India experienced its worst economic downturn and was on the verge of a sovereign default in 1991. Oil prices had skyrocketed as a result of the 1990–1991 Gulf War, and remittances from Indian expatriates had decreased. India’s foreign exchange reserves were severely depleted as a result, at less than $6 billion, they were barely sufficient to cover about two weeks’ worth of imports.
The government was also not helped by the worsening fiscal deficit situation and rising levels of foreign debt. The government’s problems were further exacerbated by a fiscal deficit of 8% of GDP and a current account deficit of 2.5% of GDP. Double-digit inflation rates also increased the burden on the average person.
Preventing a sovereign default, an ignominy that India has so far managed to avoid—was the Rao government’s top concern. There were two quick actions taken:
1. Devaluation of the rupee:
On July 1, 1991, the government and Reserve Bank of India (RBI) began a two-step devaluation of the rupee. The first devaluation was around 9% versus major currencies, and the second was about 11% two days later. To increase the competitiveness of Indian exports, this was done.
In order to make the devaluation more acceptable to all stakeholders, Rao, who is renowned for his political sagery, opted to implement it in two phases.
2. Gold holdings pledged to strengthen foreign exchange reserves:
From July 4 through 18, 1991, the central bank of India pledged its gold holdings with the Bank of England in four instalments, raising almost $400 million.
In order to raise about $200 million prior to this, on May 16, the State Bank of India sold 20 tons of gold to the Union Bank of Switzerland, or UBS.
The government had previously received emergency loans in two tranches totaling about $2 billion from the International Monetary Fund.
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