Assignment Topic: Critically evaluate the economic factors and political

compulsions which led India to introduce economic reforms in the 1990s.

“History fosters understanding by tracing origins. During the 1980s, the competitive
politics of populism, reinforced by the cynical politics of soft options, led governments
into a spending spree.”1 Government finances became increasingly unsustainable
eventually boiling into an acute economic crisis. Triggered by an increase in world
crude oil prices, following Iraq’s invasion of Kuwait in August 1990, the balance of
payments situation became almost unmanageable. In addition to this, there was
perceptible fear of the rate of inflation accelerating beyond control.

After following a strategy of self-reliance for more than forty years, India initiated
wide-ranging economic reforms in 1991. These comprehensive reforms covered
macroeconomic stabilization programmes to address fiscal and current-account
deficits and exchange rate regime. “These reforms also sought to evolve an
industrial and trade policy framework to promote efficiency, reduce the bias in favour
of excessive capital intensity and encourage an employment-oriented
industrialization. Reforms in industrial policies provided the direction for reforms in
other areas such as trade and finance. Industrial reforms sought primarily to remove-
licensing requirements, which posed significant barriers to entry, and prevented the
manufacturing sector from taking advantage of economies of scale. It also sought
substantially to deregulate industry to promote the growth of a more efficient and
competitive industrial economy.”2

ECONOMIC FACTORS - 

The first half of the 1980s saw a large increase in the central government
deficit, which can be attributed to high expenditure levels (primarily on
agricultural subsidies, defence and interest payments). In external accounts,
higher imports dominated over acceleration in exports which had stagnated
because of a decrease in demand in key markets in the industrial nations and
the Middle East, as well as disruptions in trade with the USSR. 

1. Fiscal deficit and subsequent Balance of Payments crisis -

In the early 1980s, the second oil shock, agricultural subsidies and
consumption-driven growth had pushed up the fiscal deficit which was only
enlarged in the mid-1980s by increase in the defence expenditure and
progressive decrease in direct taxes.

This deficit turned out to be the primary cause for ricocheting rates of
monetary growth, giving rise to inflationary tendencies. The Government’s
decision to borrow from the commercial banking system as well as directly
from the households meant that a greater proportion of household savings

1
https://www.livemint.com/Opinion/l46jd4x7sEnYgxizMcnq3M/1991-economic-liberalization-and-political-
process.html

2
Banga, Rashmi. (2012). Twenty Years of India's Liberalisation: Experiences and Lessons.
 were directed towards government expenditure, leaving a lower proportion for
direct use in productive sectors, such as industry and agriculture. 

This high deficit spilled over into the BoP gap resulting in a steady drop of
foreign exchange reserves. “A steady deterioration in the services account
resulted in widening of the current account deficit (CAD) and, with the aid
inflows not increasing commensurately, the increasing reliance on commercial
sources for financing resulted in the debt-service ratio rising. Imbalances
between aggregate demand and supply ultimately spilled over onto the BoP
and the gap had to be met by either running down the reserves or increasing
debt”3

These developments were contributing to a rise in inflation and exerting

pressure on the balance of payments (BoP). Thus, India was confronted with
large internal and external fiscal imbalances which made it vulnerable to
adverse external shocks in the 1990s.
 

2. Break-up of the Soviet bloc -

Rupee trade with the Soviet bloc constituted a chunk of India’s trade in the
1980s. The trade with these countries was carried out under the rupee
payment agreement (RPA), which provided a framework for the size of
turnover and commodity composition with each country (Romania,
Czechoslovakia and USSR). 4

With the introduction of Glasnost and the breaking away of the Eastern
European countries, several rupee payment arrangements (German
Democratic Republic and Poland) were terminated. The flow of new rupee
trade credits declined abruptly. This also indicated a consequent increase in
the net repayment on the rupee debt account.

