Page 300 - DECO502_INDIAN_ECONOMIC_POLICY_ENGLISH

Indian Economic Policy

Notes Trade Gap or Foreign Exchange Gap : There are two structural constraints in a developing economy
a minimum requirement of inputs to sustain a given rate of growth of GNP; and an actual or potential
ceiling on export earnings. The difference between the required imports and total exports, which is
the foreign exchange gap, is represented as :
Mn – Xn = Mo + β (Vn – Vo) – Xo (1 + x)n
Where, Mo = Observed initial level of imports,
Vo = The GNP in the initial year,
Vn = Vo (1 + r)n, r being the compound growth rate and n the number of years after o,
Xo = The initial level of export,
β = The marginal rate of imports per additional unit of GNP,
r = Rate of growth of exports.
If the foreign exchange gap is dominant, the total import capacity would be
Xn = Xo (1 + x)n
It will effectively set the limit to the increase in GNP. The constraint will be more severe if any of the
following two situations obtains :
First, it may be noted that Technical conditions of industrialisation require a complement of foreign
resources alongwith domestic resources. Second, some Strategic goods such as capital equipment
and technical know-how, are not available locally and could be procured only from external sources.
In both cases, the availability of foreign exchange can save an economy from an impasse.
Technological Gap : Technology has played significant role in economic growth. Its level in a
developing economy can be raised through certain steps. For instance, through the internal
evolutionary process of education, research, training and experience, or the external process of
importing from other countries technology can be stepped up. However, the import of technology is
related to two issues, viz., the choice of technology and local adaptation in the country. It may be
noted that foreign capital can supply a package of needed resources that can be transferred to their
local counterparts by means of training programmes and the process of learning by doing. Three
sensitive areas are touched by the foreign capital and these areas are crucial in the development
strategy.
23.2 Types of Foreign Capital

Foreign aid and private investment are two types of inflows of capital from abroad. Loans and grants
from Foreign Governments and Institutions are included in the foreign aid. Since these may have
repayment obligations, this source of foreign capital, especially loans, has a limitation. The supporters
of foreign investment have highlighted the beneficial effects in terms of encouragement to the
development of technology, integration with the world economy, exports and higher growth,
managerial expertise, etc. They have claimed that debt financing generates fixed debt servicing
obligations, while equity needs to be serviced only after profits are made. It may be observed that the
opponents of foreign investment have drawn attention to several imperfections and adverse effects,
including capital intensity of such investment, the possible adverse effects on income distribution,
inappropriate technology, transfer pricing and the negative contribution that such investment often
makes to the balance of payments of an economy.
Sources of Private Foreign Capital : There are two types of foreign private equity capital flows : (1)
portfolio investment (an investor holds shares in a firms in a developing country but is not involved
in its management) and (2) foreign direct investment (investment where the investor participates in
the management of the firm in which he owns shares); FDI comprises a larger proportion of foreign
private capital flows to developing countries than portfolio investment.
(a) Portfolio Investment : Portfolio investment contains the following.
(i) Non-residents hold equity in the joint stock companies of the recipient country,
(ii) Recipient country’s joint stock companies have creditor capital from official sources.

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