Description
In finance, the financial system is the system that allows the transfer of money between savers (and investors) and borrowers. A financial system can operate on a global, regional or firm specific level.
THE FINANCIAL SYSTEM IN INDIA
The Institute of Asian Edonomic Affairs : Indo no Kin'yi Seido (The Financial
System in India), Tokyo, 1962. 516 pp. This is a joint study by Hiro-o Hirota, Minoru Fukazawa, Toshio Murai, Fumio Okesha, Shigeyoshi Kamatani, and Yukio Kihara.
So far, Japan's interest in the Indian economy has been centred on economic development programmes and foreign trade, and, there has been little comprehensive research on their financial system. The joint research project on India's financial structure conducted recently by five researchers under the sponsorship of the
Institute of Asian Economic Affairs is the first undertaking of any magnitude on this problem. The word " financial system " bears various meanings, both broad and restrictive. This research project did not confine itself to finance in a narrow
sense, i.e., the structure of capital circulation or tq financial institutions. Rather,
the emphasis was placed on clarifying the entire structure of industrial and
flnancial circulation of funds in India. As there is a scarcity of original data available, the preparation by the researchers was, of necessity, restricted. Accordingly, this report is, in some cases, an introduction or summary of the data
on India, while some portions constitute an experimental type of report not
based on extensive research. Therefore, the connection and coordiantion between chapters are not claimed to be perfect; yet, this report is without doubt an important introduction to research on this type of problem in our country. The theme for this joint research report could also be entitled " The source
of funds for economic development and the structure of funds demand and
supply. " At present, the funds for economic development of India are mainly acquired from three sources : I ) tax revenue; 2) domestic loans, and 3) foreign loans. These three sources will be discussed in the following chapters: tax revenue in chapter one " Structure of Public Finance and Capital Formation "; domestic loans in chapter two " Financial 'Institution "; and foreign loans in
chapter five " Foreign Investments. " The structure of money demand and
supply will be examined closely in chapter two and chapter three " Agricultural Financing " and chapter four " Foreign Exchange Banks. " Especially in chapter four the histories and the present conditions of the leading domestic and fore.ign
banks now in operation in India have been thoroughly discussed. Next, the
contents of the various chapters will be reviewed.
Chapter I. Public Finance and Capital F9rmation As is the case with almost every country, the role of the Government in the economic development of India, and in consequence, the role of public
finance, especially of tax revenue has substantially increased in recent years.
Research Reports 145
India, which has been carrying out flve-year plans for over ten y ars, is suffering from the inadequacy of domestic funds available for public development
proj cts, and is now the world's largest recipient of foreign aid. The ratio of ta revenue to national income for the past several decades has been about 7 peir cent, the
lowest ratio in the world. Therefore, two of the m
st urgent problems for India are : I ) to nlarge the source of funds for public investments through
a tax reform and the collection of addition.al taxes; and 2) to rectify the inequity
of wealth, income, and tax distribution which prevails in India today. From
this viewpoint, Chapter I makes an inquiry into the present conditions of phblic finance and investments in India, centreing on the problerd of tax reform.
The two big movements towards tax reform were the Taxation Enquiry Commiss,ion in 1953 and the proposed tax reform by Nicholas Kaldor. Froin
the standpoint of social justice, the Indian Government took the policy of increasing direct taxes and decreasing indirect taxes, while, contrary to their inten-
tion, the direct taxes had to be decreased in order to promote the investment activities of the private enterprises. But, n 195 l, they reverted to the 6asier method of relying on indirect taxes to raise funds for the First Five-Yeai Plan.
The Taxation
nquiry Commission was given the task of drafting a tax
reform bill, having the objectives of both rectifying th aforementioned inequities and raising funds for development. Of course, the tr ss was on the latter, and the Commission came tb the conclusioh that various present indirect taxes, especially, the Federal excise duties and sales taxes should be extended to lower 'income brackets in order to raise needed funds for public investments, even if it would necesSarily restrain consilmption by the public.
The increase of revenue by this scheme, however, was far short of the
amount required for the Second Five-Year Plan. Besides, the effects of a positive
tax reform could not be obtained thereby. Because, the general consumption
level was very low it could not be lowered anymore. Tax-collection, in cash, was difiicult in itself. And the poor tax collecting techniques permitted tax eva-
sion. Thus, it became necessary to seek additional revenue sources which had
escaped the recommendation of the Enquiry Commission, and Mr. Kaldor was engaged by the Indian Government to draft another reform plan. The tax reform plan set up by Kaldor was aimed at overall revision of the direct taxation system, vhereas the objective of the Taxation Enquiry Commission had been to increase indirect tax revenues. He, Kaldor, believed that the direct taxation system in India was very unjust and ineffective; that enough funds for the five-year plan could be derived from effective taxation on the
minority of the wealthy class. The main point of Kaldor's reform plan was, besides
a revision of the present income tax, to cr ate anew a Tax on Wealth, a Capital Gains Tax, a General Gift Tax, and an Expenditure Tax, and to levy
these taxes at the same time the Comprehensive Return was to be filed to prevent
tax evasion. By establishing the maximum tax rate by various taxes, he tried to hold down the interfering infleunces of taxation on the economic develop-
ment. The Kald9r proposal was put into effect during the 1957*1958 fiscal year.
