Foreign Capital Requirements in India's Perspective Planning

Arjun Sengupta The desire to be free from dependence on foreign capital at an early date will be shared by most Indians. But

it is not certain that every one of us is aware of its implicatons. According to the Planning Commission's perspective plan it is expected that by 1975 the economic structure

of the country will be radically transformed and we will be firmly set on the path of self-sustained economic growth, completely independent of foreign capital.

By independence from foreign capital what in meant is that after 1975 there will be no increase in our foreign liabilities, that further inflow of foreign funds will not be needed, by that time we shall hare enlarged our domestic resources sufficiently so that after meeting the increased needs of consumption at home and the rate of investment Required to maintain a stipulated rate of growth, enough will be left to pay for amortisation, interest and dividend to foreigners for their past contributions of capital. In other words, it is claimed that domestic savings will exceed the required investment by an amount at least equal to the service payments on all forms of foreign capital coming to India until 1975. -

It is proposed here to examine this claim.

IT has been solemnly proclaimed in responsible quarters that our

country has a "date with destiny" in 1975. By that date, it is asserted with laudable optimism, the economic structure of our country wil l be radi­cally transformed and we shall be firmly set on the path of self-sustained economic growth. Among many highly desirable things that wil l happen to us by that time, one is that we shall be­come independent of foreign capital.

Presumably, this independence from foreign capital does not imply that we shall be free from all foreign liabili­ties. To the extent foreign capital comes to us in the form of private in­vestment, they will remain as that in periods beyond 1975 and a part of our resources will continue to flow out every year as dividend payments to foreigners and occasional repatria­tion of capital. In addition to this, a substantial part of foreign loans will not be liquidated by that time, and we have to provide every year funds for amortisation and interest payments abroad for many years to come. All that is meant by independence from foreign capital is that after 1975 there will be no increase in our foreign liability, that we shall be free from the need for further inflow of foreign funds. By that time we shall have en­larged our domestic resources suffi­ciently, so that after meeting the in­creasing needs of consumption at home and the rate of investment required to maintain a stipulated rate of growth, enough will be left out of those re­sources to pay for the amortisation, interest and dividends to foreigners for their past contribution of capital. In other words, domestic savings will

exceed the required investments by an amount at least equal to the ser-vice payments on all forms of foreign capital coming to India until 1975.

I examine this claim somewhat closely in this paper. The desire to be free from foreign capital at an early date is a sentiment that will definitely be shared by most Indians. But 1 am not sure if everyone of us is aware of its implications. One may suggest that our development poten­tialities are such that the need for fresh inflow of foreign funds will dis­appear by 1975 as a matter of course. Otherwise, we may introduce this ter­minal date as a policy decision and plan our developmental activity in accordance with that. In either case this has certain definite implications in terms of the magnitudes of efforts or sacrifices that will be expected of us during this period. It is only after an assessment of these magnitudes that we shall be able to decide if our aspirations have parted too much from reality or we are prepared for the task and can take the appropriate policies.

In Section I, I shall give the results of an application to Indian data of some methods that I have developed and which are presented in Section I I . In Section I I , I shall discuss some general issues relevant to the question and the methods of making quantita­tive assessment of its implications, I have made use of very simple algebraic formulas which can be easily derived by extending the Harrod-Domar for­mulas to allow for the effect of foreign capital*. This kind of aggregate app­roach, with an implicit assumption that all other relevant variables .some­

how get adjusted to each other behind the scene, can only give an overall view. But this is justified for the sim­ple reason that any plan must at least be consistent at the aggregate level and the implications of such aggre­gate model are the minimum that must be taken note of.

[I] Before proceeding with the applica­

tion to any concrete situation of the methods to be outlined in the next sec­tion for estimating foreign capital re­quirements, I should underline their aggregative nature. A l l the aggregative magnitudes involved here are in fact summaries of the corresponding de­tailed magnitudes of a long run plan, and the consistency of these magni­tudes is only a check for the internal consistency of the detailed plan. Fur­ther, estimating foreign capital re­quirements is only a part of the over­all plan and depends very much upon the consistency and accuracy of other parts of the plan.

