Revisiting the 1980s Financial Crisis in India

The financial crisis in India during the 1980s stemmed from inefficient economic management.

Government funds were generated through taxation, public sector enterprises, and borrowing when expenditures exceed income.

Imports of goods like petroleum required payment in dollars, which were earned from exports.

Challenges in Fiscal Management: Economic Disparities and Government Intervention

• Government Intervention in Challenging Times: Despite low revenues, the government increased spending to tackle unemployment, poverty, and population explosions.
  • Developmental programmes failed to generate sufficient revenue, and inadequate internal generation, particularly through taxation, exacerbated the deficit.
  • A significant portion of government spending was directed towards non-immediate return areas like the social sector and defences.
  • The income from public sector undertakings was insufficient to meet the escalating expenditure.
  • Amidst these challenges, the nation underwent a transformative phase with the introduction of the New Economic Policy (NEP) in 1991. This policy aimed at addressing economic disparities and fostering sustainable fiscal management.

Foreign Exchange and International Borrowing: Challenges and Economic Turmoil in the Late 1980s

• Foreign Exchange Dilemma: The borrowed foreign exchange was often utilised for consumption needs, while no substantial efforts were made to curtail such spending or enhance exports to balance growing imports.
• Fiscal Imbalance in the Late 1980s: By the late 1980s, the gap between government revenue and expenditure had widened considerably, making borrowing to cover the deficit unsustainable.
• Economic Turmoil: Prices of essential goods soared, and imports surged without a corresponding increase in exports, depleting foreign exchange reserves to a precarious level.

India’s Crisis Management and International Aid Amidst Financial Turmoil

• Deepening Crisis: The crisis deepened as foreign exchange reserves plummeted to a level inadequate for financing more than two weeks of imports and paying interest to international lenders.
• Seeking External Assistance: No nation or international institution was inclined to lend to India, prompting India to seek aid from the International Bank for Reconstruction and Development (IBRD) or World Bank, and the International Monetary Fund (IMF).
  • A loan of $7 billion was secured to navigate through the crisis, contingent upon India liberalize its economy, diminishing government intervention, and abolishing trade restrictions. This marked the onset of a transformative phase, known as the New Economic Policy (NEP), characterized by liberalization, privatization, and globalization.

Revolutionizing India’s Economic Landscape: The New Economic Policy (NEP) of 1991

• New Economic Policy (NEP): Complying with the international agencies’ conditions, India announced the New Economic Policy, embracing broad economic reforms aimed at fostering a competitive environment and easing entry and growth barriers for firms.
• The NEP encompassed two primary strategies:
  • Stabilization Measures: These were short-term measures, such as
    • To rectify balance of payments discrepancies.
    • To control inflation by maintaining adequate foreign exchange reserves
  • Structural Reform Measures: These are Long-term measures such as
    • To augment the economy’s efficiency and international competitiveness by eliminating rigidities in various segments of the Indian economy.
    • The core themes of the reforms were liberalization, privatization, and globalisation.

Let’s discuss these three aspects in detail.

The Evolution of Liberalization in India

• Meaning: The term liberalization embodies the removal of governmental restrictions, allowing businesses greater freedom in deciding what to import or export.
• Post-liberalization Policies: The government’s stance became more liberal with fewer restrictions imposed on trade and investment, thereby promoting a freer trade environment.
• Economic Deregulation: It aimed at deregulating economic activities.
  • It was initiated to overcome the growth impediments caused by restrictive rules and laws.
• Comprehensive Reform Policies: While some measures were introduced in the 1980s, comprehensive reform policies were launched in 1991 with the introduction of the New Economic Policy (NEP), impacting various sectors like the industrial sector, financial sector, taxation, foreign exchange markets, and trade and investment sectors.

Industrial Deregulation and Reforms: Transforming India’s Economic Landscape Post-1991

• Prior to 1991 New Economic Policy: Stringent regulatory mechanisms such as industrial licensing, restricted private sector involvement, small-scale industries reservations, and controls on price and distribution were in place.
• Post-1991 New Economic Policy Reforms: It abolished industrial licensing for most product categories, with exceptions like alcohol, hazardous chemicals, and a few others.
• Narrowing of Public Sector Exclusivity: The public sector’s exclusivity was narrowed down to atomic energy generation and some core railway transport activities.
• De-reservation: It was undertaken for many goods previously restricted to small-scale industries  and market-determined prices were introduced in most industries.

