9. 1991 Economic Crisis and Recovery Mathew Joseph BUSINESS ENVIORNMENT 9. 1991 Economic Crisis and Recovery Mathew Joseph FORE School of Management

Pre-1991 India No major crisis during 1950-1965 Average GDP growth nearly 4.5% per annum Industry grew by about 7 per cent Agriculture at 3.7 per cent Inflation only 2.5% Three major crisis situations till 1991 1965-69: Massive drought leading to poor successive harvests, devaluation, high inflation, war with Pakistan 1972-76: High inflation due to two consecutive bad harvests followed by external shock of quadrupling of oil prices 1979-82: Major harvest failure and the second oil shock in 1979 leading to substantial drop in GDP and high inflation

Economic Crisis of 1991 Gravest crisis since independence Surfaced as an external payment crisis India came to the brink of inability to meet its external obligations Had to hypothecate gold to avoid default

Background and Features of the Crisis Pre-crisis decade characterized by high growth 5.6% p.a during 1980-81 to 1990-91 against 3.5% p.a during 1951-52 to 1979-80 Growth proved unsustainable Debt-led - unprecedented debt levels: public debt (75% of GDP in 1991-92 from 49% in 1980-81) and external debt (39% of GDP) High fiscal and current a/c deficits (fiscal deficit at 9.4% of GDP in 1990-91 and current account deficit at 3% of GDP) High money supply growth and inflation (average inflation at 13-14% in 1991-92)

Background and Features of the Crisis…. Overall GDP growth collapsed to 1.4% in 1991-92 and manufacturing declined by 2.4% Foreign exchange reserves plunged to just 2-week import level Culminated in the worst economic crisis of post-independent India

Major Aspects of Policy Response 1. Lack of macroeconomic stability Macro policy response 2. Need for sustained high long-term growth Supply-side efficiency enhancing policy changes – “structural reforms”

Macro Policy Response Restoring Macroeconomic stability Both external and internal balance Optimal combination of devaluation and demand management (monetary and fiscal) policies Meade-Salter-Swan Framework

Macro Policy Response… Chart 1: Macro Stability II’: Locus of internal balance points, optimum non-inflationary output Higher domestic absorption offset by falling external competitiveness EE’: External balance curve, sustainable current account Higher absorption to be compensated by increased competitiveness IE: Attainment of both internal and external balance I Comp-etitive-ness Inflation-Surplus E’ Unem-Surplus Inflation-Deficit IE Unem-Deficit I’ E Absorption Meade-Salter-Swan Analysis

Macro Policy Response… J: Point of internal balance but external imbalance J to K involves a harsh deflationary policy to get external balance, but leads to output and employment loss J to L involves a massive devaluation to attain external balance, but generates excess demand and inflation J to IE: Optimum combination of devaluation and demand management securing the twin objectives India in Inflation-Deficit Zone -adopted a policy package of devaluation and demand contraction. Chart 2: Macro Stability I Comp-etitive-ness E’ Inflation-Surplus Unem-Surplus IE L Inflation-Deficit K J Unem-Deficit I’ E Absorption Meade-Salter-Swan Analysis

Structural Reforms Efficiency-enhancing structural (microeconomic) policies Delicensing of industry/deregulation of investment procedures De-reservation of sectors from public sector (power, telecommunications, mining, ports, roads, steel, air transport, banking, etc.) Array of reforms in the external sector (reduction of import tariffs, relaxation of import licensing, liberalisation of direct and portfolio investment, floating of the rupee, full current a/c convertibility, ..)

Structural Reforms… Reform in the financial sector (freeing of interest rates, monetary policy shift from direct to indirect measures, strengthening of prudential norms and supervision, licensing of new private banks, strengthening of debt and capital markets, ...) Fiscal reforms (reduction and rationalisation of tax rates, cutting of public expenditure esp. subsidies, divestment of public enterprises, fiscal consolidation, ...)

Reaching High Growth Trajectory Growth up from 5.6% p.a during 1980-91 to 6.6% p.a during 1992-97 Cyclical downturn to 5.4% p.a during 1997-03 but reaching highest ever 8.7% p.a during 2003-08

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