The economy weakened throughout 1989 and 1990 as a result of the Federal Reserve’s tight monetary policies. The Fed’s stated policy at the time was to lower inflation, a practice that stifled economic growth. Another factor that may have contributed to the economy’s weakening was the passage of the Tax Reform Act of 1986, which put a stop to the early to mid-1980s real estate boom, resulting in falling property values, reduced investment incentives, and job losses. In the first quarter of 1990, measurable changes in GDP growth began to show, but overall growth remained positive. The recession was triggered by a loss of consumer and corporate confidence as a result of the 1990 oil price shock, which was compounded by an already weak economy.
In 1990, what happened to the economy?
Strong economic growth, consistent job creation, low inflation, rising productivity, economic boom, and a soaring stock market characterized the 1990s, which were the consequence of a combination of rapid technical developments and good central monetary policy.
The wealth of the 1990s did not spread equally across the decade. From July 1990 to March 1991, the economy was in recession, following the S&L Crisis in 1989, a jump in petroleum costs as a result of the Gulf War, and the regular run of the business cycle since 1983. In early 1990, after a spike in inflation in 1988 and 1989, the Federal Reserve raised the discount rate to 8%, restricting credit to the already-weakening economy. Through late 1992, GDP growth and job creation remained sluggish. Unemployment increased from 5.4 percent in January 1990 to 6.8% in March 1991, and then continued to rise until reaching 7.8% in June 1992. During the recession, over 1.621 million jobs were lost. The Federal Reserve reduced interest rates to a then-record low of 3.00 percent to boost growth as inflation fell dramatically.
The economy underwent a “jobless recovery” for the first time since the Great Depression, in which GDP growth and corporate earnings returned to normal levels while job creation lagged, demonstrating the importance of the financial and service sectors in the national economy, which had surpassed the manufacturing sector in the 1980s.
Which of the following factors contributed to the 1990-1991 economic crisis?
Currency overvaluation triggered the crisis; the current account deficit, as well as investor confidence, had a key part in the severe exchange rate depreciation.
The 1980s saw enormous and worsening budgetary imbalances, which contributed to the economic disaster. In the mid-1980s, India began to experience balance-of-payments issues. As a result of the Gulf War, India’s oil import bill increased, exports decreased, credit dried up, and investors withdrew their funds. Large fiscal deficits eventually exacerbated the trade deficit, resulting in an external payments crisis. India was in serious economic distress by the end of the 1980s.
The government’s gross budget deficit (central and states) increased from 9.0 percent of GDP in 1980-81 to 10.4 percent in 1985-86 and 12.7 percent in 1990-91. The gross fiscal deficit in the center alone increased from 6.1 percent of GDP in 1980-81 to 8.3 percent in 1985-86 and 8.4 percent in 1990-91. Because these deficits had to be covered by borrowings, the government’s internal debt grew quickly, rising from 35% of GDP at the end of 1980-81 to 53% of GDP at the end of 1990-91. India’s foreign exchange reserves have depleted to the point where it could only fund three weeks’ worth of imports.
The exchange rate of India was severely manipulated in mid-1991. The fall in the value of the Indian rupee in the years running up to mid-1991 was the catalyst for this occurrence. The Reserve Bank of India took limited action, safeguarding the currency by increasing overseas reserves and slowing its depreciation. However, in mid-1991, with foreign reserves on the verge of depletion, the Indian government allowed a rapid depreciation of the rupee against major currencies, which took place in two stages over three days (1 and 3 July 1991).
What economic problem arose in 1990?
President George H.W. Bush inherited the Reagan years’ economic boom, which had revitalized the country. By July 1990, however, the economy had entered a slump. As the economy shrank and unemployment rose, the federal budget deficit grew (despite President Bush’s tax rises) (by 1.8 million workers). Although the recession ended in March 1991, the economy was still in a state of flux “Jobless Recovery,” in which unemployment remained stable. The public perception of President Bush as a tyrant exacerbated the problem “I wasn’t doing my job well enough.”
What is the significance of 1991?
The economic reforms that took place in 1991 will be recognized as a watershed point in the Indian economy. It helped to establish India as a worldwide player and a thriving market, which it is still today. The project was spearheaded by the then-Prime Minister, P. V. Narasimha Rao, who had great vision throughout his tenure as Prime Minister. Author Sanjaya Baru explains how PV’s impact on the nation’s fortunes went much beyond the economic, based on his long personal and professional relationship with the former prime minister. He presents an insider’s perspective of the politics, economics, and geopolitics that converged to make 1991 a turning point for India in his book ‘1991: How PV Narasimha Rao Made History.’