This is the reason why the exercise in this section will be confined only to the Perspective Plan for India for 1960-61 to 1975-76, prepared by the PPD. The assumption is that all other parts of the perspective plan are cor­rect and consistent. I shall only exa­mine the implications of the assump­tion made by the PPD that by 1975-76 no foreign capital inflow wi l l be necessary, in the sense of finding out what are the consistent values of the different magnitudes, if the PPD claim is borne out in practice. Further, starting from the initial values of the different vari­ables as given by PPD, I shall try to indicate the number of years required

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to attain self-sufficiency consistent with different assumptions about scle­ral intensive magnitudes. Since this exercise is concerned with the PPD plan only, I have chosen to stick to the PPD figures for the initial year 1960-61. Since estimates of foreign capital requirements must he consis­tent with the overall plan, they must be based on the initial year values of the same plan.

The PPD claims that the main role of external assistance "wi l l primarily be to fill the gap in the balance of payments rather than to supplement domestic savings." One gets the im­pression from the context that by external assistance it is meant all types of foreign capita!. So foreign capital is viewed mainly as an instru­ment for covering the foreign exchange gap, but when it is claimed that by 1975-76 inflow of foreign capital will be nil, it also implies that by that period sufficient domestic savings will be generated to eliminate the savings-investment gap.

The PPD projecton of exports for 1975-76 of Rs 1624 crores exceeds the projection of imports, excluding invisi­ble, for that, year of Rs 1610 crores. For the purpose of the present "paper I shall assume that these projections are correct. But it should be noted that the import figures of the PPD can very well be regarded as the minimum import requirements according to our terminology. The PPD itself claims that "as the proportion of luxury items and otherwise dispensa­ble goods is small in our imports, the scope for effecting any substantial saving of foreign exchange by curtai­ling imports of unessential goods is very limited." It also observes that " i t will be unsafe to provide for im­ports of commodities of value less than Rs 1350 crores in 1970-71 and Rs 1600 crores in 1975-76 in the context of a growth of industrial production of the order of 10 per cent per year."

In fact, total imports to increase from Rs 1120 crores in 1960-61 to only Rs 1600 crores in 1975-76 when national income is expected to in­crease from Rs 14140 crores to about Rs 37300 crores during this period would require a tremendous amount of effort and import substitution especi­ally in metals, machinery and chemical industries. The PPD programme envis­ages a fall in the proportion of im­ports to national income from about 8 per cent in 1960-61 to a little over

4 per cent in 1975-76 and for all practical reasons this can be regarded as the bare minimum level of imports that has to be financed.

This minimum nature of import re­quirements has to be emphasised if only to point out how much weight the PPD projections for our exports will have to bear if foreign capital re­quirement is to become nil by 1975-76 to cover the export-import gap. The PPD export projections arc highly optimistic. Total exports are expected to increase from about Rs 672 crores in 1961-62 to about Rs 1225 crores in 1970-71 and further to Rs 1624 crores in 1975-76. Agriculture and animal base exports which accounted fur more than three-fourths of our export earnings in 1961-62 would in­crease from about Rs 509 crores in that year to about Rs 722 crores by 1970-71 (a rate of growth of about 4 per cent per year), and to Rs 863 crores by 1975-76 increasing at a rale of about 3.6 per cent for these last 5 years. The proportion of the contribution of this group of products would fall to about 52 per cent in 1975-76. But exports of manufactured goods would increase from Rs 60 crores in 1961-62 to Rs 276 crores by 1970-71 and to Rs 484 crores by 1975-76. The rate of growth of exports of these items is expected to be IS.5 per cent between 1970-71 and about 12 per cent between 1970-71 and 1975-76. The expected growth of ex­ports of mineral ores is no less optim­istic. From Rs 40 crores in 1961-62, they arc expected to rise at the rate of 17,5 per cent per year to Rs 171 crores in 1970-71 and then at the rate of about 6 per cent per year to Rs 230 crores in 1975-76. All these projec­tions are obviously very optimistic— and although it is not within the scope of this paper to examine these pro­jections, it seems reasonable to harbour some doubts about them. And to the extent these estimates are subject to doubts, the claim that exports will be enough to finance the minimum im­port requirements by 1975-76 is not quite tenable.

