Indian Economic Crisis of 1991 & Reforms
(Lead architect of 1991 reforms - Dr. Manmohan Singh)
Year was 1990 and with the left wing policies prevailed over decades Indian economy has suffered from twin deficits (Government budget deficit + balance of payment deficits) for a while. Indian reserves were shrinking. Adding on was the hike of oil price caused by the Gulf war. Moody’s down graded the Indian Bonds. Growing speculations about the status of the economy and less public support lead the Congress government budget of 1991 Feb was thrown away by the Indian legislature. Foreign reserves were limited to one month’s import.
What followed was a economic crisis in full swing. The Reserve Bank of India had to airlift 47 tons of Gold to the Bank of England and another 20 tons to Union Bank of Switzerland to raise $ 600 Mn to secure the reserves. (Part of the gold was sold & balance kept as guarantee)
Chandrasekhar Government collapsed in early 1991. Later Narasimha Rao Gov. formed in 1991 June appointed Dr.Manmohan Singh as the Minister of Finance and the rest is history…
Many economists and policy critics view 1991 reforms as the major turning point of the Indian Economy. 33 years later India is on it’s way to become the 3rd largest economy within a decade.
So what were these landmark reforms of 1991?
Radical relaxation of Import restrictions
Prior to 1991 all consumer goods were restricted and some intermediate capital goods were restricted as well. The import trade is governed by a positive list (List of items which are permitted - very limited items)
1991 budget did a radical reform by freeing all capital & intermediate goods. Most consumer goods were released except for 71 items in a negative list.
This was a radical move by the congress government as the reform introduced was at the brink of a foreign currency crisis. Many traditional left wing opinions thrashed the move calling this would lead to a waste of foreign reserves and will drive the economy in to a further collapse
However, this opened up the trade flow and many investors looked at India for manufacturing as the inputs were no longer restricted. This liberated the economy and freedom of choice and consumption for the public. Suddenly the global brands were available for the average Indian consumer.
Promotion of Foreign Direct Investment (FDI) by deregulation
India before 1991 was known to be a unhealthy environment for business due to its extreme bureaucratic bottlenecks. This is mainly influenced by the soviet model socialist ideology that it’s the government that need to lead the capital investments. Foreign investments were frowned upon purely because they were “foreign”.
The budget of 1991 introduced automatic approval process for 51% of industrial categories. Meaning the approval was considered deemed. Later the number was expanded to 74% of the total categories. Today this is the case for almost 100% industrial categories
Deemed approval - When an investor apply for approval from from government authorities, the authorities are supposed to get back within designated days. If not the project is deemed approved.
Liberalization of Exchange rate
Immediate response
1991 reforms in India was mainly driven by the balance of payment crisis. As an immediate remedy the Indian rupee was devalued. This led to a immediate inflation. This was an extremely unpopular decision at the time. It was definitely a decision which was politically incorrect given the massive impact to the masses.
Devaluation was done in two phases to reduce the inflation shock. First by 9% and subsequently by 11%. It was said that the steps were taken through a secret Memo from Finance Minister to PM as there was speculation that their own cabinet itself could have strongly opposed to the idea.
It was said that under the extreme pressure PM Rao called Singh on 3rd July morning to retract the final phase of devaluation but was told it was too late.
However, the decision led to a market control of import demand (As a result of devaluation of Indian rupee - imports become more expensive) and was a safeguard to the reserves.
Long term strategy
Exchange liberalization - before 1991 Indian rupee was pegged to a basket of currencies of major economic partners. Although this meant currency stability for the economy over valued currency caused balance of payment issues since 1985. India subsequently moved to a market determined exchange rate fully in 1993. This allowed the market forces to determine the exchange rate, which was an agreed move as per IMF reforms.
Conversion from “License Raaj” to a “Investor Raaj”
The pre Independence India was shaped by British colonial influence of strong government controls which eventually lasted post independence as well. This was intensified where most of Indian leaders were influenced/inspired by the Soviet Union model during the peak of it’s power.
This created a centrally planned economic model in India. 80% of the industries were essentially closed for new entrants and required a license to operate a factory or a business. Many economists saw this and critics made the tag line that India is a “License Raaj”
.
Objective of the licensing of some of these industries were to protect certain government monopolies or strong control. It was the norm that some industries should not be open for private ownership.
As a critical reform the most Industries were exempted from the licensing process and a more business friendly environment was created. Thereby the barriers to entry for most of the industries were shattered and private businesses entered and pushed the limits of competitiveness. This brought down the average cost and pushed the efficiency levels up. This was a primary move that resulted to create a vibrant industrial sector in India owned by private sector.
This was another unpopular reform at the time where then government was criticized making a pathway for rich to become richer at the expense of public welfare.
Repealing of MRTP Act (Monopolies and Restrictive Trade Policies Act)
The act was notorious for controlling the private businesses by a iron hand. Many critics argued that bureaucrats use the act to bully businesses. A simple thing like adding an extra production line to a factory was not possible without a getting an approval from a government official who in fact had no clue on the business model. Repealing of this act created more liberal environment for business growth.
The transformation of Indian economy can not be narrowed down only to the 1991 reforms. Many other factors inclusive of below have definitely contributed.
Continuation/constancy of policy by subsequent governments despite the political differences (e.g BJP - Vajpayee gov 1996)
Many second / third generation of continuous reforms and trade liberalization
Well crafted and executed foreign policies
Political Stability
National Unity and Integrity
Growth of population & Strong Diaspora
However, after 33 years of his famous budget speech (1991 July 24) India has been true to the wise words of Dr. Manmohan Singh.
I do not minimise the difficulties that lie ahead on the long and arduous journey on which we have embarked. But as Victor Hugo once said, “no power on earth can stop an idea whose time has come”. I suggest to this august House 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.
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