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The 1991 crisis playbook
What India needs is a combination of a cheaper currency, lower inflation and healthier public finances
The economic situation right now may not be as dire as it was in 1991, but there are some broad lessons that can be learnt from the sophisticated policy response in that memorable year. One useful way to understand the response to the 1991 crisis is by looking at three broad themes.
Liquidity support: The most immediate manifestation of any balance of payments problem is that a country does not have enough dollars to pay its international bills, be they for imports or debt repayments. By early 1991, overseas Indians had already begun to pull their money out of Indian banks at a time when the trade deficit had widened because of the sudden jump in international oil prices following the first Gulf War. The Reserve Bank of India had enough dollars to pay for just three weeks of imports by the middle of the year. India was a whisker away from an international default. It eventually had to mortgage gold and seek a loan from the International Monetary Fund to help it tide over its immediate payment problems.
What is the situation now? Economists at JPMorgan estimate that India will need $85 billion to cover its current account gap in the current fiscal. Around $60 billion will come from stable sources such as foreign direct investment, trade credits and non-resident Indian deposits. Another $25 billion will be needed from more volatile sources such as portfolio flows and external commercial borrowings. These could be at risk in case global investors pull money back out of emerging markets.
But finance minister P. Chidambaram told Parliament this month that he will try to keep the current account gap down at $70 billion, presumably through select import controls and lower oil imports. The funding gap would then shrink to $10 billion, but only if the planned import compression works. In a worst-case scenario, the larger funding gap as well as a sudden stop in capital inflows, the government will have to raise $25 billion through options such as a sovereign bond, swaps lines with foreign central banks or even a loan from the International Monetary Fund. It can also use the $280 billion of reserves with the Indian central bank. A search for liquidity support should eventually stabilize investor expectations but the initial reaction could be panic, as traders see such help as a sign that the economy is in a deeper mess than assumed.
Structural adjustment: While the drying up of liquidity is the main symptom of a balance of payments problem, the underlying problem is often an overvalued exchange rate that makes exports uncompetitive. That was the challenge in 1991, despite the creeping devaluation of the previous decade. Indian exports were not competitive, so the country was unable to earn enough dollars to pay for its imports.
The obvious response is currency devaluation. That is what was done in July 1991. India then had a fixed exchange rate. Now it has a more flexible exchange rate policy, so it should eventually allow the rupee to slide against the currencies of its trading partners. But what is important here is not the nominal exchange rate but the real exchange rate, which is adjusted for inflation. The other policy goal should be to keep inflation as close to global averages as possible.
The devaluation of 1991 was just one leg of the economic adjustment. The other was in compressing domestic demand through a tighter fiscal policy, especially since there is often an umbilical link between a high fiscal deficit and a high current account deficit. The lessons are valid even today. What India needs is a combination of a cheaper currency, lower inflation and healthier public finances, though the first two could be in conflict in the short term.
Economic reforms: The currency adjustment is an immediate response to the lack of export competitiveness, but what followed in 1991 was a wave of broader economic reforms that essentially consigned four decades of economic policies to the dustbin. Those first-generation reforms are a done deal, but India has not made adequate progress in pushing ahead with important, but politically contentious, second-generation reforms that will lift productivity. The list of pending reforms is too well known to be repeated here. The other big obstacle is the poor state of Indian infrastructure, which in effect raises the cost of doing business in India. Indian manufacturing is thus hobbled.
India may not be stumbling into a full-blown economic crisis this year, but there is little doubt that the gradual withdrawal of global liquidity has brought several cracks to public attention. What was done in 1991—liquidity, adjustment and reforms—is still relevant in the current situation, when India faces its toughest economic test in two decades.
The context may be different but the underlying lessons still have value. The men in New Delhi should not need any convincing, since some of them played stellar roles in 1991 as well—Manmohan Singh, P. Chidambaram, Montek Singh Ahluwalia and C. Rangarajan.
Niranjan Rajadhyaksha is executive editor of Mint. Your comments are welcome at cafeeconomics@livemint.com. To read Niranjan Rajadhyaksha’s previous columns, go to www.livemint.com/cafeeconomics
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Business NewsOpinionThe 1991 crisis playbook
First Published:20 Aug 2013, 04:29 PM IST
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