The 1991 Indian economic crisis was an economic crisis in India resulting from a balance of payments deficit due to excess reliance on imports and other external factors.[1] India's economic problems started worsening in 1985 as imports swelled, leaving the country in a twin deficit : the Indian trade balance was in deficit at a time when the government was running on a huge fiscal deficit (although the twin-deficit hypothesis is disputed).[2]
The fall of the Eastern Bloc, which had trade relations with India and allowed for rupee exchange, posed significant issues. Towards the end of 1990, leading up to the Gulf War, the situation became dire. India's foreign exchange reserves were not enough to finance three weeks' worth of imports. Additionally, the Iraq-Kuwait conflict caused a significant shift in the trade deficit as India relied on these nations for crude oil. The surge in crude oil prices further exacerbated the imbalance in India's balance of payments. Meanwhile, the government was on the brink of defaulting on its financial obligations. In July of that year, the rupee experienced a sharp depreciation/devaluation due to the low reserves, which further worsened the twin deficit problem.[3]
In February 1991, the Chandrasekhar government was unable to pass the budget after Moody's downgraded India's bond ratings.[4] The ratings declined further due to the unsuccessful passage of the budget, making it increasingly challenging and expensive for India to borrow money from international capital markets. This placed additional pressure on the country's economy.[5] The International Monetary Fund (IMF) suspended its loan program to India, and the World Bank also discontinued its assistance. These actions limited the government's options to address the crisis and forced it to take drastic measures to avoid defaulting on its payments.[6][7][8]
To address the economic crisis, the government implemented various measures, including the pledge of a significant portion of India's gold reserves to the Bank of England and the Union Bank of Switzerland as collateral. The aim of this move was to secure much-needed foreign exchange to meet India's debt obligations and stabilize the economy. However, this decision was not without controversy and was seen by some as a drastic and desperate move. Critics viewed the decision to mortgage the country's gold as a sign of the government's limited options and inability to manage the crisis effectively.[9]
The economic crisis created a situation where India had to accept the conditions imposed by the World Bank and IMF loan, which included structural reforms. As a result, the Indian economy was opened up to foreign participation in various sectors, including state-owned enterprises. This move towards liberalization was seen by some as necessary to secure much-needed funds and prevent default on loan payments. However, it also led to concerns about the impact of foreign entities on India's economy and the potential loss of control over vital industries.[10][11]
During the 1970s, the International Monetary Fund (IMF) began to increasingly criticise capital controls and shifted its perspective away from the belief that high unemployment was primarily due to insufficient demand. Instead, it started to emphasise the significance of 'inflexible' labor markets and other supply-side factors as the main causes of economic issues. These shifting views eventually laid the groundwork for what would be recognised as the 'Washington Consensus.' These set of economic liberalisation strategies were 'recommended' (or forced) upon developing nations like India by Washington, D.C based institutions, including the IMF, the World Bank, and the United States government's economic departments.[13]
The Volcker shock caused capital outflows from the developing world, causing external dollar denominated debt crises and economic slowdowns in Latin America and other developing countries, including India.[14] This along with Gulf War oil price spike and the dissolution of the USSR and Eastern Bloc leaving the U.S. as the sole superpower gave the previously stated institutions the perfect opportunity to force its policies upon developing countries.[13]
During the mid-eighties, India started having the 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.[18] Large fiscal deficits combined with the fixed exchange rate had a spillover effect on the trade deficit culminating in an external payments crisis. By the end of the 1980s, India was in serious economic trouble.
External debt of India (1970-2020)
One of the main causes of the crisis was the accumulation of foreign debt. In the 1980s, India had borrowed heavily from international lenders, in part to finance infrastructure projects and industrialization. However, by 1991, the country was facing a severe balance of payments crisis, as it was unable to service its debt and was running out of foreign exchange reserves.[19] There were also structural problems in the Indian economy that contributed to the crisis, including low savings and investment rates, and inadequate export growth.
The foreign exchange reserves by 1991 had dried up to the point that India could barely finance three weeks worth of imports.[20]
In mid-1991, India's exchange rate was subjected to a severe adjustment. This event began with a slide in the value of the Indian rupee leading up to mid-1991. The authorities at the Reserve Bank of India took partial action, defending the currency by expanding international reserves and slowing the decline in value. However, in mid-1991, with foreign reserves nearly depleted, the Indian government permitted a sharp devaluation that took place in two steps within three days (1 July and 3 July 1991) against major currencies.
