The 1991 crisis and the New Economic Policy

In 1991, India faced a serious economic crisis. It could not repay its foreign borrowings. Its foreign exchange reserves fell so low that they could pay for less than two weeks of imports. At the same time, the prices of essential goods were rising fast.

The roots lay in the 1980s:

• The government was spending far more than it earned in revenue, and covered the gap by borrowing.
• Much of the borrowing was used for consumption, not for investments that would earn money to repay it.
• The public sector was not earning enough.
• Imports grew much faster than exports, so the country kept running short of foreign currency.

India turned to the World Bank (IBRD) and the International Monetary Fund (IMF), and borrowed US$ 7 billion. The loan came with conditions: India had to open up and liberalise its economy.

The government announced a New Economic Policy (NEP) with two kinds of measures:

• Stabilisation measures: short-term steps to correct the problems of the balance of payments (too little foreign exchange) and inflation. Devaluing the rupee was one.
• Structural reforms: long-term changes to make the economy more efficient and competitive, by removing rigidities in its different sectors.

The policies fall under three heads: liberalisation, privatisation and globalisation (often called LPG). Reform is like a change of habits when the old ones have stopped working.