1991: Sequencing Stabilisation and Liberalisation
June 1991. India's foreign exchange reserves have fallen to about $1.1 billion, enough for roughly two weeks of imports. The government has airlifted about 47 tonnes of gold to the Bank of England as collateral for a loan and is negotiating a $2.2 billion IMF standby arrangement. Inflation is near 13%, the fiscal deficit is about 8.5% of GDP, and industrial licensing covers most large industries. The IMF wants fiscal contraction, devaluation, and removal of import restrictions; the trade ministry wants tariffs retained to protect small industry; the agriculture ministry fears fertiliser subsidy cuts. A cabinet note proposes a two-stage sequence: first stabilise the balance of payments with devaluation and expenditure cuts, then liberalise licensing and trade over three years. A rival note argues for 'shock therapy' in one budget. The prime minister asks which sequence is politically and economically defensible.
1. Defend or reject the two-stage sequence. What should be front-loaded and what should wait?
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The two-stage sequence is defensible because the crisis is a liquidity and credibility crisis before it is a structural one. With reserves at two weeks of imports, the immediate task is to stop the run on the rupee and restore external confidence. Devaluation and fiscal contraction must be front-loaded: devaluation corrects an overvalued exchange rate and reduces import demand, while expenditure cuts signal that the government will not monetise the deficit. Without these, liberalisation would simply increase imports and worsen the balance of payments.
What should wait is the deeper structural agenda: industrial delicensing, tariff reduction, and public-sector reform need institutions and a political mandate. Front-loading them in one budget would create a supply shock before the external position stabilises. The risk of sequencing is that the first stage becomes permanent and the second is postponed. To prevent that, the cabinet should publish a timetable with measurable triggers: liberalisation begins once reserves cover three months of imports and inflation falls below double digits.
2. What are the main risks of 'shock therapy' compared with gradualism in this setting?
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Shock therapy risks a political and supply-side backlash. Removing industrial licensing and cutting tariffs in the same budget would expose small firms to import competition before they can adjust, while fiscal contraction reduces demand at the same time. The result could be industrial closures, urban unemployment and a legitimacy crisis for the reform programme. In a coalition government with a narrow mandate, that is a recipe for reversal.
Gradualism risks the opposite: protected firms use the delay to lobby for permanent exemptions, tariffs become entrenched, and the fiscal deficit remains high because subsidies are not cut. The 1991 crisis also creates a window for reform that may close once the immediate emergency passes. The balance is to front-load stabilisation and macro credibility, but to sequence liberalisation by sector, starting with tradable industries where competition is feasible and delaying labour-market reform until a social safety net exists. Sequencing is not delay if it has published triggers and a sunset clause for protection.
3. How can the government make liberalisation politically sustainable without abandoning the reform programme?
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Political sustainability requires visible compensation and credible commitment. The government should protect the poor from the immediate price effects of devaluation and subsidy cuts through targeted food and employment programmes rather than universal subsidies. It should also compensate affected industrial workers with retraining and adjustment assistance, and publish the criteria for tariff reduction so that firms can plan.
A second requirement is to build a pro-reform coalition outside the bureaucracy: exporters, consumers, new entrepreneurs and state governments that benefit from deli censing. Reform announcements should be framed as restoring national autonomy after the humiliation of gold airlifts, not as surrender to the IMF. The government should also retain a strategic core of public investment in infrastructure and education, so that liberalisation is not identified with state withdrawal. Finally, it should institutionalise review through an independent committee, which makes reversals harder and gives the programme a basis in evidence rather than ideology.