146 The Developing Economies
But, his plan was only partially implemented, and the anticipated results were never realized. Therefore, most of the burden of the supplementary tax vias imposed on the residents of the urban areas. Arid the tax revenue potential of the rural areas has still to be developed. Moreover, preventive measures for tax evasion seem to be inadequate. The public investment, the bulk of which
is created by increased taxes, has, in spite of the aforer lentioned difB:culties, increased considerably in recent years. It has expanded five times its original size,
while private investments expanded less than two times. Correspondingly, India's traditional dormant tax structure has finally begun to change. This is not true in all casesi for the latent tax source (pre-modern and feudalistic income) has
not yet been grasped a fact that is gradually commanding the strong attention of intellectuals.
Chapter II. Banking Institutions
Chapter 11 gives a general despription of the financial institutions of India,
classifying them into six parts; and attention is directed especially to the efficiency
of their activities. The coexistence of native banking facilities or the bazaar markets and modern banking facilities without any close relationship between the two is the main characteristic of the financial structure of India. An excerpt from the Report follows, defining each group of financial institutions.
l. The native banking facilities comprise indigenous bankers in one group and money lenders in another. The main differences are that the
indigenous bankers conduct business accepting deposits and negotiating hundisl cheques, dealing primarily in commercial loans ; while thq money lenders deal more in rural consumer loans. The rates of interest on loans made by the latter are by far higher than those charged by the former. They have one thing in common. Both banking facilities are unorganized hereditary family trades based on the caste system. The native banking facilities handle ihost of the conutry's
financial business.
2. Private commercial banks in India consist of 400 joint stock banks established under the Banking Companies Act of 1949. Of this number there are less than 80 comparatively larger banks and 16 or 1 7 foreign banks which constitute the so-called scheduled (designated) banks. To examine the conditions of the assets and liabilities of the joint stock banks, we notice that the percentage ratio of fixed deposits to liabilities on deposits has made a rapid increase in
recent years. This will naturally increase the depsoit cost, and it may be a problem that long and short term loans have not increased to date. Banking companies in India have traditionally carried on short-term commercial loans as a main function. But, India suffers from the shortage of long-term development funds. It is hoped that the present poor connection between industry and the banks is quickly remedied, and the desperately needed long-term loans will be forthcoming. 3. Among the corporate banks, the State Bank of India, the former Im1 ' darshani ' hundi a demand draft
Research Reports 147
perial Bank of IndieL, operates on an extraordinarily large scale. It is a govern-
ment bank established by the special law. Besides routine commercial banking
business, it is specifically charged with financing medium and small enterprises
and the remittance of the government's foyeign exchange. 4: The Co-operative Banks and the Land Mortgage Banks are tgricultural financing organizations under the cooperative union system established 50-60 years ago. The former, Co-operative Banks, made short-term loans and the latter
long-term loans. The description of the structure of these banks has been
omitted, but it is well to note that loans to farmers by the Co-operative Banks
account for only about 3 per cent of the agricultural flnance. It is clear from this
tbat the Co-operative Banks cannot compete with the financial strength of the farm money lenders.
5. Recently, semi-governmental or government-owned industrial finance
institutions have been established as the ordinary banks lack the capability to supply long-term industrial funds. The following six corporations have been established to supply these funds: l) Industrial Finance Corporation of India; 2) State
Financial Corporations; 3) National Industrial Development Corporation; 4) Industrial Credit and Investment Corporation of India; 5) Refln.ance Corporation for Industry; and 6) National Small Industries Corporation. Many of these have been established by funds received through foreign aid and none of these banks
have yet started full operation.
6. As for Reserve Bank of India, which is the national central bank, the
Report describes in detail its organization, duties, functions, etc., referring to the
Reserve Bank of India Act and other sources. It is noted that the assets to back the issuance of bank notes are mostly the rupee certificate (the Financ
Ministry's notes having the character of " red ink " bonds) with very little gold or foreign reserve funds. While, on the other hand, the supply of funds to the
banking facilities for loans are limited. Such a formula for supplying currency can be said to be effective for India's economic development, centred on the public sector, but, at the same time it is not in line with sound currency and accepted banking practices. Summing up the figures of all the various financial institutions, the total of bank dep.osits in India is only 20-30 per cent of the total currency. Therefore, it can be said that financial policy by the Government or the central bank does not have much influence on India's economy, nor do the interest rates accurately reflect the economic activities. The fixed deposits have recently surpassed the
demand deposits in the scheduled banks and the gap is increasing. The banks also maintain a high reserve rate of cash. These are the indicators, which relate the soundness of the bank administration to the financial market. However,
they only denote the soundnes
of the financial market itself and cannot be
considered roof that India's financial institutions are participating effectively as
financial mediators in the overall economy. All the financial institutions in India cannot be said to be contributirig effectively to the economic development of India especially in the long-term industrial investments.
