Recognize the reasons behind India’s economic crisis in the mid-1960s.
Analyze the role of external aid and foreign policy in shaping economic strategies.
Understand the policy measures and reforms from 1965 to 1991.
Examine the structural constraints and weaknesses in India’s economic framework.
Evaluate the transition to economic reforms in the early 1990s.
The Mid-1960s: Crisis and Response
By the mid-1960s, the Indian economy faced a massive crisis, transitioning from a model for development to what some viewed as a ‘basket case.’ Despite the achievements of the earlier plans, several unfavorable factors converged:
Monsoon Failures: Two consecutive droughts (1965 and 1966) significantly reduced agricultural output, with a 17% decline in overall agricultural production and 20% fall in foodgrain production.
Inflation Surge: Inflation surged to 12% annually between 1965-68, largely driven by food prices increasing by 20% per year.
Wars and Defense Expenditure: The wars with China (1962) and Pakistan (1965) caused a surge in defense spending.
Fiscal Deficit: The consolidated fiscal deficit for the government peaked at 7.3% of GDP in 1966-67.
Balance of Payments Crisis: Foreign exchange reserves deteriorated, reaching a low of $340 million, covering less than two months of imports.
Dependence on Aid: External assistance grew sharply, with the debt service ratio rising from 0.8% at the end of the First Plan to 27.8% in 1966-67.
In response, long-term planning was halted, and India adopted three annual plans (1966-69) before launching the Fourth Five-Year Plan in 1969. India also faced aid suspension by the US due to the Indo-Pak war and India’s position on Vietnam.
Economic Nationalism and Policy Reversal
Amidst pressures from the US, IMF, and World Bank, India was urged to:
Liberalize trade and industry controls.
Devalue the rupee by 36.5% nominally.
Adopt a new agricultural strategy.
While the Green Revolution was embraced, trade liberalization and rupee devaluation were met with suspicion, especially since economic conditions did not immediately improve. These initiatives were blamed for continued industrial recession, inflation, and weak export growth.
Key Responses:
Economic Nationalism: Policies reversed towards protectionism and state intervention, prioritizing a healthy balance of payments and reducing dependence on food imports.
Expenditure Cuts: A sharp reduction in government capital expenditure by 50% between 1966-71 contributed to an industrial slowdown.
Industrial Growth: Industrial growth fell to 4.99% per year from 1966-74, compared to 7.8% during 1951-66.
Important Note:
The backlash against foreign intervention, particularly after the perceived failure of rupee devaluation and trade liberalization, shaped the economic nationalist policies in India during the late 1960s.
Political and Economic Shifts Post-1967
Political developments also shaped economic policy during this period. The 1967 elections saw Congress weakened, leading Prime Minister Indira Gandhi to adopt radical socialist policies:
Nationalization of Banks: In 1969, major commercial banks were nationalized.
MRTP Act (1969): Restrictions were placed on large business houses, introducing the Monopolies and Restrictive Trade Practices Act.
Further Nationalization: Sectors like insurance (1972) and coal (1973) were nationalized, while a failed attempt to nationalize wholesale wheat trade occurred.
FERA Act (1973): The Foreign Exchange Regulation Act introduced severe restrictions on foreign investment.
This period also witnessed a rise in government control, which had long-term effects, such as inefficiency in state enterprises.
The Achievements (1965–1980s)
Despite the challenges, several achievements marked this period, especially under Indira Gandhi’s leadership:
Green Revolution Success: Introduction of high-yield variety seeds led to a 35% increase in foodgrain production by 1970-71.
Reduction in Food Imports: Net food imports dropped from 10.3 million tonnes in 1966 to 3.6 million tonnes in 1970.
Food Security: By the mid-1980s, food stocks surpassed 30 million tonnes, providing security even during severe droughts in 1987-88.
Improvement in Foreign Exchange: By 1978-79, reserves reached $7.3 billion, covering nine months of imports.
Reduced Dependence on Aid: Foreign aid, as a percentage of Net National Product (NNP), dropped significantly to 1% by 1977-78.
