the highest (respectively lowest) share of hired labour in

value added, its value added price rises the most (respectively least)

-- by 8.3 percent (respectively 1.48 percent). Real value added falls

in all sectors of the economy and is reflected in a nearly 3.5 percent

fall in GDP. There is a similar fall in gross output. The loss of

competitiveness, which mav be thought of as a real exchange rate

appreciation, leads to a 4 percent decline in exports and, given foreign

savings, in a 1 percent decline in imports. There is a 4 percent

decline in household savings, a 2.7 percent fall in private consumption

and an 8 percent decline in real investment.

Qiap-3disc-26:TIndia Shocks:4-11/86/:pp

- 57

The cost of living registers a 2 percent increase across the

board. Wage employment declines by 12 percent in sector 1 and by 11

percent in sectors 2 to 6. The CPI-deflated return to self employed

labour falls by 5 percent in sector 1 and by nearly 9 percent in sectors

2 to 6. The Gini coefficients of income and consumption inequality

increase by between 1 and 3 percentage points with the higher increase

occurring in rural areas.

Changing External Variables

The next set of experiments examines the consecuences of

varying certain external parameter; the results are summarized in

Table 3.4.

A 30 Percent Increase In Export Prices

With export volumes accounting for just over 2 percent of

gross output and barely 5 percent of GDP, a 30 percent increase in

export prices has a first round impact equalling 8 percent of GDP.

The resulting increase in demand for output, interacting with supply

elasticities arising from sectorally fixed capital stocks leads to ar

Increase of between 20 and 25 percent in output prices in all sectors of

the economy. This implies that the relative competitiveness of Indian

exports improves by between 4 percent and 8 percent. With a partial

equilibrium export price elasticity of 1.8, this translates into a

general equilibrium export price elasticity of between 0.24 and

1/ Exports rise by a factor of (1.3)1.8 1.6. With a share of 5percent this translates into a 8 percent rise in CDP.

Chap-3disc-26:India Shodcs:4-11/86/:pp

- 58-

0.50. Exports rise by nearly 10 percent; with fixed foreign savings,

imports rise by 36 percent.

The increase in output and consumer prices throughout the

economy boosts nominal magnitudes such as household savings (by 35

percent) and government revenue (by 34 percent). Although the cost of

living index rises by 25 percent for all groups, there is a negligible

negative movement in the GCni coefficients. Investment increases by 12

percent; this requires a greater than 10 percent increase in the output

of the capital goods sector. Gross outputs, as well as value added go

up in all sectors.

A 50 Percent Rise in Import Prices

The rise in import prices has two effects. First, it

impoverishes the economy, the extent of this being aiven by the share of

imports in GDP (at factor cost) - just over 7 percent. Fence the loss

in GDP is of the order of 10 percent. With an elasticity of consumption

with respect to Income of around 0.75, consumption demand would

1/ These figures are arrived at by noting that changes in value of

exports range from (1.04) and (1.08P 8 . Since the original

price change is 30 percent the elasticity lies between

(1.04).3 1 x 100 and (1.08.)3 1 x 100

Ciap-3disc-26:India Socks:4-11/86/ pp

- 59 -

potentially fall by 7.5 percent. This has the effect of depressing both

output prices and quantlties. Second, in as much as the prices of

imported intermediates go up, the economy's supply curve is shifted

backward, with the size of this effect depending on the share of

imported intermediates in urnit production costs - around 2.7 percent for

the economy as a whole. This reduces gross output and ralses output

prices. Both effects reduce output; the impact on prices is ambiguous.

The cost-push impact of dearer imported intermediates is felt

most strongly in sectors 3 and 4, where output prices rise by eight

percent. Imports fall by 37 percent. There is an 8 percent fall in

household savings and a 26 percent fall in government savings, the

latter caused by a substantial fall in profits on domestic

sales of imports. Hence, investment falls by 18 percent, leading to a

16 percent drop in the output of sector 3. GDP at market prices

declines by 2.3 percent. Gross output falls in all sectors of the

economy but value added rises in sectors 2 and 4, reflecting

substitution away from more expensive imported intermediates.

A 10 Percent Increase in Export Volume

This may be thought of as an exogenous expansion in export

markets in major partner countries. With sectorally fixed capital

stocks, the demand pull raises output prices by between 4 and 5 percent,

worsening competitiveness. This leads to exports rising by less than 2

percent. Household savings increase by 7 percent and government savings

by 21 percent. Investment goes up by 2.5 percent.

Uhap-3disc-26:1ndla Shocks:4-11/86/:pp

- 60 -

A 100 Percent Increase in Foreign Savings

This experiment doubles foreign saving in the base year. This

translates into a nearly 10% increase in total investment, and a

concomitant 9 percent increase in the gross output of capital goods.

Since expansion of domestic production requires sector 3 to bid variable

factors away from the other sectors of the economy, the output of sector

2 registers a slight decline while all the other sectors except

intermediates expand very modestly. The exception in the case of

intermediates arises because much intermediate demand originates from

the capital goods sector. The domestic production of capital goods

(X3) rises by 9 percent, while the imported component (M3) which

can substitute for it with almost unit elasticity, rises by over 18.

percent. While the cost of living increases by a uniform 8.8 percent

across the board, the Gini coefficients, once again, exhibit virtuallv

no change. The ratio of urban-to-rural per capita income increases very

slightly.

The increase in the domestic vis-a-vis international prices

triggers wage increases and the price of value added rises by between 9

and 11 percent in all sectors of the economy. This leads to significant

substitution towards imported intermediates; total imports rise by 14

percent. The price rise consequent on a doubling of foreign savings

leads to real exchange rate appreciation and cuts exports by 13

percent. GDP and private consumption rise by less than 1 percent. The

price increase generates an increase in household savings by 13 percent,

Cap-3disc-26:India Shocks:4-11/86/:pp

- 61 -

in government revenue by 15 percent and in government savings by 22

percent.

III. TRACKING HISTORY

In this section, we make an attempt to reproduce certain

salient historical developments in the Indian economy between 1973-74

and 1983-84 within the framework of the model. This simulation of

historical developments provides a benchmark against which the results

of counterfactual experiments carried out in Chapter 4 can be

compared. Inasmuch as counterfactual policy simulations need to be

compared againt a benchmark rather than with actual historical

experience, the derivation of a historical run is seen to be a necessary

intermediate step.

Attempts to simulate historical developments in the Indian

economy are plagued by two sets of difficulties. First, the model which

is implemented here assumes the economy to be in general economic

equilibrium year after year. A look at the year-to-year fluctuations of

the macroeconomic aggregates during the tracking period (see Table 3.6)

indicates that this assumption could only have been satisfied on average

over longer periods of time. Second, the model abstracts only certain

parts of reality - and those too only in the economic sphere - in a

quantifiable framework. It is necessary to bear this point in mind in

interpreting the policy experiments to be reported later: in particular,

how incorporation of lags in adjustment might modify the results.

Chap-3disc-26:Thdia hods:4-11/86/.pp

- 62 -

Methodology 1/

The tracking procedure chooses values for a set of pre-

specified parameters in order to minimize year-by-year the sum of

squared deviations between the data-specified growth rates of tracking

indicators and those generated by the model. -/ Exogenous variables for

which time series are available, e.g., unit value indices for imports

and exports, government consumption and the like, are set at their given

values throughout the period. By contrast, the parameters used in the

minimization are entities for which empirical information is not

available for years other than the base year: for example, rates of

productivity growth by sector and savings propensities of rural and

urban households. The tracking indicators are the growth rates in the

expenditure side of the national accounts at constant prices, viz., GDP

at market prices, private consumption, investment, imports and

exports. While such intertemporal calibration is standard practice

among applied general equilibrium modellers, we have formalized the

exercise by resorting to an explicit minimization. Although such a

procedure shares certain similarities with econometric estimation, it is

less systematic than the latter. The variation in the tracking

parameters - some of which are necessarily substantial in order to

1/ For technical detaiis, see H. Sierra An Intertemporal CalibrationProcedure for Applied General Equilibrium Models "(World Bank, 1986,in preparation.

2/ Since the model is calibrated to reproduce base year (1973-74) data,the tracking refers to the years 1974-75 onwards.

Chap-3disc-26:India Shocks:4-11/86/:pp

63 -

reproduce year-by-year fluctuations of the macroeconomy within an

equilibrium methodology - may be interpreted in ternis either of some

exogenous shocks or of certain policy instruments which are not

explicitly incorporated in the model. -/

Input Data

Table 3.5 presents the time-series of major exogenous

variables entering into the model. These variables are

(1) unit value indices for sector-specific imports and

exports;

(2) volume of policy-determined imports in sectors 1

(foodgrains), 2 (edible oils) and 5 (crude oil);

(3) foreign savings;

(4) domestic transfers (government transfers to

households and interest on public debt) and foreign

transfers (which comprise net (factor) income and

net current transfers from abroad);

(5) GDP deflators for US and India which are used to

convert nominal dollar and rupee transfers

respectively into real terms;

1/ There is no guarantee that the particular configuration ofparameters obtained in any year is the only one that would effect aclose correspondence in the tracking indicators. In other words,the minimization procedure used for tracking need not have a uniauesolution.

Chap-3disc-26:Tndia chocks:4-11/86/:pp

- 64 -

(6) growth of aross output of agriculture in real terms

(i.e. at 1973-74 pr,,i.v-es); 1/

(7) investment share by sector of destination for sector

1, the sum for sectors 2 to 4 i.e., manufacturing,

sector 5 and sector 6);

(8) the share of fixed investment in total investment;

and

(9) public consumption of goods and services at constant

(1973-74) prices.

Table 3.6 shows the expenditure side of the national accounts

at constant prices - GDP at market prices and its components, viz

private consumption, total investment, exports and imports. These have

been used as tracking indicators i.e., the variables whose growth rates

must be replicated as closely as possible by the tracking procedure.

A comparison between the realized growth rates and levels and

those generated by the model is presented in charts I to 10 for the

following macroeconomic variables at constant prices:

1/ Fixing the gross output of agriculture in real terms in tracking(while it is a variable in counterfactual experiments) requires thatsome parameter be allowed to vary. It is natural to choose theefficiency parameter of the agricultural production function to bevariable so that its (endogenous) movements may bo. expected tocapture weather-related fluctuations. In experiments, the grossout!t11t of agriculture is an endogenous variable, while theagricultural efficiency parameter Is kept at its "nistorical run"value.

Chap-3dIsc-26:Ihdia Sokcs:4-11/86/:pp

- 65 -

(i) Gross domestic product at market prices;

(ii) Private consumption expenditure;

(ifi) Total investment;

(iv) Exports;

(v) Imports.

In addition, Table 3.6 presents a combination of actual and model-

generated growth rates in the tracking indicators. It will be seen that

the correspondence with the growth rates is quite satisfactory, and,

turning to the levels, that the model captures turning points

successfully. This is to be expected, as the tracking procedure was set

up to minimize the squared deviations from actual growth rates rather

than levels.

Discussion of Tracking

A detailed account of the principal developments in the Indian

economy during this period was provided in Chapter 1 and will not be

repeated here. Instead, the focus is on the way in which the model

attempts to replicate those developments in order to generate a

historical.

Although every single exogenous variable has an impact on the

outcomes of the model, it proves convenient to restrict our attention to

the following three, viz., (1) the change in real agricultural output,

(2) the change in the economy's barter terms of trade; and (3) the rates

of foreign savings to gross domestic product. The time series for these

variables appears in Table 3.7.

Chap-3disc-26:India Socks:4-3.1/86/:pp

- 66 -

Chart 1

!ndia : Tracking 1 973-74 to 1 983-84GOP at Mcrkit Prices (Growth Rate)

O. 1 5 -

.12/t0.11

0.08 -1 /007-

0.05-i I

0.07 I

0 11

0-

-0.01

0 .0 j../

0.02

0. J

-0.04 -

-0.05-0:06 *

7374 7475 7576 7677 7778 7879 7980 8081 8182 8283 8384

YecrsO Model H 3istoric

India Tracking 1 97-74 to 1C983-84GOP at Mark.et Prices (1 9730w 1)

1.8

1.7 -~

1.2 -4

0. .9.2

1.744 77 5677 7377 9088 1288 .8- 1'

1.32 HstriChart.2

- 67 -

Chart 3

India : Tracking 1 973-74 to 1 983-84a- Private Consumption (Growth Rate)

0.14 -

0.12

0.1 -

0.08 t0.0

0.04

0.0

E 0.04-

-0.02

-0.02

-0.12

7374 7475 7576 7677 7778 7879 7980 8a081 8182 8283 83384

Y4eam

o Model + HbstorJc

India :Tracking 11973-74 to 1 983-84t.7 -PiaeConsumption (1973-1)

1.8

1.5c0

ES

IC

0.

7374 7475 7576 7677 7778 78379 79830 8081 8182 82813 8384

Yevarsa Model 4 Historic

Chart 4

- 68 -

Chart 5

indiQa Tracki ng 1 973-74 o I983--3Totct lrve3stments (Growth Rcte)

0.2 -

0.19 l

*0.o 1 7 --

0.184

0. 7i2

0.16 - r0.09-0.08-0.07-0.06-

0.04-

0.02 +

Years

indic rccking 197I 74- to 1 93-8Total Investrncnts (1 97v3-1 )

,,.

1.9 .

1.8 - -'~~-

,,-'

1.7 j S@

C:,.........

a, 1.6 i

E !/

1 -4'

1 .2 ,,1.2- /

1-- r---- v - -r,7Z, 34 7475 7576 7677 7773 7879 7980 8X081 8182 828.3 8384

Yearsr Moef -O 1 . ri c

rhart 6

- 69 -Chart 7

India Tracking 19723-74 to 1 983-84Exports (Growth Rote)

0.24 -

0.22-

0.2

0.16

0.16

0112 4 A4S77;77 72 E7978 O 1288

leg I '

x

0.06

0.02 -

-0.02

7374 7475 7576 7677 7778 7879 7980 8081 8182 8283 83384

Yeors

O Model + Hiatoric

india Tracking 1973-74 to 1C983-842 E:xports (1973-1)

1.9

1.7

1.6

CL&

1.3

1.2-

7374 7A.75 7576 7677 7778 7879 7980 8081 8182 8283 8384

YearsC Moa~ His3toric

Chart 8

- 70 -

Chart 9

India Tracking 1973-74 to 1983-84I0moorts (Growth Rate)

0.4

0.2~

0.21

0)

-0.1 -4 A* X~~

-0.2 -: 2 -7374 7AX75 78i6 7677 7778 7879 7980 2081 8182 8283 838S

;; Model r H1ator;c

India Tracking 1973-- 74 to 1983--84rmnorts (1973- 1)2

-

1.9e1

t.8j ,'- '

1.7 4

1.6 /.1 1

1.3j

1 -so ,1/

0.9-2

737a 7a-75 7576 7677- 7778 7879 7980 8081 8182 8283 838A

YeGNO Nodoi HVtoric

flhart 10

- 71 -

The period under consideration may be divided into two: (1)

those characterized by a dip in the agricultural harvest, viz., 1974-75,

1976-77, 1979-80 and 1982-83 and (2) those enjoying a recovery in

agricultural production, viz., 1975-76, 1977-78, 1978-79, 1980-81, 1981-

82 and 1983-84. In the first group, the downturn was the most seveee in

1979-80, followed by 1974-75 and 1976-77, whereas in the second, the

most pronounced increases occurred in 1975-76, 1977-78, 1980-81, and

1983-84. The following discussion looks at the those groups of years in

relation to terms of trade movements and foreign savings inflows.

In addition to harvest failures, 1974-75 and 1979-80 were both

characterized by sharp deterioration in the economy's terms of trade.

The extent of harvest failure was more severe in 1979-80. There was a

marked decline in GDP and private consumption, a fall in imports,

stagnation in investment and a growth in exports of 15 percent over the

previous year. In 1974-75 and 1976-77, by contrast, there was a modest

increase in model-generated GDP and a healthy increase in investment.

However, a major difference between those two years lay in the movement

of the terms of trade which led to a substantially more drastic

curtailment of imports in 1974-75. The surge in investment in 1974-75,

its respectable growth in 1976-77 in the face of a small current account

surplus and modestly rising income and a stagnation rather than decline

in investment in 1979-80 was generally brought about in the model

through a combination of increased productivity in capital goods and

consumer goods production, together with some increases in the

C'ap-3disc-26:Irdia Socks:4-11/86/.pp

72 -

productivity of intermediate goods production and, in 1975-76 and

1979-80, of the savings propensity of the private sector.

Turning to the years of agricultural recovery, it will be

noticed that the years 1975-76, 1977-78, 1980-81 and 1983-84 stand

out. GDP and private consumption increased very substantially in those

years. But there are striking differences on the foreign trade side.

Foreign savings, though positive, was much smaller in 1975-76 compared

to 1980-81 and 1983-84 (see Table 3.7). This was partly the result, as

discussed in Chapter 1, of a difference in adjustment strategy to the

first and second oil shocks and is reflected in the relative export and

import figures for those years. And the large improvement in the barter

terms of trade in 1977-78 allowed the country to sustain an import boom

despite a decline in exports brought about to some extent by the

pressure of domestic demand. The savings-investment balance for these

years was brought about by mechanisms analogous to those in periods of

agricultural decline. While 1975-76 was marked by a massive growth of

investment with comparatively limited foreign savings, precisely the

opposite was true for 1980-81 and 1983-84. This was brought about

throutgh some increase both in the productivity of capital goods

production and in the private savings propensity in 1975-76 and a

decline in both parameters in 1980-81. The productivity parameters also

fell in 1977-78 and 1983-84.

Chap-3disc-26:Thdia &ocks:4-11/86/.pp

- 73 -

In summary, the tracking in growth rates is achieved mainly by

allowing fluctuations in sector-specific productivity growth as well as

in private savings propensities. The reasons these have the expected

impact should be clear from the earlier discussion of comparative

statics experiments.

Features of the Historical Run

Table 3.7 displays the characteristics of the model-generated

historical run which is henceforth taken to be a reasonable replication

of the broad contours of development during the period. The proximity

of the ratios on the expenditure side of the national accounts to their

counterparts In the data is a function of the degree of success achieved

by the tracking procedure. The composition of value added among

agriculture, manufacturing (the sum of sectors 2, 3, and 4),

infrastructure and services was not used as a tracking indicator.

Nevertheless, the model successfully captures the declining share of

agriculture and the growing importance of services over time. However,

it understates the growth of manufacturing to some extent and overstates

the growth of infrastructure correspondingly. The table also dlsplays

the model-generated Gini coefficlents of income and consumption

inequality among the five urban and five rural groups of households in

the historical run. This indicates no change in inequality over this

period but it must be remembered that there is no data against which

this result can directly be checked. Finally, Tables 3.8 and 3.9

profile the stock of debt and debt service payments respectively in the

historical run, broken down by medium- and long-term debt both official

Qiap-3disc-26:India Riocks:4-I1/86/pp

- 74 -

and private, as well as short-term debt of maturity one year or less.

IMF debt is shown separately from 1980-81 onwards, when India negotiated

an Extended Fund Facility.

In the counterfactual policy simulations that follows, the

historical run is used as a benchmark from which deviations are

presented. During those experiments, therefore, we do not alter the

values of those parameters which are used by the tracking procedure to

generate the historical run. Experiments are defined only by changing

exogenous variables or policy parameters.

