The 1991 Economic Crisis: A blast from the past

The Indian economy has been one of the largest economic contributors to the world from 1 AD as revealed pieces of evidence. According to History, India contributed to around 35 to 40% of world GDP. Post-British rule marked a combination of protectionist, import-substitution, Fabian socialist, along with social-democratic policies that dominated the Indian economy. The economy of that time was characterised by extensive regulation, protectionism, public ownership of large monopolies, pervasive corruption and slow growth. Economic liberalization in 1991 moved the country towards a market-based economy. India by 2008 established itself as one of the world’s faster-growing economies making a mark in the world economic arena.

The Indian economy has traversed a long path to reach where it is today, good or bad. To understand how and when it reached a position of extreme significance in the world economic arena, it is important to know how it has begun in the first place. A run-through is hence significant to understand how the Indian economy is what it is today:

  • Ancient and medieval eras         

A permanent settlement, Indus Valley Civilisation, flourished between 2800 BC and 1800 BC. History has shown the existence of trade between this civilization and many others. Moreover, maritime trade is believed to be carried out copiously between South India and Southeast and West Asia from the 14th century AD. The Malabar and Coromandel Coasts is assumed to be sites of important trading centres from as early as the 1st century BC. They were supposedly used for ‘import and export’ and ‘transit points’ between the Mediterranean region and Southeast Asia. Several scholars opined that trading between India and West Asia along with Eastern Europe was active between the 14th and 18th centuries. In addition to this, the Saurashtra and Bengal coasts played an important role. The Gangetic plains and the Indus valley housed several centres of commerce carried by water. Trade via land was mostly carried out via the Khyber Pass connecting the Punjab region with Afghanistan and moved ahead to the Middle East and Central Asia. Although coins were prevalent, barter was widespread. It has been suggested that villages in that time paid a portion of their agricultural produce as revenue to the rulers, while their craftsmen received a part of the crops at harvest time for their services.

  • Mughal era

This era (1526-1793) saw unprecedented growth and prosperity of the Indian economy up until the 18th century. A well-known economist, Sean Harkin, estimated that China and India, consecutively, may have accounted for “60 to 70% of world GDP in the 17th century”. The economy of this time functioned on an elaborate system of coined currency, land revenue and trade. Under the Mughals, there was an existence of a well-developed internal trade network. At that point, India had almost 64% of its workforce in the primary sector (including agriculture) and 36% of the workforce also in the secondary and tertiary sectors which were much higher than in Europe. The industrial manufacturing economy thrived under the Mughal Empire with India producing about 25% of the world’s industrial output up until 1750. The late 17th century to the early 18th century Mughal India accounted for 95% of British imports and 40% of Dutch imports.

  • British era         

The beginning of the 19th century saw major changes in taxation and agricultural policies, which tended to promote commercialisation of agriculture with a focus on trade, resulting in decreased production of “food crops, mass impoverishment and destitution of farmers.” This was due to east India Company’s expansion which led to numerous famines. The economic policies of the British Raj caused a severe decline in the economic output of the nation and gave impetus to mass unemployment. However, after the removal of international restrictions by the ‘Charter of 1813’ trade expanded substantially with steady growth. India’s share of the world economy, however, declined from 24.4% in 1700 down to 4.2% in 1950.  Its share in the sphere of global industrial output declined from 25% in 1750 down to 2% in 1900.  The British East India Company had compelled open the large Indian market to open up to British goods, which could be sold in markets without tariffs or duties. On the other hand, local Indian producers were heavily taxed leading to a serious economic crisis. However, the end of colonial rule revealed that India inherited an economy that was one of the ‘poorest’ in the developing world. 

  • Pre-liberalisation period

The economic policy of India post-independence was influenced mostly by the colonial experience. Domestic policy during this period was all about protectionism, with a strong emphasis on import substitution industrialisation, economic interventionism, public sector run by the government, business regulation, and central planning. Trade and foreign investment policies were relatively liberal during this period. Jawaharlal Nehru, the first prime minister of India, along with a famous statistician Prasanta Chandra Mahalanobis, formulated the economic policy during the initial years of the country. The expectation was that there would be rapid development of heavy industry in both the public and private sector. The policy of concentrating on capital and technology-intensive heavy industry and abating manual, low-skill cottage industries was criticised by economist Milton Friedman as he thought that such a move “would waste capital and labour, and retard the development of small manufacturers.”