Key Economic Indicators:
Indicator
1965
1970
1980
1990
Foodgrain Production (million tonnes)
73.5
89.5
128.8
–
Foreign Exchange Reserves ($ billion)
0.34
7.3
4.1
2.24
Fiscal Deficit (% of GDP)
7.3%
3.8%
9.7%
10.4%
Debt Service Ratio (%)
27.8%
–
10.2%
35%
Emergence of Structural Problems
While India achieved some success in the 1980s, structural inefficiencies became evident, leading to the crisis in 1991.
Inefficiency in Industry: Excessive protection of domestic industries led to technological stagnation. The MRTP Act stifled large enterprises, preventing economies of scale.
Small-Scale Industry: The reservation of industries for the small-scale sector hindered competitiveness, making many sectors internationally uncompetitive.
Public Sector Inefficiency: Public sector enterprises began to run losses due to overstaffing, political interference, and trade unionism. State-run utilities, including electricity boards and road transport, became notorious for incurring heavy losses.
The 1980s: The Growth vs. Debt Dilemma
In the early 1980s, India saw a growth resurgence in several sectors:
Stock Market: By the late 1980s, the stock market had become a significant source of funding for industries.
Oil Import Substitution: By 1985, indigenous oil production met two-thirds of domestic demand.
Industrial Growth: Industrial growth picked up to 8% annually during the 1980s, compared to the low rates of the previous decades.
However, this growth was driven by domestic and foreign borrowing, leading to unsustainable debt accumulation.
Debt Trends:
Domestic Debt: Rose from 31.8% of GDP in 1975 to 54.6% in 1990.
Foreign Debt: Increased from $23.5 billion (1981) to $83.8 billion (1991).
Debt Service Ratio: Peaked at a dangerous 35% by 1991.
Important Note:
By 1991, India’s foreign exchange reserves fell drastically, prompting the sale of 20 tonnes of gold to Switzerland to avoid a debt default.
Structural Weaknesses: Need for Reform
By the late 1980s, it became clear that India’s economic policies, based on import substitution and heavy state intervention, were no longer viable. Several weaknesses had emerged:
Protectionism: The excessive protection of domestic industries led to inefficiency and technological backwardness.
Licence-Quota Raj:Regulatory restrictions stifled entrepreneurship and innovation, with the MRTP Act limiting industrial expansion.
Public Sector Losses: Public sector enterprises, especially state-run utilities, ran losses due to political interference and overstaffing.
Comparative Analysis (Industrial Growth):
Period
Industrial Growth Rate (%)
Key Factors
1951–1966
7.8
Post-independence industrial expansion
1966–1974
4.99
Fiscal tightening, industrial recession
1975–1985
5.1
| Early signs of recovery, mixed growth | | 1980s | 8.0 | Debt-led growth, unsustainable fiscal policies |
Final Years Before Reform (1985–1991)
The period from 1985 to 1991 marked high economic growth but was accompanied by a significant deterioration in the fiscal and balance of payments position.
Fiscal Deficit Explosion: The fiscal deficit grew to an alarming 10.4% of GDP by 1991, driven by increasing subsidies, populist measures like loan waivers, and rising government expenditure.
Balance of Payments Crisis: The current account deficit reached 3.5% of GDP in 1990-91, while foreign exchange reserves fell to two weeks’ import cover by July 1991.
Debt Crisis: By 1990-91, India faced a debt service ratio of 35%, a sharp rise from the manageable 10.2% in 1980-81.
Final Crisis (1991):
In 1991, the Indian economy faced an imminent crisis, with foreign lending drying up and foreign reserves depleting rapidly. The incoming government of Narasimha Rao initiated crucial economic reforms under the leadership of Manmohan Singh to stabilize the economy.
Multiple Choice Question
What was one of the primary reasons for India’s economic crisis in 1991?
a) High food grain production
b) Over-borrowing and overspending during the 1980s
c) Surge in industrial growth without technological advances
d) International aid dependency decreasing too rapidly
Answer: b) Over-borrowing and overspending during the 1980s