Sanjaya Baru will speak about his experience working with an ambitious leader and how PV Narasimha Rao staged a watershed event in Indian economic history.
Sanjaya Baru is an Honorary Senior Fellow at the Centre for Policy Research in New Delhi and a Consulting Fellow for India at the International Institute for Strategic Studies in London. He served as Prime Minister Manmohan Singh’s media adviser (2004-08). He has served as editor of the Financial Express, Business Standard, Economic Times, and Times of India, among other publications. The Accidental Prime Minister: The Making of a Prime Minister is his best-selling book.
Rama Bijapurkar is the founder of a market strategy consulting firm. CRISIL, Mahindra & Mahindra Financial Services Limited, ICICI Prudential Life Insurance Company Limited, Janalakshmi Financial Services Limited, and Redington Gulf FZE all have her on their boards as an independent director. She also serves as the chair of People Research on India’s Consumer Economy. She has a number of papers relevant to the emerging market and consumer issues.
What was the government’s immediate response to the 1991 BoP crisis?
It’s a long story, but it’s worth reading if you’re interested in India’s economic history. The Balance of Payments Catastrophe of 1991 was India’s greatest financial crisis. I’ve attempted to summarize the basic concept of balance of payment and how it leads to crises in this article. The second part of the book will go through the intricacies of India’s fiscal crisis, which contributed to the country’s economic failure, as well as the actions taken by the government to correct it. India embarked on an economic revolution that resulted in considerable economic changes. The following is a compilation of my key insights from numerous periodicals and books to which I consulted (Bibliography mentioned at the end).
India’s global transformation began with the 1991 economic reform. The transition to a new India, as well as a shift in the government’s attitude toward the role of private entities and markets in the economy. The early moves towards economic changes were the Balance of Payments crisis, followed by the pledge of gold reserves, IMF loans, and other structural adjustment programs (supported by the IMF and the World Bank). The BOP crisis was the product of India’s decades of reckless economic policy. The economy’s institutional arrangements were competent prior to 1991, but they eventually deteriorated the country’s budgetary predicament. Fiscal policy has played a key influence in India’s history. In 1991, India’s balance of payments imbalance became unsustainable. For a long period, the country was mired in massive deficits, and as a result, it faced a balance-of-payments problem.
Though the crisis was a watershed moment, it also provided an opportunity to make some major reforms in the country’s economic policies.
The government used a variety of fiscal, monetary, trade, financial, and industrial policies to tackle the crisis. Since mid-1991, the Indian economy has deviated from previous post-independence plans. Listening to the post-crisis changes, the phrases “liberalisation,” “privatisation,” and “globalisation” come to mind. Through new economic policy, India’s economy has paved the way for a new era (NEP). It is vital to understand the economic pressures that led to the crisis that prompted these reforms.
When the government spends more than it receives, it creates a deficit. When it receives more money than it spends, it is said to be in surplus. When in a deficit, it has three alternatives for covering the additional expense. Printing money, withdrawing funds from foreign currency reserves, or borrowing funds from domestic or international sources are all options. However, it is not as simple as it appears. While using these metrics, it has an impact on other economic variables. Inflation can be caused by excessive money printing. If the government borrows heavily from foreign sources, it may face a debt crisis. Excessive borrowing from domestic sources might raise interest rates and exacerbate the “crowding out” issue.
A balance of payments crisis could occur if the government depletes its foreign exchange reserves. In all circumstances, a government that runs a high deficit over a long period of time (which is not smart for a government) will face a crisis. In 1991, India experienced the greatest BOP crisis since 1947.
The third point we’ll discuss is India’s budgetary predicament, which contributed to the crisis.
The Planning Commission was established in 1950, and India has been on a path of planned growth since then. The public sector was emphasized heavily during the planning process as a means of achieving economic growth and development. The introduction of the quota-license-inspector raj established administrative restrictions over industries.
Because of the license raj system, India has had a continual trade deficit since 1950. Private savings were a way for the public sector to fund its investment and consumption. Another goal at the time was to eliminate disparities and poverty by redistributing income and wealth through taxes and transfers. There were 11 different income tax brackets to choose from. During the 1970s, the government increased income tax rates to astronomical levels. During the 1970s, the marginal rate of taxation, together with the wealth tax, reached 100%. The personal income tax rate was reduced to 77 percent in 197475, but the wealth tax rate was raised. By 198990, the central revenue shortfall had risen to 2.44 percent of GDP, up from 1.4 percent in 198081. The gross fiscal deficit of the central government increased from 5.71 percent to 7.31 percent of GDP. Even with the reduction in foreign liabilities, the total liabilities remained enormous.
