Daily Answer Writing
01 July 2021

Q) Analyze the role played by the Reserve bank of India during liberalization and its impact on the Indian economy. (250 Words)

Source: <https://www.business-standard.com/article/economy-policy/reserve-bank-of-india-the-real-hero-of-the-1991-economic-reforms-121070100027_1.html>

GS 3: Effects of Liberalization

Approach Answer:

Introduction: Liberalization means to end restrictions and open up various sectors of the economy. In the July 1991 major economic reforms were announced under great duress in this regard. Throughout the 1990s, the RBI initiated and executed one reform after another in the financial sector. The direction was unambiguous: Removal of government controls on the financial sector.

 

Steps taken by the RBI spearheaded by the then RBI governor C. Rangarajan:

              1. Better regulations: The RBI slowly put in place sturdy systems to regulate the financial markets. The Securities and Exchange Board of India had not yet grown into the regulator it has become now and the RBI, because of its age and experience, was very much the elder brother.

              2. Monetary Policy Independence: It allowed the RBI to declare monetary policy changes on its own. This has been a practice since 1997. The RBI would lay down the broad guidelines and principles and the banks would be free to do pretty much as they wished within those parameters.

              3. Greater market freedom: RBI allowed banks to open & close branches at will. Eased inter-bank lending on Bank rates.

              4. Easing Priority sector requirements: PSL guidelines were diluted & SIDBI was formed in 1990; Now PSL target shortfall funds were shared by both NABARD and SIDBI.

              5. Ease in Agricultural Loans: Banks were allowed to lend to activities that were remotely connected with agriculture or  in agri-business, yet classify them as agricultural loans.

              6. Foreign exchange markets: greater integration with global markets was being envisaged, for this it stopped the micro-management of the financial markets. A Liberalised NERA (the New Exchange Rate Arrangement) was recommended by an expert committee of the RBI, which was silently adopted.

              7. Delinking Budget deficit from monetization: Basically, this meant the RBI would stop printing notes to finance the excess of government expenditure over revenue. This gave the RBI much greater flexibility in monetary management. The Union Budget for 1994-95 had announced that there would be a limit on resort to the RBI for ad hoc Treasury Bills by the Central government.

              8. Foreign Exchange Management Act (FEMA). The RBI was consulted in the drafting of the law and the new thinking was very different from the one that had led to FERA in the 1970s it was more flexible than earlier regulations.

In short, it was the RBI that was the real hero of the 1991 reforms. It’s time for the three finance ministers of that decade to say so.

 

Impact:

  • Positive impacts:

        Diversification in Banking sector: Total non-food credit which used to hover below 20% of the total credit before 1991 is now around 50%.

        Growth in the Economy: The economy showed the average growth rate of GDP at 8% post liberalization period till 2011.

        Rise in foreign exchange: India currently has a foreign exchange of more than $600 billion which is much higher than in 1991 which was negligible.

        Fall in interest rates: The Repo rate in the 1990s hovered at around 10% which is now consistently below 5% boosting the economy and the consumption.

        

Negative impacts:

Fall in Institutional Credit: By 2002 Institutional credit fell from 64% to 57.1%.

Rural Branches closed: More than 900 rural bank branches closed down across the country.

Fall in agricultural credit: Rate of agricultural credit growth fell sharply from around 7%/ annum in 1980s to about 2%/annum in 1990s.

 

Conclusion: The impact of the liberalization on the financial sector of the country largely remained positive. However, it negatively impacted the unorganized sector. For this in 2005, New Branch Authorization Policy was announced with allowed permission to new branches only if RBI was satisfied that the banks had a plan to adequately serve under-banked areas to ensure actual credit flow to agriculture and 25% of new branches were to be opened in rural areas.

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