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Kerala, 1956 to the Present
- India's Miracle State
- Tirthankar Roy, K. Ravi Raman
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- May 2024
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- 31 July 2024
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'Kerala is different, but not in the way we think.' Economic change in this southern state has fascinated economists. Most studies focused on the state's unusual human development, asked how a poor and economically stagnant state could achieve high levels of education and healthcare and pointed to politics and government policy to answer the question. Little of that scholarship took history seriously. History, this book says, shows that the foundations of human development were laid before the formation of the state and were owed to many factors besides politics. The striking thing about the state is its unusual income growth, which has been faster than most states since the 1990s. The question the authors ask is, 'How could an income-poor state break out of stagnation so dramatically?' The answers consider past globalisation, labour mobility, a legacy of welfare spending, and the positive ways these features interacted since India's economic reforms.
Southeast Asia. Merchants, bankers, governors: British enterprise in Singapore and Malaya, 1786–1920 By Peter J. Drake Singapore: World Scientific, 2018. Pp. xii + 194. Map, Bibliography, Notes, Index.
- Tirthankar Roy
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- Journal of Southeast Asian Studies / Volume 54 / Issue 3 / October 2023
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- 04 September 2023, pp. 553-554
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- October 2023
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12 - Rural Credit
- Tirthankar Roy, London School of Economics and Political Science
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- The Reserve Bank of India
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- 10 January 2023
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- 11 May 2023, pp 523-558
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Summary
Introduction
The preamble to the Reserve Bank of India (RBI) Act enjoins the Bank to operate the credit system to the advantage of the country, a country where most of the population lives in rural areas. Further, the Bank is required to ‘study various aspects of rural credit and development’ as it may consider necessary to do so for promoting integrated rural development. From the 1970s, this aim was achieved by means of directed credit, mainly ‘priority sector lending’. The policy directed banks to lend to agriculture, small enterprises, retail trade, microcredit, education and housing, subject to certain conditions. It started with nationalised banks in 1974 and was extended to private banks in 1978. In 1985, 40 per cent of bank credit was directed to flow to priority sectors, within which 25 per cent (10 per cent of the total advances) was to go to the ‘weaker sections’ of society. Weaker sections included small and marginal farmers with landholdings of less than 5 acres, landless labourers, artisans and ‘tiny’ enterprises with loan limits up to 50,000, beneficiaries of the government’s poverty alleviation programmes, Scheduled Caste/Scheduled Tribe (SC/ST) borrowers and members of self-help groups (SHGs). A separate sub-target of 16 per cent was fixed for agriculture in 1985 and raised to 18 per cent in 1990.
The financial sector reforms from 1992 underscored that banks and other financial institutions (FIs) had to become strong and efficient (see Chapter 10.1). The report of the Committee on the Financial System (Narasimham Committee I, 1991) recommended that the directed credit programme, being an anomaly in a ‘free market competitive system’, should be phased out. The Committee on Banking Sector Reforms (Narasimham Committee II, 1998) observed that ‘a high incidence of NPAs [non-performing assets or advances] could be traced to policies of directed credit’. Other reviews also recommended reforms and scaling down. But neither the government nor the Reserve Bank was ready to deprioritise the priority sector.
Still, as more emphasis was laid on operational freedom and profitability of banks, the Reserve Bank was under pressure to pause or go soft on directed lending and its rural focus. While it avoided a reversal of its policies, occasional wavering in its resolve could be observed.
Frontmatter
- Tirthankar Roy, London School of Economics and Political Science
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- The Reserve Bank of India
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6 - Financial Markets
- Tirthankar Roy, London School of Economics and Political Science
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- The Reserve Bank of India
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- 11 May 2023, pp 187-226
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Summary
Introduction
As a result of the ongoing financial market reforms of the previous decades, there was growing integration among the three main segments of the financial market – the money market, the government securities market and the foreign exchange market – with the money market acting as the fulcrum. But through a series of institutional and technological changes, the process was taken much further during the period of study. And as it continued, the role of financial markets in the economy was significantly enhanced. The chapter describes this process (Figures 6.1 and 6.2).
