The Hindu Business Line : Revisiting the Eighties

Talking of a time 15 years ago when the country faced a financial crisis and pledged its gold with the Bank of England to raise funds, S. VENKITARAMANAN explains how the crisis alerted the public to the need for serious economic policy reforms. There are still lessons to be learnt from the experience of the 1980s. It is important to keep in mind that there are still uncertainties inherent in our dependence on volatile or temperamental sources, such as FII investments, which today sustain our current account deficit.

The current historian of the Reserve Bank of India, an eminent economic journalist himself, recently paid me a visit in connection with his mandate of recording the recollections of my stints, both in the Finance Ministry and the RBI. It gave me an opportunity to relive the stresses, strains and challenges of that period.

The discussion initially turned to what caused the crisis of 1991 and to what extent the bureaucracies in New Delhi and Mumbai could be held responsible for the decisions, or indecisions, leading to the crisis. Besides the various RBI reports, the justly famous book on the crisis by I.M.D Little and Vijay Joshi formed the anchor for the discussion.

It is fair to point out that the then Prime Minister, Rajiv Gandhi, was sensitive to the dangers of fiscal expansion and laid emphasis on additional resource mobilisation and expenditure compression.

In March 1989, after the presentation of the Budget for 1989-90, Mr Michel Camdessus, then Managing Director of the IMF, had met the Prime Minister and pointed out that the Fund was willing to take the Budget as a document of intent, which could form the basis for aid from the Washington institution.

Mr Camdessus, however, alerted Rajiv Gandhi to the dangers inherent in the foreign exchange situation, for which he offered a safety net from the IMF.

The latter was smart enough to understand the implications of this suggestion. He felt, however, that such an approach to the Fund would affect his party's electoral prospects in the forthcoming polls.

Things would have been different had he advanced the polls.

The decision to postpone the economic actions needed were basically political, but Rajiv Gandhi was determined to take the steps needed once he came back (as he hoped he would) after the elections. But that was not to be.

The then Governor of the RBI, the late R. N. Malhotra, had in 1989 alerted the Government of Mr V.P. Singh, who succeeded Rajiv Gandhi, on the need to approach the IMF for assistance. While Mr Singh did initiate some arrangements to draw the first tranche, he was advised by his aides that the situation was not that serious.

IMF assistance

The RBI also played its role in alerting the Government to the need to approach the Fund before the crisis broke out.

The years 1985-1990 were a period of robust export performance, thanks mainly to an active exchange rate policy and a fiscal policy encouraging exports.

As per RBI records, the current account deficit-GDP ratio was 1.2 per cent in 1984-85, 2.1 per cent in 1986-87, 1.9 per cent in 1986-87, 1.8 per cent in 1987-88, 2.7 per cent in 1988-89, 2.3 per cent in 1989-90 and 3.1 per cent in 1990-91, which still does not seem serious, especially given the current levels of various countries.

The macro-economic situation was, however, aggravated, in part because of the Western bankers' refusal to roll over the short-term advances they had been initially quite eager to give State Bank of India and, through it, to IOC and the State Trading Corporation (STC) between 1985 and 1990 to buy crude.

It was common practice at that time for developing economies such as India and South Korea to draw on the bankers' acceptances from bankers in New York, London and Tokyo to finance the imports of commodities such as crude oil. The goal of a stable price level naturally entailed the need for availability of these commodities in adequate measure.

SBI was able to raise short-term credits at that time. This shows the confidence that international bankers had in India. But, subsequently, there was a tightening of these markets, partly due to introduction of Basel-I norms, which constrained their willingness to roll them over.

Critical relief

The political situation following the elections of 1989-90 also led to loss of confidence in India, including a downgrading of the rating. The Joshi-Little critique is that resort to short-term loans in those circumstances was itself a mistake. But, barring resort to the World Bank and IMF, which were politically ruled out, external commercial borrowing in some form or the other was the only option. There was also a self-imposed restriction on the total exposure of the SBI to the bankers' acceptance markets. This limited imports to around $2 billion. This was done at the instance of R.N. Malhotra, and it was carefully monitored.

The situation also worsened because of the West Asian crisis following the invasion of Kuwait and consequent erosion in remittances from NRIs. The level of remittances, which had been growing strongly in previous years, virtually halved. All efforts were, of course, taken to turn the current account into surplus. This was an impossible task, given the imperatives of development of a growing economy, capital goods imports and crude prices.

The situation naturally deteriorated with the breakdown of governance following the accession of Mr Chandrasekhar, a bold and visionary leader, who took quick and rational decisions. It was owing to his courage that I, as the then RBI Governor, was able to move out gold from the RBI's coffers to the Bank of England. This had been preceded by a sale and repurchase agreement by SBI, which had been entrusted with a quantity of smuggled gold in the possession of the government.

These transactions enabled a relief of more than $500 billion, which proved critical at that time. This served as a signal to the IMF that we were willing to go the extra mile to help ourselves. It also alerted the public of India to the need for serious economic policy reforms which, as Finance Minister, Dr Manmohan Singh was able to initiate and implement successfully.

Better positioned to take risks

In the present context, the recital of the events of the 1980s may seem irrelevant, especially given our now abundant reserves.

But it is important to refer to this episode because there are still uncertainties inherent in our dependence on volatile or temperamental sources, such as FII investments, which today sustain our current account deficit.

While the rate of growth in the economy in 1989-90 was nearly 10 per cent, it is also relevant that inflationary pressures were unleashed as a result of crude price increase and post-drought scarcities.

There is a lesson to be drawn from the experience of the 1980s that, while fiscal deficit may not by itself be dangerous, it could be a recipe for disaster if adequate supplies of commodities at reasonable prices are not maintained through imports.

Fortunately, our level of reserves today enables us to take on such a challenge with much greater assurance than we could in the 1980s.

While I do not make an argument for fiscal irresponsibility, I want to stress that we can definitely undertake a bolder programme of investment expansion for productive purposes if the resulting inflationary situation can be managed with corresponding supplies both from international and domestic sources.

We are today in a position to do this without the risks of the 1980s. Incidentally, 1988-89 saw a rate of GDP growth of 10.5 per cent, with a current account deficit of just 2.7 per cent, according to RBI accounts. Maybe such numbers can be posted now too.

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