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Financial Sector Reforms in India

Financial Sector Reforms in India



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Published by Abhijit Jadhav

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Published by: Abhijit Jadhav on Sep 23, 2009
Copyright:Attribution Non-commercial


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The period immediately after independence posed a major challenge to thecountry. Due to centuries of exploitation at the hands of foreign powers, therewere very high levels of deprivation in the economy
both social as well aseconomic. To take up the Herculean task of rapid growth with socio-economic justice, the country adopted the system of planned economic development afterindependence. Due to paucity of economic resources and limitations of availability of capital for investment, the government also came up with the policyof setting up public enterprises in almost every field.The fiscal activism adopted by the government resulted in large doses of publicexpenditures for which not only the revenues of the government were utilizedbut the government also resorted to borrowing at concessional rates, which keptthe financial markets underdeveloped. The growth of fiscal deficit also continuedunabated year after year. Complex structure of interest rates was a resultantoutcome of this system.Nationalisation of major commercial banks in the late sixties and early seventiesprovided the government with virtually the complete control over the direction of the bank credit. The emphasis was mainly on control and regulation and themarket forces had very limited role to play.
The economic system was working to the satisfaction of the government. Thesocial indicators were gradually improving and the number of people belowpoverty line also declined steadily. The only problem area had been that thegrowth rate of the economy had been very low, and till late seventies, the growthrate of the GDP was hovering around 3.5 per cent per annum. It was only duringmid-eighties that the growth rate touched 5 percentage points.The situation became difficult by the eighties. Financial system was considerablystretched and artificially directed and concessional availability of credit withrespect to certain sectors resulted in distorting the interest rate mechanism. Lackof professionalism and transparency in the functioning of the public sector banksled to increasing burden of non-performance of their assets.Late eighties and early nineties were characterised by fluid economic situation inthe country. War in the Middle East had put tremendous pressure on thedwindling foreign exchange reserves of the country. The country witnessed theworst shortages of the petroleum products. High rate of inflation was anotherarea of serious concern. Most of the economic ailments had resulted due to overregulation of the economy. The international lending and assisting agencies wereready to extend assistance but with the condition that the country went in forstructural reforms, decontrols and deregulation, allowing increased role for themarket forces of demand and supply.The precarious economic conditions left the country with no alternative otherthan acceptance of the conditions for introducing the reforms.
Post Reforms
Rationalisation of the taxes has already taken place on the basis of therecommendations of Raja Challiah Committee Report during mid-nineties. Thegovernment has been able to tighten its fiscal management through the FRBMAand the continuing increase in the fiscal deficit has been contained significantly.Reforms in the external sector management have yielded results in the form of increased foreign capital inflows in terms of Foreign Direct Investment (FDI),Foreign Institutional Investment (FII) and the exchange rate has also representtrue international value of Indian rupee vis-à-vis hard global currencies.The primitive foreign exchange regulation regime controlled by FERA has beenreplaced by a liberalized foreign exchange rate management system introducedby FEMA. Introduction of such a modern management law was perhaps a pre-condition for allowing FDI and FII. In 1993, the RBI issued guidelines to allow theprivate sector banks to enter the banking sector in the country, a virtual reversalof the policy of bank nationalisation. Foreign banks were also given more liberalentry.The thrust of the monetary policy after the introduction of the process of reformshas been able to develop several instruments of efficient financial management. ALiquidity Adjustment Facility (LAF) was introduced in June 2000 to preciselymodulate short-term liquidity and signal short-term interest rates. A lot of reliance is being placed on indirect instruments of monetary policy. Strengthening

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A general discussion about Banking Sector Reforms. This can be made still informative by adding more details on various committees, and statistics

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