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Public Debt before and after Independence in India


In this article we will discuss about public debt before and after independence in India.

India’s Public Debt before Independence:

The institution of Public debt was not known to ancient Indian rulers. Hindu and Mohammedan Kings sometimes borrowed money from their bankers either on their own credit or by pledging their crown jewels or by assigning specific revenues for the discharge of that debt. The British rulers did not follow the Indian precedent but imported the more recent European institution of a national debt.

Origin and Growth:

In 1765, when the East India Company became the master of Bengal, it was already in debt which had been incurred to finance the bitter struggle against the French in the Carnatic. This debt was foisted on the revenues of the newly acquired province of Bengal. The revenues of the company, though vast, were inadequate for the frequent wars which followed.


Accordingly, the revenues of Bengal were pledged and with loans so raised, the territories of the Sultan of Mysore were partitioned, and with the help of the revenues of Mysore territories, the power of the Marathas was broken. R.C. Dutt rightly says that “India paid for her own administration; paid also for the frequent wars of conquest and annexation in India.”

Not only that, the wars of England in all parts of Asia were carried on with the army and resources of India. Ceylon, Singapore, Hong Kong, Aden, and Rangoon were all conquered by the same means.

The wars with China, Afghanistan, Burma, and Persia were provided chiefly from Indian resources, although they were fought, as Wingate explains, “in pursuance of a British policy with which the interests of India were but remotely concerned.”

In 1834, when the company lost its commercial character, the debt accumulated in this way amounted to Rs. 36.9 crores. To this, were added the debts and liabilities of the East India Company.


Under the agreement reached between the Directors of the Company and the British Parliament, the entire debs and liabilities of the Company were thrown on the revenues of India. In addition, an annual dividend of 10.5% was also to be paid on the stock of the company till 1874 when the stock could be redeemed.

As the assets proved insufficient to meet the liabilities for the stock, the balance amounting to Rs. 4.5 crores was added to the permanent debt of India. In the opinion of Prof. P. Dutt “the liabilities of 1833 became the basis of the sterling debt” of India.

The new Government of India, which was installed under the Charter Act of 1834, was totally under the control and direction of the British Government. It became a willing tool of the British ‘forward and aggressive’ foreign policy as a result of which India became the field of a number of expensive wars such as the Afghan, Sind, and Gwalior wars, the two Sikh wars, and the Second Burmese war.

The Indian public debt, therefore, continued to swell and, by the time the Mutiny broke out in 1857, the debt had reached Rs. 60 crores. The story of 1834 was repeated in 1858 when, without hesitation, the entire cost of the Mutiny was added to India’s Public debt which totaled Rs. 693 crores in 1860. The true origin of the public debt of India is, thus, explained.


While the first beginnings of the debt were due to the wars of the English against the French, its burden was aggravated by “Home Charges”.

The ‘Home Charges’ were annually remitted to England “to pay interest on money expended in India on railways and irrigation works and for other purposes of the Government, to pay for stores, charges for effective and non-effective services of British troops on Indian establishment, furlough and retired pay of Civil and Military Officers and servants of the Government and other expenditure.”

These charges rapidly increased from just Rs. 3.5 crores in 1856 to Rs. 30 crores in 1913. Faced with the large increase in the Home Charges, the Government tried to raise loans in India from Indian Landlords, merchants as well as from Europeans living in India.

Thus, loans raised to meet the expenses of various wars fought in and out of India, debts and liabilities of the East India Company, and the Home Charges constituted the public debt of India up to the end of the Company’s rule.

As can be seen, almost the whole of this sum was borrowed for unproductive purposes and the interest charges on it were a dead weight on the revenues of India. The statement made by Anglo-Indian writers that “the greater part of this debt was incurred for capital outlays on railways and irrigation” ignores the facts of history.

The reality is that up-till the advent of the First World War, India continued to be charged for British expeditions to foreign countries as well as for wars within her frontiers. The Second Afghan War and the Burmese war alone cost the Government Rs. 25 crores.

From the 60’s of the 19th century, there grew up a demand for a large expansion of public works in India, financed mainly with borrowed funds. The real motive behind this demand was to open up new channels of investment for British capital and to create new demands for British goods. The Mutiny had further impressed upon the authorities the urgency of developing communications.

