Money Supply Impact of National Currency Counterpart of Foreign Aid: An Indian Case

Abstract

FOREIGN economic assistance in the form of commodities and the sale proceeds in domestic currency of those commodities have assisted post-war recovery of West European countries and economic development of many under-developed countries like India. The real significance of the accrual and disbursement of these funds, perhaps, lies in their impact on money supply. Despite its obvious importance, however, the problem of the money supply impact of counterpart funds did not receive as much attention as it deserved, although whether use of such funds is inflationary or not was discussed to some extent.1 India, which has been receiving a large and increasing commodity assistance from the United States in recent years under P.L. 480, provides an interesting example of how variations in money supply are influenced by the accrual and disbursement of counterpart funds and how they tend to influence monetary and debt management policies. The main purpose of this article is to spell out the money supply impact of accumulation and disbursement of the counterpart funds and to indicate broadly its significance for monetary and fiscal policies pursued in India.2 The practice adopted in India for holding counterpart funds has not remained uniform. Between I956, when the foreign assistance in the form of commodities from the United States under P.L. 480 first started coming in, and the middle of I960, the counterpart funds have been held with one of the commercial banks. Since then, however, they have been held with the Reserve Bank of India, which is the central bank of the country. While discussing the Indian experience, we first concentrate mainly on the money supply impact of the accumulation of counterpart funds with a commercial bank as it has acquired greater importance and raised considerable debate.3 The latter practice has been adopted only recently; the likely consequences of the changed procedure are analyzed separately in the latter part of this paper.