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India: Monetary Process
Country Study > Chapter 6 > Character and Structure of the Economy > Finance > Monetary Process

MONETARY PROCESS


The basic elements of the financial system were established during British rule (1757-1947). The national currency, the rupee, had long been used domestically before independence and even circulated abroad, for example, in the Persian Gulf region. Foreign banks, mainly British and including some from such other parts of the empire as Hong Kong, provided banking and other services. The Reserve Bank of India was formed in 1935 as a private bank, but it also carried out some central bank functions. This colonial banking system, however, was geared to foreign trade and short-term loans. Banking was concentrated in the major port cities.

The Reserve Bank was nationalized on January 1, 1949, and given broader powers. It was the bank of issue for all rupee notes higher than the one-rupee denomination; the agent of the Ministry of Finance in controlling foreign exchange; and the banker to the central and state governments, commercial banks, state cooperative banks, and other financial institutions. The Reserve Bank formulated and administered monetary policy to promote stable prices and higher production. It was given increasing responsibilities for the development of banking and credit and to coordinate banking and credit with the five-year plans. The Reserve Bank had a number of tools with which to affect commercial bank credit.

After independence the government sought to adapt the banking system to promote development and formed a number of specialized institutions to provide credit to industry, agriculture, and small businesses. Banking penetrated rural areas, and agricultural and industrial credit cooperatives were promoted. Deposit insurance and a system of postal savings banks and offices fostered use by small savers. Subsidized credit was provided to particular groups or activities considered in need and which deserved such help. A credit guarantee corporation covered loans by commercial banks to small traders, transport operators, self-employed persons, and other borrowers not otherwise effectively covered by major institutions. The system effectively reached all kinds of savers and provided credit to many different customers.

The government nationalized fourteen major private commercial banks in 1969 and six more in 1980. Nationalization forced commercial banks increasingly to meet the credit requirements of the weaker sections of the nation and to eliminate monopolization by vested interests of large industry, trade, and agriculture.

The banking system expanded rapidly after nationalization. The number of bank branches, for instance, increased from about 7,000 in 1969 to more than 60,000 in 1994, two-thirds of which were in rural areas. The deposit base rose from Rs50 billion in 1969 to around Rs3.5 trillion in 1994. Nevertheless, currency accounted for well over 50 percent of all the money supply circulating among the public. In 1992 the nationalized banks held 93 percent of all deposits.

In FY 1990, twenty-three foreign banks operated in India. The most important were ANZ Grindlays Bank, Citibank, the Hongkong and Shanghai Banking Corporation, and Standard Chartered Bank.

Public-sector banks are required to reserve their lending based on 40 percent of their deposits for priority sectors, especially agriculture, at favorable rates. In addition, 35 percent of their deposits have to be held in liquid form to satisfy statutory liquidity requirements, and 15 percent are needed to meet the cash reserve requirements of the Reserve Bank. Both these percentages represent an easing of earlier requirements, but only a small proportion of public-sector banks' resources can be deployed freely. In late 1994, the rate of interest on bank loans was deregulated, but deposit rates were still subject to ceilings.

More than 50 percent of bank lending is to the government sector. With the onset of economic reform, India's banks were experiencing major financial losses as the result of low productivity, bad loans, and poor capitalization. Seeking to stabilize the banking industry, the Reserve Bank of India developed new reporting formats and has initiated takeovers and mergers of smaller banks that were operating with financial losses.

India has a rapidly expanding stock market that in 1993 listed around 5,000 companies in fourteen stock exchanges, although only the stocks of about 400 of these companies were actively traded. Financial institutions and government bodies controlled an estimated 45 percent of all listed capital. In April 1992, the Bombay stock market, the nation's largest with a market capital of US$65.1 billion, collapsed, in part because of revelations about financial malpractice amounting to US$2 billion. Afterward, the Securities and Exchange Board of India, the government's capital market regulator, implemented reforms designed to strengthen investor confidence in the stock market. In the mid-1990s, foreign institutional investors took greater interest than ever before in the Indian stock markets, investing around US$2 billion in FY 1993 alone.

Despite increases in energy costs and other pressures from the world economy, for most of the period since independence India has not experienced severe inflation. The underlying average rate of inflation, however, has tended to rise. Consumer prices rose at an annual average of 2.1 percent in the 1950s, 6.3 percent in the 1960s, 7.8 percent in the 1970s, and 8.5 percent in the 1980s.

Three factors lay behind India's relative price stability. First, the government has intervened, either directly or indirectly, to keep stable the price of certain staples, including wheat, rice, cloth, and sugar. Second, monetary regulation has restricted growth in the money supply. Third, the overall influence of the labor unions on wages has been small because of the weakness of the unions in India's labor surplus economy.

Data as of September 1995




Last Updated: September 1995


Editor's Note: Country Studies included here were published between 1988 and 1998. The Country study for India was first published in 1995. Where available, the data has been updated through 2008. The date at the bottom of each section will indicate the time period of the data. Information on some countries may no longer be up to date. See the "Research Completed" date at the beginning of each study on the Title Page or the "Data as of" date at the end of each section of text. This information is included due to its comprehensiveness and for historical purposes.

Note that current information from the CIA World Factbook, U.S. Department of State Background Notes, Australia's Department of Foreign Affairs and Trade Country Briefs, the UK's Foreign and Commonwealth Office's Country Profiles, and the World Bank can be found on Factba.se.

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