DEBT DEVELOPMENT: DEVELOPMENTS TO

1991 F O R E I G N E X C H A N G E C R I S I S

By 1990, there was a marked deterioration in India's

balance of payments. Although there was satisfactory
growth in exports, it was overshadowed by growth in
imports, stagnant flows in invisibles such as tourism and
private transfers, and mounting debt service burden.
The current account deficits which were sustained
mainly by borrowing from commercial sources and NRI
deposits, with short maturities and variable interest
rates, resulted in a ballooning of repayment burden
towards 1990. The size of external debt reached $ 83
billion in March 1991, 45 per 'cent of which was
contracted from private creditors and at variable
interest rates.

The debt service payments had reached 30 percent of

export earnings by March 1991, which was close to
some of the heavily indebted countries such as
Indonesia [31 per cent), Mexico [28 per cent), and
Turkey (28 per cent). Interest components alone was
about $ 4 billion, comprising some 50 per cent of the
total current account deficits and 21 per cent of the
total merchandise exports. The growth of exports in US
dollar terms was not sufficient even to pay for the
interests for each of the three years to 1990-91 and
India had to make for amortization payments by
resorting to fresh borrowing.

The foreign exchange crisis was exacerbated by the Gulf

war that began in August 1990, causing shortfall in
exports to West Asia, loss of remittances from Kuwait
and Iraq, huge foreign exchange costs of emergency
repatriation from the region and, most importantly,
additional cost of oil imports due to the oil price
increase. The Gulf crisis coincided with recessionary
trends in the West that had depressed the demand for

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 India’s exports. Furthermore, the economic decline in
Eastern Europe led to a contraction of exports to these
markets. The uncertain political climate at home along
with the precarious balance of payments situation led to
the erosion of India's credit ratings abroad. The Moody's
downgraded India's status to BB in 1990, which was the
highest s peculative grade for long-term debt.

There were indications that the net resource transfer on

account of official and private credit had become
negative in 1990-91 i.e. the fresh inflows were not even
adequate to meet the obligations on account of
amortization and interest payments. The level of
foreign exchange reserves fell to just $ 1 billion in 1990-
91. This desperate situation led the Reserve Bank of
India to sell 20 tonnes of gold in May 1991 and pledge
another 46.91 tonnes in July 1991, for meeting the
urgent foreign exchange needs and financing current
account deficits. An imminent foreign exchange crisis
loomed large before the Indian economy, with
unsustainable external debt burden.

TREND OF BOP AND FOREIGN

TRADE
THE PERIOD 1991 - 2000

1991-92: THE BOP IN A CRISIS

In the first quarter of 1991-92 the Balance Of
Payments of India witnessed a crisis of

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unimaginable proportions. With the launch of the 7th
five year plan (1985-90), the signs of a serious
macroeconomic crisis became increasingly evident.
The Indian economy entering the nineties was
marked by stagflation and a fundamental internal
and external disequilibrium- this was the result of a
number of restrictions imposed upon Indian
industry, trade and finance ever since the inception
of the 2nd five year plan (1956-61) and the adoption
of the Nehru-Mehlonobis strategy.
The economy, highly vulnerable to exogenous
shocks received a final blow due to the Gulf Crisis
and the annexation of Kuwait by Iraq, which drove
up oil prices significantly. India’s import bill as a
result widened and its trade deficit rose from Rs
619 Crores in June-August 1990 to Rs 1229 Crores
per month over the next six months. The domestic
polity of India was also fragile during this time
exacerbating the crises further. There was a loss of
international confidence in India and international
credit agencies downgraded the credit rating of
Indian entities between August 1990 and July 1991.
Apart from the expanding import bill, Indian exports
to West Asia, to the tune of Rs 500 Crores also
suffered due to a UN trade embargo placed on Iraq
and Kuwait. The payment crisis of 1990-91 was not
only because of deterioration in the trade account
but also because of adverse developments in the
capital account. Short-term credit and commercial
loans began to dry up and this was accompanied by
a net outflow of NRI deposits which began in
October 1990 and continued till 1991. In April-June
1991 the outflow was to the tune of $952 million
and this trend continued, being reversed only in
January 1992.