3. The Gulf War -

The gulf crisis had a serious impact on the import of petroleum, oil and
lubricants by India. It had to identify alternative sources for imports of these
products that were previously fulfilled by Iraq and Kuwait. Contracts for crude
oil and products were market-related which indicated sharp escalation in
India’s import bill. The level and volatility of oil prices increased sharply after
the invasion of Kuwait by Iraq. The gulf crisis clearly impacted the balance of
trade situation seen in the foreign currency assets (FCA) held by the Reserve
Bank facing a steep decline. 

It also had a significant adverse impact on the flow of remittances into India,
adversely affecting the capital account. This fall in capital inflows compounded
the problem of financing the rising level of CAD.
3
The Reserve bank of India: 1981–1997, Chapter 11 - The BoP crisis,
https://rbidocs.rbi.org.in/rdocs/content/PDFs/Chapter11_04122018.pdf
4
Kolte, Ashutosh & Simonetti, Biagio. (2018). A Contrary View on Indian Economic Crisis of 1991. SSRN
Electronic Journal.
 4. Role of the IMF and World Bank -

In India, the IMF-World Bank programme was set in motion with the fall of the
Janata Dal government of V P Singh in 1990 and the assassination of Rajiv
Gandhi. This agreement implemented shortly thereafter was to provide at best
a short breathing space.

“The IMF's 'economic surgery' requires the Indian government to cut spending
in social programmes and infrastructure, eliminate state subsidies and price
support programmes (including food subsidies) and sell off the more profitable
public enterprises at 'a good price' to the large business houses and foreign
capital.”5

The IMF loan agreement together with the World Bank Structural Adjustment
Loan (SAL) signed in December 1991 (of which the contents and conditions
were a closely guarded state secret) were intend- ed to help India alleviate its
balance of payments difficulties, reduce the fiscal deficit and relieve
inflationary pressures

POLITICAL REFORMS:

In a rather paradoxical outcome, despite lacking a clear majority in parliament, the

Rao government was able to push many reforms on which Rajiv Gandhi's
government, even with a three-fourths majority, had to ultimately reverse in 1986. To
decode this result, we must delve into the political roots of this issue.

1. Rajiv Gandhi’s tenure -

Rajiv Gandhi was elected to power, post the assassination of Indira Gandhi.
Virtually no opposition except the beginnings to factionalism within the
congress party which effectively played the role of the opposition. He started
to introduce subsidy cuts on petrol, food, fertilisers and petroleum based
products which gave the opposition a chance to argue the government was
being insensitive to the poor. The first nationwide protest developed since the
new government took over. This notion of the government being pro-rich
began to gain momentum in the press and eventually in the political process.
This backlash forced the government to re-evaluate it’s position and post
1987, the proposed budgets began to reverse the changes implemented

5
Chossudovsky, M. (1993). India under IMF Rule. Economic and Political
Weekly, 28(10), 385-387. Retrieved December 3, 2020, from
http://www.jstor.org/stable/4399453
 previously and started increasing the allocation for poverty alleviation and
advocated restoration of subsidies.

Rajiv Gandhi, at the end of his tenure said that changes had to take place
gradually but remained firmly convinced that the direction he had chosen was
right. 

2. Narsimha Rao’s tenure -

Prime Minister Narsimha Rao was weaker in parliament because his

government did not have majority support. It built on the schemes introduced
by Rajiv Gandhi like lowering already reduced personal and corporate income
taxes, de-licensing industries. Reforms included relaxing rules for FDI and in
"key" sectors, such as power, 100 percent foreign ownership was permitted.

The Rao government also had to sign a stabilization agreement with the IMF,
which is often politically controversial in the developing world due to it being
akin to mortgaging a nation’s economic sovereignty.

