Economic Crisis of

1991: Root Causes,

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What was the crisis in 1991?
• In 1991, India faced a major Balance of Payments crisis owing to high expenditure and unchecked
loans
• Balance of Payments crisis in layman’s terms means that the country was importing a lot more
than it is exporting and at the same time is depleting its foreign exchange reserves to an extent it
becomes impossible to honour all liabilities. Current Account deficit peaked at 3.1% of GDP in 1991
• A range of factors played a role in India’s unfortunate path towards this crisis. These factors were
both domestic and external in nature.
• Domestic factors include policy gaps, political instability and fiscal indiscipline. External Factors
include the Oil Shock and the Fall of Soviet Union.
•This crisis has been termed “policy-induced crisis par excellence” by some of prominent economic
historians. In the following slides we shall discuss theses causes in more detail and study their
consequences. We shall also look at India’s road to recovery from this crisis

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Causes: 1965-81
Domestic
•The Licence Raj: The Government limited the manufacturing output of the country through a
regulatory system of production licences. This in turn limited exports and thus the foreign reserves
accumulation. Even though this is not a major contributing factor to the 1991 crisis, the seeds of
conservative fiscal policy can be found here
• Increase in Government Expenditure: Fertilizer Subsidies and Procurement Costs rose steeply during
this 1977-80 under the rule of the Janata Government. It is important to note that the Janata Party
came into power after a revolt by the farmers and workers during the Emergency period. Owing to this
added expenditure, the fiscal deficit slowly climbed up during the period from below 5% in 70s to 6.5%
in 1980s
• Import Liberalization, 1976: The import liberalization policy greatly increased the number of imports
into the country while the export growth has almost remained the same. This led to a gap in the
current account which slowly culminated in the BOP crisis of 1991

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Causes: 1965-81
• Increase in External Borrowing to fund the Expansionary Fiscal policy implemented in the late
1980s. This created a huge burden of interest payments on the already falling current account
deficit
• Overvaluation of the exchange rate resulted in tight physical controls on allocation of imports.
External
•Global Oil Shock of 1979: The Oil crisis of 1979 occurred in the wake of the Iranian Revolution.
The global production of oil dipped by 4% which sent the oil prices higher amid wide-spread
panic. India is an importer of crude oil and this had a great impact on our current account deficit
which rose to 3.1% 1981.

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 Causes: 1981-90
Domestic
•Indira Gandhi, once re-elected in 1980 displayed a deviated in policy from the previous Janata Party rule and also
her own rule before the Emergency. Public Investment rose to an average of 10% in the 1980s decade increasing
current expenditure to 21% of GDP. There wasn’t any attempt to balance this load through Revenue Generation.
Ultimately most of these investments had to be funded through External borrowings from IMF, World Bank and
other Commercial sources
• The other source to fund these investments was the high bank reserve requirements which at a point in time rose
as high as 51%. All this money was borrowed by the government and the private sector experienced a credit
crunch. When this source became unviable because of looming inflation, more external debt was taken up both by
the government and the public players at higher interest rates
• Foreign Aid fell from 75% of CAD to 22% of CAD between 1980 and 1991. The Interest Payments accumulated and
by the end of the decade India was spending more money on Interest payments compared to defence budget.
•Political Instability: Before the 1991 crisis, India was governed by three separate coalition governments in a span of
one and half years. This resulted in drop in investor confidence and none of the governments’ key objective was to
handle the BOP crisis. NRIs began to pull out their deposits and exports to India stopped giving credit sales to
Indian importers due to fear of not get paid.

