Chapter Four

Financial Development Planning

4.1 Resource Mobilization

•Resource mobilization refers to the scheme of collecting funds for financing a plan.
• It involves the study of various internal and external sources of finance for the execution of the plan.

•Finance is the instrument for resource mobilization.

• It is essential for the purpose of removing maladjustments between supplies and demands of goods and
services in order to avoid inflation and balance of payment difficulties.

•If sufficient funds are not available, the achievement of plan targets becomes an
impossibility.
• The importance of resource mobilization in an underdeveloped country lies in curtailing consumption and
augmenting savings for an accelerated investment in the community.
4.1.1 Methods of Resource Mobilization

•There are mainly three items of resource mobilization to finance the public sector
Planning.
i) Domestic budgetary resources which include
- Balance from revenues – contributions of public enterprises like railways,
posts, telegraphs , retained profit of the national bank , taxation
- State provident fund
- Net market borrowings and borrowings by financial institutions etc.
ii) Deficit financing
iii) Foreign Direct Investment (FDI)
Methods…
i. Domestic budgetary sources.
Internal resources
• The principal items of internal resources are
a) current revenue balance:- current expenditure of the government.
b) Surpluses of public enterprises
c) Loans from public or public borrowings
• The increasing reliance on borrowings for financing plan outlays in each year is not a healthy sign for the economy. For it would lead
to an increase in non – plan expenditures in the form of interest payments on loans which are continuously rising every year.

d) Taxation and domestic deficit financing are also other ways of internal resource mobilization for financing a
plan.
Methods…
External Assistance
 External assistance is another source of financing a plan.
 It is a means to bridge the gap between internal sources and plan outlay.
 Efforts to mobilize domestic resources through taxation, public borrowings and deficit financing may not be
adequate which necessitate the inflow of external assistance.
• Besides supplementing domestic resources, foreign aid helps in industrialization, in building up economic overhead
capital, and in creating larger employment opportunities. It not only brings money and machines but also technical
knowhow.
• It opens inaccessible areas and exploits untapped and new resources. It removes the balance of payments problem and
minimizes the inflationary pressures. Further foreign aid helps in modernizing the backward society and strengthens
both the private and public sectors.
• However, external assistance does not flow smoothly into the country.
• It is a very uncertain source of income and involves many problems. It leads to dependency because the donors insist on aid –
tying to the purchase of goods and services at costs much higher than the Competitive world prices, and on monetary, fiscal and
export – import policies detrimental to the national interest of the recipient country
• For instance, the recipient country may be required to keep on overvalued exchange rate, low interest rate etc. Then there is the
problem of debt servicing which, if not managed properly and in time, may lead the country to “debt trap” whereby the entire
aid is utilized in debt servicing.
Methods…

ii. Deficit financing as an instrument of Development Financial Planning

• The phrase deficit financing is used to mean any public expenditure that is in
excess of current public revenues.
• In advanced countries, deficit financing is used “to describe the financing of a
deliberately created gap between public revenue and public expenditure or
a budgetary deficient.
• The method of financing being borrowing of a type that results in a net
addition to national outlay or aggregate expenditure.
Methods…
Role of deficit financing
• Deficit financing is the most useful method of promoting economic development in LDCs.
• The nature of an LDC is such that sufficient private investment is not forth- coming due to various, social,
economic and institutional factors.
• Therefore, the responsibility of augmenting the rate of net investment in the economy devolves on the government.
• On account of the lack of sufficient resources to finance public investment, governments have to resort to the method
of deficit financing.
• Deficit financing may be used for the development of economic and social overheads such as construction of roads,
railways, power projects, schools, hospital etc.
• By providing socially useful capital, deficient financing is able to break bottle necks and structural rigidities and
thereby increases productivity.
• Deficit financing may also augment community savings by increasing money incomes.
• The rationale for deficit financing is that it tends to raise the income of the entrepreneurial class which has a high
propensity to save.
• Deficit financing is always expansionary in its effects.
Methods…
Adverse effects of deficit financing
•  It has inflationary potential.
• A continuing rise in prices is a dangerous way of promoting economic development. Inflation is not only economically
but also socially undesirable as a method of financing development.
• That is why; it is the most dreaded method of accelerating the rate of economic growth.
• Inflation as a method of forced savings gives rise to considerable social costs.
• Inflation, no doubt, helps to reduce consumption and increases savings yet from the social view point; it is a wasteful
method of forcing savings.
• Inflation may retard economic development.
• With the rise in the price level, the cost of development projects also rises resulting in larger doses of deficit financing on the part of the
government. If not checked in the earlier stages, the rise in prices becomes cumulative.
• The vicious circle of more money chasing fewer goods develops which ultimately brings a total collapse of the monetary system.
• Severe inflation also leads to balance of payments difficulties because imports increase further as domestic prices rise.
• Inflation encourages the speculative and unessential transactions which are major obstacles to economic development:
• discourages domestic savings as well as foreign investment; disrupts foreign trade relations, and lowers the general efficiency of productions.
• Thus, there is little positive relation between deficit financing and economic development.
Methods…