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The graph below shows the evolution of key BOP
indicators during the Sixth (1980-85), Seventh
(1985-90) five year plans as well between 1989-90
and 1990-91. It is evident that the current a/c
balance deteriorated significantly between 1980-85
and 1990-91.

A new government assumed office in June 21, 1991

and took corrective steps immediately to restore
international confidence. To this end a new BOP
adjustment strategy was put in place and it
comprised of three elements namely- exchange rate
adjustment, fiscal correction and structural reforms
in the area of industry and trade.

The early results of the crisis management efforts in

1991-92 were encouraging: foreign currency assets
that had reached their all-time low point of $1.1
billion in July 1991 rose to $4.4 billion in February

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1992. The government was also able to bring back
gold pledged to the Bank of England and Bank of
Japan in July and it received $1.605 billion on Indian
Development Bonds, held by the SBI. There was an
increase in external assets to the tune of $ 4.6
billion. With the build up foreign reserves, there was
a gradual relaxation of import restrictions in the
second half of 1991-92.

However a lasting solution to the payments problem

lay in an improvement of the export performance
alone. The downward adjustment of the rupee
aimed at switching expenditure from imports to
exports was expected to yield a typical “J curve
effect”, wherein the trade deficit first worsens due
to the price effect outweighing the quantity effect
and then it improves due to a reduction in the
volume of imports and an increase in the volume of
exports. As a result the trade deficit during the first
six months of 1991-92 contracted significantly.

Following the unprecedented payments crisis and

the policy reforms initiated by the government in
1991 there was a marked improvement in the
external payments situation. The build-up of foreign
exchange reserves combined with stabilization and
structural reforms restored international confidence
in the India and laid the foundation for further
liberalisation measures in the realm of trade, tariff,
export credit and foreign investment policies during
1992-93.

The trade policy regime was substantially liberalised

in 1992-93 following the introduction of the
Liberalised Exchange Rate Management System
(LERMS). Under LERMS, 40% of foreign exchange
earnings from the export of goods and services had

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to be surrendered at the officially prevailing
exchange rate- this was used to purchase essentials
like petroleum, fertilizers and life saving drugs. The
rest of the 60% could be used by the exporters or
sold in the market to finance all other imports. This
was a favourable departure from the pre-reform era
wherein exporters had to surrender all of their
foreign exchange earnings to the RBI. In addition,
the mechanism of import licensing was virtually
abolished and almost all critical raw materials,
capital goods, intermediates and components
became freely importable, subject only to some
amount of tariffs. The peak tariff was also lowered
in 1992-93 in order to reduce protection to the level
of other developing countries.

The year 1993-94 has seen significant

improvements in the BOP of India. The following
table shows the key indicators of India’s balance of
payments, 1990-91 onwards.

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There was considerable improvement in the balance
of trade and this is shown in the graph given below-

The current account deficit has traditionally been

financed by recourse to external assistance from
various bilateral and multilateral sources or via
access to commercial credit. However an extremely
heartening developement during the year 1993-94
were capital inflows on account of positive response
of foreign investors to economic reforms.

Since July 1991 the Government has consistently

pursued the objective of attracting larger volumes
of foreign investment to augment the resource
availability in infrastructural and other critical areas
of the economy. During 1992-93 actual inflows of
both direct and portfolio investment together were
$585 million. In 1993-94 actual inflows were
reported to be around $1.8 billion during april-
december 1993. It is interesting to note that
between april and september 1993 the actual
inflows were around $608 million and they reached

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a high level of $1.2 billion between october and
december itself.

Structural changes in the country’s balance of

payments helped India’s external sector move away
from a foreign-exchange constrained controlled
regime to a more open, market-driven and
liberalised economy.

These structural changes were reflected precisely in

the evolution of certain key ratios over time. As far
as the current account in concerned the overall
trends can be analysed best by studying the next
two graphs.

As can be clearly seen above, one of the most

notable changes was a sharp increase in the

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coverage of imports by export earnings. In the
beginning of the eighties this ratio was only 52.4 %
and led to a massive trade deficit. This had
improved to about 70% by the end of the previous
decade. As the graph shows, from 1993 onwards,
the coverage ratio has on an average been around
85.35%.