148 The Developing Ecoleomies
Chapter 111. Agricultural Finance One chapter has been devoted to the financial problems of agriculture, the
largest industry in India (70 ofthe total popul tion; 50 of gross national production). The actual conditions of agricultural finances in India have not been grasped
in detail even by Indian researchers. The actual conditions of agricultural financing are explained, in the report, based mainly on the 1955 Report of the Reserve Bank of India, " All-India Rural Credit Survey ", which is the only
comprehensive research data concerning this problem. It is fitting to say, how-
ever, that the Report deals more with problems of rural financing or farm
debts than with agricultural financing.
The total loans by all the farmers in India is about 7,500,000,000 rupees annually and the amount outstanding is believed to be several times more. It is estimated that the average annual loan is 160 rupees per rural family; and 309 rupees per borrowing family. The average amount of funds loaned to the farmer varies from I to 10. times depending upon the state. Loans also vary
with the size of the family's farming operation ; that is, the larger the scale, the large the loan. Of the money borrowed by the farmer about 50 per cent is for family consumption, and then 28 per cent is for capital expenditure and 9 per cent normal farm operation. This is more a debt on farmers than agricultural finance, reflecting the true feature of Indian agriculture. By examining the sources of these funds this situation will be made more clear. About 76 per cent of the loans to the cultivators are made by professional or side-business (including landowners and mer!chants) Ienders; 14 per cent is borrowed from relatives; and loans from the
governments, cooperative associations and commercial banks are 3.3 per cent, 3.1 per cent and 0.9 per cent respectively; with 92 per cent of the loans b ing
" pre-modern loans. " In order to crack down on these evil practices and
the expolitation of farmers by farm-loan sharks, various legislative measures have already been introduced in the last century and special laws have been
established by the various states, to control these activities, but the situation has
not improved. On he other hand, the banking institutions that are concerned with agricultural finance are, as mentioned in the separate chapter, the Co-operative Bank, the
Land Mortgage Bank and the Reserve Bank of India. All of them have been
making efforts for many years to improve the financial position of rural communities. However, this type of agricultural financing having the character of mutual aid or, the relief of farmers to promote agriculture is too weak to exercise its influence on rural communities Inder the established pre-modern system. Of course, the savings of a minority group in the rural area is by no
means small, but as capital most- of it flows to the cities and foreign countries, and in present circumstances it is impossible to channel these funds into direct agricultural investments.
Chapter IV. Exchange Banks
Among the banks that are operating in India, the comparatively large cor-
Research Reports
1 49
porate banks of India and the branches of foreign banks which, in all, number about 90 are called scheduled banks. In India, the " foreign exchange bank " or " exchange bank " often means a bank of foreign nationality, but in this chapter, the terms will be used to
denote banks doing foreign exchange business. That is, in this chapter, the foreign trade financing problem will be taken up as follows: (1) the development of the exchange banks since the era of the East India Company in the
17th century; (2) clarification of the foreign trade financial structure, comparing the bussiness and fin ncial strength of foreign banks with that of Indian banks; and (3) the history al d the present conditions of each exchange bank is des-
cribed. This chapter is not confined to foreign trade financing as such, but
provides a concrete survey of the principal domestic and foreign banks in India. Let us next outline the contents of the Report centreing on item above 2. India was a British colony for the past two hundred years, so in the early stage of its colonial rule the advance of foreign banks into the Indian economy denoted the development of British colonial banks. But, in the 19th century, European, American, Japanese, and other various countries established exchange banks and joined in the competition. Today, besides eight English banks, nine banks from America, Japan, Pakistan, Holland, France, and China make a total of 77 foreign banks conducting business in India.
During the period when these foreign banks were being established and
developed, Indian banks, with little funds and ill-prepared for international finance,
were unable to enter the foreign exchange market. Because of the Swadeshi movement, since the beginning of the 20th century and through World War I, banks operated by Indians have enjoyed remarkable success. But the foreign exchange business was not freed from the monopoly by the foreign banks and the British Indian Government, until after the independence of India in 1947. At present, 20 Indian banks are dealing in foreign exchange including
tbc 9 Iarge scheduled banks.
When compared with the foreign banks, these Indian exchange banks are
much weaker in respect of capital, and accordingly, the foreign trade financing is still largely dependent upon the foreign banks. In recent years, however, the
advantages enjoyed by the foreign banks are gradually disappearing and as a result, an epochal situation has been created. The total volume of foreign exchange business conducted by the foreign banks is less than that of the Indian exchange banks. This is due to the follo ving reasons; the recent shortage of
of funds in the foreign banks (diminishing increase rate of deposits), the decline
in the volume of trade handled by the foreign firms, and the policy of the
Indian government to promote home banks (custoday of public funds _and
.favourable tax treatment).