Chap-Edisc-26:Thdia Shocks:4-11/86/:pp

- 75 -

Table 3.1: INDIA: Selected Features of the Economay, 1973-74

Sector 1 Sector 2 Sector 3 Sector 4 Sector 5 Sector 6 Average

Share of Value Addedin Gross Output 0.76 0.23 0.32 0.30 0.53 0.71 0.37

Share of Hired WageIncome in Value Added 0.19 0.50 0.44 0.51 0.66 0.50 0.34

Share of IntermediaceImports in GrossOutput 0.01 0.04 0.04 0.12 0 0.01 0.03

Share of PrivateConsumption in GrossOutput 0.72 0.86 0.08 0.16 0.27 0.31 0.50

Share of Exports inGross Output 0.01 0.09 0.01 0.06 - - 0.03

Share of TotalConsumption Accountedfor by Sector 0.57 0.22 0.02 0.04 0.02 0.14 -

Share of Tocal ExportsAccounced for bySector 0.13 0.56 0.05 0.26 - -

- 76 -

Table 3.2: INDIA: Selected Features of the Economy, 1973-74Share of Consumption by Seccor and Group

(Constant prices)

Sector I Sector 2 Sector 3 Sector 4 Sector 5 Sector 6

Urban

ci 0.70 0.14 0.01 0.05 0.02 0.08C2 0.66 0.17 0.01 0.05 0.02 0.09C3 0.60 0.20 0.01 0.05 0.02 0.1.2C4 0.53 0.24 0.02 0.05 0.02 0.16C5 0.41 0.25 0.02 0.04 0.02 0.27

Rural

Cl 0.74 0.12 0.01 0.05 0.03 0.06C2 0.72 0.15 0.01 0.04 0.02 0.07C3 0.65 0.20 0.01 0.04 0.02 0.09C4 0.58 0.23 0.02 0.03 0.02 0.12C5 0.47 0.26 0.03 0.03 0.02 0.20

- 77 -

Table 3.3: INDIA: Comparacive Stacics Experiments on "Incernal" Variables, 1973-74(Percentage deviation from base period)

Ricrease in Increase i-n Tcrease inTrml 3 by Lrban a by tban & ra1Mcror 1 Sactor 2 Scor 3 Ibctor 4 Sctor 5 Secror 6 5,. 5% X b 1OZ

GDP (arket prices) -17.1 4.5 -2.2 -3.2 -0.7 4.2 -1.7 -0.6 -3.8Privace Consuapiton -3.6 -4J.8 0 -0.3 -0.2 0.3 4.3 2.1) -2.7Tnvest= -65.1 -17.2 -9.2 -13.1 -2.6 -17.7 -21.4 -9.5 -9.1Eports -26.1 -12.0 -1.9 -3.1 -1.0 -5.0 -7.4 -3.3 -4.1iTporrs -14.2 -6.1 1.4 -1. 0 -4).4 -2.8 -3.9 -1.7 -1.4

(Q:ss oitpit ofAgriculttre -1. 7 -0.6 -0.3 -1.3 -0.3 -1. 0 1.1 0.4 -2. 5GCsuter goods -12.8 -8.0 -0.6 -1.5 -0.5 -1.9 1.6 0.8 -3.8Capia. gyods -59.9 -15.5 -7.3 -12.5 -2.1 -16.7 -19.1 -8.5 -7.3Interwdiates -30.6 -6.8 -1.3 -10.1 -1.4 -9.9 -7.6 -3.2 -5.0Tfrastnxrure -5.4 -1. 0 -1.4 -1.8 -5.8 -1.4 2.7 1.2 -4.3Services -4.0 -0.4 -0.6 -3.1 -0.4 -8.1 1.8 1.3 -3.7

Value Added inAglru1acre -0.8 -0.4 -0.1 -0.6 -0.2 --(.6 0.5 0.2 -2.5Cbns,rer goods -1.5 3.8 -0.6 0 -0.3 -0.7 2.4 1.0 -5.5Capital goods -54.4 -13.2 2.5 -4.4 -1.4 -13.7 -17.4 -7.8 -6.8Tncermediates -28.6 -5.9 -0.8 5.1 -3.5 -7.2 -7.8 -3.3 -6.4Infrasmruture -12.7 -2.5 1.2 0.4 5.8 -0.2 0.1 0.1 -6.7Sevices -3.2 .4 -. 1 -0.6 -0.1 3.2 1.4 1.0 -4.2

Gni Cbefficienr.s

Incne:

Urban .03 0.61 -0.06 -0.02 -0.17 0.21 0.59 0.21 1.21rai. 2.40 0.55 0.05 0.39 0.10 0.26 "-.08 -0.08 2.35

CbnsuWtion:

Urban 3.21 0.65 -0.05 -0.03 -0.16 0.24 0.65 0.24 1.29R=al 2.50 0.59 0.07 0.43 0.10 0.26 -0.10 -4).07 2.44

Cost of LivingIndex

E"ban

ca 37.1 3.2 0. 6 -2.6 0.6 4.4 7.5 3.0 2.0C2 36.0 3.6 .).7 -2.6 0.6 4.6 7.4 3.0 2.1C3 34.4 4.0 0.7 -2.4 0.6 5.1 7.2 2.9 2.1C4 32.5 4.4 0.8 -2.2 0.6 5.7 6.9 2.8 2.2C; 28.2 4.3 1.0 -2.0 0.6 7.3 6.3 2.6 2.5

Cl 38.3 3.1 ).& -2.8 0.7 4.1 7.7 3.1 2.0C2 37.8 3.5 0.6 -2.9 0.6 4.2 7.7 3.1 2.0C3 36.2 4.1 ).7 -2.7 0.6 4.7 7.4 3.0 2.1C4 34.2 4.5 0.8 -2.6 0.6 5.3 7.1 2.9 2.2C5 30.9 4.6 1.0 -2.3 0.6 6.4 6.6 2.7 2.3

'I -,,

- 78

Table 3.4: INDLA: Comparative Stacics Experiments on "External"Variables, 1973-74

(Percentage deviation from base period)

30% Rise 50% Rise 10% Rise 100% Risein Export in Import in Export in ForeignPrices Prices Volume Savings

GDP (market prices) 1.1 -2.3 0.3 0.8Private Consumption 0.3 -0. 4 0.1 0.2Investment 12.3 -18.1 2.5 9.9Exports 9.7 -7.9 1.7 -13.2Imports 35.8 -37.1 6.5 13.9

Gross Output ofAgriculture 0.7 -1.0 0.1 0.2Consumer goods 2.2 -2.6 0.4 -0.5Capital goods 10.8 -16.0 2.2 8.7Intermediates 4.7 -6.5 0.9 2.3Infrastructure 1.4 -2.0 0.3 0.9Serv!ces 1.3 -1.7 0.3 0.1

Vaiue added inAgriculture 0.2 -0.3 0.1 01

Consumer goods 0 0.3 0 -1.1Capital goods 4.1 -7.2 0.9 5.3Intermediates -1.0 1.3 -0.2 01Infrastructure 0.3 -0.4 0.1 0.6Services 0.3 -0. 0.1 -0.3

Gini CoefficiencsIncome:

Urban -0.11 0.17 -0.02 -0.11Rural -0.26 0.31 -0.05 -0.08

ConsumotionUrban -0.11 0.19 0 -0.08Rural -0.26 0.33 -0.07 -0.10

Cost of Living Indices

UrbanC1 25.3 2.6 4.8 8.8C2 25 2 2.6 4,8 8.3C3 25.2 2.7 4.8 8.8C4 25.1 2.8 4.8 8.8CS 25.0 2.9 4.8 8c8

RuralC1 25.3 2.5 4.8 8.8C2 25.3 2.5 4.8 8.8C3 25.2 2.6 4.8 8.8C4 25.2 2.7 4.8 8.8CS 25.1 2.8 4.8 8.8

- 79 -

Table 3.5: INDIA: Inpuc Data for Tracking

1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

ltnit Value Indcesfor Tzorts

P 1.00 1.16 1.28 1.17 1.09 1.09 1.23 1.02 0.82 0.71 0.68

1.00 1.77 1.27 1.33 1.11 1.03 1.18 071 0.73 0.59 0.642

P113 1.00 1.27 1.54 1.61 1.35 1.61 1.80 1.14 0.90 0.82 0.76

PM4 1.00 1.51 1.62 1.33 1.25 1.18 1.29 1.14 1.09 1.03 0.98

P 1.00 2.03 2.09 2.2. 2.15 2.00 2.93 4.09 4.43 3.94 3.41

PM6 1.00 0.92 0.8k 0.80 0.75 0.70 0.65 0.59 0.54 0.51 0.49

* 1.00 1.45 1.54 1.42 1.31 1.27 1.49 1.31 1.20 1.07 0.96P,I(average)

Cnit Value Tndicesfor Exoorts

P 1 1.00 1.21 1.10 1.04 1.44 0.95 0.52 0.77 0.84 0.65 0.62

P 1.00 1.14 1.10 1.23 1.37 1.33 1.28 1.25 1.20 1.11 1.02

PI3 1.00 0.82 1.08 1.03 1.04 0.93 1.00 0.80 0.87 0.80 0.74

I4 1.00 1.27 1.21 1.18 1.11 1.05 1.07 1.05 1.13 1.04 0.98

PI (average) 1.00 1.16 1.;12 .19 1.34 1.27 L.25 1.21 1.17 1.08 0.99

Policvy-ecerniredL-ports (tens of

mLUl.iLns)316.0 406.9 593.6 397.9 56.8 37.6 37.4 39.0 155.1 136.9 216.650.4 17.6 22.8 56.8 219.5 136.4 86.2 202.3 164.8 119.3 163.1

417.1 421.4 409.6 422.3 436.2 440.6 484.7 488.5 460.0 404.2 290.7

Foreign avin F(tens of Alliis) 479 961 579 -1031. -03 -575 -299 1996 2412 2370 2650

Donestic transfers(tens of millincs)

GTRA 477 340 4iL91 601 697 934 .1008 1490 1842 2704 2704*'N 909 1150 L350 1547 1762 2005 2392 2835 3311 4005 4005*

Foreirn Transfers(tens of nLUl.ns)

NFI -325 -291 -255 -233 -233 -156 153 298 -7 -681 -681*r 192 274 528 739 1202 1042 1624 2257 2221 2527 2527*

* 1983-84 figures wre Lmavailable and set ar their 1982-83 n1lues.

80

Table 3.5. INDIA: Input Data for Tracking (concinued)

1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

GE DeflatorUs 1.00 L09 1.19 1.25 1.33 1.43 1.55 1.68 1.84 1.96 2e04Tnda 1.00 1.17 1.12 1.19 1.24 1.26 1.46 1.62 1.78 1.91 2.14

Gross Qctput ofAgriculture, XI

(rate of grawh) 0 -6.3% 11.6% -5.0% 11.0% 3.1% -10.2% 10.4% 3.6% -2.0% 3.6%InvetsEIt Slamre _Iesination

Agriculture 0.18 0.15 0.15 0.21 0.21 0.21 0.18 0.19 0.17 0.16 0.16Mufacturing 0.29 0.37 0.30 0.23 028 0.29 0.34 0.29 0.30 0.28 (0.27Ifrastructure 0.12 0.14 0.18 0.18 0.18 0.15 0.18 0.18 0.20 0.25 02.5Services 0.41 0.34 0.37 0.38 0.33 0.35 0.30 0.34 0.33 0.31 0.32Share of xeldTnveset inTotal Tnvesmnt,

K 0.80 0.76 0.82 0.87 0.93 0.83 0.81 0.83 0.83 0.86 0.86Goxernmer GnsuWtion(tens of nsLUons) 5042.7 51LLO 6454.6 6978.7 7022.4 7507.1 7547.4 8090.6 8566.4 9713.8 10084.9

- 81 -

Tab7, 3..6: NDITA: Thraddxg Tndicators

1974-75 1975-76 1976-77 1977-78 1978-79 1979-8 1980-61 1981-82 1982-83 1983-84

GDP (Nrket Prices)

Data -0.6 9.9 1.3 8.2 6.6 -5.2 7.2 5.5 4.3 7.6bdel 1.7 14.5 1.8 7.8 7.3 -2.1 7.6 3.4 4.3 9.1

Privare (bnspticn

Cara -4.2 3.7 -2.4 15.2 2.7 -10.1 10.8 6.4 3.4 8.8e4xl 1.0 10.7 -L.3 13.8 4.0 -4.5 10.9 3.4P 4.2 L1.1

flbtal Rnestme

Data 6.3 19.4 4.2 0 19.0 0.4 8.7 5.3 1.3 6.11 6.0 17.8 3.1 1.0 18.1 -0.2 10.2 4.2 0.2 5.4

Eports

Data 8.1 16.5 19.7 -3.8 8.2 16.8 -0.3 -0.2 3.2 4.9del 6.8 16.6 22.3 -2.9 7.6 15.0 -1.4 1.5 3.3 4.4

imports

Data -13.1 1.2 -0.2 30.3 8.5 -4.1 46.7 8.0 0.2 4.1,%del 41.2 -4.3 -3.6 30.3 8.7 -3.5 48.5 7.5 0.1 4.4

- 82 -

Table 3.7: INDLA: Selected Features of the Historical Run (Model-generated)

1973-74 1974-75 1975-76 1976-77 L977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

1. Ratics to GMT

Private CaisLuzpcin 0.72 0.70 0.68 0.66 0.69 0.67 0.65 0.67 0.67 0.67 0.69GolerrmSt (Stlption 0.08 0.08 0.09 0.10 0.09 0.09 0.09 0.09 0.09 0.10 0.10'bctal Uwesntm 0.22 0.23 0.24 0.24 0.22 0.2Z5 0.25 0.26 0.26 0.25 0.24Exports 0.04 0.05 0.05 0.06 0.05 0.05 0.06 0.05 0.05 0.05 0.05Imports 0.06 0.06 0.05 0.05 0.05 0.06 0.05 0.08 0.08 0.07 0.072. tios to Thtal

Value Aded

VA (Asriailture) 0.52 0.49 0,47 0.47 0.48 0.46 O.46 0.43 0.43 0.44 0O43VA (bnufactuing a! 0.17 0.19 0.15 0.17 0.16 0.16 0.18 0.20 0.19 0.16 0.17VA (Tnfrascructre) 0.03 0.04 0.05 0.04 0.04 0.05 0.05 0.05 0.04 0.05 0.04UA (Services) 0.28 0.28 0.33 0.32 0,32 0.33 0.31 0.32 0.34 0.36 0.363. Gini Coefficients

Incoe:urban 0.47 0.47 0.45 0.47 0.47 0.46 0.47 0.46 0.46 0.47 0.46Rural 0.38 0.39 0.38 0.38 0.38 0.37 0.38 0.38 0.37 0.37 0.36ConsaWion:Urbl 0.37 0.37 0.36 0.37 0.37 0.36 0.37 0.36 0.36 0.37 0.36amral 0.30 0.31 0.30 0.30 0.30 0.30 0.30 0.30 0.29 0.29 0.28

4. a1,E in GrossCurz,ic ofgiculture (7.) 0 -6.3 11.6 -5.0 11.0 3a1 -10.2 10.4 3.6 -2.0 13.6

5. (Lag in %t Brterrms of Trae (%) 0 -27 -3 -4 20 -9 -2820 8 -2

6. Foreign Savings toGDP at Xarket Prices(%) b/ 0.8 1.5 0.6 -40.7 -0.6 -0.3 -0.2 1.2 1.1 0.7 0.7

a/ Manufacturing is the sum of sectors 2, 3 and 4.

b/ The numerator is foreign savings at 1973-74 prices multiplied by the model-generaceac investmentinilacion; che denominator is u,ociel-generated GDP at current market prices.

- 83 -

Table 3.8: INDIA: Debt Profile: Historical Run(tens of millions of 1973-74 rupees)

Medium- and Long-TermIMF Official Private Short Term

1973-74 7897.35 208.241974-75 8017.29 198.871975-76 7847.67 193.781976-77 8075.38 183.461977-78 8375.01 204.031978-79 8253.23 182.94 141.521979-80 7786.90 169.23 124.411980-81 478.71 7881.33 247.83 170.211981-82 729.52 7281.54 320.87 238.941982-83 1566.89 7772.01 480.03 546.40

- 84 -

Table 3.9: INDIk: Tocal Dbt Service: Historical Run(tens of millions of 1973-74 rupees)

Medium- and Long-TermI Official Private Short Term

1973-74 437.91 70.011974-75 464.02 64.331975-76 444.09 50.371976-77 419.61 50.311977-78 433.51 46.771978-79 469.64 52.121979-80 473.72 46.36 142.321980-81 446.48 41.91 128.121981-82 12.26 397.05 36.48 177.471982-83 51.17 411.53 74.97 278.68

- 85 -

Chapter 4: SIMULATIONS WITH THE MODEL

I. INTRODUCTION

This chapter conducts five experiments with the India model.

Their design is motivated by the policy discussion of Chapter 1.

Specifically, we ask the following questions:

(1) How would the economy have evolved had it not experienced

terms of trade fluctuations and, correspondingly, not

undertaken accommodating borrowing? [Experiment 1]

(2) What would have been the implications of pursuing an

expansionary investment program in response to the first

oil shock, supplemented by higher imports of essential

consumer goods such as food and edible oils? [Experiment

2]

(3) What would have been the consequences of the period 1973-

74 to 1983-84 not being characterized by years of drought

as well as agricultural bounty? [Experiment 4]

(4) TWhat might have happened if accumulated foreign exchange

reserves between 1976-77 and 1979-80 had been used to

boost Investment? [Experiment 4]

(5) What would have been the impact of allocating the

economy's actual volume of investment across sectors of

destination in response to considerations of short-run

profitability? [Experiment 5]

Chap-4/India Shocks:4-11-86:pp

- 86 -

Results from each experiment are presented as deviations from

the 1973-74 to 1983-84 historical run. It was already mentioned in

Chapter 3 that the experiments do not alter the values of those

parameters which are used by the tracking procedure to generate the

historical run.

Before proceeding to the experiments, it is worth making two

observations. First, the formulation of an experiment necessarily

involves some judgment as to what configuration of exogenous variables

can reasonably be assumed to come together on a particular

counterfactual. This is a familiar problem in policy modelling but

nevertheless one to which attention deserves to be drawn. Second, the

experiments devised here are based on the advantage of hindsight which

was clearly not available to policy-makers in 1973-74. Thus, the

results should not be seen as proving particular policies to be right or

wrong. Instead, they outline the consequences of an alternative set of

options from the ones historically exercised. It is also important to

remember that those options are examined within a model framework which

abstracts certain features of reality to the exclusion of others. This

procedure has the methodological advantage of allowing us to focus on

the consequences of changes in policies alone, inasmuch as the

experiments as well as the historical run keep "other things absolutely

unchanged."

