Echoes of 1990-91? Energy shock revives concerns over economic stability

Let us hope that 2026-27 will remind us of 1991-92, when economic policy shifted from increased foreign and domestic borrowing to implementing serious policy reforms

It has been 17 months since I last contributed a column to Business Standard “Macro signals flashing amber” (January 16, 2025). Today those signals are “locked and loaded” at red, to use Pete Hegseth’s favourite phrase. 

Last month, the Prime Minister emphasised the gravity of India’s economic predicament in today’s difficult global circumstances. 

In some ways, the situation is eerily reminiscent of 1990-91. Back then, the US-Iraq-Kuwait war had sharply increased the global prices of oil and gas and thus delivered a serious terms of trade shock to all major oil-importing nations like India. Today, the three-month-old massive assault on Iran by America and Israel and the consequent closure of the Strait of Hormuz have ramped up oil prices by over 50 per cent, with experts warning of even higher prices in the near future, as government and private stocks run down globally. 

By 1990-91 India’s balance of payments (BoP) had already been under severe pressure because of low exports and high fiscal deficits for several years as well as a strong policy aversion to foreign private investment. By 2025-26, India’s share of goods exports had fallen to 11 per cent of gross domestic product (GDP) from a peak of 17 per cent average in 2011-14.  The impact of this substantial decline in goods exports on the BoP current account deficit was masked by the surge in services exports and buoyancy of remittances from abroad during this period. But the recent, massive energy shock and associated jump in payments for oil and gas have highlighted the long-standing weakness in goods exports. The trend decline in its share of GDP has been due to several factors, whose influence has varied over time. One oft-underestimated cause has been the inexorable, cost-raising increase in India’s customs tariffs since 2014. The World Trade Organization data show that for non-agricultural goods, the share of tariff lines in the category 10-15 per cent increased sharply from 1.4 per cent to 33.5 per cent between 2014 and 2024 and for the tariff category 15-25 per cent from 1.7 per cent to 14.9 per cent, while the share of tariff lines in the category 0-10 per cent fell steeply from 90.5 per cent to 42.5 per cent over the same period. 

In the BoP capital account the significant decline in net foreign direct investment from annual levels of $30-40 billion to an average of just $6 billion in the last three years has aggravated the overall pressure on the BoP. Much of this sharp decline is attributable to surges in repatriation and outbound investment, both possibly signalling deterioration in the domestic investment climate. Net foreign portfolio investment also has been volatile with a strong negative bias. So, for the first time in India’s history, India’s balance of payments has come under severe pressure on both the current and capital accounts at the same time. 

The combined fiscal deficit of about 7.7 per cent of GDP in 2025-26 is clearly better than in 1990-91. But it is still high in comparison to major developing countries and our own history (such as in 2005-08). Together with our government debt to GDP ratio of over 80 per cent, it leaves very little fiscal space for manoeuvre. 

On the positive side, the government and Reserve Bank of India (RBI) have allowed the market-responsive exchange rate to depreciate, with some attempts to slow the decline by the use of forex reserves; quite different from 1990-91, when India had a fixed (to an undisclosed basket of currencies) rate system. Less positively, the government has been slow to pass on the rising oil, gas and fertiliser prices to users, preferring a mix of tax reductions, mounting losses of oil- and gas-marketing companies, increasing fertiliser subsidies and various forms of informal rationing of scarce energy.  A few days ago, the government and RBI announced a programme to induce more foreign borrowing by eliminating taxes on interest and capital gains accruing to foreign institutional investors in government bonds and protecting a category of NRI (Non-Resident Indian) fresh deposits from exchange risk by bearing the hedging cost. 

The common features of these policy responses have been a willingness to incur a higher fiscal deficit by the government and resort to greater foreign borrowing to offset the pressures on the BoP. They are justifiable as initial responses to an external energy shock, coming on top of extant weaknesses, such as in exports, foreign direct investment and fiscal parameters of deficits and debt. They buy time to implement policy adjustments that are necessary to achieve more durable and desirable outcomes in terms of economic growth and macro stability, both external and internal. They do not, by themselves, constitute a durable solution. 

If 2025-26 is reminiscent of 1990-91, let us hope that 2026-27 will remind us of 1991-92, when economic policy shifted from increased foreign and domestic borrowing to actually implementing a broad range of serious policy reforms. Given limited space, I will limit myself to suggesting reforms in three broad areas. 

First, we need to greatly improve our goods exports performance. The exchange rate depreciation to date should certainly help. We also need to roll back the customs tariff increases that have occurred in the decade plus since 2014 and move further to bring our tariffs down to the levels of Southeast Asian nations. A policy announcement of our intention should be backed by an across the board cut of 10-15 percentage points in all our tariffs on manufactured goods. No nation has become a successful manufacturing exporter while having the high, protective tariffs that we currently have. 

Second, recognising the overly restrictive weaknesses of our 2016 Model Bilateral Investment Treaty (BIT), the Budget speech of February 2025 had promised a full-scale review to make the BITs much more investor-friendly. It is high time the necessary policy changes were announced. These policies should also take account of the underlying causes of recent surges in repatriation and outbound investment. 

Third, current tax and subsidy policies point to a substantial and undesirable increase in the central government’s budgeted fiscal deficit of 4.3 per cent of GDP in 2026-27. This would fuel inflation, raise interest rates and crowd out private investment. Aside from accelerating necessary increases in energy prices, the government should implement the oft-recommended major reform of the fertiliser subsidy mechanism by moving to a system of direct benefit transfers to farmers on a per hectare basis. Reducing the exemption limit in the current personal income tax system would also raise revenues.

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The author is Honorary Professor at ICRIER, Chancellor of the Central University of Andhra Pradesh and former Chief Economic Adviser to the Government of India. The views expressed are personal