Changing Roles

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Founded under colonial rule in 1935, the Reserve Bank of India, until shortly after independence confined itself mainly to “traditional” central banking functions, including being a banker to the government and issuing currency notes. It was in the years following 1951, also the year of the launch of the First Five-Year Plan, that the bank’s role and charge underwent considerable transformation. The RBI was called upon to focus on plan financing, institution building and providing a stable financial environment for growth in a nascent economy. This was also the period when the automatic monetisation of the deficit – through the issue of ad hoc treasury bills if the government’s weekly balance fell below Rs 50 crore – commenced. Social control over banks was extended in order to address hitherto neglected “priority” sectors through the Banking Laws Bill, 1967 and the subsequent nationalisation of banks in 1969 and 1980. The changed environment of the 1970s, characterised by high inflation, a mounting fiscal deficit and the breakdown of the Bretton Woods system, led to the shift towards a monetarist approach, with the introduction of a “formal framework of monetary policy” targeting broad money (M3), as recommended by the Chakravarty Committee. By the 1980s the stresses of the geographic expansion of the bank network and a highly controlled and segmented financial market were telling on banks’ profitability and balance sheets. In 1992, financial sector reforms to improve the efficiency of financial intermediation and integrate it globally were undertaken according to the blueprint provided by the Narasimham Committee, and continue until this day. Reforms in the banking sector, debt market and external sector have taken place and the monetary policy framework has changed to promote financial deregulation and market development. The central bank has, in the process, gone from using more direct forms of control for monetary management to indirect instruments that have recast its role as a facilitator and regulator, rather than as principal actor.

Critically, what remains to be done though is legislating for the constitutional independence of the central bank itself, which has so far enjoyed limited functional autonomy from the government of India, partly because of its dependent status as encoded in the RBI Act, 1934. Central bank independence, no matter how fuzzy the concept, would not necessarily imply the lack of accountability, but rather insulate “monetary policy from partisan politics” (EPW, August 27, 2005). Similarly, transparency in the functioning of the RBI remains as yet a distant goal and it is unfortunate that the report has not dealt adequately with this question.

EPW

Economic and Political Weekly March 25, 2006