Experiment 1: No External Shock-Gum-Accommodating Borrowing

This experiment explores wqhat might have happened to the Indian

economy in the absence of exte-'nal shocks. The intention is to discover


- 87 -

the net impact of external shocks and certain policy responses to them

on the principal macroeconomic and sectoral magnitudes. For this

purpose, the counterfactual is defined to be a situation where (1) terms

of trade remain at their 1973-74 level; - (2) (i) foreign savings are

set below their historical levels by an amount equal to the sum of the

IMF's Oil Facility, external assistance from the oil exporting countries

and borrowing from the IMF's Extended Futnd Facility, net of amortization

and interest charges; while (ii) net current transfers (which include

workers' remittances) are set at their 1973 level; (3) Government-

controlled oil imports are determined with reference to the growth in

GDP and the relative price of oil, using income and price elasticities

of 1.3 and -0.3 respectively. 2/ 3/

Table 4.1 reports the time-series of foreign savings, net

current transfers and oil imports in both the historical run as well as

the no-external-shock-cum-accommodating borrowing counterfactual. It

will be noticed that foreign savings are much lower compared to the

historical run, especially in

1/ Here, terms of trade are defined as the ratio of internationalprices of substitutes for India,-exports to prices of imports.

2/ These elasticities are based on estimates for developing countriesreported in the World Development Report, 1981 (Oxford UTniversityPress for the lWorld Bank).

3/ The slowdown in developed country trading partners is not correctedfor in this experiment; since this is not regarded as an importantfactor in the Indian dase, it is not expected to make a significantdifference to the results.


1975-76 and in the years following the second oil shock. The

results of the experiment, displayed in Table 4.2, indicate that GDP,

consumption, investment and capital stock were all higher in the

historical run. The reason is as follows. While the historical run is

characterized by worsened terms of trade, it also has a substantially

lower deficit on trade and nonfactor services account. It is clear that

the lower foreign savings dominates the improvement in the terms of

trade, so that the differences between the historical run and the no

external shock counterfactual are analogouis to the differences between

the increased foreign savings experiment of Chapters 3 vis-a-vis the

base period 1973-74. GDP, consumption and investment are consistently

lower: the capital stock in 1984-85 is 8 percent lower in the no

external shock experiment. Table 4.3 also shows that the cost of living

is also lower, largely due to increased availabi±ity of food and

consumer goods. There is no change in the rini coefficients of

income and consumption inequality. The economy's stock of debt at the

beginning of 1983-84 would have been nearly 48% lower than in the

1/ The latter difference is entirely due to the Extended Fund Facility

from the IMF.

2/ The cost of living indices reported in these tables were defined in

Chapter 3. Here, they are calculated with reference to the utility

level attained in the corresponding year of the historical run.


- 89 -

historical run. - Furthermore, the historical run vis-a-vis the no

external shock scenario exhibits no discrimination in the movement of

cost-of-living indices between rural and urban sectors and within each

of the sectors.

The sectoral composition of output has an interesting

pattern. Since investment is lower, there is a substantial reduction in

the output of capital goods. This releases variable factors such as

labor and intermediates. These are absorbed in consumer goods and,

except for the last two years, mainly in the infrastructure-producing

sector which, despite lower capital stocks, increases its output

greatly. Or, to put the matter another way, the historical run bids

resources away from consumer goods and, till 1981-82, from

infrastructure and channels them towards capital goods. This looks like

neaative import substitution in sector 5 in the historical run upto

1981-82 vis-a-vis the case of no external shocks. Ftowever, it is known

that domestic petroleum production increased substantially during this

period (see Table 1.6). Since crude petroleum and natural gas accounted

for only 5 percent of the gross output of sector 5, (see the components

of this sector in Table 4.4) the behavior of the sector in the

1/ The change in debt in any year resulting from a change in foreignsavings in that year is calculated as follows. It is assumed,somewhat arbitrarily, that marginal debt has the same maturitystructure as outstanding average debt in that year. The IMF'sExtended Fund Facility (EFF) is not included in this calculation,i.e., marginal debt has the maturity structure of outstanding non-EFF debt. Alternative assumptions could easily be incorporated intothe calculations. All terminal debt figures here and subsequentlyrefer to the beginning of 1983-84.


90 -

historical run is certainly not inconsistent with positive import

substitution in petroleum.

The lower foreign savings are absorbed via lower domestic vis-

a-vis international prices,L/ 'higher exports and lower imports.

Experiment 2: Alternative Adjustment Strateay

The first oil shock was accompanied by a dip in the

agricultural harvest. As discussed in Chapter i1, policy makers

perceived the latter as being more important than the former, especially

given its potentially inflationary consequences, and applied a stiff

dose of demand management in response. This choked off investment,

generating a "deflationary" adjustment profile. This may be contrasted

with the more "expansionary" policy response to the 1979-80 roand of

shocks.

In this experiment we look at the consequences of following a

more expansionary investment strategy to the first round of shocks,

supplemented by imports of essential consumer goods such as food and

edible oils to combat inflationary pressures. The counterfactual is

defined to be a situation where (1) investment is chosen such that the

ratio of real investment to GDP at constant market prices is set (i) at

its 1978-79 historical run value for the years 1974-75 to 1977-78 and

(ii) from 1978-79 onwards at its historical run value for those

1/ This may be thought of as a depreciation in the real exchange rate.


- 91 -

years - ; (2) government-controlled imports in sectors 1 and 2 are set

such that per capita domestic availability (production plus net imports

plus stocks) of sector 1 and 2 goods every year is at least as large as

per capita availability in the historical run for that year; and (3)

government-controlled oil imports are chosen such that their ratio to

GDP equals the historical run ratio for the corresponding year.

Since investment is determined by the requirement that it

satisfy the ratios outlined in (1) above, the model solves for the

amount of foreign savings consistent with equilibrium.

Table 4.5 displays the results. Since the investment to GDP

ratio is kept at its corresponding historical run value from 1978-79

onwards, the deviation of investment from the historical run by

definition equals that of GDP, starting in that year. The higher

investment and the need to maintain the domestic availability of sector

1 and sector 2 goods at levels at least as larae as those attained m

the historical run in general call for higher foreign savings. However,

since domestic availability can be met either by increasing imports or

by reducing exports, both options are, in the absence of any further

restrictions, exploited in the experiment.

I/ The ratio of investment to GDP at market prices in the historicalrun appears in Table 3.7.


- 92 -

Two broad patterns are discernible, depending on whether price-

driven imports (i.e., those in sectors 3 and 4) dominate or are

dominated by policy-determined imports (i.e., those in sectors 1, 2 and

5). I/ Thus, corresponding to the former pattern, 1974-75 and 1977-78,

which have high investment compared to the historical run, compel the

economy to absorb the resulting foreign savings and price-driven imports

via a decrease in competitiveness and a concomitant reduction in

exports. The ircreased relative domestic prices implicit in such a loss

of competitiveness are reflected in those two years as well as to a much

lesser extent in 1981-82 (see Table 4.5). By cortrast, and

corresponding to the second pattern, years such as 1975-76, 1979-80,

1982-83 and 1983-84 are characterized by a large rise in exports; the

gain in competitiveness is not nullified by the extra imports which, for

those years, are mainly policy-determined rather than price-driven.

The behavior of the distributional characteristics is shown in

Tahle 4.6; the cost of living indices across the board are lower except

in the years of significantly higher investment. Turning to sectoral

aspects, the experiment channels variable factors such as labor and

1/ The fact that domestic availability can exceed or equalcorrespondirg historical run values raises the possibility ofmultiple solutions. While the two broad patterns identified herecan be expected to characterize other potential equilibria, theprecise configuration of exports and imports can be expected to varyacross equilibria.


- 93 -

intennediates into capital goods production at the expense of

infrastructure and, to some extent, consumer goods. The economy is left

with a capital stock in 1984-85 which is 1.8 percent higher than in the

historical run. However, the stock of terminal debt is 27 percent

higher than in the historical run as well.

Experiment 3: No Agricultural Shocks

It has already been argued that a perception that internal

shocks were more important than external shocks shaped the policies

followed in the years after 1973-74. The previous experiment asked what

might have happened if different policies had been followed, for the

same set of shocks, in response to that perception. This experiment,

somewhat by contrast asks what would have been the outcome if internal

shocks had not occurred and the actual historical policies followed. In

this experiment, therefore, we set the efficiency parameter In the

agricultural production function, which is taken as a proxy for weather-

related flucttuations, equal to its base vear (1973-74) level of

unity. - This helps bring out clearly the impact of fluctuations in

agricultural output on the historical path of the economy. The results

of this experiment and the previous one could easily be combined to

answer the question: what would have been the consequences of pursuing

an "expansionary" adjustment policy if the economy had experienced only

external shocks between 1973-74 and 1983-84? Such a "no-agricultural-

1/ It would have been possible to give the efficiency parameter a"normal" time trend instead of holding it constant in thisexperiment.


- 94 -

shock-cum-deflationary adjustment" experiment would be an obvious

counterpart to the "no external shock-cum-borrowing" experiment.

Table 4.7 reports che deviations from the historical run. In

the light of the adverse agricultural shock experiment reported in

Chapter 3, these have the expected pattern. As might he expected from

the sensitivity of investment to agricultural shortfalls noted in that

chapter, the economy's total capital stock is mostly lower than in the

historical run - indeed, 6.5 percent lower at the beginning of 1984-

85. This indicates that the cumulative effect of agricultural peaks

dominated those of the troughs in the historical run, resulting in a

relaxation of the wage goods constraint and thuis permitting higher

savings, investment and terminal capital stock.

The behavior of the cost-of-living indices is expected; they

increase (decrease) in those years when the agricultural efficiency

parameter declines (increases) relative to its historical run value for

the corresponding year (see Table 4.8). Furthermore, dips (increases)

in agricultural efficiency have a regressive (progressive) impact as

between rich and poor in both rural and urban areas without differing

between rural and urban areas as a whole.

Experiment 4: Reserve Decumulation Between 1976-77 and 1979-80

Referance has been made in Chapter 1 to the substantial

accumulation of reserves during the period 1976-77 to 1979-80. In the

following set of experiments we explore the economywide consequences of

following a less cautious policy in this regard. Specifically, we rtn

two experiments. The first, or "bold" version, asks what would have

Chap-4/India Shocks:4-11-8 6 :pp

- 95 -

happened had reserves in the years 1976-77 to 1979-80 been maintained at

a level equalling four months of imports. This is accomplished by

adding the difference between actual reserves and the "four months"

level of reserves to forelgn savings and running the model in its

"savings driven" mode. The second, or "conservative" version, maintains

reserves at a level equalling six months of imports, and adds its

difference with actual reserves to foreign savings.

The policy e\xperiment starts in 1976-77 with the historical run

level of capital stocks and reserves, so that the less cautious policy

is followed from this year onwards. Experiment 2, it will be recalled,

explored the consequences of following a more ambitious investment and

import policy from 1974-75 onwards. Some of the extra foreign savings

required there (see Table 4.5) could have come out of the decumulation

of reserves. Thus it would be both relatively straightforward and

instructive in future work to combine the themes of Experiment 2 and the

present experiment. However, since the issue of excess reserve

accumulation has featured in policy discussions in its own right (see

chapter 1), it was decided to devote a separate experiment to this

subject.

A better understanding of the ensuing results is facilitated by

referring back to the comparative statics experiment in Chapter 3 on

doubling the amount of foreign savings. It will be recalled that in the

experiment, extra foreign savings could be accommodated through a rise

in domestic vis-a-vis International prices, leading to a fall in exports

and a rise in imports. The rise in investment is met by a combination


i 96

of expanded domestic capital goods production as well as imports of

capital goods which (starting from a low base) increase twice as fast as

domestic production. The expansion of domestic capital goods production

has a tendency to bid variable factors away from the rest of the

economy, leading to a modest decline in the output of consumer goods.

Table 4.9 reports the level of foreign savings in the

historical run as well as in the two scenarios for the reserves

experiment. It will be noticed that foreign savings are very

substantially higher in the "bold'" scenario. As expected, those savings

can be accommodated via a relative decline in domestic competitiveness,

resulting in an export profile which is much lower than in the

historical run. The opposite is true for imports. Table 4.10 profiles

investment and GDP - both are higher compared to the historical run - as

well as sectoral gross outputs. Imports of capital goods, which can

substitute for the domestically produced variety with an elasticity of

nearly unity, increase much more than domestic production. The

increased investment In the "bold" scenario leads to a capital stock at

the beginning of 1S00-81 that is higher than the corresponding figures

in the historical run by 6.4 percent. The pattern of sectoral output

indicates a massive expansion in the output of capital goods and a

modest decline in the consumer goods sector caused by the bidding away

of variable factors of production.

Table 4.11 shows that the reserves experiment has a large

impact on the cost-of-living vis-a-vis the historical run, expecially in

the years 1977-78 and 1978-79 in the "bold" scenario, although not on

Chap-4/India Shocks *4-11-86:pp

-97 -

the Gini coefficients. There is a roughly 1.5 percent increase in the

ratio of urban-to-rural per capita incomes but no difference in the

relative movements of urban and rural cost-of-living indices.

The "conservative" scenario is a muted version of the above;

the numbers may be consulted in Tables 4.12 and 4.13.

Experiment 5: Investment Reallocation

The amount of capital stock in each of the six sectors of the

economy is known for 1973-74. These are updated in subsequent years in

the historical run as follows. Data are available on the allocation of

investment in agriculture (sector 1), manufacturing (the sum of sectors

2, 3 and 4), infrastructure (sector 5) and services (sector 6). Those

data are used to allocate investment across those four broad sectors,

while investment going to manufacturing is divided within sectors 2, 3

and 4 in accordance with capital stock proportions among those sectors

in the base year, i.e., 1973-74. Thus, there is nothing in the model

which ensures that the marginal product of capital stock in each sector

of the economy is equalized.

The purpose of this experiment is to begin an exploration of

different ways of allocating investment to sectors as part of an

adjustment program. Specifically, it allows the allocation of

investment to the four sectors (agriculture, manufacturing,


- 98

infrastructure, services) to respond to differences in rates of return

earned by capital in the various sectors of the economy. I/

Table 4.14 reports the results. The experiment pulls

investment out of infrastructure and services (which may broadly be

identified as nontradeables) and into manufacturing and, to a lesser

extent, agriculture. The somewhat more efficient allocation of

1/ To this end, we maintain the volume of investment every year in the

economy at its historical run level but vary its allocation

according to the rule:

Yi e 1I

where

Yi =share of new investment going to sector i

Pk.x - (i = 1, 2, 3, 4,

i tpI1 kg

i.e., xi is the normalized value of the implicit price of capital

in sector i where j runs over each subsector comprising sector i

(thus j would run over consumer goods, capital goods and

intermediate goods for i = 2, i.e., manufacturing). Since the

Yi must add upto one, X can be calibrated each year from the

data. This rule allocates more investment in a year to a sector

which has a higher current profitability in that year.

The application of this rule yields an allocation of investment to

the four broad sectors of the economy. To retain comparability with

the historical run, the division of manufacturing investment within

sectors, 2, 3 and 4 is done in accordance with capital stock

proportions among those sectors in the base year, i.e., 1973-74.


- 99 -

investment raises GDP and private consumption. - The balance of

payments, however, deteriorates on two counts. First, the intermediate

goods sector, which is one of the beneficiaries of investment

reallocation, is substantially more intensive in the use of imported

intermediates than the infrastructure and services sector (see Table

3.1). Second, the extra indome generated raises domestic demands,

especially for agricultural and consumer goods, and, notwithstanding

some increase in domestic production, a rise in the prices of Indian

goods vis-a-vis that of international substitutes. Since consumer goods

account for the vast majority of exports, (see Table 3.1) this leads to

a reduction in competitiveness and a noticeable decline in exports.

The economy is left with a capital stock which is 1.7 percent

higher at the beginning of 1984-85 but a foreign debt which is also 27

percent higher at the beginning of 1983-84 compared to the historical

run. It will be noticed from Table 4.15 that the Gini coefficients rise

in urban and fall in rural areas, while the cost of living indices are

uniformly higher for all groups of households (see Table 4.15). Thus,

no straightforward comparison is possible between the historical run,

with its attendant investment allocation, and a seemingly plausible but

myopic rule where the allocation of investment in the experiment depends

only on short-run profitability. This experiment is to be seen as only

1/ The experiment holds the physical volume of investment at itshistorical run level. However, since prices are different in theexperiment, investment-at-constant-prices in the national accountssense can differ from the historical run.


- 100 -

a first step towards examining the question of how investment is best

reallocated among sectors in response to exogenous shocks. Other, more

forward-looking rules need to be experimented with but are left for

future work.

Adjustment and Income Distribution

We have seen the Gini coefficients of income and consumption

inequality exhibit no noticeable change as between the historical run

and the experiments. The same is in general true of the share of the

bottom 40 percent in income and consumption. Thus, there is hardly any

change in overall inequality. This is commented on in Chapter 5.


Table 4.1: INDIA: No Elxternal Shock-Ctum-Accommodating Borrowing Experiment: Selected Features(tens of millions of rupees)

1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 198283 1983-84

Foreign Savings a!

ilistorical lRn 479 %I 579 -1031 -903 -575 -299 1996 2412 2370 26501N External Sloclc 479 605 -36 -1277 -1111 -676 -361 1134 1747 505 1604

Net Qirrent Thanisfers a!

Historical Pbjn 192 274 528 739 1022 1042 1624 2257 2221 2527 2527H b External Riock 192 192 192 192 192 192 192 192 192 192 .192

Sector 5 Imports (M,)

Historical Rim 417 421 410 422 436 441 485 489 460 404 291No External Skck 417 347 302 319 342 311 307 348 375 380 447

a/ There are nominal magnitudes vMich are treated with the appropriate deflators in the nodel.