The post-liberalization period has been a very contentious one. Two crises during 1991 led to a major issue regarding the balance of payments (BOP). Firstly it was the collapse of USSR and secondly the Gulf War. India found itself the possibility of defaulting on its loans. In order to cope up with this, India asked for $1.8 billion bailout loan from the International Monetary Fund (IMF). Moreover, in response to this, Narasimha Rao government, including Finance Minister Manmohan Singh, initiated reforms. The reforms reduced tariffs, interest rates, ended various public monopolies, allowed automatic approval of the foreign direct investment. Growth rates of 9% were experienced from 2003 to 2007 which moderated after the global financial crisis in 2008. Goldman Sachs in 2003 predicted that GDP of India would overtake France and Italy by 2020, Germany, UK and Russia by 2025 and Japan by 2035, “making it the third-largest economy of the world, behind the US and China.” India entered a period of reduced growth by 2012 which slowed to 5.6%. Economic recovery started in 2013–14 when the GDP growth rate accelerated to 6.4%. The growth continued through 2014–15 and 2015–16 with rates of 7.5% and 8.0% respectively. For the first time since 1990, India grew faster than China which registered 6.9% growth in 2015. The growth rate reduced to 7.1% and 6.6% in 2016–17 and 2017–18 respectively partly because of the disruptive effects of demonetization or ‘note bandi’ and the Goods and Services Tax (GST). However, as the main concern of this article is to re-visit the 1991 BOP crisis, the black spot on the economic development of the nation, in the next section let us discuss how this event unfolded and what the reaction truly was.

How did the Balance of Payment crisis genuinely transpire?

India was facing a Balance of Payments (BOP) crisis by the end of 1980s which resulted from borrowing and high expenditure of the nation. The Current Account Deficit which was 3.5% at the time also massively weakened the economy and the ability to finance the deficit. The main causes that fueled this crisis were almost all related to the borrowing of capital from abroad. The nation’s foreign exchange reserves at that point were pegged at USD 1.2 billion which depleted to half by June. This amount was scarcely adequate to cover 3 weeks of “essential” imports. India’s exchange rate was subjected to a severe adjustment by mid-1991. This event led to a slide in the value of the rupee. The authorities further slowed the “decline in value by expending international reserves”. The exchange rate, however, was disparaged by July against major foreign currencies. The immediate response of the Government of India at that point was to obtain a loan of around USD 2 billion from International Monetary Fund (IMF) by pawning 67 tons of gold reserves of India as the collateral for the loan. Several media outlets informed that at that time Reserve Bank of India (RBI) airlifted 47 tons of gold to the Bank of England and 20 tons of gold to the Union Bank of Switzerland to secure a loan of USD 600 million. These initiatives promoted economic reform process under the then government and cope up with the acute economic crisis India was facing.

According to the IMF, in a research paper regarding the 1991 shock, two external sources were major causes of the disruption of the Indian economy. Firstly, the events in the Middle East during 1990 which caused an increase in the world oil prices gave rise to the crisis.  IMF statistics reveal that “the value of petroleum imports increased by $2 billion to $5.7 billion as a result of both the spike in world prices associated with the Middle East crisis and a surge in oil import volume, as domestic crude oil production was impaired by supply difficulties. In comparison, non-oil imports rose by only 5% in value (1% in volume terms). The rise in oil imports led to a sharp deterioration in the trading account, worsened further by a partial loss of export markets (as the Middle East crisis disturbed conditions in the Soviet Union, one of India’s key trading partners).” Moreover, the Gulf crisis also deteriorated the situation of the workers’ “remittances, as well as an additional burden on repatriating and rehabilitating non-resident Indians from the affected zones.” Secondly, the slow-paced growth of important trading partners of the economy also led to the worsening of the current account. The vulnerable situation of the export markets with the declining growth of the world which has been pegged at a rate of approximately 4% in 1988 to 2% in 1991 was another reason that led to the massive decline of Indian economy. An Economic Survey of the years of 1991-92 it has been stated that the immediate cause of the loss of reserves beginning in September 1990 was a sharp rise in the imports of oil and petroleum products (from an average of $ 287 million in June-August 1990, petroleum products imports rose sharply to $671 million in 6 months). This accounted for rise in trade deficit from an average of $356 million per month in June-August 1990 to $677 million per month in the following 6 months.