It may be noted that the estimates for imports here do nor include net invisibles which continue to be a net drain on the country's foreign ex­change resources. In 1975-76 the de­ficit in net invisible account is expect­ed to be of the order of Rs 90 crores. The net investment income which has to be remitted abroad has been very conservatively estimated at Rs 216

crores in that year. The deficit has been reduced by highly optimistic estimates of net receipts on account of foreign I ravel transport and private donations.

In any case, since it is not the pur­pose of the paper to examine in detail the claim that foreign exchange gap will be eliminated In 147 5-76, we shall accept all these projectons as correct and concentrate on tin- aving-investment gap. To simplity mailers, I shall assume that tins savings-in-vestment gap is cow red by foreign capital coming in the- form of grounts only. This is obviously unrealistic but such an exercise is justified by the fact that this gives the minimum that will be required, the minimum num­ber of years that will be needed to attain independence from foreign capital.

Foreign capital will naturally come in the form of a mixed bag There will be some grants in it, bin there will also be a substantial amount of foreign direct investment as well as different kinds of loans capital, all entailing de­finite repayment obligations. It is al­most impossible to predict I no exact weights of the different kinds of foreign capital in the total inflow in the future, nor is it easy to estimate the repayment obligation. The returns on direct investment even of the past is very difficult to assess and it is even more difficult to project for the future. The terms of loan capital vary widely as between different types of loans and different sources of then. There is a marked tendency in the world today for loan termy becoming easier for the underdeveloped coun­tries, especially after the IDA has come into operation. But live re is no certainty that this trend will continue or India will benefit much from this for a long period. Bui to the extent these repayment obligations are there, they would detract from the foreign exchange available. In addition to this, there will remain payment obliga­tions of incomes on past investment so that even if all future foreign capital flows in as grants, all of it will not be available to cover the savings investment gap. As a result of all these the year of independence for our foreign capilal will only recede in the future. So to repeat, the value of 'no (the year when independence from foreign capital is achieved) ob-tained by treating all foreign capital inflows as grants will only he the minimum, which all possible realistic values of 'n' will surely exceed,

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The PPD figures for the base year, 1960-61, are given below:

Gross domestic savings as a percent­age of G N P = 9.9 per cent.

This rate of gross domestic savings is naturally higher than the rate of net domestic savings as a proportion of national income.

The rate of growth in the perspec­tive plan for the period 1960-61 to 1975-76 is expected to be 6.6 per cent per year. The following table gives the consistent values of gross mar­ginal capital-output ratio and the marginal rate of savings if, in ac­cordance with the.perspective plan, the country becomes self-supporting after 15 years (n = year of independence from foreign capital = 15).

Independent; estimates of marginal gross capital-output: ratios or of mar­ginal gross rate of savings of the re­cent past are not" available so that one can form some judgment about the plausibility of some of the figures for the future. For this reason Table 3 and 4 give alternative Figures for the consistent values of marginal net capital-output ratio and marginal net rate of savings and the number of years required to attain self-sufficiency,

although such netting involves the arbitrariness about using depreciation figures. The PPD figures for 1960-61 for net national product at factor cost or national income is Rs 141.4 (,000 millions), total net invest­ment is Rs 16.2 (,000 millions), net foreign inflow, as before, Rs 5.2 (,000 millions) and net domestic savings Rs 11.0 (.000 millions). This gives the initial rate of savings = 7.8 per cent. The PPD figure for the rate of growth of national income is 6.6 per cent per year between 1960-75. Tables 3 and 4 are based on these figures.