Table 4.2: INDIA: No External Shock-Cum-Accommodating Borrowing Experiment(Percentage deviation from historical run)

1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

C(DP 0 -1.1 -0.7 -1.3 -1.5 -0.8 -1.7 -- 2.1 -2.9 -4.9Private Cbnsumptlon 0.3 0 0 -0.3 -0.1 -0.4 -1.1 -1.2 -1.3 -3.0

nrtni,bnt -4.4 -10.2 -6.2 -11.8 -12.2 -10.0 -15.0 -18.4 -27.6 -32.1Ubports 8.7 14.0 7.0 14.7 13.6 .17.3 35.2 29.5 45.6 48.7Imports -8.6 -12.9 -8.5 -14.5 -14.9 -17.1 -28.2 -25.0 -32.6 -33.6

Gross Citputs ofAgriculture 3.5 0.2 0.2 0.1 0 0.1 -0.3 -0.6 -047 -1.8

4bnsuyer Goods 1.3 1.1 1.1 1.6 1.3 2.3 3.6 2.0 3.9 1.4Capital 0bods --3.5 -9.0 4-60 -11.3 -11.6 -9.2 -19.2 -18.4 -29.2 -34.2Intermediates 0.5 -0.8 0.5 -1.3 -1.4 0.7 -5.1 -5.8 -8.2 -13.0Infrastnrcture 12.3 15.6 14.7 11.6 16.4 27.2 17.6 8.3 -0.7 -2)0.0.Services 1.2 1.2 1.2 0.8 1.3 2.1 1.2 0 0.2 -2.5

Table 4.3: INDIA: No External Shock-Cum-Accommodating Borrowing ExperimentDistributional Cliaracteristics (Percentage deviation from historical rtin)

Cost of Living IndicesGroups 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

Irban

C1 -4.0 -7.0 -3.0 -7.0 -7.0 -9.0 -16.0 -14.0 -20.0 -23.0C2 -4.9 -7.0 -3.0 -7.0 -7.0 -9.0 -16.0 -14.0 -20.0 -22.0C3 -4.0 -7.0 -3.0 -7.0 -7.0 -8.0 -16.0 -14.0 -20.0 -22.0C4 -4.0 -7.4 -3.0 -7.0 -7.0 -8.0 -16.0 -14.0 -20.0 -22.0Cs -4.0 -7.4 -3.0 -7.0 -7.0 -9.0 -16.0 -14.0 -20.0 -22.0

Rural

C1 -4.0 -7.0 -3.0 -7.0 -7.0 -8.0 -- 16.0 -14.0 -20.0 -23.0C2 -4.0 -7.0 -3.0 -7.0 -7.0 -9.0 -16.0 -14.0 -20.0 -23.0C3 -4.0 -7.0 -3.0 -7.0 -7.0 -8.0 -16.0 -14.0 -20.0 -22.0C4 -4.o -7.0 -3.0 -7.0 -7.0 -8.2 -16.0 -14.0 -20.0 -22.0C5 -4.0 -7.0- -3.0 -7.0 -7.0 -8.0 -16.0 -14.0 -20.0 -22.0

Gini Coefficient

Urban

Income 0 -0.4 -0.4 -0.1 -0.4 -0.7 -0.4 -0.3 0.3 0Consumption 0 -0.4 -0.2 -0.1 -0.4 -0.8 -0.4 -0.3 0.3 0

Rural

Income -0.1 -0.1 -0.2 -0.2 -0.2 -0.4 -0.4 -0.1 -0.1 0.3Consumption -0.1 -0.2 -0.2 -0.2 -0.2 -0.4 -0.4 -0.1 -0.1 0.3

- 104 -

Table 4.4: INDIA: Makeup of Sector 5 from115 Sector Input-Output Table, 1973-74

Gross % of Sector 5Sector No. Name Output Gross Output

023 Coal and Lignite 30350 17.4

024 Crude petroleumiNatural Gas 9952 5e7

100 Electricity 99413 56.9

101 Gas 1098 0.6

102 Water Supply 7401 4.2

106 Communications 26626 15.2

TOTAL 174839 100.0

Table 4.5: INDIA: Alternative Adjustment Strategy(Percentage deviation froms historical run)

1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

GDP 0.6 1.3 1.2 2.1 6.4 0.4 0.2 0.1 2.2 0.8Private Conmnvption 0 0.4 0.3 0.4 0.3 0.3 0.3 0.2 1.4 0.4Investwmnt 8.0 5.8 4.4 12.4 6.4 0.4 0.2 0.1 2.2 0.8

Lflo Exports -18.3 7.7 3.9 -6.5 4.6 8.7 4.5 -1.5 15.3 9.0

Imports 8.2 14.3 5.3 11.5 -0.6 6.9 3.8 -0.4 1.0 1.6

Gross Output ofAgriculttwre 0.6 -0.7 0 0 0.2 0 0 0.5 1.4 0

(1bnsumer goods -1.4 1.1 0 0 0 -1.4 0 0 0 0Capital goods 7.5 5.7 4.6 12.4 0.8 0.7 0.5 0.2 3.1 1.2Internedtate 2.1 2.5 1.2 3.5 0.2 0.3 1.1 0.5 2.6 0.8Infrastructure 0.5 -0.6 -0.6 -0.4 -0.3 -0.1 0.5 0.5 0.7 -0.2Services -0.1 0.4 0.3 0.3 0.5 0.4 0.5 0.4 1.7 0.5

Foreign Savings 1295 1285 -652 42 -713 434 2380 2334 1990 2757(levels, tens ofmilion rupees)

Foreign Savings inHlstorical run 961 579 -1031 -903 -575 -299 1996 2412 2370 2650

(levels, tens ofmillion tupees)

t 9

Table 4.6: INDIA: Alternative Adjustment StrategyDiftributional Characteristics (PFrcentage deviation from historical nm)

Cost of Living Indices1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

Urban

Cl 13.0 -6.0 -2.0 4.2 -2.0 -5.0 -3.0 1.4 -7.0 -5.0C2 13.0 -6.0 -2.0 4.2 -2-0 -5.0 -3.0 1.3 -7.0 -5.0C3 13.0 -5.0 -2.0 4.2 -2.0 -5.0 -3.0 1.3 -8.0 -5.0C4 13.0 -5.0 -2.0 4.2 -2.0 -5.0 -3.0 1.1 -8.0 -5.0C5 13.0 -5.0 -2.0 4.3 -2.0 -5.0 -3.0 '. -8.0 -5.0

Rural

C1 13.0 -6.0 -2.0 4.2 -2.0 -5.0 -3.0 1.4 -7.0 -5.0C2 13.0 -6.0 -2.0 4.2 -2.0 -5.0 -3.0 1.4 -7.0 -5.0C3 13.0 -6.0 -2.0 4.2 -2.0 -5.0 -3.0 1.3 -8.0 -5.0C4 13.0 -5.0 -2.0 4.2 -2.0 -5.0 -3.0 1.3 -8.0 -5.0CS 13.0 -5.0 -2.0 4.2 -2.0 -5.0 -3.0 1.1 -8.0 -5.0

Ciii (befficdents

Urban

Inconr 0 -0.4 -0.1 -0.1 0.2 0.1 0 0.2 0.4 0(bnsuaption 0 -0.4 -0.1 -0.1 0.2 0.1 0 0.2 0.5 0

Rural

Incalm -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.4 -0.1(bisuop)tion -0.1 -0.1 -0.1 -).1 -0.1 0 -0.1 -0.1 -0.4 -0.1

Thble 4.7: INMIA: Nb Agricultural Iiock Fxperiment(Percentage deviation from historical run)

1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

2a. 2.9 -7.9 0.9 -3.3 -5.4; 5.9 -6.1 -4.4 1l.3 -3.3Private Consunption 0.9 -2.1 0.1 -0.7 -1.2 0.3 -2.0 -1.6 6.2 7.4Investimnt 8.9 -25.9 3.4 -11.9 -17.5 19.4 -15.3 -11.2 20.2 -31.3E,xrts 7.7 -15.0 2.0 -6.0 -9.4 17.9 -17.3 -10.0 16.5 -18.5Imprts 2.6 -5.7 0.8 -2.4 -2.8 3.1 -1.2 -1.9 2.9 -0.5

r14 Gross Output ofAgrictlture 2.2 -5.3 0.6 -1.7 -3.0 3.1 -4.1 -3.0 3.7 -6.8

Cbonsuner Goods 2.4 -5.4 0.5 -1.9 -3.7 4.1 -4.9 -3.6 4.7 -7.5Capital Goods 8.5 -25.5 3.5 -12.2 -18.1 20.1 -15.8 -11.7 22.1 -38.3Jiterlnediates 5.2 -13.6 1.5 -5.2 -8.3 10.1 -9.1 -6.9 10.7 -17.5

Infrastructure 1.3 -3.4 0 -1.3 -2.7 2.3 -2.8 -2.3 3.1 -4.7Srvices 0.4 -1.5 0 -. 5 -0.9 -0.5 -0.2 -0.9 1.5 -1.7

tnn ItemAgriculturl EfficiencyParanEter

Ilistoricalt RPn 0.97 1.05 0.99 1.01 1.02 0.96 1.04 1.02 0.97 1.06No Agricultural 9iock

Experiment 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0

Table 4.8: INDIA: No Agricultural Shodt ExerimentD1stributtonal liatracteristkcs (Based on htstorical run)

Cost of living IndicesGroups 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

Urban

C1 -6.0 15.0 -2.0 5.0 8.0 ,-80 16.0 8.0 4.3 -2.0(12 -6.0 15.0 -2.0 5.0 8.0 -13.0 16.0 8.0 3.8 -1.0C3 -6.0 14.0 -2.0 5.0 8.0 -12.0 15.0 8.0 2.8 1.0MC4 -5.0 13.0 -2.0 5.0 7.0 -12.0 14.0 8.0 1.7 0co

C C5 -5.0 12.0 -2.0 4.0 7.0 -11.0 13.0 7.0 -0.3 1.4

Rural

CL -6.0 16.0 -2.0 5.0 9.0 -13.0 16.0 9.0 4.9 -3.0C2 -6.0 16.0 -2.0 5.0 9.0 -13.0 16.0 9.0 4.5 -2.0C3 -6.0 15.0 -2.0 5.0 9.0 -13.0 16.0 9.0 3.6 -2.0C14 -5.0 14.0 -2.0 5.0 8.0 -12.0 15.0 9.0 2.5 -1.0CS -5.0 13.0 -2.0 5.0 7.0 -12.0 14.0 9.0 0.8 0.3

Gin! (Cefficient

Urban

Incuie -0.4 1.6 -0.3 0.5 0.7 -1.4 1.1 0.6 -0.6 1.6Cbnsuwption -0.5 1.7 -0.3 0.5 0.8 -1.4 1.2 0.6 -{).6 1.1

Rural

Inco,e -0.4 4 -0.1 0.4 0.7 -0.6 0.9 0.8 -0.9 1.9(bnsuiption -0.4 1.4 -0.1 0.4 0.7 -0.6 0.9 0.8 -0.9 1.9

- 109 -

Table 4.9 INDIA: Reserves Experiments (Basic Data)

1976-77 1977-78 1978-79 1979-80

Foreign Savings a'

Historical Run -1031 -903 -575 -299

Bold Scenario -87 1561 2577 2115

ConservativeScenario -899 437 1282 413

a/ Nominal magnitudes (tens of millions)

- 110 -

Table 4.10: INDIA: Reserves Experiment (Bold)(Percentage deviation from historical run)

1976-77 1977-78 1978-79 1979-80 1980-81

GDP 1.7 3.6 4.1 3.7Private Consumption 0.1 0.5 0.9 1.0Investment 11.2 28.2 28.2 23.0Exports -10.3 -23.2 -26.2 -19.5Imports 10.9 33.1 38.3 29.0

Gross Outputs ofAgriculture 0.1 0.2 0.9 1.2

Consumer Goods -1.2 -1.9 -1.2 -1.0Capital Goods 11.4 28.2 28.4 23.6Intermediates 3.1 7.9 8e9 9.5Infrastructure 0.1 2.2 3.5 4.0Services -0.1 0.3 1.0 0.9

Domestic Productionof Capital Goods 10.7 26.4 26.3 22.1

Imported CapitalGoods 18.2 47.7 49.8 38.6

Total Capital Stock 0 8.3 2.9 5.0 6.4

Urban-t o-RuralPer Capita Ratios

Income 1.0 3.2 2.6 3.1Consumption 0 1.7 1.6 1.1

Table 4.11: INDIA: Reserves Experiment (Bold)Distributional Cnaracteristics (Parcentaae deviation from historical run)

Cost of Living IndicesGroups 1976-77 1977-78 1978-79 1979-80

Urban

C1 7.0 17.0 20.0 14.0C2 7.0 17.0 20.0 14.0C3 7.0 17.0 20.0 14.0C4 7.0 17.0 20.0 14.0C5 7.0 17.0 20.0 14.0

Rural

Cl 7.0 17.0 21.0 14.0C2 7.0 17.0 21.0 14.0C3 7.0 17.0 20.0 14.0C4 7.0 17.0 20.0 14.0C5 7.0 17.0 20.0 14.0

Gini Coefficient

Urban

Income -0.1 -0.2 -0.1 -0.1Consumption -0.1 -0.2 -0.1 -0.1

Rural

Income -0.1 -0.2 -0.3 -0.4Consumption -0.1 -0.2 -0.3 -0.4

- 112 -

Table 4.12: INDIA: Reserves Experiment (Conservative)(Percentage deviation from historical run)

1976-77 1977-78 1978-79 1979-80 1980-81

GDP 0.2 1.8 2.1 1.3Consumption 0 0.1 0.4 0.4Investment 1.3 14.5 15.6 7.1Exports -1.2 -13.3 -16.3 -5.9Imports 1.2 16.2 20.4 7.7

Gross Outputs ofAgriculture 0 0 0.3 0.4

Consumer Goods -0.1 -1.2 -1.1 -0.2Capital Goods 1.3 14.4 15.7 7.3Intermediates 0.4 3.9 4c7 3.0Infrastructure 0.1 1.0 1.8 1.4Services 0 0 0.4 0.4

Domestic Productionof Capital Goods 1.2 13.6 14.6 6.9

Imported CapitalGoods 2.0 23.4 26.5 10.9

Total Capital Stocks 0 0.1 1.2 2.4 2.9

Urban-to-Rural PerCapita Ratios

Income 0 1.6 1.6 1.0Consumption 0 0.8 0.8 1.1

- 113 -

Table 4.13: INDIA: Reserves Experiment (Conservative)

Distributional Characteristics (Percentage deviation from historical run)

Cost of Living IndicesGroup 1976-77 1977-78 1978-79 1979-80

Urban

C1 1.0 9.0 12.0 14.0

C2 1.0 9.0 12.0 14.0

C3 1.0 9.0 11.0 14.0

C4 1.0 9.0 11.0 14.0

C5 1.0 9.0 11.0 14.0

Rural

C1 1.0 9.0 12.0 4.0

C2 1.0 9.0 12.0 4.0

C3 1.0 9.0 12.0 4.0C4 1.0 9.0 11.0 4.0

C5 1.0 9.0 11.0 4.0

Gini Coefficient

Urban

Income 0 -0.1 0 0

Consumption 0 -0.1 0 0.1

Rural

Income 0 -0.1 -0.1 -0.1

Consumption 0 -0.1 -0.1 -0.1

- 114 -

Table 4.14: INDIA: Investnt lla1ocation Experiment(Percentage deviation from historical run)

GrxTps 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84 1984-85

GDP 0.5 0.6 0.7 0.7 027 0.8 0.6 0.1 1.1 0.9Private Consumption 04 1.3 0.8 0.9 1.2 1.0 1.1 1.2 2.2 2.1Investnent 0.4 1.1 1.3 1.5 2.1 1.8 1.4 1.5 2.3 2.3Exports 1.7 -7.4 -1,4 -2.6 -6.4 -3.3 -5.2 -9.2 -7e2 -9.8lports -14 4.4 0.9 2.1 5.4 2.2 3.1 7.0 7.0 8.7

Gross Outputs ofAgriculture 0.2 0.4 0.3 0.3 0.2 0.4 0.5 0.3 0.6 0.6

Corusupr Goods 1.2 1.0 1.2 1.5 1.1 1.5 1.J 0.9 2.4 2.0Capital Goods 0.3 0.7 0.8 0.9 1.1 1.1 0.8 0.7 1.2 12Intermediates 0.5 -0.2 0.6 0.4 01 0.9 0.8 -0.2 0.7 0.4Infrastructure 0.2 0.5 0.1 0.0 -0.1 001 0.0 -0.3 0.6 03Services 0.0 -0.1 -0.5 -0.9 -1.1 -1.1 -1.2 -1.7 -0.6 -0.8

Capital Stocks inAgriculture 0.6 1.0 12 0.8 1.5 1.4 1.3 0.9 6.1 3e4

Consuer Goods 15.5 21.7 26.4 34.3 36.7 35.8 31.7 31.5 47.6 43.6Capital Goods 15.3 21.2 25.8 32.8 34.6 33.0 30.2 31.0 45.7 41.5Internediates 15.1 21.0 25.4 32.5 34.2 32.8 29.4 29.7 44.1 40.2Infrastructure -2.7 -4.8 -6.2 -8.4 -11.0 -9.6 -8.6 -9.7 -1.9 -8.1Services -5.2 -8.6 -11.8 -15.4 -17.7 -19.8 -21.1 -22.5 -16e3 -16.8

Ibtal 04) -0.2 -0.6 -10 -1.2 -1.6 -2.0 -2.4 5.5 3.1 L7

Foreig Saving(Level, tens of millions)

Historical Rm 961 579 -1031 -903 -575 -299 1996 2412 2370 2650nvesstment Peallo-

cation Experiment 905 889 -951 -741 4-4 -177 2153 3075 3347 4075

Terrs of Trade

Historical 1m 0.727 0.702 0.676 0.808 0.732 0.528 0.571 0.684 0.737 0.728Tnvestrient Reallo-cation Experiment 0.720 0.735 0.683 0.821 0.763 0.540 '.592 0.732 0.778 0.779

Table 4.15: INDIA: Investment 14-nallocatlo Erqerimn1:tDLstrihutlonal OiaracterisLics (Percentage deviationi froun historical nrn)

Cost of Living IndicesGroupl 197t-75 1975-76 1976-77 1977-78 1978-79 1979-80 198081 1981-82 1982-83 1983-84

Urban

ci 0 6.0 3.0 4.0 6.0 4.0 5.0 8.0 7.5 9.0C2 0 6.0 3.0 4.0 6.0 4.0 5.0 8.0 7.5 8.9C3 0 6.0 3.0 4.0 6.0 4.0 5.0 8.0 7.4 8.9C/ 0 6.0 3.0 4.0 6.0 4.0 5.0 8.0 7.5 9.0C5 0 6.0 3.0 4.0 6.0 5.0 6.0 8.0 7.4 8.9

Rural

c1 0 6.0 3.0 4.0 6.0 4.0 5.0 8o0 7.6 9.0(12 0 6.0 3.0 4.0 6.0 4.0 5.0 8.0 7.5 9.0C3 0 6.0 2.0 4.0 6.0 4.0 5.0 8.0 7.5 8.9

0 6.0 3.0 4.0 6.0 4.0 5.0 8.0 7.5 9.0C5 0 6.0 3.0 4.0 6.0 5.0 5.0) 8.0 7.5 9.0

CLIi CefficientLs

Urban

Incone 0.4 1.4 0.6 0.6 0.7 "0.7 0;7 0.6 -i c"L 1.2 >' :U w u(Cbnstnrption 0.4 1.5 0.6 0.7 0.8 0.7 0.7 0.6 1.2 1.2

Rural

Incoe -{.1 0.1 -0.1 -0.1 -0t -0.2 -0.2 -0.1 -0.3 -0.3Constwption -0.1 0.1 -0.1 -0.1 -0.1 -0.1 -).2 -0.1 -0.3 -0.3

- 116 -

Chapter 5: CONCLUSIONS

I. IMIRODUCTION

This paper offered an overview of developments in the Indian

economy from 1973-74 to 1983-84 and placed them in historical

perspective (Chapter 1). It then formulated and calibrated a six sector

general equilibrium model characterized by a detailed treatment of

distributional issues and capable of articulating the implications of

different policies for the economy's debt burden distinguished by

maturity structure (Chapter '2 and Appendices 1-3). The model was

calibrated to a 1973-74 data set specially put together for that

purpose. (Appendix 4). The responsiveness of the model to various

parameters and exogenous varibles was then examined and the information

used to allow the model to replicate actual developments from 1973-74 to

1983-84 (Chapter 4). This historical run served as a benchmark against

which counterfactual policy simulations could be compared. Various such

simulations were run and their impact on the major macroeconomic

aggregates, sectoral output, income distribution and the economy's debt

profile examined (Chapter 5).

