Economic crisis of 1991

Also called: BoP crisis 1991 · Topic: The 1991 Crisis and LPG Reforms: An Appraisal · NCERT: Class 11, Ch 3 "Liberalisation, Privatisation and Globalisation: An Appraisal"

Meaning

The economic crisis of 1991 was a balance-of-payments (BoP) crisis: India's foreign currency was running out and could no longer pay for its imports or repay its foreign loans. In July 1991, reserves of about ₹2,500 crore could pay for imports for only "a mere fortnight" (about two weeks) [3]. India came close to default (failing to repay a loan on time) on its external debt. It had to pledge its gold abroad, while inflation and the fiscal deficit were also high.

It matters because this crisis pushed India into the full LPG reforms (Liberalisation, Privatisation and Globalisation). The key measure of how bad it was:

Import cover (months) = Forex reserves ÷ Average monthly imports

Explanation

How the stress built up in the 1980s

• Growth was fast. GDP grew about 5.6% a year (1980-91). The old "Hindu rate of growth" was about 3.5%.
• The way this growth was paid for was unsafe:
• Spending was higher than income. The government spent heavily on development, the social sector and defence. None of these gives quick returns.
• Tax effort was weak, so too little tax was collected.
• PSUs (Public Sector Undertakings, which are government-owned companies) earned small profits.
• Foreign loans were spent on day-to-day use, not on investment. So the loans produced no income to repay them.

• Imports grew fast but exports were neglected. The trade gap kept getting wider.

• Result: the "twin deficits". By 1990, India had a big fiscal deficit (the government borrowing to cover the gap between its spending and its income) and a big current account deficit (CAD) (India paying foreigners more than it earned from them) at the same time.

Key numbers and formulas

• Gross Fiscal Deficit (GFD) = Total expenditure − (Revenue receipts + Non-debt capital receipts)

• Centre's GFD in 1990-91: 8.4% of GDP [4]. The Budget put it at "more than 8 per cent of GDP" [3]. NCERT gives about 8%.

• CAD = (Imports of goods and services + income paid abroad) − (Exports + income received + remittances)

• Remittances = money that Indians working abroad send home.

• CAD in 1990-91: about 3% of GDP (NCERT).

• Worked example (import cover):

• Reserves = US$1 bn. Yearly imports = about US$24 bn, so monthly imports = US$2 bn.
• Cover = 1 ÷ 2 = 0.5 month, or about 2 weeks.
• In July 1991, the ₹2,500 crore of reserves was about US$1.2 bn at roughly ₹21 per US$ [3].

Indicator (1990-91)	Level
Centre's GFD	8.4% of GDP [4]
CAD	about 3% of GDP
Inflation	about 13-14% in mid-1991; peak of 17% in August 1991 [5]
External debt	about US$84 bn (end-March 1991), with a rising short-term share
Forex reserves	about US$1 bn by June 1991; a fortnight of imports in July 1991 [3]

• Short-term debt = loans that must be repaid within one year. It is risky because lenders can refuse to roll over (renew) these loans.

Shocks that turned stress into a crisis

• Gulf War (1990-91):
• World oil prices rose, which tripled the cost of India's petroleum imports [6]. The import bill went up, the CAD grew wider, and reserves drained faster.
• Indian workers in Kuwait were sent home, so their remittances stopped.

• India's main trading partners grew slowly, which hurt Indian exports [6].

• Loss of confidence:

• Credit rating agencies downgraded India's credit rating [7].
• New commercial credit "completely dried up" [6].
• Creditors refused to roll over short-term loans [6][7].

• NRI deposits (bank deposits held by Non-Resident Indians) turned from inflows into net outflows [7].

• Political instability:

• The V.P. Singh government fell in November 1990.
• The Chandra Shekhar government resigned in March 1991.
• Only a vote-on-account was passed in early 1991, with no full budget.
• Rajiv Gandhi was assassinated on 21 May 1991.
• With no stable government, foreign lenders held back.