Accordingly, a large-scale programme of railway expansion and irrigation canals was taken up for execution. The required funds were raised by borrowing from the market, mostly in London. Besides, loans were also raised for the purchase of some existing railways and irrigation works from companies.

Thus began a steady growth in the amount of the ‘productive’ as distinguished from the ‘ordinary’ or unproductive’ debt. By 1913, India’s public debt had reached Rs. 411 crores out of which Rs. 392 crores was productive and only Rs 19 crores represented the ordinary debt.


The First World War gave a new dimension to the volume of the Indian public debt. In the first place, India was obliged to make a war-gift of Rs. 150 crores as her contribution to the British was effort. In the second place, she was faced with a succession of budget-deficits amounting to about Rs. 100 crores in six years.

The necessary funds were raised by various means, including loans. There was also an additional expenditure of over Rs 13 crores for the construction of New Delhi. As a consequence, the Public debt of India swelled to Rs. 918 crores in 1924.

A new feature of war finance was the introduction of the Treasury Bills, first introduced in 1917, for meeting Government’s disbursements on behalf of the British Government. They were again made use of for financing deficits in the post-war period when the old bills were paid for by issuing new ones.

The war also blew up the myth regarding the ‘smallness’ of the Indian money market. It was left to the war post-war period to prove that it was very much of an underestimate. The Government was able to raise the unprecedented amounts of Rs. 53 crores in 1917 and Rs. 57 crores in 1918.


Not only this. A more welcome development was the increase in the number of investors, thanks to good advertisement and provision of increased facilities as Government treasuries and sub-treasuries.

Due to the pressing war needs, capital expenditure on productive public works received a considerable set back. However, when the war was over, the Government renewed their policy of heavy capital expenditure on public works programme.

It was decided to spend Rs. 150 crores on railways in 5 years from 1922. Consequently, the productive debt increased by about Rs. 300 crores within a decade due to the construction of railways, purchase of old lines, and the as­sumption of the liabilities of some companies.

During the Second World War, the objective of public borrowing was to finance the war, to control inflation, and to finance recovery after the war was over. Controls were imposed on both consumption and investment and funds naturally flowed to Government securities.


The Government was able to raise huge loans as can be seen from the fact that the interest-bearing obligations of the Government rose from Rs. 1204 crores in 1939-40 to Rs. 2308 crores in 1945-46.

This increase in India’s public debt, though large in absolute terms, was still small in comparison with other countries. The public debt in U.S.A. rose 3 times by March 1943; in the U.K. it doubled by February 1943 while in Germany, it rose more than four times by December, 1942. The surprise is not that so small was the increase in India’s public debt but that India was able to raise even this much.

As M.H. Gopal explains:

“To start with, the loans were floated by an unrepresentative foreign Government facing strong political opposition. Secondly, the loans were for unpopular and unproductive war pur­poses. Thirdly, the rate of interest offered was not very high. Finally, no special appeal was made or was possible”.


In-spite of all these handicaps, the response of the market to Government floatation’s was very good. The reason was that, apart from sustained propaganda, the borrowing programme was so organised as to make available to the public a wide variety of securities in order to meet every type of demand. And this made the Government’s borrowing programme a striking success.

The War, however, brought about a fundamental change in the character of India’s public debt in as much as the Sterling debt, which constituted about 40% of the total in 1939, was almost wiped out and the debt became almost wholly (90%) internal.

While these were welcome trends, the rupee debt showed some disquieting features also. In the first instance, borrowing from the small persons failed and there was a decline in the Post Office Saving Banks deposits as well as Cash Certificates, both absolutely and relatively. Secondly, there was an undue reliance on short-term borrowing which led to a fall in the proportion of long-dated bonds.

In the years which followed the end of the Second World War, on account of the prevailing economic conditions, political uncertainly, lack of a consistent debt policy, and above all, the growing inflation, the Government’s borrowing programme did not evoke much response.

Inflation diverted funds into real estate, gold and silver, trading and speculative channels. Actual collections, therefore, were rather small during 1945-47. In March 1947, the public debt of India stood at Rs. 2331.98 crores.

At the time of the Partition of the country, a financial agreement was reached between the Government of India and Pakistan. Under this agreement, India undertook to take over all the liabilities of undivided India and pay the principal as well as the interest on the entire debt while the Government of Pakistan was required to pay its share of the debt, estimated at Rs. 300 crores to the Indian Government in fifty annual and equal instalments beginning from 1952.