Independent estimates of marginal net capital output ratios and marginal net rate of savings are available in RBI Bulletin of March 1965. One should of course note that there is substantial difference in the estimates: of savings and capital formation of the PPD and the RBI but the RBI figures would give some broad order of magnitudes which would enable us to form some judgment about the plausible values of different variables.

The RBI figures for the marginal capital output ratio for the period 1956-57 to 1958-39 is 4.21 and for the period 1959-60 to 1962-63 is 3.91. Alternatively for the entire Second Plan period, the RBI estimate for the marginal capital output ratio is 3.86 and for the first two years of the Third Plan (1961-62 and 1962-63) it is 3.53. As mentioned above, the marginal capital-output ratios are all intensive magnitudes, they emerge out of productive operation in different units and there is no reason for their taking one particular value rather than another. But it is difficult to think that the productivity of invest­ment wil l increase so much that there will be a declining trend in this ratio

in the near future. On the average, 1 would venture to presume that the marginal capital output ratio over the period 1960-75, will not probably fall below '3.5, or more definitely not below 3.0.

The RBI estimate for the aggregate marginal savings rate for 1956-57 to 1958-59 is only 10.7 per cent and for 1959-60 to 1962-63 is only 19 per cent. Alternatively for the entire Second Plan the marginal rate of savings was estimated to be 18.9 per cent while for 1961-62 and 1962-63 it was only 14.6 per cent. Allowing for this under­estimation of the RBI, if we assume that the marginal rate of saving will be around 20 per cent on the average for the coming years, it wil l he seen that, with a marginal capital output ratio of 3.0, we will need 64 years to be self-supporting. If we assumed an average marginal rate of savings of 25 per cent per year, it will take 19 years with an average marginal capital output ratio of 3.0, and about 35 years with an average marginal capital output ratio of 3.5 to attain independence from foreign capital.

Finally, one should note that all these figures are purely illustrative and I do not want to attach much predictive significance to any of these values. One should also remember that these calculations do not delude repayment of investment incomes abroad. But I believe I may with some reason claim, from Tables 1 and 3, that if we want to be free from dependence on foreign capital by 1975-76, we should be able to generale a marginal rate of savings of at least 27 to 30 per cent in the coming years. This is on the average for the whole period of the Third, Fourth and Fifth Plans, and if our performance uplil now has been much lower than this, we have to aim at a much higher ratio for the remaining years of this period.

[II] At any point of time, the total

amount of resources available to a country which it: can consume and de­vote to (gross) investment or use for exports is equal to the country's gross national product plus its imports, where exports and imports refer to the credit and debit items of the current accounts of the country's balance of payments. It follows from this iden­tity that at any time, the difference between a country's gross investments and gross domestic savings is neces­sarily equal to the difference between

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its imports and exports. So, a country can invest more than it can save, and thus" achieve a growth rate higher than that determined by its domestic savings rate, if it could import more than us exports by the same amount. This will naturally depend upon how it finances the import-surplus.

A justifiable assumption to make here is that over a long period an underdeveloped country should not depend upon the depletion of foreign exchange resources or selling gold to finance such import-surplus. In that case, a net inflow of foreign capital remains the only offsetting item in the balance of payments to finance the deficit in the current account.

With this assumption, the role of foreign capital in a growing economy becomes clear. A given amount of foreign capital can finance an equal amount of import-surplus of the capi­tal-receiving country and also allow its investment to exceed its domestic saving by the same amount, that is,

where the variables refer to gross investment, gross domestic savings, imports, exports and net inflow of foreign capita! at time 't ' respectively.

