The GDP growth rate improved (from an average of 2.9 percent in 1970s to 5.6 percent in 1980s) during the 1980s. This was primarily due to two reasons:

  • Liberalisation of industry and trade (reforms of 1980s, see below)
  • Borrowing from abroad and rising government expenditure at home

During the 1980s the investment-to-GDP ratio rose (investment went from about 19 percent of GDP in early 1970s to nearly 25 percent in the early 1980s) exclusively in the public sector while it fell in the private sector.

The external borrowing helped bridge the considerable gap between exports and imports and raise the total GDP growth rate. Thus, foreign borrowing made a positive contribution to growth. However it also led to a rapid accumulation of foreign debt, which rose from USD 20.6 billion in 1980–81 to USD 64.4 billion in 1989–90.

From the fiscal year 1979-80, India started facing the Balance of Payment (BoP) crisis. By the end of the 6th five year plan in 1985, India’s BoP deficit rose to Rs. 11,384 crores (from a BoP surplus of Rs. 3082 crores during the 5th five year plan ending in 1978). The second oil shock of 1979 (or the 1979 oil crisis) occurred due to decreased oil output in wake of the Iranian revolution, pushing up oil prices. In 1980, following the outbreak of the Iran-Iraq War, oil production in Iran nearly stopped and Iraq's oil production was severely cut as well, pushing prices further up). This crisis was severe and the value of imports for India almost doubled between 1978-79 and 1981-82. From 1980 to 1983, there was global recession and India’s exports suffered during this time.

To offset the BoP, a number of measures were taken, including external assistance in the form of loans and aids, withdrawal of SDR (Special Drawing Rights, which is the currency of the IMF) and borrowing from the IMF under the extended facility arrangement. During the mid- 1980s, the BoP issue occupied a central position in India’s macroeconomic management policy.

Major reforms of the 1980s:

Broadly, the reforms of the 1980s, which were largely in place by early 1988, can be divided into five categories (India in the 1980s and 1990s, Arvind Panagariya):

  • First, the OGL (Open General License List) list was steadily expanded: The inclusion of an item into the OGL list was usually accompanied by an “exemption”, which amounted to a reduction in import tariff on that item. There were 79 capital good items in the OGL in 1976; this number gradually increased reaching 1,007 in April 1987, 1,170 in April 1988, and 1,329 in April 1990. Examples of items included in the OGL are sewing machines, chocolates and food preparations.
  • Second, decline in the share of canalised imports: Canalisation refers to monopoly rights of the government for the import of certain items. Between 1980–81 and 1986–87, the share of canalised products in total imports declined from 67 to 27 percent. This was due to three reasons: (1) Increase in domestic production of POL (Petroleum, Oil and Lubricants) leading to a decline in its imports, (2) Success of the Green Revolution, which led to a decline in import of grains and (3) Decanalisation - 21 items were decanalised in April 1985 and a further 26 items were decanalised in April 1988. This change significantly expanded the room for import of machinery and raw materials by entrepreneurs. Examples of items that were earlier canalised products include crude oil and petroleum, natural rubber, cement.
  • Third, several export incentives were introduced or expanded, especially after 1985. An example of incentives includes the replenishment licenses (REP) which were given to exporters and could be freely traded on the market; they directly helped relax the constraints on some imports. Exporters were given REP licenses in amounts that were approximately twice their import needs and this therefore provided a source of input imports for goods sold in the domestic market. The REP License could be used to import items not on the OGL list.
  • Fourth, a relaxation of industrial controls, which included foreign exchange availability consideration, and removing extra layers of regulation on import.
  • Fifth, setting up of the exchange rate at a level that reduced the bias against traded goods relative to non-traded goods. The real exchange rate had depreciated as much as 30 percent between 1974-75 and 1978-79 but then appreciated slightly and then stayed unchanged until 1984-85. In the second half of 1980s, the exchange rate steadily depreciated from 12.36 rupees to a dollar in 1985, to 17.50 rupees in 1990.

Towards the end of 1980s, despite these measures, external debt was rising. While the borrowing helped the economy grow, it was also pushing us steadily towards a crash. As with external borrowing, high current expenditures within the country proved unsustainable. They manifested themselves in extremely large fiscal deficits.

These factors led to a buildup of very substantial public debt with interest payments accounting for a large proportion of the government revenues. They also inevitably fed into the current account deficits (CAD), which kept rising steadily until they reached 3.5 percent of GDP and 43.8 percent of exports in 1990–91. The outcome of these developments was the June 1991 crisis.