Financial Sector Revolution: Releasing Growth Through Post-1991 Reforms

• Prior to 1991: The financial sector, encompassing commercial banks, investment banks, stock exchanges, and the foreign exchange market, was under the stringent regulation of the Reserve Bank of India (RBI).
• Post 1991 reforms: RBI’s role transitioned from regulator to facilitator, enabling the financial sector to make autonomous decisions on various matters.
• Banking Sector Liberalization:
  • Banks fulfilling certain conditions were granted the liberty to establish new branches and rationalize existing networks without RBI’s approval, albeit with some managerial aspects retained with RBI to safeguard stakeholders’ interests.
  • The establishment of private sector banks, both Indian and foreign, was facilitated, with 
  • Foreign investment limits in banks increased to around 74%.
• Foreign Institutional Investors (FII): Like merchant bankers, mutual funds, and pension funds were permitted to invest in Indian financial markets.

Tax Reforms and the New Economic Policy: Drawing the Course for Fiscal Transformation

• Fiscal Policy Overhaul: These reforms focused on modifying the government’s taxation and public expenditure policies, constituting its fiscal policy.
• Income Tax Reforms Post-1991: 
  • A continuous reduction in individual income taxes and corporation tax rates was witnessed post-1991, promoting savings, voluntary income disclosure, and compliance.
• A Common National Market: 
  • Efforts have also been made to reform the indirect taxes and taxes levied on commodities.
  • It aims to facilitate the establishment of a common national market for goods and commodities.
• Goods and Services Tax Act 2016: 
  • It was enacted to reform indirect taxes, effective from 1 July 2017.
  • It led to the establishment of a unified indirect tax system.
  • It also simplifies tax procedures and reduces evasion.

The 1991 Balance of Payments Crisis: Foreign Exchange Reforms

• Devaluation of Currency: To address the 1991 balance of payments crisis, an immediate devaluation of the rupee was carried out, increasing foreign exchange inflow.
• Market-Determined Exchange Rates: These were based on foreign exchange demand and supply, reducing government control over rupee value.

Revitalizing India’s Global Stance: Trade and Investment Policy Reforms in the Post-1991 Era

• Key Pillar in Reforms: It focussed on enhancing international competitiveness and encouraging foreign investments and technology infusion, trade and investment liberalisation was a significant aspect of the reforms.
• Pre-reform Policies:  High tariffs and tight control over imports, which hampered the growth and efficiency of the manufacturing sector, were dismantled.
• Post 1991 Reforms: 
  • It encompassed abolishing import licencing (except for hazardous and environmentally sensitive industries).
  • To remove quantitative restrictions on imports and exports, and to reduce tariff rates.
• These measures effective from April 2001 intended to
  • Boost the competitive stance of Indian goods in international markets.
  • Foster efficiency and modern technology adoption in local industries.
  • The new economic policy ushered in an era of increased openness and global integration, propelling India towards a more dynamic and competitive economic landscape.

Privatisation

• Privatisation: It denotes the transition from government ownership or management to private sector control of enterprises. 
• Modes of Privatisation: This transition manifests in two primary ways: 
• By the government relinquishing ownership and management of public sector companies.
• By the outright sale of such companies.

Privatization: FDI Stimulator and Managerial Empowerment in India’s Economic Transformation

• Facilitating Foreign Direct Investment (FDI): 
  • Privatisation was envisaged as a catalyst for increasing the inflow of Foreign Direct Investment (FDI), thereby contributing to economic growth and modernisation.
• Enhancing PSU Efficiency through Managerial Autonomy: 
  • The government aimed to boost the efficiency of PSUs by granting them managerial autonomy. 
  • This autonomy was manifested through the conferment of special statuses like Maharatnas, Navratnas, and Miniratnas on certain PSUs, empowering them with greater managerial discretion.
  • The initiative to promote Foreign Direct Investment (FDI) and enhance efficiency through managerial autonomy was a pivotal aspect of the New Economic Policy (NEP) introduced in 1991.