However, in respect to the volume of business, the foreign banks re 5 to lO times larger than the Indian bank, indicating that the advantageous position of the foreign banks is still intact. It is to be noted however that the relative
positions of foreign banks in India among
hemselves has been shifting
recently. That is, the position of English banks has declined, while the American
150
The Developi,eg Economies
banks are enjoying a business upswing and a rapid increase in profits. The Report also describes in detail the business and the earning positions of various important foreign banks and Indian banks. It examines the basis of the operations of the exchange bank, that is, the investment in India by various foreign countries. And it delves into the trade situation handled by the domestic and foreign firms. Although the self-reliant growth of capital and enterprise of India is now an acknowledged matter of record, the aid and investments by various foreign countries are acting as an outsi e pressure in a new form. This
may suggest that the real economic independence of India is still far in the futute.
Chapter V. Foreign Investments
In the last chapter, the loans and investments to India by foreign countries for both public and private sectors will be taken up. Like public finance, dealt with in Chapter I foreign capital is not a financial problem in itself, but the problem of its presence cannot be ignored, as it forms an important source of India's development funds. The investigation of foreign investment in India is too complex a task to . be undertaken by individuals or small institutions. But fortunately, in India, the Reserve Bank of India makes it an annual task to evaluate India's interna-
tional investment position. And it has already published in report form the
results of the three large-scale special surveys and annual surveys conducted to date. In this chapter, the contents of the Reports by the Reserve Bank of India are flrst of all introduced and then analyzed in detail.
According to the report, the overall international investment position of India
grew worse in the 12 years ( 1948-60) covered by the surveys. From a credit balance of 15 billion rupee reserves dwindled to a debit balance of 9 billion rupees. This was due primarily to the Second FiveLYear Plan in which the
expansion of public investments reduced the foreign reserve and increased foreign
loans. At present 70 per cent of the debts in the public sector is loans from
America and the World Bank. Other major creditor countries are England, West Germany, and the USSR. The cumulative total of loans authorized up to the present amounts to 20 thousand million rupees, qver half of which still remained unutilized at the end of the Second Five-Year Plan. Of the 7 thousand million rupees of private foreign investment in India, over 80 pef cent is " foreign business investments. " The Reserve Bank of India's survey reveals
each year the distribution of investments by industry and by the form of
investment, England supplies 70-80 per cent of the total investments, holding almost a monopolistic position, but, of late, the investments by America and the World Bank are gradually increasing.
Seen industry wise, the three largest fields of investments are the manufacturing industry, the oil industry, and the plantations which combined is close to 80 per cent of the total investments. As for the form of investments, direct investment in. foreign companies and foreign-controlled Indian joint-stock companies accounts for 80 per cent ; while the share of portfolio investments is very small. As to the proceeds of the foreign inves.tments, the profits, or dividends
Research Reports
151
on foreign capital in the private sector reached 3 to 4 times that of the proceeds
from interest on foreign capital in the public sector. The private investments by America and England has the highest rate - of return and capital gain is
higher in India than in those countries. The aforementioned is a general outline of the survey data released by the Reserve Bank. This chapter further attempts to estimate what position and how
much influence foreign investments have on the Indian economy. In viewing the economic structure of India from the standpoint of national income by industries, the pre-modern fields are overwhelmingly large, as the modern or
capitalistic private enterprise fields employ only 3.7 per cent of the working population and contribute only 1 1 .6 per cent of the total income. Three elements constitute this small progressive economic group. They are Government enterprise, Indian capital enterprise and foreign capital enterprise. But, these three are very important in that they comprise the core of the Indian economy.
Let us refer to the foreign capital aid in the ,public sector. India's increas-
ing dependence upon foreign aid to support her economic development plans is
fast approaching the critical point. To cope with this situation, a planned programme coordinating domestic savings, domestic investments and foreign funds is requir d. Above all, a more effective mobilization of the latent, private sources of funds by the government is being strongly requested inside and outside India. This is a very dif :cult task for the Indian Government.
In order to clarify the importal ce and influence of foreign capital in the
private corporate sector as compared with the holdings of native Indian capital, the following data is set forth : The foreign capital invested in
India amounts to 25.8 per cent of the net worth (owned capital) of
all corporate enterprises in India. Its share in the total combined assets including outside capital is only 1 7.6 per cent, but it controls as much as 36.8 per cent of total corporate assets. The percentage share of foreign capital to profits after tax is 32.3 per cent, and in retained profits or reinvested profits it stands at 30.9 per cent. In the light of these figures, it can be said that the foreign capital
invested in the private sector should not be considered a mere investment, but rather the means by which a strong foothold in the management of enterprises
and in the control of the native capital has been established. Foreign captal is
thus conducting bussiness in a more favourable climate than India's capital. The proflts earning rates of foreign and Indian capital in the latest several
years are estimated at 8.81 per cent and 6.66 per cent respectively. From the aforementioned report, it can "safely be said that as a result of
the economic development, the problem of foreign capital in India's economic development finance is assuming a growing importance. This is a kind of selfcontradication for the Indian economy, and to solve this problem the tax reform as set forth in Chapter I, and changes in the finandial institutions to increase their eflicierrcy, are most urgently needed. This is of course not a problem of
financial techniques but is a problem directly connected with the political, econo-
mic, social reform and development of the entire Indian nation.
