Date: 19 September 2013

Economic Reforms of 1991 in India: Reasons, Timing and effects.

The current write up is a try to answer the question : Why economic reforms had to be
implemented in the year 1991 ? Why the need arised after 40 yrs of independence and not
immediately after the independence or 10 yrs after the independence? The main reason for this is
the huge dependency on imported products, in particular oil.
From 1947 to 1985, Indias oil demand was very low because of low industrialization. Also the
government policies didnt helped to improve it. The numbers of oil dependent products like
cars, bikes, automobiles, trucks, etc. were very less. Also because companies related to these
products were also very less and due to inferior technology the prices of these products were
very high and beyond the reach of common man. So except rich people, no one purchased these
products. So India had always sufficient foreign currency with it to pay for imported oil. India
earned its foreign currency from export of goods like coal, iron ore, agricultural products, etc. So
during this period from 1947 to 1990, the crisis of balance of payments never arised.
From 1980s onwards slowly the technology in mass production of cars and bikes increased.
Number of companies manufacturing these equipments like Bajaj, etc increased. Indian
government itself started its own company Maruti Suzuki in collaboration with Japanese
company Suzuki with the intention of serving the objective: A car affordable to common man.
For this it launched its first and most popular model Maruti 800. The government itself sowed
the seeds of economic crisis of 1991. During the period between independence and 1991 the
class of export products more or less remained same coal, iron ore, etc. These are primary
articles and less valuable as compared to electronic gadgets,etc. India never enhanced the class of
export items. So the number of cars, bikes, trucks, started increasing from 1985 onwards. Slowly
Indias demand for oil started rising. The policymakers were never able to anticipate that, due to
increase in oil demand we will face a economic crisis in near future, so we should take steps now
in order to avert the crisis. Also political environment was also unstable during this period due to
events like Indira Gandhi death and then unstable government in 1989 and 1990.
So initial problem of balance of payments that was small in nature and unnoticeable in 1985
onwards started converting into a big crisis year on year. And in 1991 it resulted into a complete
collapse of our balance of payments situation. A condition so grave arised that we didnt had a
single penny of foreign currency remaining to buy oil. To understand why this situation arised
lets understand Indias economy prior to 1991. From 1947 to 1991 Indias politics and so its
government was very much of socialist mindset. Because of recent independence from British
empire. And so it feared for any foreign interference in domestic economy. It was very much a
closed economy. The government adopted this policy because it wanted to protect Indian
companies from competition of foreign companies. So very less foreign companies were allowed
to do business or start factory in India. This too was also not easy. There were tremendous

government restrictions and barriers. So India had very few sources of foreign currency. This
created a crisis situation in 1991.
To overcome this situation , then finance minister Manmohan Singh had no option but turn
towards IMF and world bank for help and demand for loan. Also he had to keep quite a big
amount of gold from RBIs custody as a security with IMF. IMF was ready to give loan to India
but like any banker, was skeptical and non confident that India can repay the loan easily. IMF
didnt had confidence because India had not many sources of foreign currency to repay the debt.
Also the growth of Indian economy was not so convincing such that tax collection by
government would have increased in order to repay the debt. So IMF put conditions and
restrictions before Indias finance minister. The main conditions were : to allow foreign
companies to invest in India, reduce trade restrictions and barriers, reduce subsidies, adopting
flexible currency system, etc. These measures would ensure IMF that India will be able to repay
the debt. Now considering the grave situation and to meet its oil demand, our then finance
minister had no other option but to accept the rules and restrictions of IMF. Also our finance
minister was not confident of current tax collection rate and that it will increase at the optimum
desirable rate, such that future debt repayment installments will not affect growth of our
economy adversely. So to ensure steady growth of our economy our finance minister accepted
the rules and restrictions of IMF. So it resulted in so called Economic Reforms and
Manmohan Singh was glamorized in India as a successful and efficient finance minister. He was
revered as savior of Indian economy from grave crisis. His image was created as that of a
messiah.
In this way from 1991 Indias economy became a so called free market economy and slowly it
started shifting towards being more a capitalist economy than socialist economy. Initially only
few sectors were restricted to foreigners, but slowly more sectors were allowed for foreign
investment. In this way crisis situation was averted. By taking lesson from this situation, which
we faced because of our own mismanagement and lack of foresight, we (India) now keeps that
much foreign currency in RBIs custody, which will be enough to pay import bills of upto 6
months. And RBI now keeps constant watch on these foreign currency reserves and also on the
exchange rate of rupee, such that its extreme volatility does not affect the quantity of reserves.
Though exchange rate of rupee is dependent completely on market conditions, but in extreme
and rare conditions, like current situation when current exchange rate has surpassed 60 Rs. mark
for one dollar, RBI intervenes to stabilize the fall of rupee. This intervention is necessary
because our external debt is in dollars and if RBI doesnt intervene and exchange rate reaches to
very low level, then we will need more rupees to convert them into required dollars to pay the
required installment of debt repayment. This will increase already existing huge fiscal deficit and
thus less money will be left with government for development. Or else government will have to
increase the tax burden or reduce its expenditure, either way affecting growth of our economy
negatively.

Of the many options available the two main options to avoid the crisis similar to 1991 are : either
to reduce our imports by decreasing our dependency on foreign oil if possible or improve the
class of our export products from agricultural based to manufactured products.

By, Sujeet Suresh Patil,