During 197071, defense accounted for around 34% of total spending, interest payments accounted for 19%, and subsidies accounted for 3%. Furthermore, during 199091, interest payments accounted for 29% of total expenditures, with subsidies accounting for 17% and defense accounting for 15%. At the time, the public debt and subsidy burdens were both fairly heavy.
Between 1980 and 1990, there was a self-perpetuating cycle of deficit-induced inflation and deficit-induced deficit. The deficit causes an increase in the money supply, which in turn boosts prices. The increase in price causes the government’s expenditure to outpace its receipts, resulting in an increase in the deficit. Because of the quota licensing inspector raj, India has had a continual trade imbalance since 1950. The BOP crisis of 1991 resulted from budgetary imbalances affecting the foreign sector.
This was India’s greatest BOP crisis since independence. During the 1980s, the inflow of foreign borrowings grew at a rapid pace. The budget deficit of the federal and state governments reached 11% in 1991 as a result of excessive domestic spending on earnings. The total governmental debt as a percentage of GDP more than doubled, and foreign currency reserves rapidly depleted. India had double-digit inflation in 199091.
The situation has been made worse by the spike in oil prices as a result of Iraq’s invasion of Kuwait (First Gulf war). India’s credit ratings have been downgraded for the first time in its history. As a result, access to external commercial loan markets was prohibited.
Taking a condition-free loan from the IMF and borrowing money from US and Swiss banks against gold holdings were among the first steps taken to combat the crisis. The long-overdue economic changes are one positive outcome of this crisis. To address the balance of payment crisis, the government implemented a number of key policy initiatives. During 199091, the budget deficit was roughly 8.4% of GDP. The budget for 199192, which called for a 2% reduction in the fiscal deficit, only somewhat rectified the fiscal imbalances.
Fertilizer subsidies were cut in tandem with the elimination of the sugar subsidy. Excessive subsidy provision exacerbates the fiscal deficit, which was brought under control by lowering these subsidies. The quota and licensing system was abolished. Private markets, foreign investment, and trade were all made possible. To balance the budget, the government prepared the way for economic liberalization.
Various tax reforms have been implemented in order to make the tax system more stable and transparent. The lowering of tax brackets to three, with rates of 20%, 30%, and 40%, is one of them. Monetary reform played a crucial influence in balancing the budget deficit. Some monetary measures included lowering the statutory liquidity ratio (SLR) and the cash reserve ratio (CRR), as well as establishing criteria for the establishment of new private sector banks. These reforms were implemented with the goal of increasing competition among public, commercial, and international banks.
The administration opted to withdraw direct government control over capital markets and replace it with a transparent regulatory structure. Significant changes were made to industry and trade policies. By limiting the areas reserved for public sectors, the MRTP was repealed and private sector engagement in the industrial sector was allowed.
The devaluation of the rupee was one of the government’s initiatives to address the balance of payments crisis. Depreciation of a currency causes an increase in export and, as a result, an increase in foreign currency inflow. The rupee was initially devalued by around 20%. Because of excessive inflation, there was a need to close the gap between the real and nominal exchange rates. This depreciation fixed the altered exchange rate.
The year 1991 is seen as a watershed moment in Indian history. The country was in the midst of its worst economic crisis in decades, and it took advantage of the situation to make fundamental reforms to its economic policy. Since then, India’s economy has undergone tremendous transformations, and a new perspective known as New India has emerged.
What was the BoP crisis of 1991?
India’s Balance of Payments Crisis (1991). Due to a large macroeconomic imbalance, India experienced a Balance of Payments crisis in 1991. The currency crisis is also known as the balance of payment (BoP) problem. It happens when a country can’t afford to pay for basic imports or service its external debt.
What were the three possible causes and impacts of the 1990 recession?
Consumers’ pessimism, the debt accumulations of the 1980s, the surge in oil prices when Iraq invaded Kuwait, a credit crisis produced by overzealous banking regulators, and Federal Reserve attempts to control the pace of inflation have all been blamed for the recession.
What caused the recession of the 1980s?