Pakistan never paid its share. Thus, with Independence India inherited from the British a dead-weight debt which put an additional burden on the Income Tax-payer.

Ownership of the Debt:

The Indian debt consisted of rupee loans raised in India and the Sterling debt raised in England. Up to the Mutiny, the Sterling debt was small but, there­after, it began to mount rapidly.

In 1850, it amounted to a little under Rs. 4 crores (£ 3.9 million); by 1860, the expenses of the Mutiny had been added and it leapt to Rs. 28.4 crores (£ 28.4 million); by 1880, it went up to Rs. 71.4 crores (£ 71.4 million) and rose still higher to about Rs. 266 crores (£ 179 million) in 1913.

As a proportion of the total, the sterling debt formed 37% in 1879, 43% in 1881, 60% in 1901, 65% in 1913. In 1939, it amounted to Rs. 448 crores (£ 352 million) or about 40% of the total. It was during the Second World War that, as a result of the especially favourable circumstances, a major portion of the Sterling debt was repatriated and the debt became largely a rupee debt.

It is worthwhile noting that the whole of the Sterling debt was held abroad by Europeans and the interest charges on this debt went out of the country and formed an important item in the Home charges.

Even of the rupee-debt, only a small percentage was held by Indians, being only 36% in 1847, 34% in 1861, 22% in 1880 and 47% in 1913. This part of the rupee debt, which was in the hands of the Europeans, was, in effect, transferred to London. The interest on this part of the debt, therefore, was paid out of India.

Gyan Chand, therefore, classifies all debt, rupee or sterling, whether held in India or England, as External if it was held by non-Indians and Internal if held by Indians. Judged by this standard, a major portion of Indian debt was, until recently, external and interest-charges on it a drain on the country’s resources.

It is amazing to find that the government, on the one hand, complained year after year that the gradual fall in exchange upset all their calculations by increasing the burden of sterling payments and thereby landing them in deficit; on the other hand, it increased those very Sterling payments by their practice of borrowing largely in England.

Such a policy was sought to be defended on the ground that:

(a) The rates of interest were lower in England than in India and it was, therefore, cheaper to borrow in England; and that

(b) The Indian money market was too small to meet the requirements of the government.

This defence falls to pieces on closer scrutiny.

While it is true that interest rates were lower in England but they were not lower enough to compensate for the great disadvantage of having to pay interest charges in a foreign currency which involved huge loss by exchange and introduced great uncertainty in financial calculations. Even if the more important political consideration be kept aside, the disadvantages out­weighed the advantage of a lower rate in England.

As regards the second point, the myth regarding the ‘Smallness’ of the Indian money market was blown during the First World War when the government was able to raise large loans within India. The truth is that large funds, accumulated in England as a result of the Industrial Revolution, were awaiting utilisation and the Indian government, true to its salt, did not fail to oblige.

Classification of the Debt:

It may be noted that the debt inherited from the East India Company was purely ‘unproductive’, having been incurred for financing the numerous wars waged by it.

Since 1867, when public works like railways and irrigation had been com­menced, there was a steady growth in the amount of the productive as distin­guished from the ordinary or unproductive debt — a classification introduced from 1875. But this growth was more superficial than real.

What really happened was that with a view to showing accurately the amount of capital expenditure on productive works, the surplus revenue in any year was invested in public works for which the government would have otherwise borrowed. The surplus revenue so spent was charged to the ‘public works Debt’ but an equal amount was deducted from the ordinary debt.

In short, a portion of the ordinary debt was transferred to the public works debt. It was, as Anstey explains, by such book transfers that the greater part of the ordinary debt were reduced to very small proportions.

This may be seen from the fact that whereas the productive debt increased from Rs. 20.4 crores in 1875 to Rs. 415 crores in 1915, the ordinary debt during the same period declined from Rs. 102 crores to a bare Rs. 3 crores although it tended to again increase in the war and the post-war period.

This policy of book-transfers encouraged extravagance on the part of the government. According to Vakil, it provided a strong impetus to keep up a high level of taxation and to produce a surplus with which the government could, on the one hand, boast of prosperity, and on the other, spend on public works ‘without the odium and difficulties’ of raising market loans.

