Emerging Issues in Banking and Financial Sector in India

I. PREREFORM FINANCIAL SYSTEM IN INDIA AND RATIONALE FOR REFORMS The Indian financial sector today is significantly different from what it used to be a few decades back, in the 1970s and 1980s. The Indian financial system of the pre-reform period essentially catered to the needs of planned development in a mixed-economy framework where the Government sector had a predominant role in economic activity. Fiscal activism to kick start economic growth took the form of large developmental expenditures by the public sector, much of it to finance long-gestation projects requiring long-term finance. This necessitated large borrowings by the Government and to facilitate the large borrowing requirements of the Government, interest rates on Government securities were artificially pegged at low levels, quite unrelated to market conditions. The accommodative fiscal stance had to be supported by issuances of ad hoc treasury bills (issued on tap at 4.6 per cent) leading to high levels of monetisation of fiscal deficit during the major part of the eighties. In order to check the monetary effects of such large-scale monetisation, the cash reserve ratio (CRR) was increased frequently to control liquidity. Thus, the financial sector prior to the 1990s was characterised by various features as detailed below.