Miscellaneous

How India Survived through the 1991 Economic Crisis

We all know that India was in a bankrupt situation in 1991 but was saved by the then Finance minister Dr.Manmohan Singh under the leadership of P.V Narasimha Rao. India was in a critical position to pay its balance of payments. The government was running on a trade deficit pushing economy close to double debt traps near to $71 billion which made India the third most indebted nation in the world.

If it was not for the NRI deposits of approximately Rs.20000 crores, India’s international credit rating would have been collapsed and India would have defaulted in a loan payment. Most of us do not know what led India to the crisis and why there were structural changes in the economy at the macroeconomic level.

What led India to the Economic crisis:

1991 economic crisis

After Independence, India depended largely on imports from western and middle eastern countries. To buy the items from the world market, we needed US dollars-global trade currency. These imports grew substantially to 2.3 percent of GDP while the exports stood at meager 0.3 percent of GDP which is almost negligible. This imbalance in imports and exports coupled with the following events led India into a serious crisis.

1.Iraq-Kuwait war:

Iran- Kuwait war
Invasion of Kuwait

The crisis in the Gulf initiated by the incursion of Kuwait by Iraq in 1990 spiked the oil prices. This affected the Indian economy on a broader range. As Iraq and Kuwait were the foremost sources of oil imports, India had to procure the oil at higher spot rates.

It has forced India to spend more on oil imports as the condition of short term purchases with the spot rates must ensure the long term contracts at higher prices to maintain the oil supply. As an outcome, India lost most of the forex reserves led to a trade account deficit

2.Political instability:

There was political instability in the government between 1989 and 1991. There was a change of three governments in a little span of 2 years. This had lost the trust of investors. In 1991 this stop-gap government crashed. Until Narasimha Rao’s office in 1991, the Indian economy was left in gross neglect.

3.The  increase in non-oil imports:

1991 economic crisis

Between 1980 and 1990 the trade deficit increased significantly. There was a significant part of non-oil imports which constituted 91 percent and remaining constituted by oil. Thus, it is one of the major elements leading to a rise in the trade deficit. The exports of India were declining, and it was not competitive enough in the global market, which resulted in a lack of availability of foreign currency.

Hence, India was unable to earn sufficient USD to compensate for imports. This situation has extended in the form of currency devaluation of the country.

4.Licence Raj:

It was the elaborate system of licenses and regulations that were required to set up and run businesses. The private companies had to satisfy 80 government agencies to produce something and, if granted, the government would regulate production. This system made private players setting up a business a nightmare.

How India Survived:

In this situation, the Indian government has requested to international monetary fund (IMF) to provide an emergency loan of $2.2 billion by pledging 67 tons of Indian gold reserves as collateral security. IMF granted the loan with the condition of India opening up the economy and allowing foreign countries to make investments in Indian companies.

This had lead to Liberalization, Globalization and privatization(LPG) policy and other economic reforms.

The reforms:

P.V. Narsimha Rao with Manmohan Singh
Image credits: Mint
  • The reforms did away with the Licence Raj, reduced tariffs and interest rates and ended many public monopolies.
  • Automatic approval of foreign direct investment in many sectors increased forex reserves from a minuscule $132 million in 1991–92 to $5.3 billion in 1995–96.
  • Suddenly, the Bombay Stock Exchange found life after relaxing the rules of the stock market.
  • The Government started selling some of its businesses to the private sector. This brought cash and a new round of efficiency.

It was the brilliance of the then Finance minister Dr. Manmohan Singh and the then Prime minister late P.V. Narasimha Rao which brought common sense to our economy that was hard to find since 1947.

Also read my post on Sarada group financial scandal.

Thanks for reading. Stay safe.

4 Comments

  1. Anil excellent writeup and compilation bod the information in totality.

    Very good work and all the best for your future publication

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