The existence of a budget surplus should have led to remission or reduction of taxes; instead, it became the basis of additional capital expenditure.

It is also worthwhile nothing that India’s productive debt was not productive in the sense that a businessman understands it. Before 1900, Indian railways were running at a loss and, therefore, the so-called productive debt was as much a burden on the state as the ordinary one.

Besides, railway development in certain parts of India, particularly on the Frontiers, had no commercial purpose. They were definitely unproductive to a financier or investor.

Even when the railway began to earn profit, they were not run on strictly commercial lines and it was difficult to calculate the extent to which they were meeting the cost of their capital. The apparent relief to the taxpayer on account of the decline of the ordinary debt was, therefore, unreal.

Burden of the Debt:

Two things stand out prominently while assessing the burden of the public debt of India. Firstly, a substantial portion of this debt was, as Naroji explains, “political in nature, and useless, inessential and unproductive in character”, having been incurred for empire-building. India received no economic equivalent in return for it. This debt, along with interest charges on it, was a dead weight on the revenues of India.

However, interest payments on loans for railways and irrigation works and the payment for stores cannot be described as ‘Tribute’ or ‘Drain.’ These payments, in fact, represented the kind of foreign expenditure which any developing country has to incur in the early stages of economic develop­ment.

Calculated in real terms (at 1948-49 prices), the per capita public debt rose from Rs. 38.46 in 1872 to Rs. 110.28 in 1938-47 a 286% increase. Prof. P. Dutt regards it as ” not much of a burden in view of the fact that a major portion of this debt was backed by interest-bearing assets”.

However, if it is recalled that ‘Debt-Servicing’ formed (at current prices) 17.5% of tax revenues in 1872-80 and 25.8% in 1938-47 and that too where the bulk of the debt was unproductive and held by foreigners, the heavy and increasing burden of this debt becomes clear.

Secondly, a major portion of the Indian debt, rupee as well as Sterling, produc­tive as well as ordinary, was held by foreigners. The interest charges on this part of the debt, payable in London, besides introducing financial instability, were a burden on the resources of India. And this was no small burden. According to K.N. Reddy, up to 1937, 1% of India’s National Income went out of the country by way of debt services alone.

Debt Management:

Prior to the First World War, the Government of India had no definite plan for the redemption of the public debt. There was no Sinking Fund as was set up in England in 1875, although such a fund was tried on an experimental basis by Lord Wellesly in 1798.

Attempt was, however, made to reduce the debt either by utilizing revenue surpluses for capital expenditure on railways and irrigation or by payment of railway annuities. The plans for the reduction of the debt were, at best, haphazard and not based on any systematic policy.

It was in 1917 that a Sinking Fund was, for the first time, created in India in connection with the war loan of 1917. It was then decided to set aside every year a sum equal to 1½% of the amount of the loan out of which the securities of the loan were purchased and cancelled. The same procedure was adopted in connection with the subsequent loans of 1919, 1920, and 1921.

It was in his budget speech of 1924-25 that Sir Basil Blackett laid down “a regular programme based on stable and well-considered principles” for the redemp­tion of India’s public debt. In defining the principle of the Scheme, he suggested that the best way was to take the gross total of the debt, examine the capital assets held against it and fix appropriate period within which each category of debt was to be liquidated.

On the basis of this principle, the Finance Minister announced a scheme under which the government was to provide for a sum of Rs. 4 crores a year for the reduction of debt, Sterling to be converted at Rs. 15 a pound.

The scheme was adopted as an experimental measure for 5 years till the end of 1929-30 when it was further extended and kept in force unchanged except that from 1930-31, Pound was converted at the new rate of Rs. 13.33.

With effect from 1930, adequate provision also began to be made for meeting the recurring liability in respect of cash certificates which also began to be regarded as part of the government’s debt.

As Basil Blackett explained, this sinking fund did not reduce the total debt as there was considerable programme of new capital expenditure, but it did reduce the unproductive portion of it. In this respect, “the fund went a long way towards its goal.”

The sterling debt, which, before the Second World War, formed a large portion of India’s public debt, diminished in importance during the war partly because of a better exploitation of the Indian money market and partly because of a definite programme of repatriation.

Since the beginning of the Second World War, large Sterling receipts became available on account of an increasingly favourable balance of trade, recoveries from England for her purchase of goods and war-materials as well as for their share of the war expenditure incurred by India and sales of Silver in London.

