ADVERTISEMENTS:
This article provides information about the current account deficit and 1979 oil crisis that led to the liberalisation of Indian economy:
India had a persistent current account deficit since oil shocks in 1973 and 1979 but some believe that the situation worsened from the mid-1980s when the Rajiv Gandhi government relaxed import restrictions on many items.
Image Courtesy : media.npr.org/assets/img/2012/3d874d.jpg
ADVERTISEMENTS:
The trade deficit grew rapidly in the 1980s and it was felt by some commentators that the trade liberalisation initiated in the mid-80s needed to be reversed to check the growing current account deficit and to avoid a foreign exchange crisis.
However, politico-economic developments in 1989-91 made the trade deficit unsustainable and the Indian currency was perceived to be grossly overvalued. Remittances by Indian workers abroad were major source of foreign exchange for the country. However, these remittances declined both due to the international disruptions that followed the Iraq war and uncertainties in India. In June 1991, the finance ministry was put on “red alert” as the supply of foreign exchange reserves with the Reserve Bank of India dwindled to barely $ 1 billion – enough to finance only 6 weeks of imports.
The fiscal deficit, which measures the shortfall of the government’s revenues vis-a-vis its expenditures, was at an all time high nearing 8% as a proportion of GDP. Inflation in the economy was in double digits (about 12%). India was also close to defaulting on its debt service commitments on earlier loans, which it had obtained in the ’80s to finance a growing trade deficit.
ADVERTISEMENTS:
The first world oil shock began soon after Yom Kippur or Arab Israel War in 1973 when the Arab members of the Organisation of Petroleum Exporting Countries (OPEC) announced that they would no longer ship petroleum to nations that had supported Israel that is to United States and its allies in Western Europe. At around the same time. OPEC- member states agreed to use their leverage over the world price-setting mechanism for oil to quadruple world oil prices. Real oil prices peaked well above $43 per barrel in 1974.
Almost exactly five years after the first oil shock, the second began, it came in the aftermath of the Iranian Revolution. The upheaval in Iran has meant an interruption of oil supply and a loss to world production already as great as that from the 1973 embargo. With Iranian oil exports curtailed from late 1978 to the fall of 1979, the oil price nearly tripled- rising from $ 13 to $34 per barrel.
This price disturbance hit a world economy that was only about three years into recovery from the first oil shock. The second oil shock hit a world that was trapped in a vicious inflationary spiral. Both these oil shocks were comparatively persistent taking 3-5 years until real price of fell back significantly affecting the economies of almost all nations around the globe.
In these circumstances, India was forced to approach the International Monetary Fund to help it tide over the external account problem. The foreign exchange crisis, it is widely believed, paved the way for initiating the process of liberalisation and structural adjustment as part of the multilateral conditionalities on the loan sanctions. The domestic government justified the acceptance of these conditionalities citing the delicate forex reserves status.
Numerous changes in the Indian economy followed under the direction of the then Finance Minister, Dr. Manmohan Singh. Industrial delicensing and trade liberalisation along with fiscal “consolidation” were the main focus areas of the reform process.
There is an oil price rise because of a shock in the international market (like a war or natural calamity), and this leads to an increase in the price (cost) of production, which reduces demand. When demand falls, producers feel that in the next period too there will be further decline in demand and therefore reduce their investment and also the number of people they hire. The reduction in number of people in the employed pool reduces consumption expenditures leading to a further fall in aggregate demand thereby creating a vicious cycle.
In such circumstances, the only way an economy can recover is by the intervention of an autonomous agency and pushes up the demand in the economy. Since no individual rational agent in the economy has any incentive to increase its demand, the state is the only autonomous agent that has an interest and a mandate to ensure the recovery of the economy and to break this vicious circle.
If the intervention is large and sustained, it would stabilise the economy and many economists argue that stabilisation must precede the liberalisation programme. If liberalisation is undertaken, then it must be to meet the stabilisation targets of reducing inflation, a fiscal and trade deficit, and to increase foreign exchange reserves.