II. RESULTS OF THE POLICY SIMULATIONS

No External Shock-Cum-Accommodatina Borrowing

The experiments began by assessing the net impact of terms of

trade fluctuations and associated external borrowing on the Indian

economy. It was seen that accommodating borrowing from the IMF and

various oil-related development institutions after the first oil shock

Chap-5/(India Shocks:4-11-86:pp

- 117 -

and the Extended Fund Facility with the IMF after the second oil shock,

together with workers' remittances following both shocks, more than

offset the deleterious impact of terms of trade movements. GDP, private

consumption and investment would have been lower in the no external

shock-cum-accommodating borrowing scenario: indeed the capital stock in

1984-85 would have been 8 percent lower. Domestic production of

consumer goods and infrastructure would have gone up at the expense of

capital goods. This would to some extent have intensified rather than

allayed concerns that have been expressed (see Chapter 1) about the

stagnation of investment compared to the pre-1964-65 years. However, as

expected the debt burden would also have been lower - by nearly 48

percent at the beginning of 1983-84.

Alternative Adjustment Strategy

We also asked what might have happened had the ratio of

investment to GDP been stepped up following the first round of shocks,

with selective imports of consumer goods being used to combat

potentially inflationary pressures arising from harvest failure. The

higher investment would have led to a capital stock in 1984-85 which was

nearly 2 percent higher than in the historical run. GDP and private

consumption were also higher. Domestic production of capital goods

would have gone up at the expense of infrastructure and consumer

goods. In the absence of any other measures, however, the economy would

have been left with a 27 percent higher stock of debt by the beginning

of 1983-84.


- 118 -

No Agricultural Fluctuations

Since it is understood that the "deflationary" profile of

adjustment to the first round of shocks was shaped by a perception that

inflation arising from harvest failure needed to be controlled, we asked

what would have happened had agriculural shocks not occurred. The peaks

and troughs in GDP?, consumption and investment in that experiment

mirrored those in the exogenous variable which proxied weather-related

fluctuations. Thus, the above macroeconomic variables would have been

higher if weather-related dips had not occurred; their behavior would

have been the opposite in the absence of weather-related peaks. In the

light of the sensitivity o.f investment to agricultural shocks noted

earlier, the 1984-85 capital stock also have been lower - by 6.5 percent

under the no agricultural shock scenario. This shows that the

cumulative effect of agricultural peaks dominated those of the troughs

in the historical run, resulting in an enlarged supply of wage goods and

thus permitting higher savings, investment and terminal capital stock.

The assumed connection between agricultural shocks and the perceived

need to effect deflationary adjustment makes it instructive to ask what

a "no agricultural shock-cum-deflationary adjustment" would have implied

for the economy. This, however, simply involves adding the present

experiment t3 the previous one. It is an obvious counterpart to the "no

external shock-cum-borrowing" experiment.

Reserve Decumulation

The model was also used to explore the consequences of India's

following a less cautious policy with respect to reserve accumulation.


- 119 -

with actual reserves were added to foreign savings. This generated a

substantially higher profile of GUP, private consumption and investment

leading to a nearly 3 percent increase in the capital stock by 1980-81,

an increase in production of capital goods and infrastructure at the

expense of consumer goods and some widening in urban-to-rural per capita

income levels. Since "excess" reserves were available in those years,

they would have allowed the economy to sustain a less deflationary

adjustment strategy of the kind formulated in the last experiment .

However, since the extra foreign savings would have come out of reserves

rather than fresh borrowing, the debt burden would have been lower than

in the previous experiment. The question could be answered by combining

the themes of those two experiments.

Investment Reallocation

Attention was also devoted to the issue of varying the

allocation of investment across sectors as part of an overall policy of

adjusting to shocks. A seemingly plausible but myopic policy of

allowing investment allocation to take advantage of sectoral differences

in current profitability was implemented. This led to higher GDP,

consumption and capital stock, which was 1.7 percent higher in 1984-85

compared to the historical run, while pulling resources out of

nontradeables and towards the tradeable sectors of the economy. But it

also left the economy with a stock of debt which was 27 percent higher

at the beginning of 1983-84. This was the result both of higher import

intensity of sectors towards which investment was redirected, as well as

an increase in domestic demand pressure and a consequent bidding up of


- 120 -

domestiic vis-a-vis interrnational prices. This experiment, however, was

only a start towards examining the question of how investment is best

reallocated among sectors in response to exogenous shocks.

Adjustment to Exogenous Shocks and Income Distribution

An interesting feature of all the policy simulations is the

virtually uniform impact on all groups of households. Indeed, there is

hardly any movement in the Gini coefficient of income or consumption

inequality, which, under the assumption of lognormally distribuced

income and consumption, is an adequate measure of inequality. The cost

of living indices do not move significantly differently a!ross the ten

groups of households identified by the model,. Nor is there any movement

in the share of the bottom 40 percent in income and consumption. This

is partly due to the "full employment" character of the model, so that

there are roughly offsetting movements in returns to all households from

different soirces.-L Thus, while some factors gain and other lose as a

result of different policies, these do not, at our chosen level of

aggregation, make much difference to the relative incomes of

households. Since the segmented labor market-cum-full employment

assumption does not appear unreasonable and since the data do not permit

any further significant disaggregation of households, it seems

appropriate to conclude that the distributional impact of adjustment to

1/ Recall that the "full employment" assumption refers to no openunemployment of laborers. In fact, those who cannot find highpaying employment drift into low-productivity occupations where thewage must move to clear the market.


- 121 -

exogenous shocks in India was not significant. - If this conclusion is

correct, it is because the range of policies explored here do not

envisage redistribution of endowments, for example, of land and capital,

which policies would certainly change the distribution of income and

consumption. Since such redistribution was in fact not an element in

discussions of adjustment in India -iuring this period, our conclusions

on distribution appear to be warranted. It is important to stress

however that these remarks apply -:o th.e size distribution of income and

not necessarily to the regional or functional distribution of income.

As an example, we m><- point to the decumulation of reserves experiment

of Chapter 4, where the urban-to-rtural per capita income ratio changed

noticeably (see Table 4.10).

III. CONCLUDING REMARKS

In conclusion, there are three points which require explicit

mention. First, in keeping with its focus on medium-term issues such as

growth and distribution, our exercise has concentrated on the "real"

side of the economy. The exclusion of monetary considerations has been

deliberate. But it has implied that issues such as the consequences of

using deflationary monetary policy to combat cost-push

1/ Notice that we have been operating in a two-parameter lognormal

world where the entire Lor-enz curve is uniquely determined by the

distribution parameter a. Consequently, given a prior

specification of the poverty line, the Gini coefficient and the

headcount ratio measure of poverty would mostly move in the same

direction.

Chap-5/(India Shocks :4-11-86:pp

- 122 -

inflation versus adopting a more accommodating stance could not be

addressed here. I/

Second, there are certain areas which the model, as it currently

stands, is well capable of illuminating but where no experiments have

yet been done. Prominent among these are chanaes in taxes, both

domestic and trade-related, government transfers and public consumption

of goods and services. Measures such as changes in trade taxes as part

of import policy and in domestic taxes as part of resource mobilization

could easily be simulated, since consistency requires our economywide

model to keep track of components of the government budget. -/ They

could provide answers to interesting policy questions such as: by how

much would taxes have to be changed in order to finance higher

irnLvestment after the second oil shock without recourse to the IMF and

otii.eL' sources of external assistance? Indeed, the next set of issues

whf.cl-i. we intend to address using the model relate to the use of tax and

v).-taraLsfer policy both in response to exogenous shocks and, indeed, more

greerally.

Finally, the model has been run as a tool for simulation.

There remain interesting questions of optimality of adjustment and the

associated aspects of formulating forward-looking investment and current

1/ The only "anti-inflationary measure" modelled in the experiments isthe import of food and edible oils to maintain domestic availabilityat levels not falling short of those in the historical run.

2/ Thus we could have reported the impact of the Chapter 4 experimentson the government budget for every year.


- 123 -

account behavior. Intertemporal optimization of the India model as

currently formulated would be prohibitive at the present time. However,

work has been done as part of this research project on approximation

techniques which allow such experiments to be done. These have been

implemented in a preliminary way in a companion study on adjustment in

Thailand. 2/ We hope to apply those ideas to study the optimality of

adjustment in India in future work.

1/ H. Sierra and T. Condon," An Approximation Technique for Computing

Optimal Dynamic Paths." (Development Research Department, The World

Bank, October 1985, processed).

2/ S. Devarajan and H. Sierra, "Growth Without Adjustment: Thailand,

1973 to 1982," (Country Policy Department, Discussion Paper No.

1986-5), World Bank, December 1985.


- 124 -

Appendix 1: Equations of the Model I/ 2/

Production Equations:

Sector 1 (Agriculture)

Recall that the CES tree structure in agriculture is given by

x

z

V N

S \ ND NM

H Ls

1/The notation is described on pp. 150-158.

2/A standard reference on computable aeneral equilibrium models isK. Dervis, J. de Melo and S. Robinson, General Eouilibrium Models forDevelopment Policy (Cambridge University Press, 1982).

Appendixl/India Shocks/PMitra:4-11-86:pp

- 125 -

ax

Ix I - aaG 1X- Ia 1 7X IX a" (A l 1 -I a 1(1.1) Xz(.)X=(GBG G P XXA [(Al') P X

(supply of X)

(1.2) Z = X AX - 1 ) Xpz

(demand for Z)

X-I I

(1.3) pG = A P a (X)XXG G

(rental rate on G)

(1.4) V = Z pVV

(demand for V)

(1.5) N =- ~ cZN aN

(demand for N)

z 1 -a a 1- a 1 - a(16) Pz - (a PV Z+ aN P N

(pricing rule for Z)

Appendixi/India Shocks/PMitra:4-11-86:pp

- 126 -

(1.7) ND = N ( D N aN

D

(demand for ND)

(1.8) NM = N PNM JNM

(demand for NM)

(1-9) P [aN 1 +N Nl aNN l N

D ND

(pricing rule for N)

(110) ND a.P (1 + t ) where i is the using sectorD .5 XND

(pricing rule for ND)

(1.11) pNM M . Pi (I + tN + tRM where i is the using sector

(pricing rule for N)


- 127 -

ctP sp a.(1.12) S =V

(demand for S)

(1.13) LW = VBLR lP )LW

(demand for LW)

P1 - a, a 1 - a ~ 1-

(1.14) Pv s Ps + eg LRV

(pricing rule for V)

(1.15) LR -SSjL

(demand for LS)

(1.16) H S BHS 1H(C S

(demand for H)

p1as P 1 -a aSr L1I -~ I 1 as

Ps Ln ) S + aLS SB ) IH SL

(pricing rule for S)

Appendixl/India Shocks/PMitra:4-11-86 :pp

- 128

Equations (1.1) - (1.17) describe the production side of

sector 1, agriculture.

Equation (1.1) is a CES output supply function expressing X

as a function of the output price, P., input price, PZ and supply of

infrastructure, G where

A: rate of Hicks-neutral technical progress

B.: rate of factor j-augmenting technical progress

elasticity of substitution between Z and G.IX

Equation (1.2) is an input demand function for Z, while

equation (1.3) residually yields the rental rate earned by

infrastructure in the agricultural sector. Equations (1.4) and (1.5)

are the demand equations for value added and intermediates, while (1.6)

expresses Ez in terms of the prices of its constituent inputs, PV and

PN. Equations (1.7) and (1.8) are demand functions for ND and NM, while

(1.9) expresses PN in terms of the prices of ND and NM. Equations

(1.10) and (1.11) define P and PN as weighted averages of theirND N

component prices, with the weights being the input-output coefficients

making up those aggregates. Notice that the summations in (1.10) and

(1.11) exclude sector 5; the interindustrial flow from sector 5 (public

infrastructure) to any sector j is G. which appears at the upper

level of the CES tree. Equations (1.12) and (1.13) are the demands for


- 129 -

S and LW, while (1.14) is the price of value added. Again, (1.15) and

(1.16) are the demands for LW and H, with (1.17) being the price of S in

terms of its constituents.

Sectors 2, 4, 5, 6

Equation (1) to (11) are identical to those above.

Since the.portion of the tree below value added in sectors 2

to 6

is:V

K s lw

equations (12) - (16) are replaced by the following:

(2.12) K =V -1 ( e V )vpK

(demand for K)

(2.13) Lw V B LV W VLW

(demand for Lw)

(2.14) Ls V a 1 Vp

(demand for L5 )

Appendixl/India Shocks/PMitra :4-11-86 :pp

- 130

(2.15) PV = + a a ) L---aBK T VWU LuS'~

(pricing rule for V)

Sector 3

Equations (1) to (11) are identical to those above.

Equations (12) to (15) are identical to (2.12) - (2.15)

Since sector 3 has significant quantities of almost-finished

imports, M, it is necessary to add the following ecuations:

(3.16) X - (CX) (CX)-CX

(demand for X)

(3.17) M - (CX) (p + +~M1 tFM + RMM

(demand for M)

(3.18) PCX xa + - (PM (I + tFM)

(pricing rule for CX)

Consumer Prices

Consumer and producer prices are connected via indirect taxes

and trade margins. Define

(4.1) Po = Px for sectors 1, 2, 4, 5, 6; = P. for sector 3

Appendixl/India Shocks/PMitra:4-11-86 :pp

- 131 -

Then

(4.2) PC= P (I + tFT + t )c 0 FT) RMD

(consumer price of goods)

(4.3) PCLS = PLS (1 - tw)

(household return to self-employed labor)

(4.4) pCLW =LW (1 - tW)

(household return to wage labor)

(4-5) PcK PK

(household return to capital)

where tFD :tax rate on final demand

tRD :trade margins on final demands

tW :tax rate on wages


- 132 -

Income Generation

Five types of income are identified by the model

(5.1) Y = pCLS Ls

(income from self-employment net of depreciation)

(5.2) Y2 = pCLW Lw

(wage income)

Y3 PCH H (1 tp)

(land/capital incomenet of depreciation in sector 1)

Y3 PCK K (I -tp)

(capital income net of depreciation in sectors 2,3,4,6)

(5.3) y3 = p K ti (1 - tp)

(capital income net of depreciation in sector 5)

where tp = rate of profit tax

= proportion of capital in sector 5 (public which

Appendixl/lndia Shocks/PMitra:4-11-86:pp

- 133 -

is owned by the private sector.

(5.4) y P G (1 - 0)

(income from infrastructural flows)

where e = subsidy to intermediate users of infrastructure

(5.5) Y= GTRA + GTRB + NCT + NFI

(nonproduction-related income)

where

GTRA = interest on the national debt

GTRB = government transfers to households

NCT = net current transfers from the rest of the world

NFI = net factor income from the rest of the world

Depreciation is defined as

D1 = H PH H + 6I PLS LS

(5.6)

Di kPKK+ tSLS (i 2-.6)

where 6 is the rateof depreciation.


134 -

Demand Equations

Let Yij be the ith type of income generated in production sector j

(i = Self-employed, Wage, Capital, Infrastructural)

(6.1) i i (Y i2 +Yi 6) + 5

It is assumed that the ith type of production income in the

rural areas comprises all income from sector 1 (agriculture) and a

proportion N of those originating in sectors 2 and 6 (consumer goods

and services).

(6.2) 6 R1 j=1ij

This defines the ih type of urban income.

Thus, Y5 is divided between rural and urban areas in the proportionff to 1-Tr.

55

R 5 Ry z y

i=l

(6.3)

0 i=1Let Gih share of the ith type of income accruing to houseltold

income

class h in sector 0 ( E ih= 1 0 = R,U for each i)


- 135 -

There are fifteen income-earning household classes in each of

the rural and urban sectors.

Then the income accruing to class h is

(6-4) Y = =z hQ YQ

Define

( = share of total households in a household class hh(O = R,tJ; h = 1, 15)

The mean and variance of household income in each sector are given by

'5 Q(6-5) y = 0 hYh

h=1

o0 0 - 2(6.6) V = E (Y Q

15

Let (6.7) Y h=i be the per capita income for Sector Q.PO

To help match disparate data sources on savings and income on

the one hand with household consumption expenditure on the other, it is

assumed that the distribution of popuilation according to per capita

household consumption expenditure and income is bivariate lognormal. It


- 136 -

follows (see (15) - (20) in Appendix 3 on the bivariate lognormal

distribution) that the mean (1y) and standard deviation (ay) of the

logarithm of per capita incomes are given by

(6.8) 2 ay)

v0 1

( 6 e 9 ) a = u (log [1 + - 2

where u is a factor converting variance of the household income into

that for per capita incomes.

The corresponding mean (p i) and standard deviation (a ) of the

logarithm of per capita expenditure may be written -

1/ It follows from equations (8) and (9) of the appendix on the

bivarate lognormal distribution and the ensuing discussion that

a° -Q -2c y

0Q 0

yc a0y

Appendixl/India Shocks/PMitra :4-11-86 :pp

- 137 -

(6.10) Q - + SQ QC

(6.11) aQ = k a' (Q= R,U)

Let N(xJ0, 1) denote the cumulated area under the standard

normal distribution (with mean zero and standard deviation unity) up to

the variate value x. It can be shown that (see Appendix 3 on the

bivariate lognormal distribution)

(a) Share of total population up to per capita expenditure

level c is given by:

(6.12) N [co C - c10, 1 = r (c) given 11 and aa Ic cc

(b) Share of total consumption accruing to the of population

up to per capital expenditure level c is given by

log c - p(6.13) N c - alO,1j = (c) given p and a

c

(c) Share of total income accruing to the population up to per

capita expenditure level c is given by

(6.14) [log c - - yc a |0, 1] = 6 (c) given a a and pNdia a SYC: y C, y ycC

Appendixl/India Shockcs/PMitra:4-11-R6:pp

- 138 -

Five classes, generally indexed by k, are identified for the

ensuing analysis of consumption.

Let CR c's c1 , cR be the upper limit of the class intervals1' 2' 3'

for first four classes (rural)

and CUI C 2, C4 - do - (urban)

then (1) the proportion of total population in five classes is given by

nQ n ( (C0)

n2 ~n(C 0 ) - n (C0 )

(6.15) nQ = ni (C0) - n (co)3 2

nQ = n (C0 ) - n c4 3

nQ= n (co~) - (CQ)nQ = n (CQ) - (C4°)5 '5 '4

(2) the proportion of total consumption accruing to five classes is

given by

QQ = p(C0)

-2 = (co) - (C0)2 2 1

(6S.16) 03 = (C0 ) - Q (C0)33 2

0 = p (CQ) - (co)

Q0 + ((:Q) - (C4 )


- 139 -

(3) the proportion of total income accruing to five classes is given by

ro = 6 (C)1 1

0r = 6 (CQ) - 6 (CQ)22 1

(6.17) rQ = 6 (C0) - 6 (CO)33 2

ro = 6 (C) -6 (Co)44 3

rQ = 6 (Co) - 6 (C0 )5 5 4

Mean per capita consumer expenditure in each of the rural and urban

sectors (see equations (16) in Appendix 3) is given by

(6.18) CQ = exp [Q+ 1 (a0 2 , (O = R, IJ)

Derive the per capita levels of consumption and income in each household

consumption group (Ck, and 7n) as follows:

-0 00

(6.19) 0 COk (k 1,...,5)k 0nk

-o o(6.20) k (i 1,...,5)

where n k OQ and rQ have been defined in (6.15) - (6.17).

