India's War

by Srinath Raghavan

  Such concerns apart, the immediate problem for India was – to borrow Keynes’s famous phrase – how to pay for the war. After all, the real burden of a war cannot be postponed: goods and supplies required by the fighting forces can only be provided through accumulated stocks and current production. The aggregate annual outlay of the Indian government during these years increased by almost forty times, to Rs. 40,000 million. The challenge for the Indian government was to finance these requirements.

  There are only three ways of financing a war: to tax, borrow or print money. The Indian government had to resort to all of them in about equal measure. It had recourse both to indirect and to direct taxes. Prior to the war, indirect taxes – customs and excise duties – had been the main source of revenue for the government; the structure of taxation, in the jargon, was rather ‘regressive’.53 During the war, imports plummeted by almost 60 per cent from the pre-war level, due to prioritization and disruption of shipping as well as the need to conserve precious foreign exchange for essential war goods. As a consequence, customs duties also fell sharply. Although the government increased the rates, the yield of customs duties continued to fall until 1945–46. The decline in customs revenues led the government to increase excise duties on articles of consumption – both by increasing the rates and by subjecting more items to the levy. Even so, the total yield of indirect taxes continued on a downward slope.54

  Source: R. N. Poduval, Finance of the Government of India since 1935 (Delhi: Premier Publishing, 1951), Table VII

  Figure 7. Indian war expenditure, 1939/40–1945/6

  To increase its revenues, the government had to rely more on direct taxes. Indeed, income taxes came to be the mainstay of the government’s revenues during the war years. The war thus induced a fundamental change in the structure of taxation from a regressive system to a progressive one. As a proportion of total tax revenue, income tax rose by over threefold. The basic rates of income tax and super tax were left unchanged and increases were obtained by means of surcharges. The highest rate of income tax (including surcharges) during the war touched 30 per cent, while super tax – an additional levy on the very wealthy – went up to a maximum of 66 per cent. The exemption limit for income tax remained Rs. 2,000, except for 1942–43 when it was temporarily lowered to Rs. 1,500 in order to widen the tax net. Other steps were also taken to increase tax collection, such as the introduction of a pay-as-you-earn system from 1944–45. Corporate tax increased from 6.25 per cent in 1938–39 to 18.75 per cent in 1944–45. From 1940–41, a tax of 50 per cent was imposed on any ‘excess profits’ earned by businesses over their standard profits earned in the previous years. From 1941–42, this excess profits tax was increased to 66.66 per cent.55

  Tax Yield (Rs. million)

  * Including provincial shares; # Including non-tax revenue such as railways, post and telegraph, salt, etc.

  Source: N. C. Sinha and P. N. Khera, Indian War Economy: Supply, Industry and Finance (New Delhi: Combined Inter-Services Historical Section, India & Pakistan, 1962), Table 4.

  Altogether, total revenues from tax and non-tax sources amounted to only 36.6 per cent of the total war expenditure of the Indian government. This was partly because the population base for income tax was meagre: it rose from 286,000 people in 1938–39 to 428,500 in 1945–46. This reflected the fact that India was a country with low per capita income and that the tax bureaucracy was weak. Further, while income tax rates in wartime India became comparable to countries like Britain, corporate tax rates – including the excess profits tax – were considerably lower. Indian business saw the war years as an opportunity to recover from the losses of the previous decade and so resisted further increases in the excess profits tax. And the government was too dependent on industry to apply the squeeze.

  To plug the gap, the government resorted to borrowing from the public, and the government’s rupee debt increased sharply. Throughout the war, the government was the main borrower in the money markets. From 1943, businesses had to obtain the government’s sanction for any new capital issue – sanction that was denied to companies that were not producing essential goods. In consequence, the government was also able to borrow cheaply. The government bonds were floated at 3 per cent interest. The period of maturity of the first tranche in 1940 was six years; thereafter it steadily lengthened to fourteen and twenty-five years in the 1945 issues. Rupee counterparts were also issued for the sterling debt repatriated. Further, the government sought to mobilize small savings. A slew of post-office savings bank schemes as well as national savings certificates and defence savings certificates were offered.56

  Subscriptions to Government Loans (Rs. million)

  Year Bonds Small Savings Total

  1940–41 1,125.0 –265.5 859.5

  1941–42 743.6 –132.4 611.2

  1942–43 1,037.6 –28.0 1,009.6

  1943–44 3,155.6 257.1 3,412.7

  1944–45 2,222.6 418.1 2,640.7

  1945–46 3,292.4 633.5 3,925.9

  Total 11,576.8 882.8 12,459.6

  Source: N. C. Sinha and P. N. Khera, Indian War Economy: Supply, Industry and Finance (New Delhi: Combined Inter-Services Historical Section, India & Pakistan, 1962), Table 9.

  Borrowing accounted for 31.2 per cent of the total war outlay of the government. Why did the government not do better given its monopoly in the financial markets? In the first place, the small savings schemes did dismally until 1943–44. In the waves of panic following the fall of France and the Japanese advance towards eastern India, there had been heavy withdrawals from post offices across the country. This was triggered by a lack of confidence in the ability of the Raj to hold its own. Only after the military situation began looking up did the small saving offerings find increasing numbers of takers.

