REPORT ON

‘THE ECONOMIC CRISIS OF INDIA- 1991”

SUBMITTED BY-

ANKUSH SINHA RAY

1120008

DMBA-1 SEC B

KIIT UNIVERSITY

In 1991, in the wake of an exceptionally severe balance of payments crisis. The need for a policy shift had become evident

much earlier, as many countries in east Asia achieved high growth and poverty reduction through policies which emphasized greater export orientation and encouragement of the private sector. India took some steps in this direction in the1980s, but it was not until 1991 that the government signaled a systemic shift to a more open economy with greater reliance upon market forces, a larger role for the private sector including foreign investment, and a restructuring of the role of government. The government was close to default, its central bank had refused new credit and foreign exchange reserves had reduced to such a point that India could barely finance three weeks’ worth of imports. India had to airlift its gold reserves to pledge it with International Monetary Fund (IMF) for a loan. This report discusses about what led to the crisis, how it was controlled and what were the measures taken to permanently reform the economic policy of the country.

What actually happened ?A Balance of Payments crisis in 1991 which pushed the country to near bankruptcy. The Rupee devalued and economic reforms were forced

upon India. India central bank had refused new credit and foreign exchange reserves had reduced to the point that India could barely finance three weeks’ worth of imports

1. Almost all countries in the world depend on the global economy for a wide variety of things. For India, we depend on West Asia for our oil, South Africa for our gold, US for our technology, South east Asia for vegetable oil etc. To buy these items from the world market, we need US dollars - the global currency of trade. The only way to earn dollars is by selling enough of our stuff in the global economy (exports).

Since 1960s, India depended on the Soviet Union for our exports - as we failed to develop good economic relationships with the US and Western Europe. In late 1980s, Soviet Union started to crack and by 1991they were split into 15 nations (Russia, Kazakhstan, Ukraine, etc). Now, India had a major problem because our primary buyer was in turmoil. Exports were down significantly.

2. Meanwhile, there was Saddham Hussain who had his misadventure into Kuwait in 1990. This led US to war with Iraq in early 1991. Oil fields started to burn and ships found it hard to reach Persian gulf. Iraq and Kuwait were our big suppliers of oil. The war led to destruction of our oil imports and the prices shot up substantially - doubling in a few months. Gulf War and 1990 oil price shock.

3. In the late 1980s India's political system was imploding. Prime Minister Rajiv Gandhi was involved in a series of troubles - Bofors scandal, IPKF misadventure, Shah Bano case that eventually led to his ousting in 1989. What followed were two more terrible leaders who were as unstable as they were incompetent. This had a huge effect on Indian economy that was totally forgotten in the political crisis. in 1991 this stop-gap government crashed. Until Narasimha Rao was

sworn as Prime Minister in 1991, Indian economy was left in gross neglect.

Thus, 1991 was the year of perfect storm. This triple crisis brought India on its knees. On the one end, our primary buyer is gone. On the other hand, our primary sellers were in war. In the middle, our production was effectively stopped by political crisis. We were running out of dollars to buy essential items like crude oil and food from the rest of the world. This is termed a "Balance of Payments Crisis" - meaning India was not able to balance its accounts - exports were significantly less than imports.

Since, we didn't have many dollars, we went and begged the IMF - the pawn shop of the world. They asked us to pledge our gold reserves in return for the interim loan of $3.9 billion (a huge sum for India then) just as the neighborhood moneylenders ask for our gold when we want an emergency loan. We took 67 tons of our gold in two planes - one to London and other to Switzerland to get this assistance.

Indian policy response to economic crisisLiberalisation : It means to free the economy from direct or physical controls imposed by the government. Prior 1991, government had imposed several types of controls on Indian economy e.g. industrial licensingsystem, price control or financial control on goods, import license, foreign exchange control, restriction on investment by big business houses, etc.

India began its "liberalization" when Rao became our Prime Minister on 21st June 1991. Essentially it was the undoing some of the policies that Nehru and his family put in place in our country.

1. We did away with many of the import restrictions. Until 1991, we imposed a 400% customs duty on many products. Industries had to beg to get an essential ingredient imported. By 1991, the duties on many products were reduced substantially. This brought new growth in our industries.

2. Import licensing was abolished. Until 1991, you need a license to import anything and this license was very hard to get.

3. Government did away with the production licensing in many industries. Until 1991, you needed government's permission in what to produce and how much to produce. In one stroke, the restriction was removed in many industries.

