1991 goes down in history as the year that marked the ideological defeat of socialism in India at the hands of economic realism.
After more than four decades of socialism, India was days away from bankruptcy and forced to turn to the International Monetary Fund (IMF) for a bailout. The condition? That India abandon its socialist economic structure and pursue capitalist reforms.
There was little choice. India’s economy was in a shambles, with fiscal deficit at an unsustainable 8.5% of the economy and the current account deficit touching 3.5%. With total external debt at US$72 billion, India had become the world’s third largest debtor after Brazil and Mexico.
Investor confidence in India was at an all-time low and both the World Bank and the IMF were reluctant to sanction new loans. Meanwhile, foreign suppliers were refusing to honour letters of credit issued by Indian banks that were not approved by a foreign bank.
By January 1991, foreign exchange reserves had dropped to US$1.2 billion; by June, this had halved and was barely enough for roughly three weeks of essential imports. For the first time in history, India was on the verge of a debt default.
In technical terms, India was experiencing a classic example of balance of payment crisis: high fiscal and current account deficits, external borrowing to finance the deficits, rising debt service obligations, rising inflation, and inadequate exchange rate adjustment.
In non-technical terms, the country of 846 million — also the world’s largest socialist democracy — was going bankrupt.
Though the crisis was primarily due to the ballooning of fiscal imbalances over the 1980s, two significant world events precipitated the unprecedented crunch in 1991.
First, the Gulf War increased petroleum import costs in 1990-1991 by half to US$5.7 billion. The government had to bear the additional burden of airlifting and rehabilitating more than 100,000 Indian workers from the Middle East as well as suffer a big drop in remittances from the region.
The second cause was the global recession: world growth had declined to 2.25% in 1991 from 4.5% in 1988. Export growth in the US — India’s largest market — turned negative in 1991. Even more damaging were the events that led to the eventual collapse of the Soviet Union, once a major patron and supporter of India.
Domestically, India was also suffering from political instability.
In the summer of 1990, the National Front coalition government was facing violent nationwide protests by students over its affirmative action policies. In November, the coalition collapsed when the Bharatiya Janata Party pulled out over a disagreement about the building of a temple. The new government was formed, only to also collapse barely four months later, leaving India without a government at its most crucial hour. In May 1991, while campaigning for the federal elections, former prime minister Rajiv Gandhi, leader of the Congress party, was assassinated.
In reaction, and in parallel to these developments, the economic situation worsened.
To keep the foreign reserve ratio above US$1 billion, the caretaker government sold 20 tonnes of gold to obtain a loan of US$240 million. The new government, which took office on June 21, 1991, pledged a further 20 tonnes of gold to Union Bank of Switzerland and 47 tonnes to Bank of England as part of a bailout deal with the IMF.
But the IMF wanted more; it wanted India to undertake a series of structural economic reforms. Many in India, which considered itself the leader of the non-aligned world, viewed the potential arrangement with pain, even embarrassment. Forced between retaining a populist socialist economic structure and introducing reforms at the cost of public anger, prime minister Narasimha Rao chose the latter.
He directed his finance minister Manmohan Singh, the present prime minister, to initiate wide-ranging policy reforms. Steps were undertaken to reduce excessive government controls, liberalise trade, allow foreign investment, encourage private sector business, and gradually embrace globalisation.
The crisis of 1991 thus gave birth to a new India, a capitalist India. AR