Although the external crisis paved the path for liberalisation, the depth of the
crisis cannot sustain reforms. The way the crisis was perceived and resolved
in India's political institutions is of particular importance. “A restructured
economic policy is reflected in national budgets, and economic reforms must
necessarily pass parliamentary scrutiny in India.”6

Opposition disapproval was 2 pronged - 

 Aimed at the loss of economic sovereignty, alleging that the budget

had supposedly been passed by the IMF before being presented to the
parliament. 
 Concerned about the pro-rich and pro-urban orientation of the new
policies. They were apprehensive that the reforms would lead to labor
retrenchment from the public sector undertakings, leaving lakhs of
workers unemployed.
           
            Despite vigorous criticism, the budget was passed.

3. Identity Politics and communal tensions in the political landscape

The Rao government had initiated reforms at a time when Hindu nationalism
was rising as a political force. Hindu nationalist BJP was the second largest
party in the country. In 1990, it had led the movement for the demolition of the
Baburi mosque, touching off ghastly Hindu-Muslim riots, polarizing the
electorate and national politics, and causing a great deal of anxiety about
violence and order in the country.

6
Ashutosh Varshney (1998) Mass politics or elite politics? india's economic
reforms in comparative perspective, The Journal of Policy Reform.
 The subsequent budgets would have been blocked and reforms brought to a
standstill if the remaining opposition parties had coordinated their moves and
jointly voted against the government. 

Instead, coalitions were increasingly formed against the Hindu nationalists,

not against the Congress. The left - the Communists and the lower caste
Janata Dal and its allies - disliked the reforms, but they disliked Hindu
nationalism even more. Hindu nationalism posed the greatest threat to the
lower-caste Janata. The former wanted to organize the lower Hindu castes
against the upper Hindu castes, whereas Hindu nationalists were trying to
build a united Hindu community against the Muslims, seeking to override and
displace caste as an issue in political mobilization. The triumph of one implied
the eclipse of the other. The Congress party was no longer the principal
enemy of the Janata party.

The Janta, prioritised identity politics over economic reform. The BJP pulled in
remarkable electoral dividends over building a temple in Ayodhya, hence,
gave religious issues more importance. Although the Janata and BJP bitterly
criticized several aspects of the reforms in the early 1990s, neither was
prepared to go to the extent of issuing a strict directive to its party men in the
House to vote against the budget. A coordinated voting between the BJP and
Janata and its allies was necessary to defeat the budget, but that did not
happen. The demolition of the Babri Masjid in late 1992 convinced the Janata
party to vote in favour of the budget while the BJP voted against the budget,
because it thought right-wing nationalism had to be contained.

“India's economic reforms kept progressing because the political context had
made Hindu-Muslim relations and caste animosities the prime determinant of
political coalitions.”7

The reforms were only successful because other issues were considered
more pressing to their national agendas by other parties, something that did
not occur in Rajiv Gandhi’s tenure allowing economic policies to become the
focal area.The deviation of limelight from the economic policies to other
matters was pivotal in the liberalisation reforms of the 1990s. 

CONCLUSION:

Post-independence India was one of the classic cases of dirigiste – i.e., state-
directed – economic development. Not only was the state highly interventionist, but
the economy came to acquire a sizable public sector, especially in areas of
infrastructure and basic industries. The “mixed” economy that thus came into being,
together with the fact that the polity was characterized by multiparty parliamentary
democracy with a largely free press and significant freedom of expression, invested
the Indian experiment with a novelty and uniqueness, which attracted worldwide
attention and gave rise to a vast theoretical literature.

7
Ashutosh Varshney (1998) Mass politics or elite politics? india's economic
reforms in comparative perspective, The Journal of Policy Reform,
“Overall, India's experience of Liberalization has been gradual, voluntary and tailored
according to the needs of the economy. The role of the state has been to use
markets to not only maximise commercial objectives but also seek to galvanise at
tempts to attain social objectives.”8 The cautious approach towards Liberalization
has provided the state with enough policy space to pursue development-led
Liberalization.

             

8
Banga, Rashmi. (2012). Twenty Years of India's Liberalisation: Experiences and Lessons.