Emergency steps to stop the crisis

• Import compression: imports were cut sharply, and part of the gold stock was used [6].
• Gold sale with an option to buy back: in April 1991, the government raised US$200 million from Union Bank of Switzerland (UBS) [2]. NCERT describes this as about 20 tonnes sold through SBI in May 1991. Both describe the same deal.
• Gold pledge: the RBI pledged 46.91 tonnes of gold with the Bank of England and the Bank of Japan for a loan of US$405 million. It repaid the loan between September and November 1991 [2].
• Devaluation: the rupee was devalued in two steps on 1 and 3 July 1991, by about 18% against the US dollar in total [8].

• Rupee cheaper → Indian exports cheaper abroad → exports rise, imports fall → CAD narrows.

• IMF stand-by arrangement: on 31 October 1991, the IMF approved SDR 1,656 million (about US$2.2 bn), to be drawn over 20 months [2].

• A stand-by arrangement is an IMF loan, given on conditions, for short-term BoP problems.

In India

• RBI: holds the forex reserves, pledged the gold, and devalued the rupee in July 1991 [2][8].
• Ministry of Finance: in the Budget 1991-92 speech (24 July 1991), Finance Minister Manmohan Singh said the BoP had "lurched from one liquidity crisis to another since December 1990" [3]. This speech marked the start of the LPG reforms.
• IMF: gave the stand-by loan of SDR 1,656 million (October 1991) [2].
• After stabilisation: inflation fell from its 17% peak (August 1991) to below 7% by 1993-94 [5].
• Background (NCERT Class 11): partial reforms in the 1980s covered industrial licensing, EXIM policy, technology upgradation, fiscal policy and foreign investment. The 1991 reforms were the first big, system-wide reform.

Don't confuse with

• Banking crisis: in a banking crisis, banks fail at home. 1991 was a BoP crisis, a shortage of foreign currency to pay for imports and foreign debt.
• Fiscal deficit vs current account deficit: the fiscal deficit is the government's borrowing gap (8.4% of GDP) [4]. The CAD is the whole country's gap with the rest of the world (about 3% of GDP). In 1990-91 India had both, the "twin deficits".
• Devaluation vs depreciation: in devaluation, the government or central bank officially lowers the currency's value, as in July 1991 [8]. In depreciation, the currency loses value through market demand and supply.
• Gold pledge vs gold sale: the pledge (46.91 tonnes, Bank of England and Bank of Japan, US$405 mn) was security for a loan. The sale with repurchase option (US$200 mn, UBS, April 1991) was a separate deal [2].

Prelims Hooks

• 1991 was a balance-of-payments crisis, not a banking crisis or a growth crisis. Reserves covered only a fortnight of imports (July 1991) [3].
• Gold pledged: 46.91 tonnes with the Bank of England and Bank of Japan, for a loan of US$405 mn [2]. Trap: the gold was not pledged with the IMF or the US Federal Reserve.
• Devaluation: two steps on 1 and 3 July 1991, about 18% against the US$ in total [8].
• IMF stand-by arrangement: SDR 1,656 mn (about US$2.2 bn), approved 31 October 1991 [2].
• GFD = Total expenditure − (Revenue receipts + Non-debt capital receipts). It was 8.4% of GDP in 1990-91 [4].
• Statement traps: the crisis came after fast growth (about 5.6% a year, 1980-91), not stagnation. Reform began in the 1980s, not in 1991. NRI deposits turned into net outflows, and India's credit rating was downgraded [7].

Mains Points

• How growth is paid for matters: the 5.6% growth of the 1980s rested on fiscal deficits, short-term foreign debt and foreign loans spent on consumption. Growth paid for this way cannot last. The same lesson applies to today's debates on fiscal deficits and short-term external debt.
• Twin deficits plus a loss of confidence: large fiscal and current account deficits left India weak. Then the Gulf War, political instability, a rating downgrade and NRI outflows turned slow stress into a sudden crisis [7]. This is why buffers matter: enough forex reserves, fiscal deficit rules, and less short-term debt.
• A crisis can drive reform: the 1980s saw only partial liberalisation. The 1991 crisis, with the gold pledge and the IMF loan, created the political will for full LPG reforms. You can use this in GS-III answers on how crises push structural reform.

Read more

• Background: the 1980s build-up and the 1991 crisis