Yukio Kihara
doc_615168877.pdf
In finance, the financial system is the system that allows the transfer of money between savers (and investors) and borrowers. A financial system can operate on a global, regional or firm specific level.
THE FINANCIAL SYSTEM IN INDIA
The Institute of Asian Edonomic Affairs : Indo no Kin'yi Seido (The Financial
System in India), Tokyo, 1962. 516 pp. This is a joint study by Hiro-o Hirota, Minoru Fukazawa, Toshio Murai, Fumio Okesha, Shigeyoshi Kamatani, and Yukio Kihara.
So far, Japan's interest in the Indian economy has been centred on economic development programmes and foreign trade, and, there has been little comprehensive research on their financial system. The joint research project on India's financial structure conducted recently by five researchers under the sponsorship of the
Institute of Asian Economic Affairs is the first undertaking of any magnitude on this problem. The word " financial system " bears various meanings, both broad and restrictive. This research project did not confine itself to finance in a narrow
sense, i.e., the structure of capital circulation or tq financial institutions. Rather,
the emphasis was placed on clarifying the entire structure of industrial and
flnancial circulation of funds in India. As there is a scarcity of original data available, the preparation by the researchers was, of necessity, restricted. Accordingly, this report is, in some cases, an introduction or summary of the data
on India, while some portions constitute an experimental type of report not
based on extensive research. Therefore, the connection and coordiantion between chapters are not claimed to be perfect; yet, this report is without doubt an important introduction to research on this type of problem in our country. The theme for this joint research report could also be entitled " The source
of funds for economic development and the structure of funds demand and
supply. " At present, the funds for economic development of India are mainly acquired from three sources : I ) tax revenue; 2) domestic loans, and 3) foreign loans. These three sources will be discussed in the following chapters: tax revenue in chapter one " Structure of Public Finance and Capital Formation "; domestic loans in chapter two " Financial 'Institution "; and foreign loans in
chapter five " Foreign Investments. " The structure of money demand and
supply will be examined closely in chapter two and chapter three " Agricultural Financing " and chapter four " Foreign Exchange Banks. " Especially in chapter four the histories and the present conditions of the leading domestic and fore.ign
banks now in operation in India have been thoroughly discussed. Next, the
contents of the various chapters will be reviewed.
Chapter I. Public Finance and Capital F9rmation As is the case with almost every country, the role of the Government in the economic development of India, and in consequence, the role of public
finance, especially of tax revenue has substantially increased in recent years.
Research Reports 145
India, which has been carrying out flve-year plans for over ten y ars, is suffering from the inadequacy of domestic funds available for public development
proj cts, and is now the world's largest recipient of foreign aid. The ratio of ta revenue to national income for the past several decades has been about 7 peir cent, the
lowest ratio in the world. Therefore, two of the m
st urgent problems for India are : I ) to nlarge the source of funds for public investments througha tax reform and the collection of addition.al taxes; and 2) to rectify the inequity
of wealth, income, and tax distribution which prevails in India today. From
this viewpoint, Chapter I makes an inquiry into the present conditions of phblic finance and investments in India, centreing on the problerd of tax reform.
The two big movements towards tax reform were the Taxation Enquiry Commiss,ion in 1953 and the proposed tax reform by Nicholas Kaldor. Froin
the standpoint of social justice, the Indian Government took the policy of increasing direct taxes and decreasing indirect taxes, while, contrary to their inten-
tion, the direct taxes had to be decreased in order to promote the investment activities of the private enterprises. But, n 195 l, they reverted to the 6asier method of relying on indirect taxes to raise funds for the First Five-Yeai Plan.
The Taxation
nquiry Commission was given the task of drafting a tax
reform bill, having the objectives of both rectifying th aforementioned inequities and raising funds for development. Of course, the tr ss was on the latter, and the Commission came tb the conclusioh that various present indirect taxes, especially, the Federal excise duties and sales taxes should be extended to lower 'income brackets in order to raise needed funds for public investments, even if it would necesSarily restrain consilmption by the public.
The increase of revenue by this scheme, however, was far short of the
amount required for the Second Five-Year Plan. Besides, the effects of a positive
tax reform could not be obtained thereby. Because, the general consumption
level was very low it could not be lowered anymore. Tax-collection, in cash, was difiicult in itself. And the poor tax collecting techniques permitted tax eva-
sion. Thus, it became necessary to seek additional revenue sources which had
escaped the recommendation of the Enquiry Commission, and Mr. Kaldor was engaged by the Indian Government to draft another reform plan. The tax reform plan set up by Kaldor was aimed at overall revision of the direct taxation system, vhereas the objective of the Taxation Enquiry Commission had been to increase indirect tax revenues. He, Kaldor, believed that the direct taxation system in India was very unjust and ineffective; that enough funds for the five-year plan could be derived from effective taxation on the
minority of the wealthy class. The main point of Kaldor's reform plan was, besides
a revision of the present income tax, to cr ate anew a Tax on Wealth, a Capital Gains Tax, a General Gift Tax, and an Expenditure Tax, and to levy
these taxes at the same time the Comprehensive Return was to be filed to prevent
tax evasion. By establishing the maximum tax rate by various taxes, he tried to hold down the interfering infleunces of taxation on the economic develop-
ment. The Kald9r proposal was put into effect during the 1957*1958 fiscal year.