The 1981-82 recession was the greatest economic slump in the United States since the Great Depression, prior to the 2007-09 recession. Indeed, the over 11% unemployment rate attained in late 1982 remains the postwar era’s pinnacle (Federal Reserve Bank of St. Louis). During the 1981-82 recession, unemployment was widespread, but manufacturing, construction, and the auto industries were especially hard hit. Despite the fact that goods manufacturers accounted for only 30% of overall employment at the time, they lost 90% of their jobs in 1982. Manufacturing accounted for three-quarters of all job losses in the goods-producing sector, with unemployment rates of 22% and 24%, respectively, in the home building and auto manufacturing industries (Urquhart and Hewson 1983, 4-7).
The economy was already in poor health prior to the slump, with unemployment hovering at 7.5 percent following a recession in 1980. Tight monetary policy in an attempt to combat rising inflation sparked both the 1980 and 1981-82 recessions. During the 1960s and 1970s, economists and politicians thought that raising inflation would reduce unemployment, a tradeoff known as the Phillips Curve. In the 1970s, the Fed used a “stop-go” monetary strategy, in which it alternated between combating high unemployment and high inflation. The Fed cut interest rates during the “go” periods in order to loosen the money supply and reduce unemployment. When inflation rose during the “stop” periods, the Fed raised interest rates to lessen inflationary pressure. However, as inflation and unemployment rose concurrently in the mid-1970s, the Phillips Curve tradeoff proved unstable in the long run. While unemployment was on the decline towards the end of the decade, inflation remained high, hitting 11% in June 1979. (Federal Reserve Bank of St. Louis).
Because of his anti-inflation ideas, Paul Volcker was chosen chairman of the Federal Reserve in August 1979. He had previously served as president of the New York Fed, where he had expressed his displeasure with Fed actions that he believed contributed to rising inflation expectations. In terms of future economic stability, he believes that rising inflation should be the Fed’s top concern: “It is what is going to give us the most troubles and cause the biggest recession” (FOMC transcript 1979, 16). He also thought the Fed had a credibility problem when it comes to controlling inflation. The Fed had proved in the preceding decade that it did not place a high priority on maintaining low inflation, and the public’s belief that this conduct would continue would make it increasingly difficult for the Fed to drive inflation down. “Failure to continue the fight against inflation now would simply make any subsequent effort more difficult,” he said (Volcker 1981b).
Instead of focusing on interest rates, Volcker altered the Fed’s policy to aggressively target the money supply. He chose this strategy for two reasons. To begin with, rising inflation made it difficult to determine which interest rate targets were suitable. Due to the expectation of inflation, the nominal interest rates the Fed targeted could be relatively high, but the real interest rates (that is, the effective interest rates after adjusting for inflation) could still be quite low. Second, the new policy was intended to show the public that the Federal Reserve was serious about keeping inflation low. The anticipation of low inflation was significant, as present inflation is influenced in part by future inflation forecasts.
Volcker’s initial efforts to reduce inflation and inflationary expectations were ineffective. The Carter administration’s credit-control scheme, which began in March 1980, triggered a severe recession (Schreft 1990). As unemployment rose, the Fed relented, reverting to the “stop-go” practices that the public had grown accustomed to. The Fed tightened the money supply further in late 1980 and early 1981, causing the federal funds rate to approach 20%. Long-term interest rates, despite this, have continued to grow. The ten-year Treasury bond rate surged from around 11% in October 1980 to more than 15% a year later, probably due to market expectations that the Fed would soften its restrictive monetary policy if unemployment soared (Goodfriend and King 2005). Volcker, on the other hand, was insistent that the Fed not back down this time: “We have set our course to control money and credit growth.” We intend to stay the course” (Volcker 1981a).
High interest rates put pressure on sectors of the economy that rely on borrowing, such as manufacturing and construction, and the economy officially entered a recession in the third quarter of 1981. Unemployment increased from 7.4% at the beginning of the recession to nearly 10% a year later. Volcker faced repeated calls from Congress to loosen monetary policy as the recession worsened, but he insisted that failing to lower long-run inflation expectations now would result in “more catastrophic economic situations over a much longer period of time” (Monetary Policy Report 1982, 67).
This perseverance paid off in the end. Inflation had dropped to 5% by October 1982, and long-term interest rates had begun to fall. The Fed permitted the federal funds rate to drop to 9%, and unemployment fell fast from over 11% at the end of 1982 to 8% a year later (Federal Reserve Bank of St. Louis; Goodfriend and King 2005). Inflation was still a threat, and the Fed would have to deal with several “inflation scares” during the 1980s. However, Volcker’s and his successors’ dedication to actively pursue price stability helped ensure that the 1970s’ double-digit inflation did not reappear.