These sterling resources were utilised to purchase, in the open market, non-terminable sterling securities which were can­celled and replaced by rupee loans. In 1940, under another scheme, holders of sterling loans were given the option of converting their holdings into rupee loans. Sterling loans of the value of £ 28.5 million was thus converted.

A further sum of £ 90 million was compulsorily repatriated with the co-operation of the British Government when it issued orders compelling holders of sterling debt, living in U.K., to sell their stocks to the British Government for delivery to the Government of India at market price.

The Indian Government, on its part, forced Indians holding steeling stock, to sell it to the Reserve Bank. As a result of these operations, within a period of a few years, about Rs. 450 crores of sterling debts, incurred over a period of about 100 years, were wiped out and the Indian debt became, almost wholly, a rupee debt.

By converting the external sterling debt into an internal rupee debt, India saved the drain of interest payment to the previous sterling holders outside India. The government also made a small saving in interest because of the lower rate on rupee loans. Financially India’s position was considerably strengthened by enabling the Reserve Bank to hold somewhat lower proportion of external assets than before.

The conversion of the Sterling stock into rupee securities broadened the market for the gilt-edged securities in India. The greatest gain, however, was that it led to greater financial equality between India and England and this made for a healthier monetary position for this country.

India’s Public Debt after Independence:

Planning was bound to strain the financial resources of our country. In fact, a measure of strain is implicit in any development plan for, by definition, “a plan is an attempt to raise the investment above what it would otherwise have been.”

It follows that correspondingly larger effort is necessary to secure the resources needed. It is from this point of view that the task of mobilising resour­ces became both important as well as urgent with the advent of economic planning in India.

From now onwards, Public borrowing became an integral part of government’s economic policy for raising revenues and also to “convey to the people the larger purpose for which loans were being raised and to facilitate their participation in the development programme on the largest possible scale”.

Since 1951, the public debt of India rapidly increased. The total interest- bearing obligations of the Government of India increased from Rs. 2523 crores in 1951 to Rs. 10,796 crores in 1966 showing an increase of 27% in the First, 97% in the Second and 70% in the Third Plan. Taking together the period of the three plans, the public debt of the Government of India showed a 327% rise.

Significantly, India’s foreign debt rose even more rapidly —from Rs. 50 crores in 1951 to Rs 2629 crores in 1966 showing an increase of little less than 3 times in the first Plan, more than 6 times in the Second and 3 times in the Third Plan. Major portion of this debt-almost 1/2 —was held by the U.S.A. followed by the U.S.S.R., West Germany, the U.K., Japan and other countries.

This phenomenal increase in India’s public debt was the subject of much adverse comment both inside and outside the Parliament. A belief was held in certain quarters that the Government was borrowing excessively, that the burden of the debt was increasing day by day and that, as C.H. Bhabha warned, ” any false sense of complacency might lead us fast towards the much —dreaded path of national bankruptcy.”

The Estimates Committee of the Parliament even raised the question of prescribing statutory limits to Government’s borrowing under Article 292 of the Indian Constitution. Such excessive concern regarding the mounting debt was, however, without much substance.

An Charles Whit­tlesey points out:

“During the 125 years period extending from 1690 to the end of the Napoleonic wars in 1815′ the rise in the national debt of England was persistent and substantiality stood at twice the level of the National Income at that time. And yet during these years, the Industrial Revolution was successfully nurtured in Great Britain. It is also relevant that the lesser but still large burden of debt imposed on the economy of the U.S. during and after World War II did not prevent a rapid and unusually long sustained expansion of output in the succeeding decade and a half. It would seem reasonable to conclude that the burden of a large public debt is not a decisive obstacle to economic growth.”

In reality, what should cause anxiety is not the increase in the size of the debt but the way it is utilised. In India, fortunately, public debt was tagged to the requirements of economic development. This is borne out by the fact that in the decade 1950-51 to 1960-61, the interest-bearing obligations of the Government increased by Rs. 3801 crores and interest-bearing assets by Rs. 3409 crores.

In other words, nearly 90% of the obligations had been productively utilised and were likely to yield income flows over a long period of time.

Even otherwise, the debt-National Income ratio of 54% as at the end of the Third Plan was still small when compared with the sky high level of 144% in U.K., 70% in U.S.A. and 80% in Canada. Therefore, viewed from a long period perspective, all anxiety on account of our mounting debt should disappear.