The linear expenditure system (LES) for expenditure class k

and sector j is given by


- 140 -

6(6.21) i Pc +b, (C Pc xk.) ,forgiven x,, and .

where Ckj = per capita expenditure on commodity/sector j

for the kth expenditure class (k = 1...5, j = 1...6).

where xk' is the committed quantity in LES for the kth expenditure

group (i = 1, 2, ...5) and jth sector-specific consumption (j = 1, 2,

...6) and b is the marginal budget share for the kth expenditure

group and jth sector specific consumption.

Estimates of the parameters (xkj. bkj) are available for k = 1..., 5,

j 1..., 6 and for rural and urban population separately.

Aggregate jth sector-specific household consumer expenditurxe is given by

5 NR5(6.22) C. = _ NECR + U-

( k=1 k kj k=1 k ki

where Nk is the size of population in kth expenditure class given byk

N0 = n k TOTPQk k

Net household savings are given by

5k=l k k k nk Pk k kk

k=1 k=I

R U tand Pk , Pk signify population in the k expenditure class, whence

Appendixi/ndia Shocks/PMitra:4-11-86:pp

- 141 -

(6.23) SAV =Tp- z nH R t )+TP , l tk=1 k tCtk=1 r k ~

System Constraints

Material Balances

Final demand equals the sum of private and public consumption

and the sum of net fixed and replacement investment by sector of origin.

(7.1) FDi C + GOV1+ FITi + RI

The sum of domestic production, stocks carried over from the

previous period and imports must equal the sum of final and intermediate

demands, export demand and changes in stocks this period. Sector 6 has

an extra source of demand arising from the application of trade and

transport margins in all sectors of the economy.

i + F.i + E a.. ND. - M. + E + 6 (i = 1,2,4)

t-l 6 G+6

X=+ D. + 6 G + iE. (i 3)

i i i i

i i * i j=1 1i i P- j=1


- 142 -

+ 9 Jti + £>P |+6 (in Sector 6)

Exports are a downward sloping function of export prices relative to

prices of international competitors, as weLl as incomes in the rest of

the world.

pe

(7.3) Ei = X\OLi (i = 1,2,3,4)

where e is the base year nominal exchange rate and asterisks signify

international export prices.

Export prices differ from output prices by export trade margins

(7i4) i t (i = 1,2,3,4)

1

Final imports in sectors 1, 2 and 5 are controlled by the government

M= M, (i = 1,2,5)(7.5)

= g (i = 3,4,6)

The flow of infrastructural services to intermediate users is controlled

by the government.

(7.6) G= (i = 1 .... 6)

Public consumption demand for each sector is given.


- 143 -

(7.7) GcVi GOJVi (i = 1..6)

Gross fixed investment demand for each sectors I output is afixed proportion yi of total fixed investment and is defined by

6-(7.8) C mi Yi [Pc I+ E D;i (i = I...6)i, i j=1

6where GFIi Fii + RIh, Z 1 and K is proportion of fixed

i=1investment in total gross investment.

Changes in stocks by sector bear a fixed proportion wi tototal changes in stocks and are defined by

6t(7.9) p E i = W. (1-K) [PO I + . D.J (i 1... 6)

6where Z u I

i=1

The amount of land, the stock of capital in each sector, thenumber of self employed in sector 1 and total labour in sectors 2 to 6

are given in the initial period.

(7.10) H JH

(7.11) Ki =K (i = 2....6)


- 144 -

(7.12) Ls =L1 '

6(7.13) Z (Ls + L ) LNAG

i=2 i

It is assumed that the economy starts with no carryover of

stocks from the pre-hase period

-i 0 (i = 1...6)

Wages of organized labour in rural and urban areas are indexed

to their respective CPI's

(7.14) i-) = X (i = 1....6)i Ii

0*iere X (< 1) captures the degree of indexation.

The consumer price indices to which wages are tied in sectors

1 and in 2 to 6 are simple geometric averages of specific price indexes

for rural and urban households respectively.

Cpk = I C CPkR)0.2 I =k=l

(7.15)

CPIi = ( E c CPIk ,U) (i-2,. ,6)

The group specific indices are defined by


145 -

(7.16) GCPIO0 - (O = R, U)

1=1

Import prices are internationally given:

(7.17) P = ePNj Nj

where asterisks signify international import prices.

The economy's balance of payments constraint is given by

6(8.1) Fe = [P Ni 1 +j I PMj NMi

PO(1 + tR ) * NCT - NFI

NCT net current transfers from the rest of the world

NFI net factor income from the rest of the world

The savings investment equality is

6 6(8.2) SAV + Fe + SG tK Yi pc+ (l-K) i di o I

where SG is government savings, the difference between government

revenue (REV) and expenditure (PUBEXP).

6 ~6 6REV~~2 = .P 0 N + t m~. P t N + t P FD + t E.j ji ° NDN Di Ni 3 M. N F n0 i E.


- 146

+tW(PLS L s+ P LW )+ (PGp -PC5 ) CTi i

(8.3)

P K 5 p pH T + tPPK K5 (l-I) + t Z P K

+ tFM PM M3 + i {Po - PM (1 + tRMM B Mi3 3 i•#3 i j j

Thus, government revenue is the sum of tax revenue on intermediates and

final goods, tariff revenue on intermediates and, where applicable,

exports and final imports, revenue from wage and capital income and

income from infrastructure.

6

(8.4) PUBEXP = GTRA + GTRB + E PC GOVi=l

the sum of interest on the national debt, transfers to households and

the value of government consumption.

Thus, government savings

(8.5) SG = REV - PUBEXP

But (8.5) is not separately imposed, since it may be derived from the

other equations of the system.


- 147 -

Finally, total investment is determined in (8.2) as the sum of

savings, whence change in stocks and fixed investment demand by sector

follow from equations (7.7) and (7.9).

It has implicitly been assumed that depreciation is used to

undertake replacement investment in the same year. Since Yi signifies

the proportion of all investment (whether net fixed or replacement)

which must be met by sector i (E = 1) , it is natural to definei

replacement investment by sector of destination as

D.(9.1) T 6 1

0 [° +tRMDj + tFD] Yjj=1 j J J

Fixed proportions of total net fixed investment augment

capital stocks in each sector, net of depreciation

6Z D.

t+1 tJ

14 H I K [I y.

t -H)-IR = 1 <I 6

j-l j cj

(9.2)

6E D.

(K K)-IR = Xi X [I + 6 (i= 2 ... 6)

j=1 J cj

where


- 148 -

6(9.3) £ 1

i=1-= .Xi

Time series of L LNAG are provided to update those variables.

TJpdating Income and Expenditure

Equations (5.1) to (5.5) delineate five sources of householdincome. In years other than the base year, these are deflated by thefollowing price indices:

p t pOCLS CLS for self-employment income

p L / P0 for wage IncomeCLW CLW

Pt / P 0 for land incomeCH CH~

r t 0PCK / PCK for capital income

pt pO for infrastructural income

Nonproduction related income is deflated using the GDP deflator.

Incomes, so deflated, are used to calculate means and

variances as in (6.6) to (6.9). The bivariate lognormal thus has the

Appendixi/India Shocks/PMitra:4-11-86.pp

- 149 -

interpretation of being a joint distribution of per capita real incomes

and real expenditures.

To calculate the per capita expenditure levels CK entering in

the linear expenditure system (6.21) for subsequent years, it is

necessary to update the base year class limits, using the following

formula:

tR 6 t R 6 0 6 P. bk(9.4) Ckt = P cj xkj + ICckO - P cj xkjI ' (I ) kjJ=1 = j=I P.

where

Ct : upper limdt of expenditure class interval k in sector Q in year t

QC%D: upper linit of expenditure class interval k in sector Q in year O

(9.4) ensures that Ckt generates the same utility at year t prices,()0 0Pi , as does Cko at year prices, Pj, provided the indirect utility

function corresponding to the linear expenditure system (6.21) is

cardinalised such that, for any set of consumer prices, utility isproportional to the value of endowments minus the value of committed

consumption levels.


- 150 -

Notation

a- =

aji domestic input output coefficients

A = rate of Hicks-neutral technical progress

bkj marginal budget share for jth sector consumption by

expenditure class k

B. = rate of factor j augmenting technical progress

Ci = total private consumption of good i

Ck per capita expenditure of expenditure class k

Ckj = per capita expenditure on commodity j by expenditure class

k

CQ= upper limit of expenditure class interval k in sector Q

CPI = consumer price index

CX = gross output of sector 3

D. ¢ depreciation in sector j

Appendixi/India Shocks/PMitra:4-11-86:pp

e base year nominal exchange rate (rupees per dollar)

Ei = exports of good i

F = foreign savings (in dollars)

FDi = final demand for good i

FIi = fixed investment demand for good i

G = flow of infrastructure

GCPI - group-specific consumer price index

GOVi = government consumption of good i

GFIi = gross fixed investment demand for sector i

GTRA = government transfers

GTRB = interest on national debt

H = land

I = aggregate net investment


- 152 -

IRi replacement investment by sector of destination i

k constant relating standard deviation of per capitaexpenditure to standard deviation of per capita income

K capital

LNAG m stock of nonagricultural labor

LS = self emploved labor

Lw = wage labor

mji import coefficients

Mi final imports of good i

nk proportion of population in expenditure class k, sector 0

N= CES subaggregate of domestic and imported intermediates

NCT net current transfers from abroad

ND = fixed proportions bundle of domestic intermediates

Appendixl/India Shocks/PNitra:4-11-86:pp

- 153 -

NFI - net factor income from abroad

NM = fixed proportions bundle of imported intermediates

P price

PC - consumer price

p= prices of Indian exportables

PI international export prices

P= output price

PM = price of imported intermediates (?)

0Pk= population in expenditure class k

0k= proportion of consumption in expenditure class k, sector Q

PUBEXP = government expenditures

rk = proportion of income in expenditure class k, sector Q

REV = government revenue


- 154 -

Ri = replacement investment demand for good i

S CES subaggregate of land and self-employed labor

SAV = household savings

SG government savings

tASi change in stocks of good i

tE rate of export tax

tFD tax rate on final demand

tFM = tax rate on final imports

TOTPQ = total population in sector 0

tp rate of profit tax

t = trade margin on final demand

tR1iE = trade margin on exports

Appendixl/India Shocks/PPNitra:4-11-86:pp

- 155 -

tRMM = trade margin on imports

tW= tax rate on wages

V value added

Vy = variance of per capita income in sector 0

Xkj commltted quantity of jth sector consumption by

expenditure class k

X = gross output (except in sector 3)

XVOL - income in trading partner countries

Q= income accruing to asset owning class h in sector 0

Yi type of income

Yk per capita income of expenditure class k

Y amount of ith type of income originating in production

sector j

Y0 = aggregate income in sector 0 (rural/urban)


- 156 -

y mean household income in sector q

=0Y per capita income for sector 0C

Z = CES subaggregate of value added and intermediates

a - share parameters in production function

Yi proportion of fixed investment demand directed at sector i

EC price elasticity of export demand

X = wage indexation parameter

0'1 - mean of logarithms of per capita consumption, sector 0

0p mean of logarithms of per capita incomes, sector Qy

py = coefficient of correlation between log y and log c

a = elasticity of substitution

a0 - standard deviation of logarithms of per capita

consumption, sector 0


- 157

= standard deviation of logarithms of per capita income,

sector Q

h proportion of households in asset owning class h

I proportion of capital in sector 5 which is owned by the

private sector

O= subsidy to intermediate uses of infrastructure

= rate of depreciation

= proportion of income originating in sectors 2 and 6 going

to rural households

"ih share of ith type of income going to asset owning class h

r = proportion of nonproduction related income going to ruralhouseholds

K = share of gross investment accounted for by fixed capitalformation.

xi proportion of changes in stocks accounted for by sector i


- 158 -

x proportion of total net capital formation going into

sector i

u a adjustment factor for number of individuals in a

household.


- 159 -

Appendix 2: The Debt Module

Let Dt be the total stock of debt in period t, and NF t net foreign

borrowing.

Then:

Dt = Dt-I + NFBt

where:

NFBt = CAt + It + t -DFIt

CA = current atcount deficit

I interest payments

a = change in reserves

DFI = direct foreign investment (the component for

repayment of past debt

Given CAt (from base run path), It, and St (obtained from

data), the value of DFIt (direct foreign investment) is residually

obtained so that NFBt reproduces historical data. All data have to be

expressed in base year local currency.

There is a different maturity structure for official and

private medium-term debt as well as for short-term debt. It is assumed

in the experiments that additional borrowing is split between medium

(official and private), and short-term debt according to the proportions

in the historical run.

Appendix2/India Shocks:PM:4-11-86:pp

- 160 -

For experiments, it is necessary to know how additional

borrowing in year t affects the stream of service payments (and hence

the current account deficit) in future years. It is assumed that the

interst rate, grace period and maturity period for additional borrowqing

in any year are the same as those the country faced for actual borrowing

in that year. Moreover, it is assumed that the stream of service

payments to repay a given loan is constant across the years in which the

payments are made. Thus, if the country borrows NFB in year 0 at an

interest rate r, with a grace period g and a maturity period m, then it

pays rNFB during years (1, 2 ... , g). For the remaining m-g years, -/

the country pays a constant service payment S per year. The present

value of this strean should equal NFB (the outstanding debt at year g)^

M S = NFBE (1+r)t g

t=g+l

or

S-r(l+r) >-gNFS NFB

To compute the allocation of S between interest and

amortization, notice that indebtedness follows the difference equation:

Dt = (l+r)D t- s - S

or

Note that we assume the maturity period of a loan includes thegrace period.

Appendix2/India Shocks :PM:4-11-86:pp

- 161 -

ft t-1D t (l+r) D - Z (1+r) Sft t=O

Thus the interest payment on this additional debt at time t is

It r = r(l+r) D - [(l+r) - 11.

The amortization payment at time t, At. then is the difference between S

and It"

Now, the actual service payment at t, St is the sum of service

payments on debt contracted at different years in the past. Hence,

ft-ilft

St Z ak NFB + Stk=O

where

rk if t - k < gk

t. rk (1 +rk k

ak if mk> t - k > gk +1(l+rk) m -g 1

if t - k > mk

Similarly, the interest payment at t, It, is given by the sum of the

interest payments on debt contracted earlier.

t-1 ,t1~ t ttlk-4It k=O (Yk NFBk (I + yktl ky St(( + tzt- I) AI

where


- 162 -

rk if t - k mkand Y 0 t mk

O if t - j>mkt t

S = aNFBk k

The elements St, It are parameters that are obtained residually so

that the values S., kI are equal to historical values.

Appendix2/India Shocks:PM:4-l1-86 :pp

- 163 -

Appendix 3: The Bivariate Lognormal Distribution

A standard treatment on the lognormal distribution is

Aitchison and Brown.-L The following exposition is self-contained.

The joint density

The probability density function (p.d.f.) of the joint

lognormal distribution of two variables y and c may be written:

A y,c) 1 - exp - 2 o- [- - 2yc a2yy c 2 92r 2(l-p ) y

~yc y

log y - log c - p logc- . 2

-2 Py c)( - ) + ()] 1a a ay c c

The marginal distribution of y is:

Ay(y) = r A (y,c) dc (2)

1/ J. Aitchison and J. A. C. Brown The Lognormail Distribution(Cambridge University Press, 1969),


- 164 -

The expression in square brackets in (1) is

log y - 2 log y lOgc log c lc 22Pyc ( a ) ( C)y y c c

log cc log y- u 2 lo p

c r , )l + (1 Q2 _ _ _

P3 a Pa )a t p

c y y

log e b 2 2 log y-

a + y c ac y

where b = Ic + Pyc (7) (log y- Yyy

Hence

log c-b 2 log 2

A (y) =f exp - 12 _ _ + ( yc ) a( d cy c ayaor/1-pyc 2Tr 2(1-pC) aY

(log y - u 2 - (log c - b) 2exp[- 2 a - ] exp a 2 -p

Y c PVC dc (3)y Ty V02 7r c a/1 - py 2 7r

Appendix3/India Shocks :PM:4-11-86 :pp

- 165 -

The integrand in (3) is the p. d. f. for a variable ca

distributed lognormally with mean b ( Vj + p c (log y - ii) and2 2 yvariance ac (1 - p C).

H?ence the integral is unity and

(log y - 2 )exp l- 2

2 a

AY(y) y a (4)

2.Hence y is distributed lognormally with mean p and variance a * Morey

compactly,

(A a 2) (5)y y

Similarly,

c A a ) (6)c c

Now,

A (y, c) = A (y) A (cjy) (7)

where A (c|y) is the conditional p.d.f. of c given y. The

manipulations leading up to (2) and (4) then show that

a2 2| y A (l + p - (log y - ij ) a 2(1 - p )2

A dc ycIa y c yc

Appendix3/India Shocks :PM:4-1 1-86 :pp

- 166 -

Thus

ycay

Since the coefficient of log y, in the above expression for the linear

conditional mean E(log c flog y) is P a , which is the product of thea y

correlation coefficient with a, it follows that py, is they

correlation coefficient between log y and log c.

It can be shown in analogous fashion that

yc A ( + p -a (log c - pc a 2 (1 -p2 (10)

Moments

The product moments of (1) about the origin are

1 = J y cq A(y,c) dy dc (11)

Substitute y = log y, c = log c to get

exp [py + qcj N(y,c) dy dc

where N(y,c) is the joint normal p.d.f. of y and c Thus,

Iiq f Jf [exp pyl N(y) [jI- [exp qc] N(c|y) dc] dy (12)


- 167 -

From the properties of the normal density,

aA q a (1p)ep [qcJ N(c|y) dc = exp {q I + p c (y - p) + C 2 C

yIt follows that 2 2

a qc p ) a A A

{1' OP-q p- qp I exp i Y(Lp p ')j N (y) dyyer y c a Y

The properties of the normal density again yield

2 2a A A

xp P[(p + qP py )y] N(y)d = exp {(p + qP a (P + qp aT y

Thus

2

2 2 2 (+q a C )a qa 2 (1 pC) a 2 ~ yclJq=exp {q vi - q p- + 2 e+p (p + qp -22 + a ______

pq c yc a y 2y yca vry 2

This may be simplified to

1a 2p 2+2p aapq +a~ 2q2V yc 1 exp ( i p + p q + 2 7 (13)

A d Iy c 2


- 168-

Substitution yields

2

-exp lly + 2

lo 2

14exp [p +

10I exp 2L,iy + a 2 (14)

10 2

exp 2[it + a

1a 2 + 2 a CT +ac 2111 exp [(i + v1 + 2 y C c

1y

Thus

2

y = exp [i.zy+ 2Y - ( 15)

2

c = exp [ IA + 2 ( 16)

1 1 2 -2 2 (17)

Va = 120 -( 10 y [x ay(7

-2. 2Var c = c [exp (aC)-l (18)

COV(y,c) 1 I 1 0 = Y [exp (Pyc a a) -1) (19)11 1 "yc y c

Cov(y,c)

Correlation coefficient Var y V Var c

Appendix3/India Shocks:PM:4-1 1-86:pp

- 169 -

exp [p a a - 1]

2 c 2 l2 (20)[exp ( a ) - ]2 [exp (ac) - 1]

W4e next establish the relations (6.12) - (6.14) appearing in

Appendix 1.

Let A(c) denote the marginal p.d.f. of c,

Then

JC A(c')dc' = n(c) is the share of the total population up to per0

capita expenditure level c. Hence

log c - PC 1 which establishes (6.12)n(c) = N [ a I 0,1]c

Jc c' A(c') dc'

Next, J c' A(c') dc' is the share of total consumption0

accruing to the population up to per capita expenditure level c.

