How India came out of the 1991 economic crisis Liberalization greatly helped, but consistency is required for full benefits

• A sharp rise in world oil prices and a fall in remittances had resulted in the depletion of forex reserves to less than US$6 billion, just enough to pay two weeks of imports

In 1991, the Indian economy was in dire straits, in some ways like what Sri Lanka has been going through in the past year. Unlike Sri Lanka, India did not default on external loans but was on the verge of it. It pledged its gold holdings to save its skin.

A sharp rise in world oil prices and a fall in remittances had resulted in the depletion of forex reserves to less than US$6 billion, just enough to pay two weeks of imports. A fiscal deficit of 8% of GDP and a current account deficit of 2.5% of GDP combined with double-digit inflation added to the government’s woes, recalls a writer in The Print. Inflation cast a heavy burden on the middle classes as well as the very poor.

According to Outlook India, between 1980-81 and 1990-91, India’s domestic public debt grew from 40% of the GDP to 55%. External public debt rose from 8.7% of the GDP to 12.7%, and that was when exports contributed less than 8% of India’s GDP.

Import liberalization, which began in 1976, had resulted in rapid growth in imports. Admittedly, imports consisted largely of capital and intermediate goods, but export growth was not commensurate. Food and export subsidies had become a burden on the exchequer, as were salary increases in the burgeoning public service and para-state organisations that had mushroomed in the socialist era.

During the short-lived government of Prime Minister Chandrashekar, the IMF provided Special Drawing Rights (SDR) of US$ 1.27 billion. But it did not help. The government was forced to sell gold. In May 1991, India airlifted 20 tonnes of confiscated gold to UBS a bank in Zurich to raise US$ 240 million. In July, another 47 tonnes of gold were pledged with the Bank of England to raise US$ 600 million. This helped the government stave off default. Eventually, India was able to recover the pledged gold.

Prime Minister P.V. Narasimha Rao and Finance Minister Dr. Manmohan Singh, who had assumed office after the political turbulence and instability of 1989-90, devalued the Rupee by 11%. The aim was to increase exports and secure dollars for the country.

While the Chandrashekhar government could not get time to solve the underlying economic problem in a comprehensive way, the successor regime of Narasimha Rao had the time to take the economic bull by the horns.
The Rao-Manmohan duo took steps to liberalize the economy which was caught in the mire of debilitating socialism, statism and protectionism. The government announced a new trade policy. Non-essential imports were curbed. Imports through State-owned organisations virtually ceased. The private sector was empowered to import. State monopolies in many sectors were ended.

And to attract foreign investment, automatic approval for FDIs up to 51% equity was given. Previously, the cap was 40% on foreign equity investments. All these measures had a salutary effect on economic activity. FDIs began to flow and domestic investment rose.

Taxes were increased, and prices were hiked to fill the State coffers. Even items of common consumption like petrol, cooking gas and fertilizers were not spared, though these measures would not have been very popular. Corporate tax was also increased. Together with that, a scheme for people to declare their unaccounted wealth was announced. Those declaring unaccounted wealth were given immunity from prosecution as well as interest and penalty as an incentive.

In a stirring speech in parliament while presenting the 1991-92 budget Finance Minister Manmohan Singh said: “No power on earth can stop an idea whose time has come. I suggest that the emergence of India as a major economic power in the world happens to be one such idea. Let the whole world hear it loud and clear, India is now wide awake. We shall prevail. We shall overcome.”

Above all, the politically astute Prime Minister Narasimha Rao had taken key leaders in the Opposition into his confidence so that resistance in parliament was minimal or muted.

“The reforms were hugely successful,” said economist Montek Singh Ahluwalia in an interview to The Hindu in July 2021. Ahluwalia was one of those involved in the liberalization process. He pointed out that GDP growth averaged 7% from 1992 to 2017, compared with an average of 5% in the preceding ten years and 4% in the preceding 20 years. Poverty also declined. Between 2004-05 and 2011-12, about 140 million people were pulled above the poverty line.

But the reform process was not consistent over time, Ahluwalia regretted. Financial sector reforms are short of expectations. Primary education and health are still not getting their due. This is why India is still at the lower end of the middle-income group of countries, he said. Many more reforms are needed to get to the top of the group.
The private sector is still not able to invest in “sensitive sectors” freely and 860 items are reserved for the inefficient small-scale sector when it would be better to exploit economies of scale. India progressively lowered import tariffs from an estimated 57.5% in 1992 to 8.9% in 2008, but this trend has been reversed over the past few years, Ahluwalia said.

India is still not psychologically geared to welcoming FDI, he pointed out. The recent withdrawal of Western investments from China has benefitted Vietnam and not India. India should have joined the Regional Comprehensive Economic Partnership (RCEP) but it did not because it was committed to ensuring protectionism at home, Ahluwalia said.

He further noted that India has been seeing a concomitant growth in employment. And employment in manufacturing has not increased as rapidly as needed. Most of the increase in employment, including in manufacturing, was not regular contractual employment but informal non-contractual employment. This is because of the existence of rigid and unrealistic labour laws that militate against the efficient use of labour.

There has been a substantial slowdown in GDP growth after 2016-17 with employment falling from 474 million in 2011-12 to 469 million in 2018-19. The problem was most severe among the youth, who experienced unemployment of 18%, Ahluwalia said. Liberalization greatly helped, but consistency is required for full benefits, he stressed.