Pattern of Ownership:

The pattern of ownership of the debt reveals that the banking sector was the most important source of borrowing for the Government. In 1951, the Reserve Bank’s share in Government securities amounted to 22.7% and, after remaining relatively small till 1960, rose to 25.4% in 1961 and 30.8% in 1966. Similarly, the share of commercial and co-operative banks varied between 20 — 28% during 1951-66, being only 21.6% in 1966.

On the other hand, the share of individuals declined from 3.8% in 1959 to 1.4% in 1966. This shows that public participation in India’s public debt was very much limited and that major portion of it did not represent genuine savings of the community but money created by the banking institutions. The Reserve Bank’s purchase of Government securities resulted in the creation of fresh money and was, therefore, inflationary.

Likewise, the purchase of Government securities by commercial banks was almost always financed out of adhoc loans from the Reserve Bank of India or out of Reserve Bank’s loans advanced against the Government securities held by commercial banks. This sort of financing of public debt was “highly inflationary” in nature.

Maturity Pattern:

Turning to an analysis of the maturity pattern of the Government debt, we find that there was a marked imbalance in its maturity distribution. While the proportion of long-term loans of over 10 years maturity declined from 36.1% in 1951 to 28% in 1966, short-term loans of less than 5 years maturity increased from 22.2% in 1951 to 41% in 1966.

Preponderance of short-term loans was due to the Government’s excessive reliance on the banking sector which had special preference for investment in short- term loans. This, however, had serious consequences.

Apart from frequent redeeming or replacement of maturing securities, the preponderance of short-dated debts implied that the commercial banks were able to expand their credit to the private sector freely in the knowledge that they could always obtain extra-cash by simply allowing some of their holdings of securities to mature.

This, in other words, meant a considerable weakening of the Reserve Bank’s hold over the banking system especially in a period of mounting inflation in the country.

Burden of the Debt:

The burden of the public debt can be assessed in relation to national income, government revenues and expenditure, pattern of ownership etc. The ratio of public debt to national income is an important indicator of the manageability- or otherwise of public debt in an economy. Seen from this angle, the concern expressed in certain circles regarding the burden of India’s internal debt was without much substance.

This is evident from the fact that although the ratio of internal debt to national income increased from 27% in 1951 to 46.5% in 1966, it was still very small when compared with other countries like England, Ireland, Belgium and Canada. A recent study shows that the domestic public debt as a per cent of gross domestic product, was 78.8 in U.K., 68.7 in Ireland, 48.2 in Belgium and 47.5 in Canada.

Despite the steep rise in India’s public debt, interest cost amounted to only 2.6% of the National Income in 1966. This could not be very burden-some in view of the fact that a large part of the debt was held by the “Captive Market” comprising the Reserve Bank, the State Bank of India, the Life Insurance Corporation, the Commercial and Co-operative Banks, the Industrial Finance Corporation and the Provident Funds.

As a result, a major share of the interest payment on the internal debt really went to the government or semi-government institutions. In other words, it represented a mere book- adjustment. Besides, the burden of the interest-payments was off-set to a great extent by the interest-bearing earnings of the Government.

In 1965-66, for example, the government still had an excess of Rs. 935crores of capital outlay and loans advanced over its debt and liabilities. The income-creating effect of public debt, therefore, made its burden still less generous.

It is true that the ratio of interest-payment to tax-revenues increased from 9.4% in 1951-52 to 19.8% in 1965-66 but it neither allowed desirable social expenditure to diminish-nor made the budget inflexible. Allocation of funds for development and welfare activities increased along with an increase in the allocations of funds for debts services.

The debt, however, imposed a severe burden on the community, especially the weaker sections, in so far as it was inflationary in character, having been raised not out of genuine savings but credit created by the banks.

As regards external debt, it falls in a different category because interest- payments on this debt represented income-flows out of the country and a definite burden on the country. In 1965-66, external debt service charges amounted to 0.7% of the National Income, 8.9% of the government’s tax revenue and 19% of the total export earnings of the country.

As B.R. Shenoy points out, the burden of foreign debt was further increased by the misuse and diversion of loans to non-plan purposes.