This marked improvement in the export-import ratio

combined with an improvement in the invisibles
account, has resulted in a sharp reduction in the
current account deficit also. It came down from
unsustainable levels of 3.3% of the GDP in 1990-91
to around 0.1% of the GDP in 1993-94. During 1994-
95 there was a large increase in imports by 22.9%
in line with the expansion of industrial growth and
investment activities. Invisible payments also rose
considerably reflecting the liberal policy regime for
current payments. As a result the current account
deficit as a percentage of the GDP rose from
abnormally low level of 0.1% to around 0.8% which
is also mo dest.
In the following two years, that is, between 1995-96
and 1996-97, the current account deficit widened
further. However, given the renewal of economic
activity this was expected and did not pose much of
a problem as it was sustained by adequate capital
inflows. The magnitude of the current account
deficit also reflected the availabilty of foreign
investment or external resources to bridge the
savings-investment gap in the economy in order to
maintain the growth momentum post-liberalisation.

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The first indicator of a decline in the inflow of debt-
creating capital is the significantly lower levels of
External Commercial Borrowings (ECB) as a
proportion of total capital infows. In 1991-92 this
percentage was as high as 30.6% and it declined to
just about 9.1% in 1993-94. This was primarily a
result of a concious government policy to maintain
a strict control over external indebtness and
resulted favourably in improving the credit rating of
India by international agencies.
During 1994-95 the relative increase in ECB inflows
was primarily on account of some private sector
power and petroluem companies finalising their
financing packages. Care was taken to ensure that
infrastructural projects have adequate access to
external commercial borrowing while keeping
external debt within permissable limits. Similarly,
the year 1995-96, saw a large demand for such
borrowing with several projects of petroleoum, oil
exploration and telecommunications coming up.
However, annual ceilings on borrowings were
placed and were monitored closely. ECB duing
1996-97 remained mostly subdued.

After a spurt in the share of external assistance in

total capital inflows to around 64% in 1991-92,
mainly on account of the need of exceptional
financing to tide over the balance of payments
crisis, there was been a consistent decline of the
same in the subsequent years, as can be seen in
the graph above. In addition, a number of measures
were taken during 1994-95 to ensure better
utilization of the existing external aid. These
included advance release of funds to state

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governments, disintermediation of loans to central
public sector units, setting up of a Project
Management Unit (PMU) as part of the department
of Economic Affairs to monitor, supervise and
streghthen various projects. In addition, the India
Development Board (IDB) was also formed which
recommened the reduction of emergency
assistance in view of India’s enhanced capacity. In
1994-95 we also decided to not approach the IMF
for a medium term extended fund facility which we
had contemplated earlier and made advance
repayments of our previous borrowings.

The BOP account of India, after undergoing a crisis

in 1990-91 recovered remarkably in the mid 90’s
and consolidated it’s position and growth as the
country entered the new millenium. One of the
highlights of the period under review was the East
Asian Currency Crisis of 1997-98. Almost all major
economies of Asia went into recession during this
time and their balance of payments suffered from a
fundamental disequilibrium on account of massive
capital flights that subsequently took place. In a
globalised world economy, India was naturally not
completly immune from the crisis but it’s impact on
the economy was not catastrophic and we did not
experience any major shocks.
A study of some of the main indicators of the
external sector during this period would help give a
better idea of the progressions that were taking
place in the economy.

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The continued sluggishness of exports for the third
year in succession since 1995 became a genuine
cause of concern. Infact in 1997-98 there was a
deceleration of exports by 3.9% as can be seen in
the graph above. The unimpressive export
performance was because of a decline in world
trade since the second half of 1997, a decline in
export prices of some major items of manufactured
goods, growing infrastructure bottlenecks and
appreciation of the rupee in real effective exchange
rate terms. Export growth from 1998 to 2000
showed a welcome recovery to the tune of 11.6% in
1998-99 and 20.4% in 1999-2000.

Reflecting the trends of exports and imports, the

deficit on the trade account of the BOP declined
from 3.8% of the GDP in 1997-98 to 3.1% of the
GDP in 1998-99. However the deficit in 1990-2000
widened again, reflecting the above explained
trends.

The table below gives an account of the different

components of the capital account and enables us
to compare the position of the capital account vis-a-
vis what it was in 1990-91.

