The Flow of Funds in Indian Manufacturing Sector

An econometric model portraying the behaviour of flow of funds in manufacturing sector has been developed. Given the balance sheets constraint, decisions to acquire physical assets and other decisions about source and allocation of funds are governed by profitability, liquidity and transaction requirements. Based upon these criteria, a self-contained model for explaining the data sources and uses of funds pertaining to the Indian Manufacturing Sector has been developed. It consists of 12 behavioural equations and several identities. The equations are fitted to annual flows of funds related to data over the period 1954 through 1970. Main conclusion of this preliminary investigations are as follows: 1. Profits after tax are not sensitive to changes in capacity utilization rate, but are highly sensitive to changes in sales. 2. There is no evidence of direct effect of changes in interest rates or other monetary policy instruments on the components or internal funds. Interest rates, however, are found to exert pressure on the flow of external funds to the manufacturing sector. 3. Inventory and fixed investment are found to be sensitive to variations in the availability of external funds. Monetary policy affects the manufacturing sector through the funds availability (has a quantity effect) rather than through interest rates (price effect). 4. Liquidity as well as interest cost considerations play important role in determinine the allocation of funds between financial assets, like marketable securities, accounts receivable and cash and bank balances. 5. Thus, fiscal policy, as reflected in terms of tax parameters has a direct impact on the cash f.low position of the manufacturing sector and thereby affects its decisions to invest and hold inventories. Monetary policy affects the portfolio of financial assets and external funds; its effects on the decisions to invest and hold stocks are only indirect and remote.