According to Friedman, “If there is no change in the term of the present debt and if additional aid is forthcoming in reasonably adequate amounts on terms similar to those of aid given in 1966, the absolute level of annual debt services is likely to double by the early 1970’s and treble by the end of decade. In this case, the debt service obligations might increase to 30-40% of export earnings, depending on the rate of export expansion.” This shows the magnitude of the burden of India’s external debt.

It is sometimes argued that the rise in external indebtedness and service charges is an inevitable accompaniment of economic development. In this connection, the experience of certain countries like Canada where the ratio of debt-services to export earnings was 25.3% and 30.7% respectively in 1929 and 1939 is also cited.

This, however, does not prove that this ratio must be allowed to rise to the same level in India also. India’s balance of payment position, since the beginning of the second plan, was precarious. Any outflow of foreign exchange not only added to the burden but also ate away a chunk of what little precious exchange was available for development, thereby creating the external debt servicing problem of a severe nature.

Debt Management:

Debt management, in the context of the planned development of an under­developed country, should have two objectives:

(a) It should promote savings and provide funds for investment in the public sector without impinging on the private sector.

(b) It should promote development within the overall framework of monetary stability. In other words, it should minimise the risk of inflation. The technique of debt-management adopted in India did not correspond to these objectives.

It has already been noted that a major portion of the Government’s securities was held by the ‘Captive Market.’ What was termed ‘borrowing from the public’ was, in-fact, provided by financial institutions and represented credit expansion and not real savings of the public. This led to inflation and instability in the country.

Turning to the maturity pattern of the debt, we find that 72% of the debt was in the maturity group of less than 10 years.

This shift in the maturity pattern of the debt, from long-term to short-term, whether caused by banking sector’s preference for short-term bills as Sree Kantadharaya contends or by the narrow spread between long-term and short-term rates of interest as Bhargava holds, had serious repercussions on the application of traditional monetary weapons to control the inflationary situation in the country.

It allowed the commercial banks to freely expand their credit for they could always obtain extra cash by allowing their short-dated securities to mature.

In order to maintain price stability in the country, it was absolutely necessary to lengthen the maturity period so as to reduce the liquidity in the economy as well as to establish a rational link between the maturity period of public loans and returns from the public projects with long gestation period.

It is, therefore, clear that the debt-management policies, followed in the post-Independence period, brought large funds for the plans but did not support the objective of maintaining monetary stability in the country.

As regards the management of the foreign debt, the government tried:

(a) To obtain loans on softer terms;

(b) To secure a longer spread of the repay­ment period;

(c) To increase repaying capacity through expert promotion on one hand and import-substitution on the other. This can be seen from the fact that in 1961, loans carrying medium rate of interest of between 2.5 to 5% constituted 54% of the total; in 1966, their proportion had declined to 51%.

Likewise, the proportion of loans carrying a high rate of interest of over 5% came down from 38% in 1961 to 25% in 1966. In addition to obtaining loans on easier terms, the Government also tried to secure loans with a longer maturity period.

The result was that loans with a maturity period of less than 10 years declined from 4% in 1961 to 2.5% in 1966 while loans with a maturity period of more than 20 years increased from 35.4% to 53% during the same period.

A lower interest rate or a longer maturity period alone could not have solved the problem of the repayment of India’s foreign debt. For that, it was necessary to expand the country’s exports and increase foreign exchange earnings. It is here that the performance was most disheartening. India’s exports remained practically stationary till the end of the second plan.

Following the introduction of several export promotion measures, exports began to look up —they grew at the compound rate to 4.5% during 1958-59 to 1964-65 only to suffer a decline in 1965-66. It was this failure of the exports to sufficiently expand which made the burden of external debt services particularly heavy.

During 1962 — 66, while India’s debt services rose by 84%, her exports recorded a mere 14% increase and were hardly sufficient to finance even the maintenance imports.

Import substitution in some of the important items like Iron and Steel and basic chemicals was certainly helpful in lessening the strain on the balance of payments position. But there was no reduction in total imports and trade deficits because of greater imports of capital goods and materials.

On the whole, the period saw a growing burden of foreign debts on the country’s balance of payments. No long term solution had been found to the problem of how to finance India’s expanding development effort. She was forced to seek new aid to increase her debts. This position was contrary to China’s for since 1950, China was self-sufficient, and in 1965, even finished paying off her debts.

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