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As can be seen in the table above, the external
indebtness of India has improved by leaps and
bounds since 1990-91. This shows a sound recovery
from the massive crisis that we had faced in the
early 1990’s.

While there has been a continous decline on various

front of indebtness, this period also saw favourable
developements in terms of increased foreign
investment on the whole.

To conclude this particular phase in the history of

India’s balance of payments it can be said that a
major outcome of India’s economic reforms in the
1990s with respect to the succeeding decade was
the evolution of the external sector with
considerable inner strength to meet the challenges
of foreign as well as domestic shocks.

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The need of the hour at that point in time was to
strengthen our policy stances in the areas of fiscal
balance, exports, POL imports, tourism earnings,
foreign investment flows and domestic monetary
and fiscal policies. This was with a view to help India
to grow in an environment of a viable BOP,
reasonably stable exchange rate, a sustainable
external debt profile and an external sector with
durable strength and vigour.

CONCLUSION

India’s post-independence development strategy was

both inward-looking and highly interventionist,
consisting of import protection, complex industrial
licensing requirements, financial repression, and
substantial public ownership of heavy industry.
However, macroeconomic policy sought stability
through low monetary growth and moderate public
unfavourable supply shocks (e.g. from oil price increases
or poor weather conditions). The current account was in
surplus for most years until 1980, and there was a
reasonable cushion of official reserves. Official aid
dominated capital inflows.

During the first half of the 1980s, the current account

deficit stayed below 1½ percent of GDP. While export
growth was slow, the trade deficit was kept in check, as
a rapid rise in domestic petroleum production permitted
savings on energy imports. At the same time, the high
proportion of concessional external financing kept debt
service down.

In the second half of the 1980s, current account deficits

widened. The emphasis of India’s development policy
shifted from import substitution toward export-led

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growth, supported by measures to promoted exports
and liberalizes imports for exporters. The government
began a process of gradual liberalization of trade,
investment and financial markets. Import and industrial
licensing requirements were eased, and tariffs replaced
some quantitative restrictions. Export growth was rapid,
due to initial measures of deregulation and improved
competitiveness associated with the real depreciation of
the rupee. However, the value of imports increased at a
faster clip. The volume of petroleum imports increased
by over 40% from 1986-87 to 1989-90, with the growth
of domestic petroleum production slowing and
consumption growth remaining strong. A deterioration
of the fiscal position stemming from rising expenditures
contributed to the wider current account deficits. For
instance, imports of aircraft and defence capital
equipment rose sharply. The balance on invisibles also
deteriorated as debt-service payments ballooned.

Current account deficits in the second half of the 1980s

exceeded the availability of aid financing on
concessional terms and consequently other sources of
financing were tapped to a greater extent. In particular,
the growing current account deficits were increasingly
financed by borrowing on commercial terms and
remittances of non-resident workers – which meant
greater dependence on higher cost short maturity
financing and heightened sensitivity to shifts in creditor
confidence.

Two sources of external shocks contributed the most to

India’s large current account deficit in 1990-91. The first
shock came from events in the Middle East in 1990 and
the consequent run-up in world oil-prices, which helped
precipitate the crisis in India. The rise in oil imports led
to a sharp deterioration in the trade account, worsened
further by a partial loss of export markets (as the Middle
East crisis disturbed conditions in the Soviet Union, one
of India’s key trading partners).

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Second, the deterioration of the current account was
also induced by slow growth in important trading
partners. Export markets were weak in the period
leading up to India’s crisis, as world growth declined
steadily from 4½% in 1988 to 2¼% in 1991. The growth
of U.S. fell from 3.9% in 1988 to 0.8* in 1990 and to -1%
in 1991. Consequently, India’s export volume growth
slowed to 4% in 1990-91.

India’s balance of payments in 1990-91 also suffered

from capital account problems due to a loss of investor
confidence. The widening current account imbalances
and reserve losses contributed to low investor
confidence, which was further weakened by political
uncertainties, and finally by a downgrade of India’s
credit rating by the credit rating agencies. Commercial
bank financing became hard to obtain, and outflows
began to take place on short-term external debt as
creditors became reluctant to roll over maturing loans.
Moreover, the previously strong inflows on non-resident
Indian deposits shifted to net outflows.

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