Working Paper
Country Study 13

India's first two bouts of orthodox stabilization policy following independence were quite different. The first, prompted by a prolonged drought at home and the wars with China in 1962 and Pakistan in 1965, was relatively mild in form. The rupee was devalued, the elaborate panoply of export incentives and import restrictions was partially dismantled, but no real attempt was made to apply the fiscal and monetary brakes. The author argues that the psychological repercussions were greater than the economic. India had learnt that foreign aid could no longer be relied upon and even greater emphasis must be placed on generating resources internally.On the second occasion, reactions to the upsurge in inflation generated by the quadrupling of oil prices in 1973-74 and a prolonged agricultural slump at home were accordingly much more vigorous, and the fiscal and monetary brakes were slammed on hard. The author argues that, in the event, the toughness was excessive. The slump in agriculture was followed by a prolonged boom, which quickly punctured the upsurge in inflation; while the external balance was improved by a sustained rise in exports, especially to Opec countries, and a rapid build up in remittances from Indian migrant workers, again mostly in the Gulf. As a result, the main constraint on the Indian economy in the late 1970s was not foreign exchange, agriculture or domestic savings but aggregate demand.The author argues that this constraint was initiated by the stabilization policies of 1973-75 and perpetuated by the profound changes in income distribution which had been caused by those policies and the shocks which preceded them. These costs India could ill afford. Worse still, the changes had had the effect of increasing the economy's import propensity. The appropriate response to the second oil price shock, and to any future contingency, has therefore to be substantially different. In particular, the author argues the case for an alternative package centred on a multi-tier exchange rate regime.