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What Caused the 1991 Currency Crisis in India?

Autor:   •  March 17, 2011  •  Essay  •  2,699 Words (11 Pages)  •  1,438 Views

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Macro Economic Assignment

Submitted by : Group 12/13_SectionH2

WHAT CAUSED THE 1991 CURRENCY CRISIS IN INDIA?

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 sector deficits. Consequently, inflation remained generally low except in response to 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 11/2 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. India's development policy emphasis shifted from import substitution toward export-led growth,

supported by measures to promote exports and liberalize 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 the 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 more than 40 percent 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 defense 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 nonresident workers, which meant greater dependence on higher cost short maturity financing and heightened sensitivity to shifts in creditor confidence. India's external debt nearly doubled from some $35 billion at the end of 1984/85

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