1. 9. 1991 Economic Crisis and Recovery Mathew Joseph
BUSINESS ENVIORNMENT
Economic Crisis and Recovery
Mathew Joseph
FORE School of Management

2. 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
: Massive drought leading to poor successive harvests, devaluation, high inflation, war with Pakistan
: High inflation due to two consecutive bad harvests followed by external shock of quadrupling of oil prices
: Major harvest failure and the second oil shock in 1979 leading to substantial drop in GDP and high inflation

3. 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

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

5. Background and Features of the Crisis….
Overall GDP growth collapsed to 1.4% in 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

6. 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”

7. 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

8. 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

9. 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

10. 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, ..)

11. 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, ...)

12. Reaching High Growth Trajectory
Growth up from 5.6% p.a during to 6.6% p.a during
Cyclical downturn to 5.4% p.a during but reaching highest ever 8.7% p.a during

13. The End