India on the Move - a Macro Perspective

INDIA ON THE MOVE - A MACRO PERSPECTIVE.

Group 9, Section - 2

 Anupam Sabat - DM 14110

 Susan Cheeran Chandy - DM 14152

 Namita Verma - DM 14238

 Abhina Mudgal - DM 14267

 Naman Sreen - DM 14265

 Anil Kumar Sankuru - DM 14203

During the 1980's, India started having balance of payments problem. India was close to default, the central bank (Reserve Bank of India) had refused further credit and the foreign reserve had fallen to such a low that they couldn't even finance 3 weeks of imports. The 1991 economic crisis happened mainly due to the following reasons:

* India's exchange was being subjected to severe adjustment. The RBI tried to save the situation by defending the currency and slowing down the rate at which it declined.

* Due to the foreign reserves being depleted, India allowed the rupee to be depreciated in two instalments, i.e. first by 9.5 percent and then by 23 percent of the dollar.

* The middle-eastern crisis and the rise in oil prices lead to a severe hit to the Indian current account deficits. The import for oil in those years had increased by approximately Rs 4 billion because of the spike in prices and the imports in our country increased due to the short supplies (gulf crisis).

* The world growth had declined by 4.5% in the years preceding 1991. The decline being even greater for the U.S growth causing a hit to our exports.

* Another reason was the political instability. The Janta Dal had come into power and they formed a coalition government. However they got involved in caste and religion disputes. V.P.Singh's government fell in 1990 after his forced resignation, giving rise to a caretaker govt in 1991.

* India's balance of payments suffered capital account problems because of loss of investor trust. The widening current account imbalances and reserve losses were the main contributors to their ill trust. And was further downgraded by India's credit rating.

* The economic crisis was primarily due to the large and growing fiscal imbalances over the 1980s.Large fiscal deficits, over time, had an impact on the trade deficit culminating in an external payments crisis.

* In mid-1980s, defence expenditure increased and direct taxes were reduced. Indirect taxes made the large chunk of tax revenue. In 1990, fiscal deficit formed around 11.8% of GDP.

* Since these deficits had to be met by borrowings, the internal debt of the government accumulated rapidly.

Current Account Deficit:

* During mid-eighties, India started having balance of payments problems due to following factors. India's CAD rose above 3% of its GDP in year 1990.

Import prices rose:

* Iraq's invasion of Kuwait and consequent run-up in the world oil prices made petroleum imports expensive.

Exports Declined:

* Soviet Union was India's largest export market. Due to Middle East crisis, conditions deteriorated in Soviet Union during 1989. Unsteady growth in other trading partners also resulted in a slow export volume growth.

Foreign Remittances Declined:

* Foreign remittances from migrant Indian workers in the Middle East declined due to Iraq's invasion of Kuwait. The foreign exchange reserves had dried up to less than US $1 Million and India could barely finance three weeks' worth of imports.

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* To finance the twin deficits, India relied on external funds. Foreign investment at 0.1 percent of GDP during 1985-1990 was negligible. During 1980-1985, nearly half of external financing needs were met by external assistance. By the mid-1980s, "aid weariness" forced the government to rely more

* On commercial borrowing. External debt (with a large proportion of short-term debt) started dominating the balance sheet, peaking at 38.7 percent of GDP in 1991-1992, with the debt-export ratio at 563 percent.

Currency Overvaluation:

* Devaluation of Indian Rupee had started in 1960s due to the wars with China (1962) and Pakistan (1965). Augmented by above conditions, foreign lenders refused to roll over their short term maturing debt and started pulling money out of India. NRI community also started to withdraw their savings in Rupees. Government was forced to devalue Rupee in order to restore balance and increase exports.

* The Government borrowed from RBI to cover up the deficit. Money supply expanded as a result which led to high inflation. Also, there was a large domestic demand due to public sector wage increases in 1980's that further fuelled inflation.

After being faced with the most serious balance of payment crisis India had to take up some drastic reforms. The short term measures was to meet payment crisis, the long term objective was to put the economy on a steady growth path. The new economic policy on 1991 introduced was done to remove trade barriers and import substitution. The caretaker government in order to meet its deficits was to secure a loan of 2.2 billion.

* The key objective was to bring growth of aggregate demand in line with the long term growth path of the economy and hence reduce domestic inflation and improve balance of payments.

* The Structural adjustment measures were aimed at improving the supply side of the economy and hence long term growth.

* There was a larger role of the private sector including foreign investment.

* Massive deregulation of the industrial sector was done in order to bring in competition and increase efficiency.

* The current account deficit which was $10 billion in 1990-91 came down to $2.3 billion in 1994-95

* Agricultural sector recorded an annual growth of 3.5% from 1992-95

* The share of India's agricultural exports in world exports of the same commodities increased from 1.1 percent in 1990 to 1.9 percent in 1999, whereas it had declined in the ten years before the reforms.

* Rupee devalued from Rs.22 per dollar to Rs.32.43 per US$ (The rupee was devalued 22% against the US$ in 1993 and became convertible on the current account in