Safe limits of deficit financing

1) Growth rate of the economy
2) Growth of the monetized sector
3) Increase in loans and taxes
4) Control over wages and prices
5) Creation of import surplus
6) Increase in supply of goods
7) Increase in equity capital, undistributed profits and budgetary surpluses.
8) Spirit of sacrifice .
Methods…
iii. FDI
• Foreign capital can enter into a country in the form of private capital and /or public capital.
• Private foreign capital may take the form of direct and indirect investments.
• Direct investment
• This means that the concerns of the investing country exercise de facto or de jure control over the assets created in
the capital importing country by means of that investment.
• Direct investments may take many forms
- The formation in the capital importing country of a subsidiary of a company of the investing country.
- The formation of a concern in which a company of the investing country has a majority holding
- The formation in the capital importing country of a company financed exclusively by the present concern situated in the investing
country.
- Setting up a corporation in the investing country for the specific purpose of operating in the other concerns or
- The creation of fixed assets in the other country by the nationals of the investing country.
- Such companies or concerns are known as transnational corporations (TNCS) or multinational corporation (MNCs).
Methods…
•Direct private investment (DPI) has been concentrated mainly in the extraction of raw materials like:
- iron
- crude oil
- manganese
- bauxite
- copper
- Electric energy etc.
•Only a small percentage of DFI has gone to manufacturing and distribution.
Merits of private Foreign Investment ( PFI)
1. PFI provides finance, managerial, administrative and technical personnel, new technology, research and innovations in products and
techniques of production which are in short supply in LDCs.
2. It encourages local enterprises to invest in collaboration with foreign enterprises.
3. FDI helps in filling the savings gap and the foreign exchange gap in order to achieve the goal of national economic development in LDCs.
4. A part of the profits from PFI is generally reinvested into the expansion, modernization or development of related industries.
5. PFI adds more value added to output in the recipient country than the return on capital from foreign investment. In this sense, the social
returns are greater than the private returns on foreign investment.
6. PFI also brings revenue to the government of an LDC when it taxes profits of foreign firms or gets royalties from concession agreements.
7. PFI helps in raising productivity and hence the real wages of local labor.
8. It helps to reduce the balance of payments problem by encouraging the production of manufactured articles, for both domestic market and
foreign markets.
9. PFI encourages its local entrepreneurs to invest in other LDCs.
Methods…
Demerits of Private Foreign Investment
1. the recipient country may be required to provide basic facilities like land, power, and other public utilities, concessions
in the form of tax holidays, development rebates, rebates on undistributed profits, additional depreciation allowance,
subsidized inputs, etc.
• such facilities and concessions involve cost in absorbing an LDCs resources that could be utilized elsewhere by the government
2. To attract PFI, LDCs must provide sufficient facilities for transferring profits, dividends, interest and principal.
• If these payments lead to a net capital outflow, they create serious balance of payment which eventually leads to Debt servicing.
3. PFI increases investment, employment, income and savings in LDCs. However, it adversely affects income distribution
when it competes with home investment.
• Capital and other resources may flow to foreign enterprises in preference to domestic enterprises.
• This may reduce profits in the latter, thereby discouraging local enterprise.
4. Most (PFIs) reserve key executive posts for their nationals and pay them very high salaries with many perks (fringe
benefits) which are a huge drain on the resources of the recipient country.
5. PFI brings in highly capital-intensive technologies which do not fit in the factor proportions of LDCs.
• Most of the time obsolete and outdated machines and techniques are imported which involve high social costs in terms of replacement after
a few years.
6. PFI involves costs in the form of a loss of domestic autonomy when foreign firms interfere in policy making decisions
of the government of an LDC which favors the foreign enterprises.
• Such interference is usually resorted to by the multinational corporations.