  In the second place, the government was unwilling to offer a coupon of more than 3 per cent on its bonds. It felt that increasing the interest rates on bonds would be fatal, as it might lead to speculation about a continuous rise in the rates. As the governor of the Reserve Bank of India (RBI) put it, ‘the cheap money policy on which the present war is being financed is therefore of vital importance’.57 Although the subscription rate increased after 1942–43, it did not reach the expected levels. Fluctuations in the yield of the government’s regular 3.5 per cent rupee paper suggest that depending on the progress of the war the market’s willingness to sponsor the cheap money policy also changed. (Yield is inversely proportional to price, so an increase in yield means a drop in the trading price of the bond. In other words, investors want a higher rate of interest on government borrowings.) The fall of Singapore led to such a sharp fall in the price of securities that in March 1942, the government ordered the fixing of a minimum price for its bonds.58

  Current Yield of the Government of India’s 3.5% Rupee Bond

  Date Yield (%)

  Jun-39 3.68

  Oct-39 4.38

  Apr-40 3.68

  Jun-40 4.07

  Dec-40 3.72

  Jun-41 3.65

  Dec-41 3.80

  Mar-42 4.17

  Jul-42 3.85

  Sep-42 3.72

  Jun-43 3.70

  Dec-43 3.58

  Dec-44 3.51

  Jun-45 3.44

  Source: Calculated from Abhik Ray, The Evolution of the State Bank of India, Volume 3, 1921–1955 (New Delhi: Sage, 2003), pp. 244, 247, 252, 256–8.

  The most important reason for the government’s inability to borrow adequately – as indeed its inability to gather sufficient tax – was politics. Given the political gridlock and uncertainty, public support for the war effort was muted. As Amery noted in late 1943:

  The fact cannot be ignored that, of all the united nations none has felt less moral incentive to co-operate in the prosecution of war than India. The Indian war effort … is pretty frankly a mercenary undertaking so far as the vast majority of Indians are concerned … we have to reckon all the time with strong forces which if not positively pro-Japanese, are certainly anti-British, or
at best are indifferent.59

  In any event, the government filled the remaining gap of 32.2 per cent of the overall war expenditure by cranking the printing presses. This amount was not much short of the share of expenditure incurred by India on behalf of London. Here the sterling balances came in handy. The government asked the RBI to treat sterling balances in London as assets against which it was entitled to print rupee notes of about two and a half times their sterling value.60 The expansion in currency naturally resulted in galloping inflation and the over-heating of the economy.

  Wartime Inflation

  Year General Index of Wholesale Prices Notes in Circulation (Rs. million)

  1938–39 NA 1,743.9

  1939–40 125.6 1,981.3

  1940–41 114.8 2,280.3

  1941–42 137.0 2,874.8

  1942–43 171.0 5,134.4

  1943–44 236.5 7,771.7

  1944–45 244.2 9,686.9

  Aug 1945 244.1 11,387.0

  Source: Statistics Relating to India’s War Effort (Delhi: Government of India, 1947), Tables 46, 47.

  Although the RBI had an Indian at the helm from mid-1943, it felt legally bound by the Reserve Bank of India Act to issue currency against sterling assets. In public, Governor Chintaman Deshmukh gamely insisted that inflationary financing was unavoidable: ‘There is only one country in which the whole of the amount disbursed can be withdrawn by Government by means of taxation and borrowing, and that is, Utopia.’61 Other Indians associated with the RBI were not to so coy. Manilal Nanavati, a deputy governor until October 1941, wrote to the finance member of the viceroy’s Executive Council: ‘the expansion of currency against purchases by His Majesty’s Government … Is this not an abuse of the Reserve Bank Act that the Bank should be used to finance these purchases?’62 The Indian directors on the board of the RBI, too, were deeply concerned about the spiralling inflation. Purshottamdas Thakurdas suggested that the government should make its borrowing more attractive by offering high interest for short periods and by making the bonds tax free if necessary. Kasturbhai Lalbhai tabled a resolution in May 1944 suggesting a limit on currency expansion.63

  Indian economists also weighed in with their views in public. C. N. Vakil, a professor at the Bombay School of Economics, published a pamphlet in January 1943, The Falling Rupee. This was the first serious attempt at bringing to public notice the problems of war finance. In an excoriating critique of the government’s approach, Vakil argued that British demands of India must be met by payment in durable assets; by payment in gold; by the British government raising rupee loans in India; and by the liquidation of British assets in India. A series of pamphlets were published in the following months, including two by G. D. Birla, advocating similar ideas.