Then

(log C CC c' A(c') dc' = C exp [ - c ] dc'o ocaCY2 r 2 ca

cC

(log c, 1 co c a V2X exp [log c' ,- c_2 dc'

c2

I. fcogciC, 2 2a exp(i+-2-) c { 2Clogc' + ac)r }dc'a Y2 r 2 0C' ~ 2 Ccc 2a


- 170 -

a 2

Since, t (163, r- ct AWc) dc' = (,u 0 + 2c3o c 2

c C

(C) = log c p ich establishes (6.13)

ic Ea C Iolc

Next ,

=E(vfo c' c)6(c) = . IE(Cy)

= EC(y - 02 log c' s log c)

E(y)

ECtI log c+pE< S log C' s log c) - -a p V' L(lop [ 0 c

(y -a~ T 00 y Pyca

~1 2 (1 P ~ ~C)l 2 C+ f aex1pP (logcxpd-glog c'-cd

Put x 3 t to get


- 171 -

E(y| - X log c' 6 log c) - exp [ + 2 a2(1-o2 )]

1 l1Og c ~ cy 2y1 2727 ac exp [...p c craxl dx

16g c -

= exp I lJ+ -ah-2 fy=T 2 y2] ac exp [ (x -p a )2] dx

2 YC [y

E(y) (Nlog c - - P 10JJ,il

Thu8s,

(d) = N ( a C p caj 0,1], which establishes (6.14).Ca S


- 172 -

Appendix 4: Data Base

Compilation of basic parameter estimates for the model is an

inherently complex task bristling with several difficulties. To start

with, official statistics are not always available according to the

concepts used in the model. Secondly, the breakdown of the available

conceptually appropriate statistics into certain components such as

rural-urban, different sectors or different classes of households is not

available. Thirdly, the available breakdown into components may refer

to a time-point or time period other than the one for which the model is

being computed. Consequerntly, in a large number of cases, a variety of

transformations and manipulations have to be carried out on the original

data involving assumptions which appear prima facie 'plausible'; and in

some cases, it is even necessary to make an educated guess regarding the

rplausible' parameters in the absence of any empirical studies and

data. All these operations inevitably involve subjective judgements

which may differ from researcher to researcher or even for the same

researcher at different points of time. In this appendix, we spell out

the data sources as well as the particular judgments made in making the

data consistent with the requirements of th;e model.

Appendix/India Shocks:4-11-86:pp

- 173 -

Alphabetical List of Abbreviations of Data Sources

Ahmad-Stern (Private Communication)

Chandhok H. L. Chandhbk: Wholesale PriceStatistics. India, 1947-1978. Economic andScientific Research Foundation, Delhi(1978) Volume I.

CMIE-BS Centre for the Monitoring of IndianEconomy: Basic Statistics Relating to theIndian Economy. Volume I (All India)(October 1979)

CSO-ASI Central Statistical Organization AnnualSurvey of Industries. Factory Sector 1973-74.

CSO-NAS Central Statistical Organization; NationalAccounts Statistics, various issues.

CSO-NAS-IOTT Central Statistical Organization; NationalAccounts Statistics: Input-OutputTransactions Table 1973-74, (Sept. 1381).

ILO-WLF-SEAL International Labor Organization, AsianEmployment Programme: Women in Labour ForceBangkok (1981) paper by K. C. Seal: "Womenin the Labour Force in India: A Macro-LevelStatistical Profile, pp. 21-92.

LB-RLE-1974-75 Labour Bureau: Rural Labour Enquiry: 1974-75 Final Report on Employment andUnemployment in Rural Labour Households,Part I.

NCAER-1975-76 National Council of Applied EconomicResearch: Household Income and ItsComposition 1975-76 (1980).


- 174 -

NSS-17th Round National Sample Survey Organization: 17thRound on Consumer Expenditure 1961-62

NSS-26th Round National Sample Survey Organization: 26thRound on Landholdings, 1971-72.

NSS-27th Round National Sample Survey Organization: 27thRound on Employment and TTn-Emplovment.1972-73.

NSS-29th Round National Sample Survey Organization. 29thRound on Self-employed Households in Non-agricultural Enterprises, 1974-75.

PPD-TN Perspective Planning Division: TechnicalNote on the Fifth Five Year Plan (1974-79)(1973).

R-M-LES R. Radhakrishna and K. N. Murty: Models ofComplete Expenditure Systems for India,IIASA, Laxenburg (May 1980).

RBI-1971-72 Reserve Bank of India: All India Debt andInvestment Survev 1971-72.

RBI-Raj Committee Reserve Bank of India: Capital Formationand Saving in India 1950-51 to 1979-80.Report of the Working Group on Savings(Chairman: K. N. Raj) (February 1982).

RG-CI-1971--ET Registrar General's Office: Census ofIndia, 1971, Establishment Tables


- 175 -

1 * SECTOR SPECIFICATION AND INPUT-OUTPUT MATRIX

Sector specification for the model has to take into account the

structural features of the economy under consideration as well as the

range of questions on which the model is expected to shed some light.

At the same time, sectoral detail is constrained by considerations of

data availability on other sectoral parameters and computational

costs. In the present exercise, we have divided the Indian economy into

the following six sectors:

(i) Agriculture including allied activities such as

forestry, fishery, logging, etc.;

(ii) Manufacturing of consumer goods;

(iii) Manufacturing of capitcal goods (including

construction);

(iv) Manufacturing of intermediates (including non-fuel

minerals);

(v) Public sector infrastructure;

(vi) Services.

The breakdown of the manufacturing sector into consumer goods,

capital goods and intermediates is based on the criterion of the

dominant use pattern of the gross output of sectors into the three

categories mentioned. Public sector infrastructure is taken to include

coal and lignite, crude petroleum and natural gas, electricity, gas and

water supply, railways and communications. Services other tharn public

sector infrastructure are included in sector 6.

Appendix/India Shocks:4--11-86:pp

- 176 -

The base year of the exercise was chosen to be 1973-74. This

choice was governed by two considerations. First, this is the latest

year for which a detailed input-output transactions table is

available. Secondly, it also happens to be a year towards the end of

which a major oil price hike took place and adjustment to this external

shock is the main purpose of the present study. Our presumption is that

this year would provide the best available approximation to the pre-oil-

crisis structure of the Indian economy.

The input-output transactions matrix was aggregated to our six

sectoral classification from the 115 sector table published by the

Central Statistical Organization (CSO-NA-;3-IOTT). See Tahle 1 for the

details of the mapping scheme. The aggregated transactions matrix is

given in Table 2.

2. IMFORT-FLOW MATRIX

For deriving the import-flow matrix correspnding to the input-

output transactions matrix, the source is PPD-TN from which we can

obtain the (projected) import-flow matrix for 1973-74 at 1971-72 prices

for a 66 sector breakdown. The following steps are involved in deriving

the required import-flow matrix:

Step 1: Aggregate the PPD-TN import-flow matrix to our six-sector

aggregation based on the mapping scheme given in Table 1.


- 177 -

Eable 1.. Lpping Schem for Sectoral Aggregation

1-scription 60-Sector 115-Sector 66-Sector

of the Sector Classification Classification Classification

of CS0-MAS-1981 CSO-ISS-I1T of PPD-TN

1. Agriculture 01 to 07 001 to 022 OL0to 05

2. Consuner Goods 12 to 17,19,21,24 033 to 045, 1:1 tol5,17,18,21047 to 050054,055

3. (pital GoodsIncl. Construction 38 to 43, 45 078 to 096, 099 40 to 57, 63

4. Intermediate 10,11,18,20,23, 025 to 032, 046 06 to 10,16,19,20

Goods 25 to 37, 44 051 to 053, OYo 22, 24 to 39

to 061,063 to 069 58 to 61070 to 077, 097,098, 110 to 103,106

5. PLblic Sector 08,09,45,47,48,51 023,024,100 to 102 06,09,62,64

Ilfrastructure 106

6. Services 49 to 60 excluding 104 to 105 Eccluding 65,66

51 106

Step 2: Unit value indices for imports for 1973-74 with 1971-72

100 are derived for the six-sectors. These are used to

update the import-values from PPD-TN to get sectoral

composition of imports at 1973-74 prrices. The comparison

of these imports with the actual imports derived from

CSO-NAS-IOTT indicated the following:

(a) UJpdated imports of sector 1 from PPD-TN are

much lower than CSO-NAS-IOTT because actual

imports of cereals during 1973-74 were not

anticipated at the time of PPD-TN matrix. We

Appendix/India Shocks :4-11-86 :pp

- 178 -

Table 2-: Domestic Input Output Table(tens of millions of rupees)

gricult Cbns-Good CPpuIod ntd P nfr Service

Agricult 5905.23954 3784.51775 710.24921 531.68783 0.10034 1011.21908Cons-Good 586.82633 1354.10141 28.76109 170.28924 7.35997 128.15986Cap-Cbod 232.63936 88.16267 640.47815 187.29123 381.59979 550.12085Int-Good 488.13250 593.66308 2854.34983 2480.13564 69.35998 1497.26245Pub-Infr 188.12000 140.39000 214.58000 999.52000 462.10000 269.42000Service 555.27227 1C69.95509 1231.97171 1355.99606 228.84991 1712.12776

assume that the difference between the CSONAS-IOTT-based

imports of sector 1 and the updated imports of sector 1

for intermediate use from PPD-TN accounts for imports of

cereals for private consumption.

(b) For the remaining sectors, we apply the percentage

composition of each row of imports between

intermediate and final use from PPD-TN to the CSO-

NAS-IOTT-based sectoral imports. We assume that all

final use imports of sectors 2 and 4 go into private

consumption, those of sector 3 into gross fixed

investment and those of sector 6 into public and

private consumption according to PPD-TN composition

for sector 6. The final aggregates are as follows.

Step 3: Column (2) in Table 3 is used as sectoral control total

for intermediate use while applying RAS procedure to PPD-

TN based intermediate import flow matrix. It may be


- 179 -

added that whatever biases that may have existed in PPD-

TN matrix are translated into the import-flow matrix that

we have derived.

Table 3. Derived Aggregated Use-Pattern ofCSO-NAS-IOTT-Based Sectoral Imports (Rs. lakhs)

Imports forSector Intermediate Private Public Gross Fixed Total

Use Consumption Consumption Investment (2) to (5)(1) (2) (3) (4) (5) (6)

1 28578 31599 - - 601772 6718 5043 - - 117613 2278 - - 52356 546344 103112 14911 - - 1180235 41709 - - - 417096 - 3339 5361 - 8700

Total 286304

Note: Column (6) is from CSO-NAS-IOTT transactions matrix.

3. DERIVNTION OF SECTOR-SPECIFIC DEPRECIATION

CSO-NAS-IOTT based transactions matrix provides sectoral

figures of gross value added (GVA for short) gross of depreciation.

These figures must be disaggregated into depreciation and incorae-types

for the CGE model. The first step in this connection consists of

deriving sector-specific depreciation estimates which are discussed in

this section.

For sectors 1 (agriculture) 5 (public sector infrastructure)

and 6 (services), depreciation estimates are directly available from the

disaggregated tables in CSO-NAS (1981). The major problem is to get the


- 180

separate depreciation estimates for the three categories (sectors 2, 3

and 4) of the manufacturing sector according to the classification

adopted in this study. For this purpose, we have drawn on the

disaggregated tables available in CSO-NAS (1981) and CSO-ASI (1973-74)

for the factory sector. CSO-NAS (1981) tables provide disaggregated

figures of net value added (NVA) for the registered segment of the

manufacturing sector according to our classification. However, the

disaggregated tables for the unregistered manufacturing from CSO-NAS

(1981) are not detailed enough to be reduced to our classification.

CSO-ASI (1973-74) indicate NVA as well as depreciation separately but

only for the registered segment with nearly full coverage. These

sources are combined in the following procedure which is applied to each

of the sectors 2, 3 and 4:

(i) Get the ratio of depreciation to NVA (to be denoted

as dR) from CSO-ASI (1973-74) for the factory

sector;

(ii) Multiply NVA for the registered sector from CSO-NAS

(1981) by dR from step (i) to deduce depreciation

which when added to NVA from CSO-NAS (1981) gives us

GVA for the registered segment (to be denoted as

GVAR);

(iii) Subtract GVAR from the aggregate (registered plus

unregistered) GVA from CSO-NAS-IOTT to derive GVA

for the unregistered sector (to be denoted as GVAIUR)

as a residual;


- 181 -

(iv) Get the ratio of depreciation to GVA for the

aggregate unregistered manufacturing segment (to be

denoted as UR) from CSO-NAS (1981);

(v) Multiply GVAIR. from step (iii) by DUR to get the

sector specific depreciation for the unregistered

segment of the sector;

(vi) Subtract sector-specific depreciation from step (v)

from GVAUR to deduce net value added for the

unregistered segment.

It may be noted that NVA and depreciation are available

separately from CSO-NAS (1981) disaggregated tables for construction (to

be included in sector 3) and non-fuel minerals (to he included in

sector 4). Final estimates are as follows:

Table 4: Sector-specific Estimates of Depreciation and of Netand Gross Value Added

Sector NVA Depreciation GVA (Rs. lakhs)

1 2 61 28 89 6 26 46 2 67 55 352 23 90 43 1 92 90 25 83 333 35 41 64 2 47 54 37 89 184 32 12 89 4 73 78 36 86 675 14 34 31 3 16 56 17 50 876 1 39 87 43 11 68 52 1 51 55 95

Total 5 06 95 59 30 25 76 5 37 21 35

Appendix/India Shocks :4-11-86:pp

- 182

4 DERIVATION OF THE MATRIX OF '-TAX FACTOR INCOMES

We distinguish the following factor incomes:

(1) compensation of employees;

(ii) interest;

(iii) rent;

(iv) profits and dividends;

(v) mixed income of the self-employed.

We derive 5 (income types) x 6 (sector) matrix in two stages.

In the first stage we make the following assumptions to break

down net value added (NVA) in each sector (derived in section 3) into

the five components.

Sectors 1: Percentage composition of NVA in the primary sectors

across factor income given in Table S-8 of CSO-NAS

(1981) is applied to NVA in sector 1.

Sectors 2, 3 and 4:

(i) Sector specific share of compensation of employees

in NVA from CSO-ASI (1973-74) is applied to the

sector-specific MIA for the registered sector.

(ii) Sector-specific non-wage income in the registered

sector derived as a residual has the same internal

composition across interest, rent and profit and

dividend as the factor incomes originating in the

private organized sector given in Table S-1O of

CSO-NAS (1981).


183 -

(iii) Sector-specific NVA in the unregistered segment has

the same composition across factor incomes as that

for the total unorganized sector given in Table S-9

of CSO-NAS (1981).

(iv) Within each sector, we pool the registered and

unregistered segment to arrive at the first stage

composition for the sector.

Sector 5: Percentage composition NVA across income types is

the same as that for departmental enterprises given

in Table S-18 of CSO-NAS (1981).

Sector 6: Services sector is broken into three subsectors for

each of which we assume a sub-segment-specific

composition of factor incomes. Details are as

follows:

Table 5: Assumptions Made Regarding the Services Sub-sectors forPre-tax Factor Incomes

Assumption Regarding Broad Sector WhoseFactor Income Composition is Applied to

Sub-sector of Services NVA in Sub-sector

6.1 Transport by other means Transport, Commerce and Trade(other than Railways) andStorage Trade, Hotels andRestaur, :'lts

6.2 Banking and Insurance, Finance and Real EstateReal Estate, Dwellingsand Business Services

6.3 Community and Personal Same as 6.3Services, GovernmentAdministration and

defense

bbte: Eight-and-side breakdown is taken t-tt Table S-8 in CSO-NAS (1981).

- 184

Sector-specific steps described above gives us the 5 (factor

incomes) x 6 (sector) first stage matrix whose column totals are sector-

specific NVA derived in the previous section. However, its new-totals

do not necessarily add up to the economywide factor-income composition

aiven in CSO-NAS (1981). In the second stage, we assume the columns

corresponding to sectors 1, 5 and 6 to be reliable as they are derived

on the basis of more or less direct information given in CSO-NAS. For

sectors 2 to 4 we have made assumptions on the basis of different

sources. We, therefore, subtract stage one factor-incomes from sectors

1, 5 and 6 from the economywide factor incomes to derive factor-income

control totals for the manufacturing sector as a whole which are

consistent with CSO-NAS (1981). We use these control totals in the

second stage to apply an RAS procedure to 5 (factor incomes) x 3

(manufacturing sectors) sub-matrix, keeping fixed the column totals.

This provides us with a 5x6 factor income matrix which is consistent

with sector-specific NVA derived in sector 3 and the economy-wide

factor-incomes from CSO-NAS (1981).

The resulting factor income matrix is given in table 5.

5. RURAL-URBAN DIVISION OF POST-TAX FACTOR INCOMES

The sectoral factor incomes generated in the process of production

need to be mapped into rural and urban segments of the population

because the estimated parameters of the Linear Expenditure System are

available not according to sectoral classification but according to

rural-urban division of the population.

Appendix/Ineia Shocks :4-11-86 :pp

- 185 -

For this purpose, it is necessary first to net out direct taxes from

the factor incomes derived in section 4. In this connection, we make

the following assumptions: (1) no direct tax is paid on agricultural

incomes; (2) corporate taxes are paid by non-wage non-self-employed

income-earners in non-agricultural sectors, and (3) direct taxes other

than land-revenue are paid by earners of wage and self-employed income

in non-agricultural sectors. Using the CSO-NAS (1981) figures, the

average direct tax rates are:

(i) 11.00 percent for non-wage, non-self-employed

incomes in non-agriculture; and,

(ii) 4.50 percent for wage and self-employed incomes in

agriculture.

Using the factor-incomes derived in the last sector, the overall

pre-tax income per capita per month works out at Rs. 71.84 for 1973-74.

The next step is to derive rural and urban per capita income.

-uLet a, XR and X be the per capita income for the entire (rural

plus urban) population, rural population and urban population

respectively.

-R RLet a and (1-a ) be the rural and urban shares of the population.

- R-R R -ITX = a X + (1-R) x

-R R R --[x [a + (1-a ) X R3 -Rx

so that X ------

x


- 186 -

Wle use the following estimates for 1973-74.

Table 6: Factor-income Matrix (Rse. lakhs)

Factor Income Sector 1 Sector 2 Sector 3 Sector 4

1. Compensationof Employees 48 36 46 12 56 05 16 27 77 17 07 22

2. Interest 7 9l 71 2 60 86 2 57 57 3 81 69

3. Rent 4 10 22 33 81 65 81 47 01

4. Profit &Dividends 4 33 74 3 45 98 2 19 99 4 28 09

5. MixedIncome 1 96 56 76 4 93 73 13 71 43 6 48 88

Total 2 61 28 89 23 90 43 35 41 64 32 12 89

Factor Income Sector 5 Sector 6 All Sectors

1. Compensationof Employees 9 94 12 73 78 60 1 77 99 22

2. Interest 2 87 01 7 68 86 27 47 70

3. Rent 28 83 15 48 54 21 34 29

4. Profits andDividends 1 24 35 4 50 32 20 02 47

5. Mixed Income - 38 41 11 2 60 11 91

Total 14 34 31 1 39 87 43 5 06 95 59


- 187 -

Total population: 580 million

Rural population: 458 million

Urban population: 122 million

R Rso that a - 0.79 and (1-a ) = 0.21 . TTsing these estimates, we

get

Table 7: Per Capita and Aggregate Pre-Tax Incomes for theRural and the Urhan Population

Per Capita Pre-Tax Income Aggregate Pre-Tax Income(Rupees) (Rs. Million)

Rural population 60.51 33 71 96.8Urban population 114.37 16 97 59.1Total population 71.84 50 69 55.9

The difference between the aggregate income for the rural

population and the factor incomes originating in agriculture, turns out

to be Rs 7 59 07.9 million. We assume that this difference is taken

away from sectors 2 and 6. The above difference is 46.35 percent of the

post-tax income originating in non-agricultural sectors 2 and 6. The

final division is presented in the following table.

