The Indian Economy Overview

The World Bank and India

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Somalia : A Victim of Adjustment

Recently, Somalia received the attention of global media because of extreme hunger conditions and starvation of its 8 million population.

In early 80s, Somalia was forced by economic difficulties, due to its war with Ethiopia, to yield to WB & IMF demands in order to renegotiate the foreign debt. In lieu of new loans by the Bank, the structural adjustment program was implemented in Somalia. Under adjustment, Somalia's debt stock rose from $1639 million in 1985 to $2444 million in 1990. Services in this period reached $379 million. The debt stock/GNP ratio was 283% in 1990. In other words, the country became totally dependent on its creditors with per capita GNP in that year was $96 while the debt burden on each Somalian reached $281. Almost 100% of the debt was related to official creditors.

With forced cuts in food subsidies and increased food imports, food aid was multiplied by an annual growth of 31% during 1975 and 1985. The best arable lands were largely taken over by government officials, traders and the military. Instead of promoting food production for the internal market, the creditors encouraged the production of "high value added" products like fruits, vegetables & cotton aimed at exports. The devaluation of the Somalian Shilling imposed in June 1981 by the IMF forced upward prices of all agricultural inputs. The devaluation also affected the price of medicine for cattle, along with privatization of veterinary services, the livestock was decimated and the entire pastoral economy collapsed. The collapse of cattle farming since 1984 was beneficial to Australia and the European Community. Frozen and chilled beef replaced Somalian beef exports to Saudia Arabia and other Gulf countries.

Besides, health and education programs were drastically cut. The health expenditures in 1989 were 78% lower than in 1975. Between 1981-89, school enrollment fell 41%. About 25% of primary schools were closed down due to lack of books and other educational materials.

The collapse of beef exports caused a sharp decline in the inflow of foreign currency and had a serious impact on the balance of payments position and public finances. Small farmers were erased by the dumping prices of North American subsidized cereals. The state support to agriculture ceased and therefore production in State farms decreased.

This was complemented by massive cuts in public sector jobs with declining real wages and growing unemployment.

In January 1991, when the civil war was already rampant, the creditors including the Bank imposed new adjustment policies aimed at reduction of public expenditure, closure of state companies and restructuring of the Central Bank.

Somalia is an illustration of what may happen to a poor country when the country's interests are sacrificed at the altar of market forces.

Great Men Think Alike

The government is maintaining that the new economic policies have not been dictated or even influenced by the IMF or the World Bank. But whose opinions do the report on the financial system submitted by the Narasimhan Committee reflect? The report is just an elaboration of the recommendations made by the World Bank in its confidential report "India: Financial Sector Report". Incidentally, the Narasimhan panel included professors, economists and bureaucrats who had long innings both in government and IMF-World Bank. The following comparison brings out how the panel members and their counterparts in the Bank think alike.

World Bank : Reduce the budget deficit and start lowering the cash reserve and statutory liquidity requirements (SLR) with the objective of bringing the combined ratio down to 30% in three years and subsequently moving to market determined interest rates on Government debt...

Panel : In line with the government's decision to reduce the fiscal deficit to a level consistent with macro-economic stability, the SLR (should) be brought down in a phased manner to 25% over a period of about five years, starting with some reduction in the current year itself... The committee proposes that the Reserve Bank of India consider progressively reducing the cash reserve ratio from its present high level.

World Bank : Immediately re-categorize commercial bank lending to larger borrowers among small scale industrialists and farmers, thus reducing the priority sector lending target from 40% to about 10% in three years.

Panel : Directed credit programs should be phased out. The committee proposes that the priority sector be redefined to comprise small and marginal farmer, the tiny sector of industry, small business and transport operators. The credit target for this redefined priority sector should henceforth be fixed at 10% of the aggregate credit.

World Bank : Allow competition by easing private sector entry and expansion.

Panel : There should not be any differences in treatment between public sector and private sector banks. There should be no bar on new banks coming up in the private sector.

World Bank : In the medium term introduce floating interest rates based on a market determined prime rate.

Panel : The medium term objective should be to move towards market determined interest rates.

How Import Liberalization is Supposed to Work
attainment of a 'realistic' rupee dollar i.e.devaluation removal of quantitative restrictions and lowering of tariffs increase in imports cheaper inputs & inter- mediate goods rate
| | |
export production stimulated resulting in export boom increase in imports of consumer and luxury goods local producers forced to cut costs in order to compete with cheaper imports
| | |
shift of resources from capital intensive, domestic-oriented production labor intensive, export-oriented. more jobs, higher incomes lower production costs
  |
  improvement in people's welfare, industrialization of the countryside lower cost of living
Where it Could Go Wrong
Removal of quantitative restrictions and lowering   Attainment of a 'realistic' rupee dollar rate i.e. devaluation
|   |
increase in imports trade imbalance persists further rupee devaluation export boom fails to materialize due to world recession, low export prices and rising protectionism in the developed countries
| | |
import-dependent industries that produce for the domestic market incur higher production costs production veers away from the domestic to the export markets  
     
increase in prices due to rupee devaluation now bigger than the fall in prices due to import liberalization benefits of higher rupee earnings from exports fail to trickle down to lower income classes in the absence of wage increases, land reform and other redistributive schemes  
| |  
higher prices, further shrinking of already greater inequality narrow market  
| |  
higher costs of living & layoffs more poverty, country still remain underdeveloped  


Export and Perish
Devaluation by one country may generate a spiral of competitive devaluations by others producing and exporting similar kinds of products. This may result in oversuppliers of commodities in the international market and price crashes. This is the 'fallacy of composition'. In fact the structural adjustment prog-rammes of the IMF/World Bank often suffer from this 'fallacy of composition'. For instance in 1975, copper exporting countries such as Zaire, Zambia, Chile and Peru approached the IMF for help to tide over their balances of payments crises. The IMF advised them to devalue and expand copper exports under its country-by-country approach. As a result of which there was a sharp fall in the price of copper in the international market. Consequently, these countries plunged into deeper debt.

For the last 40 years, primary commodity prices on the inter-national market have been falling. These commodities include agricultural goods or minerals and other raw materials. In fact, the 1985, raw material prices, in real terms i.e., after adjustment for inflation, were 27% lower than their average price in the 1950s. While a part of the explanation for this trend can be found in the changing patterns of demand in the advanced, industrialized countries (for example, the replacement of old metallic substances by polymers, plastics and other synthetic materials) these do not tell the full story. The other, when these countries, under extreme pressure to export, actually start doing so, they find that only traditional goods can be exported. They can only dream of exporting manufactured goods, never realize it. Eventually with declining prices and increasing glut and further fall in prices they cannot but remain at the receiving end.


For further details contact:PIRG (Public Interest Research Group) 142, Maitri Apt, Plot No 28, Indraprastha Ext. Delhi 110092. India. Ph: 2432054 Fax: 2224233 email: kaval@pirg.unv.ernet.in


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