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Causes: 1981-90
External
• Fall of the Soviet Union: Soviet Union was one of the largest importer of Indian goods and also
had Rupee trade agreements through which payments were made in Rupees, reducing the need
for foreign exchange. The fall of Soviet Union not only effected our exports but also the
dismantled the rupee agreements with eastern European constituents of earlier soviet union.
• Iraq-Kuwait War, The Gulf Crisis: Similar to the Oil shock of 1980, The gulf crisis, emanating from
the Iraq-Kuwait war, increased the price of oil greatly from $17 a barrel to $36 a barrel within a
period of 3 months, thus increasing the cost of imports. This is owing to the fact that India still
imported oil in huge volumes despite increased domestic production

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1991 Crisis in Numbers
• The roots of the balance of payment crisis lay in, the Government deficit (% of GDP)
investment-savings deficit driven by fiscal excess, reliance on
external borrowing to fund deficits and the inability of export
growth to keep pace with the growth in imports.
• Gross fiscal deficit of the state and central governments rising
to 10.4 % of GDP owing to increased expenditure
• Trade Deficit increased from Rs. 12,400 Cr in 1989-90 to Rs.
16,900 Cr in 1990-91 Current Account Deficit(% of GDP)

• CAD to GDP ratio rose to 3.1% in 1990-91. Fiscal Deficit to GDP

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1991 Crisis in Numbers
• Between 1980 and 1991 Domestic Public Debt grew from 40% of GDP to 55% of GDP. In the
same period external debt rose from 8.7% of GDP to 12.7% of GDP
• Forex reserves dropping to just one month worth of imports in 1990-91. Between May and July
1991, the reserves ranged between Rs. 2500 Cr to Rs. 3300 Cr.
• Rate of inflation reached 13.87% in 1991 due to the crisis.

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Road to recovery
•India secured a bailout from the IMF by pledging 67 tons of gold in exchange for $2.2 billion
•The World Bank followed with a structural adjustment loan (SAL)
•These programs would initiate the process of liberalization
•The IMF and WB would guide and support India in enacting reforms
•The reforms would work at correcting the deficit as well as changing trade policy & industrial
policy
•The public sector reforms would make it easier for FDI

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Industrial policy
FM Manmohan Singh introduced various reforms that would alter the existing policies :
• Industrial licensing was abolished for all industries, except those listed in annex II.
• Annex II initially had 18 industries listed, which remained subject to licensing. As time passed, the list of industries here were trimmed,
with only 5 sectors left.
• These include i) Defence ii) Atomic substances iii) Gambling iv) Alcohol v) Tobacco
• Monopoly of public sector companies in many industries was abolished.
• All sectors were opened to private enterprises except those listed in Annex I
• Only 8 sectors had a public sector monopoly
• Annex I was eventually trimmed, with only railway transportation and atomic energy left.
• Removal of entry restriction on MRTP firms
• The MRTP Act was restructured to remove the Rs 25 Crore limit for firms to be classified as monopolistic.
• Instead the government would focus on regulating monopolistic and restrictive trade practices of firms having more than 25% of the
market share.

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Trade Liberalization
Most consumer goods remained under licensing(30% of tariffs)
◦ These goods were freed of licensing through settlement of a dispute via the WTO Dispute Settlement Body
◦ Some goods like fertilizer and petroleum remain canalized, and would require licenses for imports
◦ Tariff rates were gradually reduced and the number of tariff bands were decreased.
◦ Top rate was 85% in 1993-94 and fell to just 50% in 1995-96

Prior to 1991, exports of 439 items were restricted and subjected to controls
◦ This was reduced to 296 in the March 1992 import-export policy

The rupee was devalued by 18% against the dollar

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Foreign Investment
Freeing up foreign investments helped liberalize trade in service sectors like banking and
telecommunications
◦ Companies with foreign equity could raise it up to 51%
◦ FDI was extended to oil and gas
◦ NRI investment up to 100% equity was allowed in high priority industries
◦ Disinvestment of equity by foreign investors was no longer at prices determined by the RBI
◦ Foreign companies were allowed to use their trade marks on domestic sales.

These policy reforms have been integral in the resurgence of the Indian economy and the growth of
its GDP
◦ At an aggregate level the growth rate was 6.3% for 1988-2006 vs 4.8% for 1981-88
◦ In trade, merchandise exports in 1990-91 were $18.1 billion; and have grown up to $102.7 billion in 2006-07.
Service exports were $60.6 billion in 2005-06

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Thank you!

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