ABSTRACT
In India, the Reserve Bank of India (RBI) Act sets out the central bank’s objectives as being ‘to regulate the issue of the bank notes and the keeping of reserves with a view to securing monetary stability and generally to operate the currency and credit system of the country to its advantage’. These objectives have generally been interpreted as price stability and economic growth, and they have remained unchanged since the enactment of this Act in 1934, though their relative emphasis has changed depending on the prevailing circumstances (Reddy, 2005: 222). In contrast, monetary policy procedures in India have undergone significant changes which reflect financial sector reform begun in the early 1990s. Prior to the reform, the RBI had long been constrained by government fiscal management.
For instance, government budget deficits were mainly financed by the central bank through the issuance of 91-day ad hoc Treasury Bills as well as the pre-emption of the commercial banks’ resources under the Statutory Liquidity Ratio (SLR) requirement. Additionally, monetary expansion emanating from deficit financing was accommodated through an increase in the Cash Reserve Ratio (CRR) requirement.1 As a part of financial reform, however, in September 1994, the RBI entered into an agreement with the government to limit the issuance of 91-day Bills and these were finally eliminated in April 1997. Further, the CRR and the SLR have been gradually reduced, and the CRR is now used as a complementary operating instrument. As a result, the RBI has reined in the automatic monetization of budget deficits and has successfully increased its operational independence in monetary policy management. In terms of operating instruments, during the 1990s, the RBI gradually shifted the emphasis from
direct instruments such as the CRR to market-based instruments, and has expanded the array at their command. In April 1997, the RBI reactivated the bank rate by linking it to all other interest rates, and this is now used to signal the medium-term stance of monetary policy. Moreover, against the surge of capital inflows in the latter half of the 1990s, the RBI implemented open market sales to sterilize the monetary impact, and in June 2000 introduced a fully fledged liquidity adjustment facility (LAF) to modulate day-to-day liquidity conditions.2 A series of these indirect instruments has been available following deregulation of the administered interest rate structure, the development of a government securities market, and the increased integration of different financial markets.
