State of Economy in 1991 and Need for Economic Reforms

Launching its First Five Year Plan (April 1, 1951), India started its journey to economic development treading the path of socialistic pattern of society. Between 1st to 6th five year plans, the public sector was assigned the primary role in the process of growth and development. Private sector was to play only a secondary role. Industry and trade were subjected to many restrictions including quotas of production and permits of export and import. The focus was on protecting the domestic industry from international competition. However, growth of private monopolies was to be curbed. It is not denying the fact that initially the policy of licenses, permits and quotas yielded some good results, but the end result was disappointing. While public sector enterprises became the breeding centers of corruption and inefficiencies, private sector (in the absence of competition), failed to diversify or modernize. The cumulative effect was that our economy started slipping into stagnation, and by the end of June 1991, we landed into an unprecedented economic crisis. The situation was so alarming that our reserves of foreign exchange almost dried up and were barely enough to pay for two weeks’ imports. New loans were not available. Large amounts were withdrawn from the accounts of Non-resident Indians (NRIs). There was an erosion of confidence of the international investors in the Indian economy. Industrial growth was scraping the bottom. Prices of essential goods were sky-rocketing. Indeed, there was a wake-up call for an impending economic collapse. Following observations highlight the seriousness of the situation and the need for economic reforms.

Fiscal Deficit

Fiscal deficit refers to borrowings by the government on account of the excess of its expenditure over revenue during a year. It is measured as a percentage of GDP. High fiscal deficit indicates poor financial health of the economy, particularly, when government expenditure is related to non-development programs and policies. High fiscal deficit triggers inflation, leading to (i) high cost of living for the people, and (ii) high cost of inputs for the producers. It hinders the process of growth and development.

Fiscal deficit was estimated to be 5.4 per cent of GDP in 1981-82 to shot up 8.4 per cent of GDP in 1990-91. There was a serious apprehension that the government was getting into a debt trap. It led to erosion of faith of international financial institutions. For any financial support, the international financial institutions placed conditions to open up the economy.

Balance Of Payments (BoP) Crisis

BoP deficit is the difference between total receipts and total payments of a country on account of its economic transactions with rest of the world. Payment for imports and receipts for exports are the two principal items of BoP.

BoP accounts are split as: (i) Current Account, and (ii) Capital Account.

Current account covers export and import (of goods and services). Capital account covers investment and borrowings. In the context of the Indian economy, current account balance has often been in the negative (indicating CAD-Current Account Deficit). The deficit on current account has often been met through borrowings (in the capital account). Thus, high CAD along with high borrowings (from rest of the world) has been a stable feature of India’s BoP accounts. By the end of 1990, both CAD and borrowings had peaked up to alarming limits. High borrowing was the consequence of high CAD. And, high CAD was the consequence of high imports and low exports.

In 1980-81, balance of payments on current account was adverse to the tune of Rs. 2,214 crore and in 1990-91 it rose to Rs. 17,367 crore. Foreign loans which were 12 per cent of GDP (gross domestic product) in 1980-81, rose to 23 per cent of GDP in 1990-91. Accordingly, the burden of foreign debt service increased tremendously. In 1980-81, foreign debt service constituted 15 per cent of our export earning while in 1990-91, it rose to 30 per cent. This caused a severe depletion in our Forex reserves and crises of confidence in the international foreign exchange market.

Gulf Crisis

On account of Iraq war in 1990-91, prices of petrol shot up. India used to receive huge amount of remittances from gulf countries in foreign exchange. In the wake of war, this took a serious hit. Gulf crisis thus further deepened the BoP crises.

Fall In Foreign Exchange Reserves

In 1990-91, India’s foreign exchange reserves fell to such a low level that these were not enough to pay for an import bill of even 10 days. Forex reserves that were Rs. 8,151 crore in 1986-87, declined sharply to Rs. 6,252 crore in 1989-90. The situation became so grave that the government had to mortgage country’s gold reserves with the World Bank to discharge its foreign debt servicing obligation. In such a state of crises, the government had to helplessly resort to the policy of liberalization as advised by the World Bank.

Price Spiral (Inflation)

Price spiral had assumed alarming proportions. At one stage, average annual rate of inflation was found to be 16.7 per cent. Prior to 1991, despite good monsoon for three consecutive years, prices of foodgrains had tended to rise. Because of increasing pressure of inflation, economic crisis deepened from bad to worse. Inflation was triggered largely by a rapid increase in money supply. This, in turn, was due to excessive resort to deficit financing. Deficit financing refers to borrowing from Reserve Bank of India by the government to cope with its deficits.

(Reserve Bank offered loans by printing additional currency.) Inflation pushed up domestic cost of production and dampened domestic and foreign demand for our products. ‘Slow-down Crises’ were precipitated (compounded) in the economy.

Poor Performance Of PSUs

In 1951, there were just 5 enterprises in public sector in India but in March 1991, their number multiplied to 246. Several thousand crores of rupees were invested in their expansion. In the initial 15 years, their performance was encouraging but thereafter most of these started showing losses. Because of their poor performance, public sector undertakings degenerated into a liability.

The combined effect of these factors was that the government was compelled to seek economic asylum from the World Bank and IMF (International Monetary Fund). To manage the crises, India was granted a loan of $7 billion, but it was a tied loan-tied to a set of economic reforms that the government was compelled to pursue. Liberalization, Privatization and Globalisation were the three basic elements of economic reforms, or the elements of NEP (New Economic Policy).

Liberalization, Privatization and Globalization

Battling the economic crises of 90’s, the Government of India initiated a series of economic reforms, which came to be known as New Economic Policy (NEP). Three broad components of NEP are as follows:

  • The policy of liberalization (L) in place of licensing (L) for the industries and trade.
  • The policy of privatization (P) in place of quotas (Q) for the industrialists, and
  • The policy of globalization (G) in place of permits (P) for exports and imports.

Thus, LPG was set to replace LQP in 1991 and this was manifested in the Industrial Policy, 1991, which is discussed in next article.