If gross incremental capital-output ratio is denoted by k, and the rate of growth of GNP by r, then

where Y GNP at time t. The rate of savings is expected to

rise over time. Let so be the average rate of savings at the initial period and s, the incremental savings rate and assume the savings function to be of the form.

These give us a unique relationship between the rate of growth r and the net inflow of foreign capital. Given the incremental capital output ratio, marginal rate of savings, average sav­ings rate at the initial period and The initial and the current level of G N P we can obtain the net inflow of foreign capital received to achieve a target rate of growth, or what rate of growth can be achieved with a given inflow

of foreign capital. Note also

or a larger inflow of foreign capital can achieve a higher rate of growth.

This way of looking at the relalion-ship between foreign capital and the rate of growth of G N P implies that every year the import-surplus some­how gets adjusted to the net inflow of foreign funds. Total imports be­come automatically equal in the two exigenous variables Xt and Ft and the growth rate entirely depends on how far F can eliminate the bottle­neck of the low rate of domestic sav­ings. But imports may not be so freely adjustible in the underdeveloped country and a more realistic model should contain some additional con­straints in the form of some kind of import bottlenecks.

For instance, one may assume that there is a rigid relation between the minimum level of imports required and the level of G N P , In that case a given amount of foreign capital by financing a rate of investment in ex­cess of domestic savings may not achieve an increase in income, as determined by the capital output ratio, if the maximum level of imports corresponding to the increased level of income exceeds the exports by more than the given inflow of foreign capital. Alternatively, one might suggest that there is a minimum proportion of investment, expenditure which must be spent on imports. In that case the rate of growth determined, ceteris paribus, by a rate of investment corres­ponding to a given inflow of foreign capital may not he achieved if the minimum imports out of that invest­ment expenditure exceed the exports by more than the given inflow of foreign capital.

In either case the condition for a given amount of foreign capital inflow to achieve a rate of growth of income determined by the amount of savings investment gap it can finance, is that M < X + F, where M stands for the minimum level of imports. If this condition is not fulfilled, there will he two operative constraints on the level of income and its growth. The solu­tion of the system then will depend upon whichever constraint is more restrictive, i e whichever gives the minimum solution.

Bruno and Chenery in their model for the Israeli economy introduced a variant of the first kind of import restriction mentioned above and osti-maled the import requirements from the solutions of an input-output model under some strict assumptions. They observed that at lower levels of G N P

the import bottleneck is more restric­tive than the savings bottleneck. Their method can be described in a simpli­fied form in the following way, Let the import minimum

the import bottleneck is more restric­tive than the savings bottleneck. Their method can be described in a simpli­fied form in the following way, let the import minimum

which gives a relationship between G N P and foreign capital.

The alternative method of introduc­ing this import restriction, in the form of some minimum developmental im­ports being a fixed proportion of gross investment, seems to me to be some­what more realistic than the Bruno-Chenery method. In a planned economy, where the Government can erfectively use fiscal, monetary and other kind of quantitative controls, the relative prices, the exchange rate and import-substitution, at least in consumption, are very much dependent on policy decisions and it is difficult to conceive of a minimum import requirement as a given proportion of G N P or total private and public consumption ex­penditure. On the other hand the proportions of gross investment to be spent on developmental imports will depend very much upon technological relationships. Gross investment here is the required investment correspond­ing to a target rate of growth and the overall incremental capital-output ratio is a summary of the detailed capital requirements of all the differ­ent projects which have to be carried out to achieve that rate of growth. If there is little technological substitut-ability between different kinds of capital goods in any of these projects, it is possible to calculate the amount of capital goods that have to be im­ported for any level of required invest­ment from the expected availabilities of these goods within the economy.

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This relation Rives the upperbound to the rate of growth of G N P that can he achieved in this system. A net inflow of foreign capital, by covering the savings-investment gap, as in equation (5), cannot achieve a rate of growth which is higher than

The rate of growth can he equal to it, when the savings-investment gap is ex. aetly equal to the gap between exports and the minimum imports, or it can be less, when the economy is able to im­port more than the minimum.