In addition to shocks from external factors that had given rise to this issue, there was the prevalence of internal factors that coupled with these resulted into what we know today as the ‘Balance of Payment crisis of 1991. The prevalent political uncertainty peaked in 1990 and 1991. A wide array of articles recognized that post-1989 elections, the then ruling party refused to form a coalition government. However, following this, the Janata Dal formed a coalition government which became entangled in caste and religious matters. Moreover, this government fell immediately after a coerced resignation by V. P. Singh in December 1990. A “caretaker” government was set up until new elections had been scheduled which were held on May 1991. India’s crisis was also due to low investor confidence. Finance in the commercial sector became really tough as businesses became reluctant regarding rolling out loans. Moreover, various researches have unearthed that the “previously strong inflows on nonresident Indian deposits shifted to net outflows. Pieces of evidence in regards to the economy put forward the fact that ‘current account deficits” played a vital role in this crisis. Nevertheless, the method Granger and Gonzalo employing “joint information from the error correction model” determined that Indian rupee was overvalued at the time of crisis in 1991 making it be one of the major reasons that unfurled this economic crisis.

So, how did India come out of this acute crisis?            

One of the leading media outlets of India, the Economic Times, has asserted that several policies initiated during P. V. Narasimha Rao government acted as the main force that strategically assisted the derailed economy of the nation. Talking about the issue, it explained that 4 major economic reforms deserve our attention. They are:

  1. Fiscal Correction: Export subsidies were either put an end to or trimmed to a large extent.
  2. Trade Policy Reforms: This reform eased license appropriation and several regulations regarding trade. 20% devaluation of Rupee was done to make exports competitive.
  3. Industrial Policy Reforms: This move freed industries from “Licensing and Inspector Raj”. The industrial sector was made competitive and domestic supply chains were smoothened.
  4. Public Sector Reforms: This sector was given more “operational freedom”.

A major shift in the war chest by 2020

The picture changed drastically with the passage of more than 20 years. India emerged as the 5th largest ‘Foreign Exchange Reserve’ holder across the globe. Financial Express explained that the foreign reserves surpassed $500 billion for the first time ever. The principal economic advisor to Ministry of Finance, Sanjeev Sanyal, wrote in a tweet, “As I have been saying in recent weeks, demand suppression (such as lockdown) would push the INR to appreciate after an initial capital outflow”. Moreover, Sanyal opined that “Now, as we open the economy to remove demand suppression, and push up credit growth, we will both revive imports and foreign capital inflows”. $2 billion stored in FDI, FII and inflows by the corporate sector moved Indian Rupee to 75-mark against the USD. “RBI’s dollar-buying intervention in significant quantum fulfils its twin objective of not allowing the pair to get strengthened past 75.00 mark in order to support the country’s sagging exports as well as a strong forex kitty allows the bank to intervene in the market to cap any slide in rupee devaluations in offshore and onshore,” Amit Pabari, managing director, CR Forex Advisors, told Financial Express Online. Forex reserves are usually resources available to the government in the form of gold, Special Drawing Rights (SDRs), Foreign Currency Assets (FCA). “During the reporting week, reserves held in gold declined by $329 million and stood at $32.352 billion. Similarly, special drawing rights of the IMF (SDRs) fell by $10 million to $1.4 billion and the central bank’s reserve position in the IMF stood at $4.2 billion, with a fall of $120 million during the period” stated Financial Express in one of their reports.  

The efflux of Indian Foreign Exchange reserves is of utmost importance to India as when it faces any financial crisis these reserves are that one thing the country can fall back on as explained by The Indian Express. The reserves have risen drastically from an appallingly poor situation of $5.8 billion in 1991. “RBI has likely prevented any sharp depreciation in the currency yesterday by booking profit on the dollars bought at lower levels. Therefore, it is likely that rupee will trade in the range of 75.00-76.20 levels due to RBI’s intervention on both the sides,” Amit Pabari of CR Forex Advisors said. Nonetheless, irrespective of the bulge of Indian Foreign Reserve, the 1991 economic crisis will always compel people, not only Indian but also around the globe, to take a walk down the memory lane and re-conceptualize whatever happened back then. Several emergent issues regarding the economic sphere in India have posed as the question if history is repeating itself. The current economic scenario as a result of the ongoing pandemic can be to some extent compared with that gloomy time and has also resulted in massive anxiety around the globe with the realization that there might be a rise of severe worldwide financial crisis. In this case, Indian Government has been trying to come up with policies to maintain the economic equilibrium in order to avert such a situation in the nation, but it is believed by a number of policymakers and experts in the field that India will recover in this sphere, maybe slowly, but steadily.

                                                                                                                                          By Sagarika Mukhopadhyay

Published by youngindianrevolution

An Organisation which stands for the Liberation of Human Mind from the dominant shackles put up by the society.

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