# **1. Introduction**

India’s economic growth accelerated in the second half of the 1980s along with rising fiscal imbalances. The latter spilled over into current account deficits, depleting reserves and leading to a balance-of-payments (BOP) crisis in 1991. As part of the program of stabilization and structural reform that followed the crisis, customs and excise duties were cut and taxes on financial intermediation lowered with the object of creating more competitive and efficient real and financial sectors. This marked a break with decades of protection and financial repression. The fiscal deficit was also cut and the capital account partially liberalized to attract foreign portfolio and direct investment. As a result of these reforms, the economy grew rapidly and fiscal and government debt indicators improved dramatically during the five years 1992/93-1996/97, which coincided with the Eighth Plan period. But during the Ninth Plan period 1997/98-2001/02, growth slowed and fiscal deficits went back to their pre-1991 crisis levels, raising concern about the slowing pace of fiscal and structural reform.<sup>2</sup> Government debt grew rapidly as revenues fell and interest payments climbed, although inflation and interest rates started falling in line with global trends toward the end of this period. Annex 1 contains background material on the 1991 crisis and summarizes studies on government debt sustainability through the 1990s.

Looking back over the last two decades, India’s macroeconomic report card has been mixed. Its growth performance during the 1980s was exceeded by only 9 out of 123 countries, and that during the 1990s by just 19 out of 137 countries.<sup>3</sup> But India has also ranked high on fiscal deficits. In 2000, out of 74 countries with a population exceeding 10 million, only 7 had general government fiscal deficits exceeding 7 percent of GDP. India was one of them and only Turkey and Zimbabwe had higher deficits.<sup>4</sup> Ahluwalia (2002a) presents data showing that India’s fiscal and debt indicators are comparable to or worse than those of Argentina, Brazil and Turkey, countries that have actually experienced a serious recent macroeconomic crisis. He nevertheless concludes that India is not vulnerable to an external crisis in view of its build up of foreign exchange reserves, capital controls, flexible exchange rate system and widespread public ownership of banks. This stands in contrast to 1991, when India suffered a fiscal-BoP crisis with fiscal deficits of comparable size but much lower debt. What has changed is the reserve build-up. But does this mean that concern about the fiscal stance is misplaced?

No, for three key reasons. The first is that even though growth rose from a 3.5 percent trend rate over the previous three decades to close to 6 percent over the 1980s and 1990s, this has not been enough. India starts the twenty-first century with per capita income around half that of China and Indonesia, countries that in 1970 were at comparable stages of development.<sup>5</sup> Not surprisingly, the National Development Council mandated a target of 8 percent per year in real GDP growth for the Tenth Plan (2002/03-2006/07); but the macroeconomic chapter of the Plan makes it clear that achieving this goal calls for a substantial cut in the fiscal deficit to raise public savings and investment. The second point is that interest payments are claiming a growing share of revenues, limiting government capital expenditure and spending on priority social programs. During the 2003/04 Union Budget discussions, the Finance Minister informed the Rajya Sabha that "Of our revenue, 50 percent is swallowed by payment of just interest on (government) debt. Another 20 percent goes on subsidies and 25 percent on defense. What am I left with?”<sup>6</sup> In other words, the quality of the fiscal stance has deteriorated and options for adjustment are going to be constrained by the high level and non-discretionary nature of interest payments. Third, even though the high reserves offer insurance against a 1991-type crisis, this does not rule out a fiscal

> 2 Ahluwalia (2002b), Williamson and Zagha (2002).

> 3 Srinivasan (2001).

> 4 Acharya (2001, 2002a, 2002b).

> 5 World Bank (2003), Figure 1.

> 6 Times News Network, Times of India, New Delhi, March 14, 2003.

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