It can also be seen that this upper-bound or the import constraint on the rale of growth becomes less and less restrictive as time goes on. If exports increase at a faster rate than GN P then even if foreign capital inflow tapers off this will not offset the effects of increasing exports as it is normally only a fraction of total ex­ports. Further, there is every .eason to expect that mt will decline over time, as with the rising G N P, more and more of different kinds of capital goods will be produced domestically. Thus, in the long run the savings investment gap will determine the effect of foreign capital on the rate of growth, although in the early phase of development the import constraint may be more important.

From the relation (7) it is possible to calculate the number of years after which the minimum import-require­ments can be fully financed by the country's exports without being supple­mented by foreign capital. Let n be the year when such independence from foreign capital is achieved. Then

It should be clear from the above discussion that this n need not be equal to the n obtained from the relation (4). The latter gives the number of years after which the coun­try will generate enough domestic savings to finance the investments required to attain a given rate of

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growth without depending on foreign capital. This can be obtained from the relation (4) in the following way:

from which the value of n can be obtained.

It is obvious from all this that the essential condition for the country's becoming independent from foreign capital at a future date is that s > k. r or the marginal rate of savings should exceed the required rate of investment. Further, smaller will be the value of n, i e earlier will be the year of such self-sufficiency, the bigger the difference between the marginal rate of savings and the required investment and the higher the value of the initial rate of savings

Until now, no reference has been made to the problem of repayment and servicing of foreign capital. Un­less foreign capital comes purely in the form of grams and donations, funds will have to be provided very year for dividend or interest and amortisation payments. This implies that there will be an annual drain from the country's domestic savings as well as from its foreign exchange earnings an amount equal to the pay­ment of investment and amortisation abroad. Since the minimum import requirements, considered above have been made to depend either only on the rate of" investment or on domestic expenditures, this drain in foreign ex­change and domestic savings 'which any foreign capital inflow other than grants necessarily entails has to be explicitly taken into account in the equation of foreign capital require­ment.

Before we introduce this factor, it should be clear that the relations (4), (5) and (9) all refer to the case of foreign capital inflow purely in the form of grants. No repayment obliga­tion is attached to them, and after the nth year that is, the year of independence from foreign capital is reached, the country's domestic sav­ings will exceed the required invest­ment rate. In that case, if the same rate of growth is maintained, the country wil l have to export capital

abroad. Otherwise the country's rate of growth wil l have to increase every year so that the rate of investment required to achieve the higher rate of growth is equal to the increasing domestic savings. The model then will look like a simple Harrod-Domar system.

This increasing rate of growth will approach, as time passes, s for the

k expression 1/k (s —s0) V0

will become smaller and smaller.

I shall consider in the following two types of foreign capital inflow which have some form of repayment obligation attached to them, In case A, I shall consider the case of direct foreign investment which entails an obligation of payments of dividend income abroad but no repayment of c a p i t a l . There may be some repatriation of direct/foreign invest­ment every year, but since this is not necessarily related to the past inflow, it will not be explicitly introduced in the system. As the foreign capital inflow figures are netted against out­flows, such repatriations will be reflect­ed in the size of the foreign capital. In case B, I shall consider the case of foreign loan capital which has an obligation of a series of interest and amortisation payments abroad for a stipulated period attached to it . The important difference between foreign loan capital and foreign direct invest­ment is that the former liability is totally liquidated after a stipulated period while even when no net direct investment is flowing in, the country has to provide for dividend payments abroad for an idefinitc period.