  In April 1943, Vakil rallied a group of twenty leading Indian economists to issue a joint statement. The economists stated that the inflation in India was ‘a deficit-induced, fiat money inflation. It is the most disastrous type of inflation.’ Calling for ‘immediate and drastic measures to check inflation’, they outlined a series of measures to soak up the excessive liquidity in the economy: steeper progression in rates of income tax; absorption of all profits above a limit by taxes or enforced special loans; and a Keynesian ‘comprehensive scheme of compulsory savings’.64 The government took no heed. However, when the Gandhian economist J. C. Kumarappa published articles attacking government policy and quoting extensively from Vakil, he was immediately sentenced to two years’ imprisonment.65

  The war-induced inflation benefited certain sections of Indian society.66 Big business, especially the industrialists, obviously made huge windfalls from the booming prices. The urban middle classes did not do well, however. A survey of middle-class families in Bombay – those with pre-war incomes between Rs. 50 and 300 – found that their aggregate income had increased by 45 per cent, but this was insufficient to compensate for the rise in the cost of living. The families were forced to change their patterns of consumption. While the consumption of food-grains – rice, wheat, pulses – did not change much, the intake of other items reduced considerably: clarified butter by 42 per cent, potatoes by 37 per cent, sugar by 28 per cent, milk by 18 per cent and meat by 15 per cent. Despite these cutbacks, the families spent 99 per cent more on food items than before the war. Aggregate expenditure on food rose to 51 per cent of income, as opposed to 37 per cent before the war.67 The position of those on the lower rungs of urban society could be precarious. The wife of a soldier wrote from the town of Sargodha in Punjab:

  everything is very dear. For 6 months I have been feeling uneasy … At present I am in great difficulty … The creditors are troubling me and I have mortgaged all my ornaments. I am in a crisis … Your children have been starving continuously for 3 days. My plight is very bad.68

  The pattern in rural India was not dissimilar. Large peasant-proprietors gained from the surge in prices for agricultural commodities. Very like big business, the combined result of soaring profits and restricted consumption for these groups was an increase in savings and in potential post-war investment. The effect on other sections of rural society was mixed. In the wake of the Great Depression, which had immiserated large sections of agrarian India, the war years came as a balm. Rural families that had been pushed into debt during the previous decade now found that the increasing demand as well as rising prices for their produce enabled them to pay off their debt. An inquiry into the villages of the Ludhiana district of Punjab found that even poor cultivators were partially able to shake off the manacles of debt. If nothing else, ‘a rise in the mortgage value of land … made it possible for them to redeem a part of their land simply by changing the mortgagee’. The wages of labourers working on the farms rose over fourfold during the war. Yet even in the Punjab, the most prosperous agrarian province of India, the rise in income trailed the overall rise in prices.69 As the father of a Punjabi soldier wrote in early 1943, ‘every domestic requirement has become scarce and expensive, particularly articles of food and clothing. Their prices have quadrupled.’70

  In most other parts of rural and urban India, the numbers of those skirting the edge of subsistence was much larger. The soaring inflation thus led to deprivation and hunger in many parts, and to starvation and famine in some. The famine in Bengal of 1943–44, which resulted in perhaps 3 million deaths owing to starvation and disease, was the extreme manifestation of the problems triggered by inflation. It is also the best studied.71 As Amartya Sen has famously argued, the famine was caused not by a shortage in the availability of food in the province but by the drastic reduction in the ‘entitlements’ – the overall ability to obtain food – of the Bengali people. This, in turn, was primarily due to the war-induced inflation.72

  Other factors, such as the ‘denial’ policy that destroyed the boats – in case these might be useful to the invading Japanese – and livelihoods of fishing communities, the panic hoarding by producers and traders, the inefficiency of the local government in procuring and distributing food-grains to various districts, and the unwillingness of the government to initiate a famine works programme to increase the purchasing power of the destitute, grimly exacerbated the problem. Irrespective of the causes, the consequences could have been mitigated by channelling large quantities of food through a public distribution system. Shipping of imports was constrained by the competing demands of war. More importantly, Churchill was cruelly callous in his consideration of Wavell’s requests for imports of food-grains into India. ‘I hate Indians’, he told Amery. ‘They are a beastly people with a beastly religion.’ Even when overall demands on British shipping dropped, Churchill held that ‘We cannot afford to send ships merely as a gesture of goodwill.’73

  The calamity of Bengal has engendered an understandable desire to find the guilty men. Yet, however appalling Churchill’s attitude and devastating the consequences for Bengal, the taproot of the problem was the inflationary financing of the war. Indeed, deprivation and hunger stalked large parts of India from late 1942. ‘Dearness has surpas
sed all limits and is worrying me too much’, wrote the father of a soldier from Gonda in the United Provinces:

  Adults can bear sufferings and can live without food for some time, but infants can’t survive for even an hour. I am helpless to make both ends meet … Death is better than this life. I am tired of this state of affairs and sometimes I think of putting an end to my life. We are experiencing days of Judgment and the people will starve to death, if these conditions continue.74

  The mother of another soldier wrote from Ranipet in Madras Province: ‘Our food problem still shows no sign of improvement. You see my son, I have to purchase the foodstuff at very high prices, to manage other daily necessities, pay the tuition fees for the children, pay the medical bill and meet with many other items.’75

  A wife wrote from Hyderabad State:

  I am too helpless to make both ends meet. Dearness is increasing day by day. Prices have risen double, treble and quadruple even in some cases … You are always asking me to send a photo of mine and children; but it would cost me at least five rupees nowadays and where will I get so much … Please increase my allotment, otherwise we are really going to starve.