1991 INDIA ECONOMIC CRISIS

Causes and consequences

Crisis was caused by current account deficits and currency overvaluation.

The economic crisis was primarily due to the large and growing fiscal imbalances over the 1980s. During mid eighties, India started having balance of payments problems. Precipitated by the Gulf War, India’s oil import bill swelled, exports slumped, credit dried up and investors took their money out

Large fiscal deficits, over time, had a spill over effect on the trade deficit culminating in an external payments crisis. By the end of 1990, India was in serious economic trouble.

The gross fiscal deficit of the government (center and states) rose from 9.0 percent of GDP in 1980-81 to 10.4 percent in 1985-86 and to 12.7 percent in 1990-91

For the center alone, the gross fiscal deficit rose from 6.1 percent of GDP in 1980-81 to 8.3 percent in 1985-86 and to 8.4 percent in 1990-91. Since these deficits had to be met by borrowings, the internal debt of the government accumulated rapidly, rising from 35 percent of GDP at the end of 1980-81 to 53 percent of GDP at the end of 1990-91. The foreign exchange reserves had dried up to the point that India could barely finance three weeks worth of imports.

Devaluation of Indian Rupee started in 1960s due to the wars with China (1962) and Pakistan (1965). Due to large government budget deficits, drought there was a sharp rise in prices due to inflation. The Indian Government was forced to start liberal policies in order to stabilize the economy, which in turn resulted into the huge devaluation of the Indian Rupee. Once again, the government decided to devaluate the rupee. Due to the currency devaluation the Indian Rupee fell from 17.50 per dollar in 1991 to 26 per dollar in 1992

1991 Indian Economic Crisis Confluence of factors that precipitated Indian economic crisis:

Import prices went up:

Iraq’s invasion of Kuwait and consequent run-up in the world oil prices made petroleum imports expensive.

Exports declined:

Simultaneously, conditions in Soviet union, India’s largest export market deteriorated due to middle east crisis and shaky growth in other trading partners also led to a slow export volume growth.

Foreign remittances declined:

Foreign remittances from migrant Indian workers in the middle east declined due to Iraq's invasion of Kuwait.

Political Uncertainty:

After a poor performance in the 1989 elections, the previous ruling party Congress led by Rajiv Gandhi didn’t form a government. Janata Dal, led by VP Singh formed a coalition government which got involved in Mandal commission disputes. Singh’s government fell immediately after his forced resignation in December 1990. A caretaker government under Chandra Shekhar was appointed until the new elections that were scheduled for May 1991. And finally, Raji Gandhi was assassinated in May 1991.

Fall out:

Credit dried up as foreign lenders refused to roll over their short term maturing debt and started pulling money out and Non Resident Indian (NRI) community also started to withdraw it’s savings in Rupees. Government was forced to devalue Rupee.

Reserve Bank of India had to pledge India’s gold reserve to secure an emergency loan from the IMF which caused national outrage resulting in the caretaker government’s ouster and Congress won the fresh elections. PV Narsimha Rao took over as the Prime Minister in June 1991 and installed Dr. Manmohan Singh as the Finance Minister who used the crisis as an opportunity to start liberating the Indian economy from government regulations. Rest is history.

Root cause of the crisis:

Gross (state and center combined) fiscal deficit (Expenditure more than Revenue) reached 12.7% in 1990-91. The Government borrowed from RBI to cover up the shortfall (deficit) not covered by the revenue. Money supply expanded as a result which led to high inflation. Government debt increased to 53% of GDP at the end of 1990-91 and the interest payments increased to 20% of the total central government expenditure in 1990-91