Pathways Through Financial Crisis
Global Governance 12 (2006), 413– 429
Pathways Through Financial Crisis: India
Arunabha Ghosh
India survived near-crisis situations twice in the 1990s. How did internal and external constraints shape that country’s ability to respond to the crises? This article argues that India’s success can be attributed to four sets of decisions taken during the period 1991–1997: devaluation, involvement of the IMF, partial liberalization of the domestic financial sector, and gradual opening up of the external sector. The article analyzes the options, political opposition, and eventual outcomes for each set of decisions. India’s ownership of its reform program helped set the pace of reform, while close interaction between technocrats and the IMF added credibility. But the balance between entrenched traditional interest groups and the demands of new interests determined the scope of reform. KEYWORDS: India, financial crisis, economic reform, IMF, interest groups.
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ndia survived near-crisis situations twice in the 1990s, and in 1991 was nearly bankrupt. In response, a reform process began. Engagement with the International Monetary Fund (IMF) had its risks: if India could not deliver on its promises of economic reform, investors would exit again; if the government pushed too hard on reforms, domestic opposition would become unmanageable. In 1997–1998 the Asian financial crisis again threatened India. Macroeconomic fundamentals were vastly different, but political instability and external shocks were common in both episodes. How did internal and external constraints shape India’s ability to handle financial crises in the 1990s?
The 1991 Crisis In 1991, India experienced a classic external payments crisis: high fiscal and current account deficits, external borrowing to finance the deficits, rising debt service obligations, rising inflation, and inadequate exchange rate adjustment. In 1979, the oil shock, agricultural subsidies, and a consumption-driven growth strategy had
Pathways Through Financial Crisis: India
Arunabha Ghosh
India survived near-crisis situations twice in the 1990s. How did internal and external constraints shape that country’s ability to respond to the crises? This article argues that India’s success can be attributed to four sets of decisions taken during the period 1991–1997: devaluation, involvement of the IMF, partial liberalization of the domestic financial sector, and gradual opening up of the external sector. The article analyzes the options, political opposition, and eventual outcomes for each set of decisions. India’s ownership of its reform program helped set the pace of reform, while close interaction between technocrats and the IMF added credibility. But the balance between entrenched traditional interest groups and the demands of new interests determined the scope of reform. KEYWORDS: India, financial crisis, economic reform, IMF, interest groups.
I
ndia survived near-crisis situations twice in the 1990s, and in 1991 was nearly bankrupt. In response, a reform process began. Engagement with the International Monetary Fund (IMF) had its risks: if India could not deliver on its promises of economic reform, investors would exit again; if the government pushed too hard on reforms, domestic opposition would become unmanageable. In 1997–1998 the Asian financial crisis again threatened India. Macroeconomic fundamentals were vastly different, but political instability and external shocks were common in both episodes. How did internal and external constraints shape India’s ability to handle financial crises in the 1990s?
The 1991 Crisis In 1991, India experienced a classic external payments crisis: high fiscal and current account deficits, external borrowing to finance the deficits, rising debt service obligations, rising inflation, and inadequate exchange rate adjustment. In 1979, the oil shock, agricultural subsidies, and a consumption-driven growth strategy had
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Thomas, “The Evolution of the Securities Markets in India in the 1990s,” Indian Council for Research on International Economic Relations Working Paper No. 121.2002, available at www.icrier.res.in/publications.html (accessed May 2004). 43. Phone interview with Arvind Virmani, 8 May 2004. 44. Y. V. Reddy, “Exchange Rate Management: Dilemmas,” Reserve Bank of India Bulletin 51, no. 9 (1997): 701–708. 45. Ahluwalia, “India’s Vulnerability,” p. 210. 46. The Foreign Investment Promotion Board, chaired by the principal secretary to the prime minister, was created to expedite FDI proposals. 47. For a discussion, see Y. V. Reddy, “Managing Capital Flows,” lecture at the Asia-Pacific Research Center, Stanford University, 23 November 1998, reprinted in Y. V. Reddy, Monetary and Financial Sector Reforms in India: A Central Banker’s Perspective (New Delhi: UBSPD, 2000). 48. D. Nayyar, “Capital Controls and the World Financial Authority: What Can We Learn from the Indian Experience?” in J. Eatwell and L. Taylor, eds., International Capital Markets: Systems in Transition (New York: Oxford University Press, 2002), p. 101. 49. For details on the case, see Acharya, “Macroeconomic Management,” pp. 221–222. 50. Reserve Bank of India, Annual Report 1996–97 (Mumbai), p. 122. 51. This explains why V. Joshi, “India and the Impossible Trinity,” World Economy 26, no. 4 (2003): 555–583, labels India as having an “intermediate regime Arunabha Ghosh 429 with capital controls,” as opposed to what the government called “market-determined” rate or the IMF characterized as “independently floating” rate. 52. They shared information on other countries’ strategies. Phone interview with Arvind Virmani, 8 May 2004. 53. International Monetary Fund, “Press Information Notice: IMF Concludes Article IV Consultation with India” (Washington, DC: IMF, 1997), available at www .imf.org/external/np/sec/pn/1997/pn9711.htm (accessed March 2004). 54. Reserve Bank of India, Annual Report 1996–97, p. 19. 55. Interview with Manmohan Singh, New Delhi, 27 June 2003. 56. Akira Ariyoshi et al., “Capital Controls: Country Experiences with Their Use and Liberalization,” IMF Occasional Paper No. 190 (Washington, DC: International Monetary Fund, 2000), p. 84, available at www.imf.org/external/pubs/ft/op/ op190/index.htm (accessed March 2004). 57. “Indian Test Match,” The Economist, 14 August 1997. 58. Acharya, “Macroeconomic Management,” p. 238. 59. Nayyar, “Capital Controls,” p. 117. 60. Discussion based on Ahluwalia, “India’s Vulnerability,” and Nayyar, “Capital Controls.” 61. N. Jadhav, “Capital Account Liberalisation: The Indian Experience,” paper presented at the conference “A Tale of Two Giants: India’s and China’s Experience with Reform and Growth,” International Monetary Fund and National Council of Applied Economic Research, New Delhi, 16 November 2003, p. 29, available at www .imf.org/external/np/apd/seminars/2003/newdelhi/jadhav.pdf (accessed March 2004); R. Kohli, “Capital Flows and Their Macroeconomic Effects in India,” IMF Working Paper 01/192 (Washington, DC: IMF, 2001), p. 17, available at www.imf.org/ external/pubs/cat/longres.cfm?sk=15471.0 (accessed March 2004). 62. D. Nayyar, Economic Liberalization in India: Analytics, Experience, and Lessons (Calcutta: Centre for Studies in Social Sciences, 1996), p. 33. 63. N. Bajpai, J. D. Sachs, and N. Volavka, “India’s Challenge to Meet the Millennium Development Goals,” Centre on Globalisation and Sustainable Development Working Paper No. 24, April 2005, available at www.earthinstitute.columbia.edu/cgsd/documents/bajpai_indiamdgchallenge.pdf (accessed May 2006). See also A. Deaton and J. Dreze, “Poverty and Inequality in India: A Re-examination,” Economic and Political Weekly, 7 September 2002, pp. 3729–3747. 64. On unequal growth across states, see G. Datt and M. Ravallion, “Is India’s Economic Growth Leaving the Poor Behind?” Journal of Economic Perspectives 16, no. 3 (2002): 89–108. 65. 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