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The period immediately afterindependence posed a majorchallenge to the country. Due tocenturies of exploitation at the

hands of foreign powers, there were veryhigh levels of deprivation in the economy—both social as well as economic. To take upthe Herculean task of rapid growth withsocio-economic justice, the countryadopted the system of planned economicdevelopment after independence. Due topaucity of economic resources andlimitations of availability of capital forinvestment, the government also came upwith the policy of setting up publicenterprises in almost every field.

The fiscal activism adopted by the gov-ernment resulted in large doses of publicexpenditures for which not only the revenues of the government were utilizedbut the government also resorted to bor-rowing at concessional rates, which keptthe financial markets underdeveloped. Thegrowth of fiscal deficit also continuedunabated year after year. Complex struc-ture of interest rates was a resultant out-come of this system.

Nationalisation of major commercialbanks in the late sixties and early seventiesprovided the government with virtually thecomplete control over the direction of thebank credit. The emphasis was mainly oncontrol and regulation and the marketforces had very limited role to play.

The economic system was working tothe satisfaction of the government. Thesocial indicators were gradually improvingand the number of people below povertyline also declined steadily. The onlyproblem area had been that the growth rateof the economy had been very low, and tilllate seventies, the growth rate of the GDPwas hovering around 3.5 per cent perannum. It was only during mid-eightiesthat the growth rate touched 5 percentagepoints.

The situation became difficult by the

eighties. Financial system was considerablystretched and artificially directed and con-cessional availability of credit with respectto certain sectors resulted in distorting theinterest rate mechanism. Lack of profes-sionalism and transparency in the func-tioning of the public sector banks led toincreasing burden of non-performance oftheir assets.

Late eighties and early nineties werecharacterised by fluid economic situationin the country. War in the Middle East hadput tremendous pressure on the dwindlingforeign exchange reserves of the country.The country witnessed the worst shortagesof the petroleum products. High rate ofinflation was another area of serious concern. Most of the economic ailmentshad resulted due to over regulation of theeconomy. The international lending andassisting agencies were ready to extendassistance but with the condition that thecountry went in for structural reforms,decontrols and deregulation, allowingincreased role for the market forces ofdemand and supply.

The precarious economic conditionsleft the country with no alternative otherthan acceptance of the conditions forintroducing the reforms.

Post Reforms

Rationalisation of the taxes hasalready taken place on the basis ofthe recommendations of RajaChalliah Committee Report during

mid-nineties. The government has beenable to tighten its fiscal managementthrough the FRBMA and the continuingincrease in the fiscal deficit has beencontained significantly. Reforms in theexternal sector management have yieldedresults in the form of increased foreigncapital inflows in terms of Foreign DirectInvestment (FDI), Foreign InstitutionalInvestment (FII) and the exchange rate hasalso represent true international value of

Financial Sector Reforms in India

ARTICLE

Reforms is an ongoingprocess and a fewreforms here and therekeep taking place inany economic systemas per the needs oftime. But economicreforms in the Indianeconomy in true sensetook place only afterthe economic crisisduring 1991. Thoughthe reforms were wideranging andencompassed all thesectors of the economy,yet the focus of alleconomic reforms inthe country has beenon the financial andexternal sectors’overhauling. Theprocess of financialreforms is still on; onlytheir speed varies andthe focus keeps gettingshifted from one issueto the other. With theDraft Report ofRaghuram RajanCommittee on FinancialSector Reforms alreadysubmitted, a lot morechanges are on theanvil.

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ARTICLE

Indian rupee vis-à-vis hard globalcurrencies.

The primitive foreign exchangeregulation regime controlled byFERA has been replaced by a liberal-ized foreign exchange rate manage-ment system introduced by FEMA.Introduction of such a modern man-agement law was perhaps a pre-condition for allowing FDI and FII. In1993, the RBI issued guidelines toallow the private sector banks toenter the banking sector in the coun-try, a virtual reversal of the policy ofbank nationalisation. Foreign bankswere also given more liberal entry.

The thrust of the monetary policy after the introduction of theprocess of reforms has been able todevelop several instruments of effi-cient financial management. A Liquidity Adjustment Facility (LAF)was introduced in June 2000 to pre-cisely modulate short-term liquidityand signal short-term interest rates.A lot of reliance is being placed onindirect instruments of monetarypolicy. Strengthening and upgrada-tion of the institutional, technologi-cal and physical infrastructure in thefinancial markets has also improvedthe financial framework in the country.

Economy and Reforms

The introduction of financialsector reforms has providedthe economy with a lot ofresilience and stability. The

average annual growth rate of theeconomy during the post-reformperiod has been more than 6 percent, which was unimaginable adecade before that. The economywithstood boldly the Asianeconomic crisis of 1997-98. Even theeconomic sanctions by the US andother developed countries after thenuclear testing did not affect theeconomy to the extent apprehended.The current global slowdown andsub-prime crisis affecting thebanking system all over the worldhas not impacted the Indianeconomy to that extent.

Banking and insurance sectorsare booming. While the private andforeign banks are giving stiff buthealthy competition to the publicsector banks, resulting in overallimprovements in the banking servic-es in the country, the insurance sec-tor has also witnessed transforma-tion. The consumer is a gainer withthe availability of much better anddiversified insurance products.

The stock exchanges in thecountry are in the process of adopt-ing the best practices all over theworld. The RBI has also been able tocontrol and regulate effectively the

operations and growth of the Non-Banking Financial Companies(NBFCs) in the country.

A few changes which are on theanvil pertain to the legal provisionsrelating to fiscal and budget man-agement, public debt, deposits,insurance etc. As per the FinanceMinister, future reforms by makinglegal changes also pertain to bank-ing regulations, Companies Act,Income Tax, Bankruptcy, negotiableinstruments etc.

But there are certain issues thatcall for more cautious approachtowards the financial sector reformsin the future. The social sectorindicators—like availability ofdoctor per 1000 population,availability of health institutions,quality of elementary education,literacy rate, particularly among thefemales—are some of the areas ofserious concern. Countries like

China, Indonesia and even Sri Lankaare much better than India in mostof the social sector indicators.

Despite being among the mostrapidly developing economies of theworld, the literacy rate and povertypercentage are two biggest embar-rassments and the country still lan-guishes at 128th position in theHuman Development Index of theUNDP, where it is virtually stagnat-ing for the last about five years. Fur-ther, the systems should also be ableto check any unusual rise in pricesto protect the common man frominflation.

One of the major criticisms ofthe government policy has been thatthe reforms have lacked the humanface, as the government has beenover-obsessed with the idea ofachieving higher growth rate andfiscal and monetary management,rather than addressing the needs forequitable and inclusive growth. Thereforms process has ignored thecommon man and the trickle downtheory has actually failed to deliver.

The Planning Commission, whilefinalising the Eleventh Five-Year Planhas now sought to achieve theoverall objective of achieving the‘inclusive growth’, i.e., to include allthose in the process of economicgrowth, who has remained excludedfrom the process of economicgrowth experienced by the countryduring the past decades.

While the reforms are expectedto aim at reforming the entirefinancial sector, it is also the

responsibility of thegovernment to ensure that the

financial system helps inreducing the incidence of

poverty.

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