146 The Developing Economies
But, his plan was only partially implemented, and the anticipated results were never realized. Therefore, most of the burden of the supplementary tax vias imposed on the residents of the urban areas. Arid the tax revenue potential of the rural areas has still to be developed. Moreover, preventive measures for tax evasion seem to be inadequate. The public investment, the bulk of which
is created by increased taxes, has, in spite of the aforer lentioned difB:culties, increased considerably in recent years. It has expanded five times its original size,
while private investments expanded less than two times. Correspondingly, India's traditional dormant tax structure has finally begun to change. This is not true in all casesi for the latent tax source (pre-modern and feudalistic income) has
not yet been grasped a fact that is gradually commanding the strong attention of intellectuals.
Chapter II. Banking Institutions
Chapter 11 gives a general despription of the financial institutions of India,
classifying them into six parts; and attention is directed especially to the efficiency
of their activities. The coexistence of native banking facilities or the bazaar markets and modern banking facilities without any close relationship between the two is the main characteristic of the financial structure of India. An excerpt from the Report follows, defining each group of financial institutions.
l. The native banking facilities comprise indigenous bankers in one group and money lenders in another. The main differences are that the
indigenous bankers conduct business accepting deposits and negotiating hundisl cheques, dealing primarily in commercial loans ; while thq money lenders deal more in rural consumer loans. The rates of interest on loans made by the latter are by far higher than those charged by the former. They have one thing in common. Both banking facilities are unorganized hereditary family trades based on the caste system. The native banking facilities handle ihost of the conutry's
financial business.
2. Private commercial banks in India consist of 400 joint stock banks established under the Banking Companies Act of 1949. Of this number there are less than 80 comparatively larger banks and 16 or 1 7 foreign banks which constitute the so-called scheduled (designated) banks. To examine the conditions of the assets and liabilities of the joint stock banks, we notice that the percentage ratio of fixed deposits to liabilities on deposits has made a rapid increase in
recent years. This will naturally increase the depsoit cost, and it may be a problem that long and short term loans have not increased to date. Banking companies in India have traditionally carried on short-term commercial loans as a main function. But, India suffers from the shortage of long-term development funds. It is hoped that the present poor connection between industry and the banks is quickly remedied, and the desperately needed long-term loans will be forthcoming. 3. Among the corporate banks, the State Bank of India, the former Im1 ' darshani ' hundi a demand draft
Research Reports 147
perial Bank of IndieL, operates on an extraordinarily large scale. It is a govern-
ment bank established by the special law. Besides routine commercial banking
business, it is specifically charged with financing medium and small enterprises
and the remittance of the government's foyeign exchange. 4: The Co-operative Banks and the Land Mortgage Banks are tgricultural financing organizations under the cooperative union system established 50-60 years ago. The former, Co-operative Banks, made short-term loans and the latter
long-term loans. The description of the structure of these banks has been
omitted, but it is well to note that loans to farmers by the Co-operative Banks
account for only about 3 per cent of the agricultural flnance. It is clear from this
tbat the Co-operative Banks cannot compete with the financial strength of the farm money lenders.
5. Recently, semi-governmental or government-owned industrial finance
institutions have been established as the ordinary banks lack the capability to supply long-term industrial funds. The following six corporations have been established to supply these funds: l) Industrial Finance Corporation of India; 2) State
Financial Corporations; 3) National Industrial Development Corporation; 4) Industrial Credit and Investment Corporation of India; 5) Refln.ance Corporation for Industry; and 6) National Small Industries Corporation. Many of these have been established by funds received through foreign aid and none of these banks
have yet started full operation.
6. As for Reserve Bank of India, which is the national central bank, the
Report describes in detail its organization, duties, functions, etc., referring to the
Reserve Bank of India Act and other sources. It is noted that the assets to back the issuance of bank notes are mostly the rupee certificate (the Financ
Ministry's notes having the character of " red ink " bonds) with very little gold or foreign reserve funds. While, on the other hand, the supply of funds to the
banking facilities for loans are limited. Such a formula for supplying currency can be said to be effective for India's economic development, centred on the public sector, but, at the same time it is not in line with sound currency and accepted banking practices. Summing up the figures of all the various financial institutions, the total of bank dep.osits in India is only 20-30 per cent of the total currency. Therefore, it can be said that financial policy by the Government or the central bank does not have much influence on India's economy, nor do the interest rates accurately reflect the economic activities. The fixed deposits have recently surpassed the
demand deposits in the scheduled banks and the gap is increasing. The banks also maintain a high reserve rate of cash. These are the indicators, which relate the soundness of the bank administration to the financial market. However,
they only denote the soundnes
of the financial market itself and cannot be
considered roof that India's financial institutions are participating effectively as
financial mediators in the overall economy. All the financial institutions in India cannot be said to be contributirig effectively to the economic development of India especially in the long-term industrial investments.
