Foreign Exchange Crisis India: 1991

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Foreign Exchange Crisis India: 1991

– Abhishek

As 1980s was coming to an end, Indian economy stood facing a Balance of Payments (BoP) crisis, which was caused due to unsustainable and ill defined borrowing and high expenditure stats and strategies. Current Account Deficit (3.5 percent) in 1990-91 astoundingly broke Indian Economy spine and got the survival of it hard as well as ability to finance deficit gone out of reach.The economic crisis was primarily due to the large and growing fiscal imbalances over the 1980s.The gross fiscal deficit of the government (centre and states) rose from 9.0 percent of GDP in 1980-81 to 10.4 percent in 1985-86 and to 12.7 percent in 1990-91.

Mentioned Amount is Indian Currency and In multiples of crores.

Mentioned Amount is Indian Currency and In multiples of crores.

Mentioned Data Illustrated on X-axis in Ratio

The fiscal deficit to GDP ratio was more than 7 percent during the two years 1989-90 and 1990-91.

ForEx reserves, were meant to cover import costs for two years, but it was just sufficient to cover close to two and half months of imports.

BoP(Balance of Payments) crisis adversely affected the industrial sector. The growth rate was 8 percent in the end of 1980s. In 1989-90, it was 8.6 percent and in 1990-91 it was 8.2 percent.

Mentioned Data on X-axis is Percentage.

Mentioned Amount is Indian Currency and In multiples of crores.

The main causes behind the Balance of Payments crisis of 1990-91 were as follows:

  • War(Iran-Kuwait): The oil import bill increased by about 60 percent in 1990-91 and remained 40 percent above the 1989-90 level the next year.  As noted in Economic Survey (1991-92):
    The immediate cause of the loss of reserves beginning in September 1990 was a sharp rise in the imports of oil and petroleum products (from an average of $ 287 million in June-August 1990, petroleum products imports rose sharply to $ 671 million in 6 months). This accounted for rise in trade deficit from an average of $ 356 million per month in June-August 1990 to $ 677 million per month in the following 6 months.
  • Break-up of the Soviet Bloc: The flow of new rupee trade credits declined abruptly in 1990-91. Further, there was also a decline in our exports to Eastern Europe—these exports constituted 22 .1 percent of total exports in 1980 and 19.3 percent in 1989; but they declined to 17.9 percent in 1990-91 and further to 10.9 percent in 1991-92.
  • Political Uncertainty and Instability: This led to delay in tackling the ongoing balance of payment crisis, and also led to a loss of investor confidence.
  • Loss of Investors’ Confidence: The loss of investors’ confidence, commercial bank financing became hard to obtain, and outflows began to take place on short-term external debt, as creditors became reluctant to roll over maturing loans.
  • Slow Growth of Important Trading Partners: The decline was even greater for the U.S., India’s single largest export destination. In the United States, growth fell from 3.9 percent in 1988 to 0.8 percent in 1990 and to -1 percent in 1991.
  • Fiscal Indiscipline: 
    Throughout the eighties, all the important indicators of fiscal imbalances were on the rise. These were the conventional budgetary deficit, the revenue deficit, the monetized deficit and gross fiscal deficit. Moreover, the concept of fiscal deficit is a more complete measure of macroeconomic imbalance as it reflects the indebtedness of the Government. This gross fiscal deficit of the Central Government has been more than 8 percent of GDP since 1985 – 86, as compared with 6 percent in the beginning of 1980s and 4 percent in the mid – 1970s.
  • Increase in Non-oil Imports: Trade deficit increased from an average of 1.2 percent of GDP in the seventies, to 3.2 percent of GDP in eighties.

Oil and Non- Oil Imports (In Rs. Crores)

  • Rise in External Debt: The current account deficit was mainly financed with costly sources of external finance such as external commercial borrowings, NRI deposits, etc.

    In the context of external debt the following observations are worth considering:0

    • Government of India’s immediate response was to secure an emergency loan of USD 2.2 billion from the International Monetary Fund by pledging 67 tons of India’s gold reserves as collateral. The Reserve Bank of India had to airlift 47 tons of gold to the Bank of England and 20 tons of gold to the Union Bank of Switzerland to raise USD 600 million.

These moves helped tide over the balance of payment crisis temporarily and kick-started P V Narasimha Rao’s economic reform process.

The crisis was caused by currency devaluation; the current account deficit, and investor confidence played a significant role in the sharp exchange rate depreciation.

The economic crisis was primarily due to the large and growing fiscal imbalances over the 1980s.The gross fiscal deficit of the government (centre and states) rose from 9.0 percent of GDP in 1980-81 to 10.4 percent in 1985-86 and to 12.7 percent in 1990-91.

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.

Ref: Wikipedia 

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