How the economy found its feet


The events of 1991 highlight the resilience of the political process despite all its flaws and warts

It is 25 years since July 1991, etched in memories as a watershed, when economic liberalisation began life in India. The story starts earlier. I lived through that era as Chief Economic Adviser to three successive governments in a span of two years marked by economic crises and political uncertainties.
During the 1980s, the competitive politics of populism led governments into a spending spree. But it was not possible for the government, or the economy, to live beyond its means year after year. The fiscal regime was unsustainable. The inevitable crunch did come. The minor oil shock of 1990 following Iraq’s invasion of Kuwait was the last straw that broke the camel’s back. The balance of payments situation became almost unmanageable.
We simply could not default on our international payments obligations. It would have turned us into a basket case. It was firefighting day by day, surviving month by month, while working at solutions, whether borrowing from the International Monetary Fund (IMF), imposing massive cash margins on imports, or selling gold confiscated from smugglers. This provided breathing time, enabling us to strategise for what needed to be done when an elected government assumed office. This happened in late June 1991.

Meeting the challenge

It was the worst crisis in the economy of independent India. The prospect of default hung over our heads, much like the proverbial Sword of Damocles, for almost 12 months. The continuing political uncertainties compounded difficulties. Yet, there was a strong determination to meet the challenge. It is mirrored in three stories.
In mid-October 1990, a month before it fell, the V.P. Singh government decided to approach the IMF for a loan. This step was recognised as essential despite caricature perceptions of the IMF as a moneylender in the Shylock tradition. The successor Chandra Shekhar government, hesitant to begin with, quickly endorsed the idea. Over the next two months, I led our negotiations with the IMF for borrowing under the first credit tranche and the Compensatory and Contingency Financing Facility (designed to help meet the increased cost of petroleum imports). It was a tough process, but we obtained $1.8 billion with minimal conditions in late January 1991. The resolve of the government to avoid default and the stature of the Republic of India, even in deep crisis, helped us drive a hard bargain.
The comfort did not last long. The Congress party withdrew support and the Union Budget could not be presented in February 1991. We had a caretaker government and a general election to come. But the liquidity crunch was on. Foreign exchange reserves were perilously low. There was capital flight from non-resident deposits. In this milieu, restoring international confidence was imperative. In the midst of the election process, the caretaker government decided to ship 20 tonnes of gold, confiscated from smugglers, to raise $200 million from the Union Bank of Switzerland through a sale-with-a-repurchase option. In a society where only a bankrupt household would mortgage its gold, it was a brave decision that was also high risk. The shipment process had a script that could match a thriller. It was kept secret. And it bought us most valuable time.
The election process, prolonged by the assassination of Rajiv Gandhi, was completed in June 1991. The situation was dire. P.V. Narasimha Rao was Prime Minister designate but had not yet been sworn in. Late at night on June 20, 1991, Cabinet Secretary Naresh Chandra, Finance Secretary S.P. Shukla and I met him at 12, Willingdon Crescent. For the meeting, I had prepared a note on the crisis in the economy with a handwritten annexure on a strategy outlining measures that needed to be announced before the Budget, plus what needed to be done in the Budget, setting out alternatives and their implications. He read the note and spent some time with us in discussion. The resolve to do whatever was essential came through clearly.

Making tough decisions

These events do highlight the resilience of the political process despite all its flaws and warts. Two short-lived governments that inherited an economic crisis made tough decisions instead of postponing the day of reckoning. The governmental system and its institutions did everything to avert default even when there was no elected government that could make policy decisions. A minority government that had not yet won a vote of confidence in Parliament acted promptly and decisively. Cynics might think it was the crisis that focussed minds. But there was more.
In the eventful month that followed, between June 24 and July 24, 1991, critical decisions were made: sharp depreciation in the exchange rate of the rupee, using gold held as reserve assets by the Reserve Bank of India (RBI) to borrow, announcing dramatic changes in economic policies, presenting a Budget that delivered the much-needed fiscal adjustment, inter-alia by slashing subsidies and raising prices of petroleum products. The decision to negotiate a Stand-By Arrangement with the IMF and a Structural Adjustment Loan from the World Bank was also made around then. I led these negotiations, which were concluded in late September 1991.
In my view, any government that came to power in mid-1991 would have done almost the same. The blueprints existed. There was little choice. Even so, the outcome was possible only because we had an elected government after months of political instability, and a Prime Minister, Narasimha Rao, who was most decisive in this crisis situation and quietly persuasive in political management. There were dissenting voices, rather than consensus, both in the Congress Party and in the Opposition. But there was recognition of the deep crisis in the economy among politicians across parties. And no one was willing to bring down the minority government to force yet another election on people.

Effective governments

At this juncture, 25 years later, it must be stressed that reforms are means, not ends. The essential objective is the well-being of our people. In this quest, markets and governments are complements, not substitutes. There are many things that only markets can and should do. However, there are some things that only governments can and must do. If governments perform these tasks badly, it is not possible to dispense with governments and replace them with markets. Governments must be made to perform better. Indeed, efficient markets need effective governments.
Deepak Nayyar is Emeritus Professor of Economics, Jawaharlal Nehru University, New Delhi. He served as Chief Economic Adviser, Government of India, from 1989 to 1991, and as Vice Chancellor, University of Delhi, from 2000 to 2005.
Keywords: 25 years of reformsDr. Manmohan Singh1991 BudgetGeneral BudgetP.V. Narasimha Rao


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