148 The Developing Ecoleomies
Chapter 111. Agricultural Finance One chapter has been devoted to the financial problems of agriculture, the
largest industry in India (70 ofthe total popul tion; 50 of gross national production). The actual conditions of agricultural finances in India have not been grasped
in detail even by Indian researchers. The actual conditions of agricultural financing are explained, in the report, based mainly on the 1955 Report of the Reserve Bank of India, " All-India Rural Credit Survey ", which is the only
comprehensive research data concerning this problem. It is fitting to say, how-
ever, that the Report deals more with problems of rural financing or farm
debts than with agricultural financing.
The total loans by all the farmers in India is about 7,500,000,000 rupees annually and the amount outstanding is believed to be several times more. It is estimated that the average annual loan is 160 rupees per rural family; and 309 rupees per borrowing family. The average amount of funds loaned to the farmer varies from I to 10. times depending upon the state. Loans also vary
with the size of the family's farming operation ; that is, the larger the scale, the large the loan. Of the money borrowed by the farmer about 50 per cent is for family consumption, and then 28 per cent is for capital expenditure and 9 per cent normal farm operation. This is more a debt on farmers than agricultural finance, reflecting the true feature of Indian agriculture. By examining the sources of these funds this situation will be made more clear. About 76 per cent of the loans to the cultivators are made by professional or side-business (including landowners and mer!chants) Ienders; 14 per cent is borrowed from relatives; and loans from the
governments, cooperative associations and commercial banks are 3.3 per cent, 3.1 per cent and 0.9 per cent respectively; with 92 per cent of the loans b ing
" pre-modern loans. " In order to crack down on these evil practices and
the expolitation of farmers by farm-loan sharks, various legislative measures have already been introduced in the last century and special laws have been
established by the various states, to control these activities, but the situation has
not improved. On he other hand, the banking institutions that are concerned with agricultural finance are, as mentioned in the separate chapter, the Co-operative Bank, the
Land Mortgage Bank and the Reserve Bank of India. All of them have been
making efforts for many years to improve the financial position of rural communities. However, this type of agricultural financing having the character of mutual aid or, the relief of farmers to promote agriculture is too weak to exercise its influence on rural communities Inder the established pre-modern system. Of course, the savings of a minority group in the rural area is by no
means small, but as capital most- of it flows to the cities and foreign countries, and in present circumstances it is impossible to channel these funds into direct agricultural investments.
Chapter IV. Exchange Banks
Among the banks that are operating in India, the comparatively large cor-
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1 49
porate banks of India and the branches of foreign banks which, in all, number about 90 are called scheduled banks. In India, the " foreign exchange bank " or " exchange bank " often means a bank of foreign nationality, but in this chapter, the terms will be used to
denote banks doing foreign exchange business. That is, in this chapter, the foreign trade financing problem will be taken up as follows: (1) the development of the exchange banks since the era of the East India Company in the
17th century; (2) clarification of the foreign trade financial structure, comparing the bussiness and fin ncial strength of foreign banks with that of Indian banks; and (3) the history al d the present conditions of each exchange bank is des-
cribed. This chapter is not confined to foreign trade financing as such, but
provides a concrete survey of the principal domestic and foreign banks in India. Let us next outline the contents of the Report centreing on item above 2. India was a British colony for the past two hundred years, so in the early stage of its colonial rule the advance of foreign banks into the Indian economy denoted the development of British colonial banks. But, in the 19th century, European, American, Japanese, and other various countries established exchange banks and joined in the competition. Today, besides eight English banks, nine banks from America, Japan, Pakistan, Holland, France, and China make a total of 77 foreign banks conducting business in India.
During the period when these foreign banks were being established and
developed, Indian banks, with little funds and ill-prepared for international finance,
were unable to enter the foreign exchange market. Because of the Swadeshi movement, since the beginning of the 20th century and through World War I, banks operated by Indians have enjoyed remarkable success. But the foreign exchange business was not freed from the monopoly by the foreign banks and the British Indian Government, until after the independence of India in 1947. At present, 20 Indian banks are dealing in foreign exchange including
tbc 9 Iarge scheduled banks.
When compared with the foreign banks, these Indian exchange banks are
much weaker in respect of capital, and accordingly, the foreign trade financing is still largely dependent upon the foreign banks. In recent years, however, the
advantages enjoyed by the foreign banks are gradually disappearing and as a result, an epochal situation has been created. The total volume of foreign exchange business conducted by the foreign banks is less than that of the Indian exchange banks. This is due to the follo ving reasons; the recent shortage of
of funds in the foreign banks (diminishing increase rate of deposits), the decline
in the volume of trade handled by the foreign firms, and the policy of the
Indian government to promote home banks (custoday of public funds _and
.favourable tax treatment).