4. Rao put domestic economic back on track with two stars - Montek Singh and Manmohan Singh. Huge spur was given to our local industries. Stock market rules were relaxed.

5. Manmohan abolished "gold smuggling" (remember 1980s Bollywood movies?) in one go. He effectively allowed Indian expats to bring back 5 kilos of gold with them with no duty. Now, nobody had a reason to smuggle gold & electronics.

6. Singh and Rao allowed foreign investors to come. Until then India was living in the paranoia of East India company. Many sectors were opened for foreign investment and collaboration. Now, companies like Coke and Nike could come in. Suddenly, Bombay Stock Exchange found a life.

7. Government started selling some of its businesses to the private. This brought cash and new round of efficiency.

8. Industrial de-licensing followed shortly afterward. Industrialists could finally breathe free of the License Raj. Narasimha Rao

announced the de-licensing on the same day that Manmohan Singh presented his budget. Before anyone knew it, industrial licensing was abolished.

9. The MRTP Act (that protected businesses from monopolies) was reformed and India could finally be on the path to producing competitive and productive industries.

10. Gradual reduction of import duties followed, allowing foreign investments to slowly start flowing in. More clearance was given to capital goods.

11. Slowly, taxes were lowered (income and corporate taxes) and Foreign Technology Agreements started getting signed.

12. In cities where the population was less than a million, they didn't even need Government permits for industries.

13. The threats of massive layoffs were avoided by legislating judiciously and exercising regulations carefully

The role of Narasimha Rao and Manmohan Singh :

The result of all this was that Licensing slowly became the exception rather than the rule. Every industry (except two) was opened to private sectors. Foreign technology was accepted liberally and foreign investment was allowed in a large number of industries. The monopoly laws were revised and there was no more restrictions on companies wanting to grow big.

Narasimha Rao and Manmohan Singh, basically braked with careful deregulation and accelerated by reducing bottlenecks.

They had to continually assure every worker striking (from the banking sector to farmers, from opposition Yatras led by the BJP to the trade

unions) that there wouldn't be layoffs and that workers would be protected. These reforms were both revolutionary and incremental.

Effects of the new economic policy :

The result of this was that the Indian economy grew to 7.5% of GDP (from USD 130 million in 1992, to USD 5 billion, in 1996).

Cities started to grow and became centers of post-liberalization industrialization. Atal Bihari Vajpayee continued with Manmohan Singh's economic reforms and India welcomed IT and BPOs. Manmohan Singh's government in 2004, again continued with market liberalization and larger role for enterprises. 

India's capital markets found exponential growth. The number of listed companies grew and resulted in a healthy trend of development in

India. Even though there are serious environmental impacts to India's growth story, India found a unique brand of capitalism (a form of laissez-faire capitalism very different from the free-form capitalism in USA or China).

The Narasimha Rao government ushered in several reforms that are collectively termed as liberalisation in the Indian media. Although, most of these reforms came because IMF required those reforms as a condition for loaning money to India in order to overcome the crisis. There were significant opposition to such reforms, suggesting they are an "interference with India's autonomy". Then Prime Minister Rao's speech a week after he took office highlighted the necessity for

reforms, as New York Times reported, "Mr. Rao, who was sworn in as Prime Minister last week, has already sent a signal to the nation—as well as the I.M.F.—that India faced no "soft options" and must open the door to foreign investment, reduce red tape that often cripples initiative and streamline industrial policy. Mr. Rao made his comments in a speech to the nation Saturday night." The foreign reserves started picking up with the onset of the liberalisation policies and peaked to $314.61 billion at the end of May 2008.

A program of economic policy reform has since been put in place which has yielded very satisfactory results so far. While much still remains on the unfinished reform agenda, the prospects of macro stability and growth are indeed encouraging.

Conclusion

Thus we see how poor macro policies of the government plunged the Indian economy into a major crisis and disrupted the business environment, and how subsequent corrective macro policies helped in the rebuilding of the business environment and put greater resilience in the Indian economy. The growth spurt prior to 1991 was fragile and volatile. There was a jump in the growth rate during 1977-79, massive decline in 1979-80, a jump again in 1980-82, return to the ‘hindu rate’17 during 1982-88 except 1983-84, climb up again in 1988-91 and crisis in 1991-92. However, after 1991, the macroeconomic stabilization policies helped the Indian economy to deliver sustained