With India’s foreign exchange reserves at $1.2 billion in January 1991[21][22][23] and depleted by half by June,[23] barely enough to last for roughly 3 weeks of essential imports,[22][24] India was only weeks away from defaulting on its external balance of payment obligations.[22][23]
Government of India's immediate response was to secure an emergency loan of $2.2 billion[25][26][27] from the International Monetary Fund by pledging 67 tons of India's gold reserves as collateral security.[9][26] The Reserve Bank of India had to airlift 47 tons of gold to the Bank of England[18][21] and 20 tons of gold to the Union Bank of Switzerland to raise $600 million.[18][21][28] During the transport of the gold reserves to the airport, the van experienced a tyre burst and caused panic.[29][30][9] The government, in the midst of the 1991 Indian General Elections, conducted the airlift with secrecy.[31] The news of the government pledging the entire gold reserves against the loan outraged national sentiments and caused a public outcry.[18][24] The gold was transported to London via a chartered plane from May 21 to May 31, 1991.[18] The Chandra Shekhar government, which authorised the airlift, had collapsed a few months later.[18] This move was seen as prioritising the balance of payment crisis over the welfare of the Indian people and kick-started P.V. Narasimha Rao's economic reform process.[21]
The reforms formally began on 1 July 1991 when RBI devalued Indian Rupee by 9% and by a further 11% on 3 July. It was done in two doses to test the reaction of the market first by making a smaller depreciation of 9%.[32] The economic reforms pushed by Prime Minister Rao were met with significant opposition from those who believed that they were an interference with India's autonomy. The speech made by then Prime Minister Rao, a week after taking office, emphasized the need for these reforms. As reported by the New York Times, "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 the bureaucratic red tape that stifles initiative, and streamline industrial policy."[33]
Since the implementation of economic reforms in 1991, India has experienced substantial economic growth and has emerged as a prominent participant in the global economy. The liberalization policies of the Indian government have facilitated this growth by attracting foreign investments, increasing trade relations, and promoting domestic economic reforms.
However, while some argue that these policies have benefited India, there are criticisms that suggest otherwise. Some experts argue that the growth has been uneven, and the benefits of liberalization policies have not been equally distributed across the country. Inequality has increased as the divide between the rich and poor has widened, and marginalized communities have been left behind. Additionally, some have argued that liberalization policies have had negative impacts on the environment and have not addressed issues related to sustainability and social justice.[34]
Despite these criticisms, the Indian government continues to promote liberalization policies and seeks to further integrate into the global economy. The success of these policies remains a subject of debate and continues to be a significant point of discussion among policymakers, economists, and civil society groups.
India's gross domestic product (GDP), adjusted for inflation, increased from $266 billion in 1991 to $3.7 trillion in 2023, while its purchasing power parity increased from $1 trillion in 1991 to $13 trillion in 2023.
Poverty has declined steeply from 55.1% in 2005-06 to 16.4% in 2019-20.[35] In addition to the economic growth and development, access to basic necessities such as food, shelter, and healthcare have drastically improved for people in India. Additionally, life expectancy has consistently improved from an average of 58.7 years in 1990 to an average of 67.2 in 2021.[36] However, it is to be noted that life expectancy increased at roughly the same rate even before liberalisation.
These challenges while not unique to developing countries, are being addressed considerably well by India over the last few decades. The Indian government has implemented various policies to address these issues, such as poverty alleviation programs, healthcare initiatives, and education reforms. While progress has been significant, there is room for more to promote sustainable development in India.[37]
Continued Current Account Deficit
Despite implementing liberal reforms in 1991, India has been unable to eliminate its Current Account deficit. In contrast to countries like China and Vietnam, which have managed to achieve a surplus, India continues to face this imbalance. Consequently, India relies on foreign capital inflows in the form of Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) to meet its balance of payments requirements. However, this dependence on foreign investment makes India more susceptible to external shocks.
An example of such vulnerability is the potential impact of the U.S. Federal Reserve raising interest rates. In the event of a rate hike, foreign investors in "risky" emerging markets like India may redirect their investments towards "safe" markets such as Europe and the U.S. As a result, these investors would sell their assets denominated in Indian Rupees in exchange for foreign currency assets. Consequently, India's foreign exchange reserves would diminish, and the value of the Rupee would weaken and imports would become more expensive.[38]
