1991 India Economic Crisis - Causes and Consequences

Causes and Consequences

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

The economic crisis was primarily due to the large and growing fiscal imbalances over the 1980s. During the mid-eighties, India started having balance of payments problems. Precipitated by the Gulf War, India’s oil import bill swelled, exports slumped, credit dried up, and investors took their money out. Large fiscal deficits, over time, had a spillover effect on the trade deficit culminating in an external payments crisis. By the end of 1990, India was in serious economic trouble.

The gross fiscal deficit of the government (center 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. For the center alone, the gross fiscal deficit rose from 6.1 percent of GDP in 1980-81 to 8.3 percent in 1985-86 and to 8.4 percent in 1990-91. Since these deficits had to be met by borrowings, the internal debt of the government accumulated rapidly, rising from 35 percent of GDP at the end of 1980-81 to 53 percent of GDP at the end of 1990-91. The foreign exchange reserves had dried up to the point that India could barely finance three weeks worth of imports.

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 expending international reserves and slowing the decline in value.However, in mid-1991, with foreign reserves nearly depleted, the Indian government permitted a sharp depreciation that took place in two steps within three days (1 July and 3 July 1991) against major currencies.