However, in respect to the volume of business, the foreign banks re 5 to lO times larger than the Indian bank, indicating that the advantageous position of the foreign banks is still intact. It is to be noted however that the relative
positions of foreign banks in India among
hemselves has been shifting
recently. That is, the position of English banks has declined, while the American
150
The Developi,eg Economies
banks are enjoying a business upswing and a rapid increase in profits. The Report also describes in detail the business and the earning positions of various important foreign banks and Indian banks. It examines the basis of the operations of the exchange bank, that is, the investment in India by various foreign countries. And it delves into the trade situation handled by the domestic and foreign firms. Although the self-reliant growth of capital and enterprise of India is now an acknowledged matter of record, the aid and investments by various foreign countries are acting as an outsi e pressure in a new form. This
may suggest that the real economic independence of India is still far in the futute.
Chapter V. Foreign Investments
In the last chapter, the loans and investments to India by foreign countries for both public and private sectors will be taken up. Like public finance, dealt with in Chapter I foreign capital is not a financial problem in itself, but the problem of its presence cannot be ignored, as it forms an important source of India's development funds. The investigation of foreign investment in India is too complex a task to . be undertaken by individuals or small institutions. But fortunately, in India, the Reserve Bank of India makes it an annual task to evaluate India's interna-
tional investment position. And it has already published in report form the
results of the three large-scale special surveys and annual surveys conducted to date. In this chapter, the contents of the Reports by the Reserve Bank of India are flrst of all introduced and then analyzed in detail.
According to the report, the overall international investment position of India
grew worse in the 12 years ( 1948-60) covered by the surveys. From a credit balance of 15 billion rupee reserves dwindled to a debit balance of 9 billion rupees. This was due primarily to the Second FiveLYear Plan in which the
expansion of public investments reduced the foreign reserve and increased foreign
loans. At present 70 per cent of the debts in the public sector is loans from
America and the World Bank. Other major creditor countries are England, West Germany, and the USSR. The cumulative total of loans authorized up to the present amounts to 20 thousand million rupees, qver half of which still remained unutilized at the end of the Second Five-Year Plan. Of the 7 thousand million rupees of private foreign investment in India, over 80 pef cent is " foreign business investments. " The Reserve Bank of India's survey reveals
each year the distribution of investments by industry and by the form of
investment, England supplies 70-80 per cent of the total investments, holding almost a monopolistic position, but, of late, the investments by America and the World Bank are gradually increasing.
Seen industry wise, the three largest fields of investments are the manufacturing industry, the oil industry, and the plantations which combined is close to 80 per cent of the total investments. As for the form of investments, direct investment in. foreign companies and foreign-controlled Indian joint-stock companies accounts for 80 per cent ; while the share of portfolio investments is very small. As to the proceeds of the foreign inves.tments, the profits, or dividends
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151
on foreign capital in the private sector reached 3 to 4 times that of the proceeds
from interest on foreign capital in the public sector. The private investments by America and England has the highest rate - of return and capital gain is
higher in India than in those countries. The aforementioned is a general outline of the survey data released by the Reserve Bank. This chapter further attempts to estimate what position and how
much influence foreign investments have on the Indian economy. In viewing the economic structure of India from the standpoint of national income by industries, the pre-modern fields are overwhelmingly large, as the modern or
capitalistic private enterprise fields employ only 3.7 per cent of the working population and contribute only 1 1 .6 per cent of the total income. Three elements constitute this small progressive economic group. They are Government enterprise, Indian capital enterprise and foreign capital enterprise. But, these three are very important in that they comprise the core of the Indian economy.
Let us refer to the foreign capital aid in the ,public sector. India's increas-
ing dependence upon foreign aid to support her economic development plans is
fast approaching the critical point. To cope with this situation, a planned programme coordinating domestic savings, domestic investments and foreign funds is requir d. Above all, a more effective mobilization of the latent, private sources of funds by the government is being strongly requested inside and outside India. This is a very dif :cult task for the Indian Government.
In order to clarify the importal ce and influence of foreign capital in the
private corporate sector as compared with the holdings of native Indian capital, the following data is set forth : The foreign capital invested in
India amounts to 25.8 per cent of the net worth (owned capital) of
all corporate enterprises in India. Its share in the total combined assets including outside capital is only 1 7.6 per cent, but it controls as much as 36.8 per cent of total corporate assets. The percentage share of foreign capital to profits after tax is 32.3 per cent, and in retained profits or reinvested profits it stands at 30.9 per cent. In the light of these figures, it can be said that the foreign capital
invested in the private sector should not be considered a mere investment, but rather the means by which a strong foothold in the management of enterprises
and in the control of the native capital has been established. Foreign captal is
thus conducting bussiness in a more favourable climate than India's capital. The proflts earning rates of foreign and Indian capital in the latest several
years are estimated at 8.81 per cent and 6.66 per cent respectively. From the aforementioned report, it can "safely be said that as a result of
the economic development, the problem of foreign capital in India's economic development finance is assuming a growing importance. This is a kind of selfcontradication for the Indian economy, and to solve this problem the tax reform as set forth in Chapter I, and changes in the finandial institutions to increase their eflicierrcy, are most urgently needed. This is of course not a problem of
financial techniques but is a problem directly connected with the political, econo-
mic, social reform and development of the entire Indian nation.
Yukio Kihara
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