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Financial Sector Reforms in India
Reforms is an ongoing
process and a few
reforms here and there
keep taking place in
any economic system
as per the needs of
time. But economic
reforms in the Indian
economy in true sense
took place only after
the economic crisis
during 1991. Though
the reforms were wide
ranging and
encompassed all the
sectors of the economy,
yet the focus of all
economic reforms in
the country has been
on the financial and
external sectors’
overhauling. The
process of financial
reforms is still on; only
their speed varies and
the focus keeps getting
shifted from one issue
to the other. With the
Draft Report of
Raghuram Rajan
Committee on Financial
Sector Reforms already
submitted, a lot more
changes are on the
anvil.
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T
he period immediately after
independence posed a major
challenge to the country. Due to
centuries of exploitation at the
hands of foreign powers, there were very
high levels of deprivation in the economy—
both social as well as economic. To take up
the Herculean task of rapid growth with
socio-economic justice, the country
adopted the system of planned economic
development after independence. Due to
paucity of economic resources and
limitations of availability of capital for
investment, the government also came up
with the policy of setting up public
enterprises in almost every field.
The fiscal activism adopted by the gov-
ernment resulted in large doses of public
expenditures for which not only the
revenues of the government were utilized
but the government also resorted to bor-
rowing at concessional rates, which kept
the financial markets underdeveloped. The
growth of fiscal deficit also continued
unabated year after year. Complex struc-
ture of interest rates was a resultant out-
come of this system.
Nationalisation of major commercial
banks in the late sixties and early seventies
provided the government with virtually the
complete control over the direction of the
bank credit. The emphasis was mainly on
control and regulation and the market
forces had very limited role to play.
The economic system was working to
the satisfaction of the government. The
social indicators were gradually improving
and the number of people below poverty
line also declined steadily. The only
problem area had been that the growth rate
of the economy had been very low, and till
late seventies, the growth rate of the GDP
was hovering around 3.5 per cent per
annum. It was only during mid-eighties
that the growth rate touched 5 percentage
points.
The situation became difficult by the
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ARTICLE
eighties. Financial system was considerably
stretched and artificially directed and con-
cessional availability of credit with respect
to certain sectors resulted in distorting the
interest rate mechanism. Lack of profes-
sionalism and transparency in the func-
tioning of the public sector banks led to
increasing burden of non-performance of
their assets.
Late eighties and early nineties were
characterised by fluid economic situation
in the country. War in the Middle East had
put tremendous pressure on the dwindling
foreign exchange reserves of the country.
The country witnessed the worst shortages
of the petroleum products. High rate of
inflation was another area of serious
Contents or Translation of contents of this document must not be reproduced in any manner without prior permission.
concern. Most of the economic ailments
had resulted due to over regulation of the
economy. The international lending and
assisting agencies were ready to extend
assistance but with the condition that the
country went in for structural reforms,
decontrols and deregulation, allowing
increased role for the market forces of
demand and supply.
The precarious economic conditions
left the country with no alternative other
than acceptance of the conditions for
introducing the reforms.
Post Reforms
R
ationalisation of the taxes has
already taken place on the basis of
the recommendations of Raja
Challiah Committee Report during
mid-nineties. The government has been
© The Competition Master.
able to tighten its fiscal management
through the FRBMA and 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 represent true international value of
 ARTICLE
Indian rupee vis-à-vis hard global
currencies.
The primitive foreign exchange
regulation regime controlled by
FERA 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. In
1993, the RBI issued guidelines to
allow the private sector banks to
enter the banking sector in the coun-
try, a virtual reversal of the policy of
bank nationalisation. Foreign banks
were also given more liberal entry.
The thrust of the monetary
policy after the introduction of the
process of reforms has been able to
develop several instruments of effi-
cient financial management. A
Liquidity Adjustment Facility (LAF)
was introduced in June 2000 to pre-
cisely modulate short-term liquidity
and signal short-term interest rates.
A lot of reliance is being placed on
indirect instruments of monetary
policy. Strengthening and upgrada-
tion of the institutional, technologi-
cal and physical infrastructure in the
financial markets has also improved
the financial framework in the
country.
Economy and Reforms
T
he introduction of financial
sector reforms has provided
the economy with a lot of
resilience and stability. The
average annual growth rate of the
economy during the post-reform
period has been more than 6 per
cent, which was unimaginable a
decade before that. The economy
withstood boldly the Asian
economic crisis of 1997-98. Even the
economic sanctions by the US and
other developed countries after the
nuclear testing did not affect the
economy to the extent apprehended.
The current global slowdown and
sub-prime crisis affecting the
banking system all over the world
has not impacted the Indian
economy to that extent.
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Banking and insurance sectors
are booming. While the private and
foreign banks are giving stiff but
healthy competition to the public
sector banks, resulting in overall
improvements in the banking servic-
es in the country, the insurance sec-
tor has also witnessed transforma-
tion. The consumer is a gainer with
the availability of much better and
diversified insurance products.
The stock exchanges in the
country are in the process of adopt-
ing the best practices all over the
world. The RBI has also been able to
control and regulate effectively the
While the reforms are expected
to aim at reforming the entire
financial sector, it is also the
responsibility of the
government to ensure that the
financial system helps in
reducing the incidence of
poverty.
operations and growth of the Non-
Banking Financial Companies
(NBFCs) in the country.
A few changes which are on the
anvil pertain to the legal provisions
relating to fiscal and budget man-
agement, public debt, deposits,
insurance etc. As per the Finance
Minister, future reforms by making
legal changes also pertain to bank-
ing regulations, Companies Act,
Income Tax, Bankruptcy, negotiable
instruments etc.
But there are certain issues that
call for more cautious approach
towards the financial sector reforms
in the future. The social sector
indicators—like availability of
doctor per 1000 population,
availability of health institutions,
quality of elementary education,
literacy rate, particularly among the
females—are some of the areas of
serious concern. Countries like
China, Indonesia and even Sri Lanka
are much better than India in most
of the social sector indicators.
Despite being among the most
rapidly developing economies of the
world, the literacy rate and poverty
percentage are two biggest embar-
rassments and the country still lan-
guishes at 128th position in the
Human Development Index of the
UNDP, where it is virtually stagnat-
ing for the last about five years. Fur-
ther, the systems should also be able
to check any unusual rise in prices
to protect the common man from
inflation.
One of the major criticisms of
the government policy has been that
the reforms have lacked the human
face, as the government has been
over-obsessed with the idea of
achieving higher growth rate and
fiscal and monetary management,
rather than addressing the needs for
equitable and inclusive growth. The
reforms process has ignored the
common man and the trickle down
theory has actually failed to deliver.
The Planning Commission, while
finalising the Eleventh Five-Year Plan
has now sought to achieve the
overall objective of achieving the
‘inclusive growth’, i.e., to include all
those in the process of economic
growth, who has remained excluded
from the process of economic
growth experienced by the country
during the past decades.