Appendix/India Shocks: 4-11-86:pp

188 -

Table 8: Derivation of Rural and Urban Factor Incomes

( Rs. millions)

Wage Profit Self employedIncome Income Income Total

1. Total pre-tax factorincome originatingin non-agriculturalsectors 129627.6 52487.9 63551.5 245667.0

2. Pre-tax incomeoriginating insector 2 and 6 86346.5 34083.7 43348.4 163778.6

3. Post-tax income,line 1. 123794.4 46714.2 60691.7

4. Post-tax income,line 2. 82460.9 30334.5 41397.7

5. 53.65 percent ofline 4 44240.3 16274.5 22209.9

6. Line 3 minus line4 41333.5 16379.7 19294.0

7. Total post-taxurban income line5 plus line 6 85573.8 32654.2 41503.9 159731.9

8. 46.35 percent ofline 4 38220.6 14060.0 19187.8

9. Agriculturalincome 48364.6 64493.3 148431.0

10. Total post-taxrural income:line 8 plus line 9 86585.2 78553.3 167618.8 332757.3

Appendix/India Shocks :4-11-86 :pp

- 189 -

The figures in the above table are different from these earlier

presented for two reasons. First, the percentages used in line 5 and 8

and derived on the previous page are based on pre-tax income and are

applied to post-tax income. The error leads to a slightly different

rural-urban distribution of pre-tax income than that for post-tax income

presented on the previous page. Secondly, the self-employed or mixed

income in agriculture given in section 4 is divided into two

components: imputed labor income component under the assumption that

self-employed receive the same wage as the pure wage-employed in

agriculture and the residual capital income. The imputed labor-income

appears under the 'self-employed income' category whereas the residual

capital income is included in profit-income. The adjustment was based

on the number of agricultural laborers available in LB-RLE-1974-75 and

the total work-force in agriculture estimated in section 6 below.

6. DISTRIBUTION OF WORK-FORCE BY SECTORS FOR 1973-74

Total work-force estimate of 239.18 million is arrived at by

applying the work-force participation ratios of 0.4342 (rural) and

0.3305 (urban) from NSS-27th round to the estimated population (in

millions) of 488 (rural) and 122 (urban). Share of work-force in

agriculture from the usual status industrial distribution (USID) for the

NSS-27th round, namely, 73.6 percent, given in ILO-WLF-Seal was used to

get agricultural work force of 176.06 million. An estimate of the

number of agricultural laborers of 43.61 million from LB-RLE-1974-75 was

taken to apply to 1973-74 to get the self-employed workers as a

residual.


190 -

For the non-agricultural sectors, total work-force was derived

by applying the proportionate composition of USID work-force for the

27th round given in ILO-WLF-SEAL. The estimates of the organized sector

work-force were taken from CSO-ASI (1973-74) for the manufacturing

sectors 2 to 4 and CMIE-BS (1977) for sectors 5 and 6. The work-force

in the unorganized segment was derived as a residual. The resulting

estimates are as follows:

Table 9: Distribution of Work-Force by Sector(millions)

Sector No. Total Work Force Organized Segment

1 176X062 12.31 2.173 6.2X3 7.184 8.23 2.155 2.86 2.866 33.44 8.12Total 239.18 17.48

While we use the agricultural-non-agricultural breakdown of the

work-force in the base year calibration of the model, sectoral work-

force figures are derived on the basis of the labor market assumptions

*contained in the model. For this purpose, we assume that the

agricultural laborer gets the average wage of Rs. 1116 derived by

combining the wage income in agriculture with the work-force of

agricultural laborers derived on the assumption of the usual status

unemployment rate of 0.66 percent. The organized sector worker in non-

agriculture is assumed to receive a uniform average wage of Rs. 7400


* 191 -

(approximately) derived by combining wage-income in these sectors with

the organized sector work-force given above. Subject to these wage

rates, the model endogenously allocates the labor first to the wage-

labor segment in agriculture and the organized segments in non-

agricultural sectors. The residual absorption of work-force in the

self-employed or unorganized segments is derived under the assumption of

labor-market clearing wage rate in the self-employed segmentso

7. DERIVATION OF BASE-YE SECTORAL CAPITAL STOCTa

The empirical basis of these figures is somewhat weak. As a

first approximation we derived the capital stock for 1973-74 by

interpolating the figures given in RBI-Raj Committee for 1970-71 and

1979-80 for broad sectors and adjusted them to 1973-74 prices using the

investment deflators. We compared these estimates with the sectoral net

value added and non-wage income to see the implicit ratio of capital

stock to net value added and the gross pre-tax rate of return. The

results appeared 'reasonable' for sectors 2, 5 and 6 and absurd for the

rest. For sectors 1, 3 and 4, we arbitrarily assumed a gross rate of

return of 12.5 percent to derive the capital stock figures. The

resulting ratios of capital stock to net value added appeared

'reasonable' and hence were accepted. The final figures used are as

follows:


- 192

Table 10: Estimates of Sectoral Capital Stock, Gross Pre-tax

Rates of Return and the Ratio of Capital Stock to Value Added

Gross Pre-Tax Ratio of CapitalCapital Stock Rate of Return Stock to Net

Sector (Rs. Millions) (%) Value Added

1 515946.4 12.5 1.972 29 570.0 21s67 1.243 43475.2 12.5 1.234 68543.2 12.5 2.135 168695.0 2.61 11.76

6 417500.0 6.62 2.99Total 1243729.8 17.49 2.45

8 . HOUSEHOLD CONSUMER EXPENDITURE

It is necessary to establish a correspondence between:

(a) the vector of household consumer expenditure

available at 1973-74 producer prices from CSO-NAS-

IOTT according to the six-sector aggregation adopted

in the study; andy

(b) the parameters of the Linear Expenditure System (LES

for short) estimated at 1961-62 market prices

according to nine commodity breakdown for the five

aroups of consumers each (defined according to the

per capita expenditure classes at 1970-71 market

prices) for tha rural and urban population available

from R-M-LES.

The required correspondence involves the following major steps.

Appendix/India Shocks:4-11-8f6:pp

- 193

8.1 Conversion of the vector of household consumer expenditure in

(a) from producer prices to market prices. In this scheme, trade and

transport margins paid on sectoral consumer expenditure at producers'

prices are collected together in sector 5 (railway) and sector 6 (trade

and other transport services) whereas indirect taxes paid by consumers

are collected together as a separate entry. The details of consumer

expenditure at producer prices on these items are available from the

115-sector classification given in CSO-NAS-IOTT. While consumer

expenditure at producer prices on trade can be entirely taken to be the

intermediate trade margin, there can be final consumer expenditure on

railways as well as on other transport which has to be distinguished

from transport margins.

From CSO-NfAS (1981), we find that out of the gross earnings of

the government railways from 1973-74, shares of freight and passenger

transport are 65 and 35 percent respectively. No such evidence is

available for transport other than railways. We make the following

assumptions:

(i) 100 percent of consumer expenditure on trade (Rs.

2312.24 crores) consists of trade margins;

(ii) 65 percent of the consumer expenditure on railways

(Rs. 392.25 crores) consists of (railway) transport

margins;

(iii) 85 percent (arbitrarily) of consumer expenditure on

transport other than railways (Rs. 1613.09 crores)

consists of transport margins;


194 -

We subtract (i) and (iii) from sector 6 and (ii) from sector 5

to get the following expenditure on margins and indirect taxes.

Table 11: Estimates of Trade and Transport Margins in Final

Consumption Expenditures

Trade Rs. 2312.24 crores

Railways Rs. 255.20 crores

Transport other than railways Rs. 1371.13 crores

Indirect Taxes Rs. 1642.80 crores

Total Rs. 5581.37 crores

We have tried to distribute Rs 5581.37 crores across commodity

producing sectors 1 to 4 under the assumption that no margins arid

indirect taxes are paid by sectors 5 and 6.

Wie then attempted to get a 6-sector aggregation of consumer

expenditure at market prices from the disaggregated tables on consumer

expenditure given in CSO-NAS (1981). Wgherever these details were not

sufficient, we used the composition from the 115-Sector detail (at

producer prices) from CSO-NAS-IOTT to arrive at the first approximation

of the vector of consumer expenditure at market prices according to the

six-sector aggregation. A comparison with the input-output based vector

of consumer expenditure at producer prices yielded the first iteration

of implied margins plus indirect taxes. This did not succeed because

of crude approximations involved in matching the aggregation schemes.

Consequently, we ended up postulating the following 'reasonable' margin

plus indirect tax rates as percentages of final consumer expenditure at

producer prices.

Appendix/India Shocks:4-11-86 :pp

- 195 -

Table 12: Sector-specific Margins Plus Indirect Taxes asPercentages of Final Consumer Expenditure at Producer

Prices

Sectors Percent2 403 604 501 (residual) 8.12

The margins had to be iteratively adjusted during the process

of generating an overall consistent data set needed to calibrate the

model.

8.2 Conversion of P-M-LES parameters to 1973-74 market prices. As

mentioned at the beginning of this section, "committed quantities" for 5

groups of consumers each for the rural and the urban population are

available at 1961-62 market prices, whereas the per capita expenditure

limit (PCEL for short) defining the 5 grotups of consumers are at 1970-71

market prices. Both of these need to be converted to 1973-74 market

prices which is the base year of our exercise. In the absence of a

retail price index, the wholesale price index for appropriate commodity

groups from CHANDHOK with different rural-urban weights for sub-

categories from NSS-17th Round was utilized.

The following table gives the relevant indices for the nine-

commodity groups of R-M-LES for rural and urban population separately.


- 196

Table 13: Price Indices Used for Converting LES Parameters to1973-74 Market Prices

Indices for 1981-74 withService 1970-71 = 100 1961-62 = 100Number Commodity Group Rural TJrban Rural Urban

(1) (2) (3) (4) (5) (6)

1 Cereal & Cereal Substitutes 1.346 1.356 2.075 2.075

2 Milk & Milk Products 1.501 1.501 2.880 2.880

3 Edible Oils 1.897 1.897 3.485 3.485

4 Meat, Fish, Eggs 1.760 1.518 4.036 4.036

5 Sugar & Gur 1.106 1.139 3.221 2.554

6 Other Food Items 1.305 1.300 2.677 2.253

7 Clothing 2.151 2.151 1.858 1.860

8 Fuel & Light 1.329 1.329 2.151 2.151

9 Other Non-Food 1.329 1.329 2.056 2.056

The indices in columns (3) and (4) are used in updating PCEL

using formula (9.4) in Appendix 1 of Chapter 2 and those in columns (5)

and (6) are used to update the 'committed quantities' of LES. We assume

the same index to apply to all the 5 groups of consumers in the

rural/urban population.

8.3 Mapping of R-M-LES 9 commodity groups into 6-sectors of input-

output table. For this purpose, we used NSS-17th Round detailed data,

The transformation matrix is given in the following table.


* 197 -

Table 14. Thansformation kttrix for Mapping LES C(nmxoity Groups intoI-0 Classification

Input R-14IES COmoditv GroupOutputSector 1 2 3 4 5 6 7 8 9

1 1.0000 1.0000 0.0 1.000 0.6220 0.8644 0.0 0.0 0.00532 0.0 0.0 1.0000 0.0 0.3780 0.1356 1.0000 0.0 0.09053 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.03084 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.5316 0.00525 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.4684 0.04266 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.7656

The above transformation matrix was used to derive the 6-sector

aggregation of LES.

The 6-sector aggregation of LES was used along with the income

distribution module given in chapter 2 to arrive at an estimate of

aggregate consumption and savings consistent with CS0-NAS (1981). The

sectoral breakdown of this aggregate did not match with the sectoral

breakdown at market prices derived in section 8.1 above. This

adjustment was done as follows:

Let Cj be the aggregate consumer expenditure from 8.4 for consumer

group i, sector j and population group p

where i = 1, 2,....5

j 3 1, 2,...6

p = rural., urban


- 198 -

Ci' be the aggregate consumer expenditure from 8.11 and consistentij

with I-0 for consumer group i sector j and population p.

Data = Z C C from 8.1 above.i=1 j=1 P=R,U j j

Problem: To derive C j given Cii to make the LES parameters consistent

with CSO-NAS.

Step 1: Divide aggregate consumer expenditure Cj between rural

and urban in the same proport4on as

RU R UI Cl. and I C Let these be denoted by C; and C.

R UStep 2: Use C. and C. as row totals in an RAS procedure

applied to

[Cij and [C i] matrices to get [CiI and [C i'

Step 3: Let xP be per capita 'committed quantities' from 6-

sector aggregation of LES and CF and Cp be the perij ij

capita magnitudes corresponding

to Ci and C j in step 2 above.


- 199

-pLet xij and bij be the LES parameters consistent

with CSO-NAS (1981) totals.

then -P =P Cij i i

ii

and b = __ij 6

- (Ep- ip)J=1 ij ij

where i = 1, 5, j = 1, 6, p R, U

9 INDTLRECT TAXES ON INTERMEDIATE INPUTS AND FINAL DEMANDS

Ahmad-Stern provided the sectoral breakdown of import duties,

excise duties, other indirect taxes and subsidies according to the 115

sector classification in CSO-NAS-IOTT for the year 1973-74. Aggregating

this breakdown to six-sectors and relating import duties to imports,

excise duties to domestic gross output, other taxes to domestic gross

output plus imports and subsidies to domestic gross output, we obtained

the following tax rates.


- 200 -

Table 15: Sector-Specific Rates of Indirect Taxes byTypes of Taxes

Other indirectSectors Import Duties Excise Duties taxes Subsidies

1 0.0458 0.0048 0.0055 -0.01252 0.3340 0.1011 0.0275 -0.00393 0.5118 0.0138 0.0232 0.04 0.4783 0.1436 0.0444 -0.00265 0.0 0.0 0.0166 0.00816 0.0 0.0 0.0272 0.0076

For getting the indirect tax rates on domestic and imported

intermediate inputs, we applied the excise tax rates to the domestic

flow matrix and import duty rates to the import-flow matrix. The

resulting matrices were column-wise prorated to add to the total

indirect taxes available from CSO-NAS-IOTT. Adding the resulting

matrices row-wise and relating them to the intermediate inputs -

domestic and imported separately - the average tax rates on domestic and

imported intermediates were obtained. A similar procedure was applied

to each component vector of final demand - domestic and imported - to

arrive at indirect tax rates for final demand assuming that other

indirect taxes and subsidies were applicable to final demand. The

resulting tax rates are given below.


- 201 -

Table 16: Sector-specific Rates of Indirect Taxes on Domestically

Produced and Imported Intermediate Inputs and Final Demand

Indirect Tax Rate Indirect Tax RateSector On Intermediate Inputs On Final Demand

Domestic Imported Domestic Imported

1 0.0212 0.3134 -0.0025 0.07312 0.0865 0.1629 0,2495 0,6728

3 0.0972 0.4247 0.0287 0.37814 0.1212 0.2790 0.2469 0.7236

5 0.1268 0.8461 0.0 0.0

15 0.1056 0.6715 0.0 0.0

10. PARAMETERS RELATED TO INCOME DOUSTRIBUTION

Production-related post-tax factor incomes are of three

types: income from self-employment, income from wage-employment and

profit-income. In addition, there are two types of non-production-

related incomes: transferred rent from infrastructure and transfers -

domestic as well as international. These incomes are mapped into

fifteen types of households for the rural and urban population. The

rural household types are distinguished according to landholding sizes

which are given in NSS-26th Round and RBI-1971-72 whereas the urban

household types are first nine decile, next five percentile and the last

five one-percent fractiles given in NCAER-1975-76.

We make the following assumptions.

Rural: 1. Income from self-employment and rent from

infrastructure are distributed according to the

distribution of owned area in the landholding

categories as given in NSS-26th Round.


202 -

2. Licome from wage-employment is distributed according

to the distribution of agricultural labor households

in the landholding categories as given in RBI-1971-

72.

3. Profit income is distributed according to the

distribution of total value of non-land assets in

the landholding categories as given in RBI-1971-72.

4. Transfers are distributed according to the weighted

average of the proportions related to incomes from

self-employment, wage-employment and profit incomes.

Urban: 5. Income from self-employment and rent on

infrastructure are distributed among different

household types according- to the distribution of

total income given in NCAER-1975-76.

6. Income from wage employment is distributed among

different household types according to the

distribution of wage and salary income given in

NCAER-1975-7 60

7. Profit income is distributed according to the

distribution of total assets in the urban areas as

given in NCAER-1975-76.

8. Transfers are distributed according to the weighted

average of the proportions related to incomes from

self employment, wage employment and profit incomes.

Appendix/India Shocks:4-11-86;pp

- 203 -

The first-iteration value of a and S, k and pcy (see (6.10)

and (6.11) and .ootnote 1 relating to (6.10) in Appendix 1 to chapter 2)

are derived separately for the rural and the urban population from

NCAER-1975-76. For this purpose, we have used the size distributions

according to per capita incomes given on p. 202 (rural) and p. 203

(urban) in NCAER-1975-76- The final values adopted have been such as to

make the resulting aggregates consistent with CSO-NAS (1981) for the

year 1973-74.

11. TIR-SERIES OF EXOGENOUS VALRABLES

11.1 import and export prices are aggregated to the six-sector

classification from a more detailed breakdown available from the

Directorate General of Commercial Intelligence, Calcutta. Weights are

corresponding imports and exports available from 115-sector breakdown in

CSO-NAS-IOTT.

11.2 Exogenous imports of sectors 1, 2 and 5 are at 1973-74 prices

are derived by multiplying the base-year value by the corresponding

volume indices for a given year with 1973-74 = 1.00.

11.3 Volume of government consumption at 1973-74 prices. This is

obtained by deflating the current price value by the price-deflator for

hotisehold consumption for a given year with 1973-74 = 100. Source is

CSO-NAS.

11.4 Transfer incomes are distinguished according to the following

types: national debt interest, other domestic current transfers, net

factor income earned from abroad, net current transfers from the rest of

the world. These are taken from CSO-NAS.

Appendix/India Shocks: 4-1i-86:pp

- 204

11.5 Exchange rates are taken from the Economic Reoort of the World

Bank for India.

11.6 Percentage allocation of cross domestic capital formation by

sector of destination is taken directly from CSO-NAS Lor sectors 1, 2 to

4, 5 and 6.

1 .7 All the tracking indicators are compiled from CSO-NAS.

ADpendix/India Shocks :4-11-86 :pp

(coping with internal and external exogenous …documents.worldbank.org/curated/en/...coping with...

Documents