Case A Here, let us suppose that all foreign

capital is coming in the form of direct investment. The required amount of foreign capital is no longer simply the difference between the required rate of investment, to achieve a target rate of growth and the rate of savings. Funds have to be provided in foreign exchange every year to pay for the dividends on the past foreign invest­ments and the amount of foreign capital required every year will be equal to the gap, between the required investment plus such dividend pay­ments and domestic savings, If Do is the accumulated foreign investments

T H E E C O N O M I C W E E K L Y August 14, 1965

at the initial year and i , the average rate of dividends to be paid on the jth year's inflow of direct investment, then foreign capital required at nth period will be

From this relation, by putting Fn

O, one is able to determine the number of years after which no fresh inflow of foreign capital, all coming in the form of direct investment is required to maintain a given 'ale of growth.

As before, this essential condition for independence from foreign capital at a future date is s > Kr or the marginal rate of savings should exceed the rate of investment required. But the period taken to achieve this inde­pendence will obviously be longer than in the case of grants. The pure siv-ings-inveslmerit gap will be coveted at a relatively early period, but inflows of foreign capital will continue to be required as domestic savings will not be sufficient to pay for dividends on the accumulated investment. Only, at the year of independence, domestic savings will be enough to meet the needs for the required investment as well dividend payments. But, as men­tioned earlier, this does not mean that after the year , all domestic sav­ings can be invested. A gum of

be paid continuously, if no capital is repatriated and only the amount of savings in excess of thus sum can be invested. So, after the year the rate of growth will start rising, as in the case of grants, but at a much slower rate.

Case B

In the case of foreign loan capital payment obligations abroad include in addition to interest payments every year amortisation payments for every loan. The exact time profile of such payments wil l depend upon the arrangements for amortisation and

interest payments for different kinds of loans. Interest and amortisation can be charged on the net debt out­standing, in which case loans are not completely liquidated but the unliqui­dated balance of each loan becomes smaller and smaller every year. On the other hand while interest is "narg-ed on the net debt outstanding, yearly amortisation may be 1/T of the originall value of each loan for T periods. Alter. natively, the equal instalment method may be followed, when amortisation and interest on each loan are paid off in a series of equal annual instal­ments.

There may be several other ways of charging interest and umortisation on different kinds of loans,and in any particular year the total amount of foreign loan will be composed of several kinds of loans subject to different methods of charging interest and amortisation rates. Quite often some kind of "grace period" is attached to official loans when the interest and/or amortisation payments do not begin t i l l some years after the loans are granted.

I shall consider here only the equal instalment method which is probably the most commonly used method for different kinds of official loans. It is also easily comparable to the earlier results and can highlight the issues involved in any such illustration. Ac­cording to this method, if F is the amount equal to a F will be repaid every year, from one year after the loan is gran led, for a period of T years to pay off both the principal and the interest on such loan. This 'a' can be called the rate of servicing of foreign loans. The stream of annual payments is like an annuity, the present discounted value of which is equal to the original value of the foreign loan.

If v 1 4 i, where i is the rate of interest, using the standard formula for the present value of an anuity, we get

Note that the value of 'a' depends only on the rate of interest and the period of loan T. If i is given, then a will be larger, smaller the value? of T. The grace period can be easily accommodated within this formula. Suppose a loan is granted for 10 years of which for the first ten years no

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of independence the entire amount of domestic savings cannot immediately be channelled into investment, the amount of the drain of resources on account of service charges on foreign loans will be declining until the year n + T - 1, after which no mere service charges will be required. Thus in the cast; of foreign loans between the years n and n + T — 1 the rale of growth of the economy will be increasing at a slower rate than in the case of grants but at a faster rate than in the case of direct investment. But after n + T - 1 years, the rate

of growth wil l he similar for both the cases of foreign loans and foreign grants.

C A Alter : "The Servicing of Foreign Capital Inflows by Under­developed Countries", in "Econo­mic Development of Latin Ame­rica", (ed) Ellis and William; Bruno and Chenery: "Develop­ment Alternative in an Open Eco-nomy: the Case of Israel', Econo­mic Journal, March 1962; Demar: "The Effect of Foreign Invesi-ment" in "Essays in the Theory of Economic Growth".