One of the broader objectives of the reform was to facilitate market integration. Market integration has obvious advantages. It allows economies of scale, more competition, and reduces prices and costs. It allows market participants more choice of investment instruments and allows them to spread risks. Integration also increases the effectiveness of regulation and policy. On the other hand, there is a risk. An integrated market may spread impulses arising in one market to the others, which can be beneficial if the impulse is a growth-inducing one, and hurtful if it is in the nature of a crisis. These expected gains and risks are of special interest to this chapter.
Within the money market, the call money market occupies a strategic position by serving as the equilibrating mechanism between day-to-day surpluses and deficits in the financial markets, and by transmitting the monetary policy impulses to the financial system quickly and efficiently. Consequently, it is the focal point for the Reserve Bank’s operations in influencing liquidity conditions. In the government securities market, major reforms were undertaken to deepen and widen the market, and thereby encourage transactions, and support these with financial accommodation under the liquidity adjustment facility, or LAF (see Chapter 3). The foreign exchange market grew in importance in the context of the large inflow of foreign funds and liberalisation of the foreign exchange regime. The foreign exchange market also operated in close affinity with the call money market on account of the day-to-day liquidity management operations of the Bank.
The rest of the chapter is divided into four main topics: an overview of major developments in the financial markets, the money market, the government securities market and the foreign exchange market.
Tables
- Tirthankar Roy, London School of Economics and Political Science
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9 - Currency Management
- Tirthankar Roy, London School of Economics and Political Science
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- The Reserve Bank of India
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Summary
Introduction
Currency management involves matching the supply of currency (notes and coins) to levels of demand, efforts to achieve self-sufficiency in the production of notes and coins, creating appropriate denomination mix, improvement in distribution networks, withdrawal and destruction of notes, and enhancement in the security features of currency notes. These responsibilities are discharged by the Department of Currency Management (DCM). The function of note issue and currency management is performed through the Reserve Bank’s regional issue offices and sub-offices, and a wide network of currency chests maintained by banks and government treasuries spread across the country. The Bank also coordinates with various agencies such as the note printing presses, mints, railways, police, Indian Airlines (subsequently known as Air India) and the Indian Air Force.
The activities of the Bank in this field encompass both policy matters and institutional measures. The former includes forecasting annual requirements of coins and notes, liaising with the printing presses and mints, and dealing with security issues and counterfeits jointly with other agencies of the government. The latter includes periodic allocation of notes and coins amongst the Bank’s regional offices, extending currency chest facilities to banks, processing and destruction of soiled notes, revision of policy and procedural guidelines on note exchange facility, adjudication of notes and responding to queries received in this regard, and various customer service issues.
Notwithstanding the decline in the share of currency in broad money after the nationalisation of banks (July 1969, see Figure 9.1), cash remained an important mode of payment in the Indian economy. During the reference period, currency in circulation was an important indicator of economic activity, especially in rural India. Cash demand tended to increase at the beginning of the month, when salaries were spent, and tapered off towards the end of themonth. Similarly, currency seasonality, by and large, mirrored events, such as festivals, elections and the seasonality of economic activity.
The importance of cash in the economy made currency management a particularly significant operation as these impacted the economic and social fabric of a vast segment of the population in one form or other. The long-run secular decline in the share of currency in broad money, however, continued.
Acknowledgements
- Tirthankar Roy, London School of Economics and Political Science
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Foreword
- Tirthankar Roy, London School of Economics and Political Science
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Summary
Unravelling the past in an objective and systematic manner brings with it many positive learnings that can shine a light on the path ahead. While grappling with contemporary complex policy dilemmas, a reference to institutional history often provides valuable guidance on time and context specific policy responses and their impact. I am happy to note that the documenting of its history by successive generations is entrenched as a living tradition in the Reserve Bank of India. This volume – The Reserve Bank of India (1997–2008), the fifth in the series – provides an absorbing and insightful account of central banking in India and the ethos in which it evolved over the period from 1997 to 2008. With this volume, the institutional history of the RBI has been recorded for 73 of the 87 years of its existence.
This volume has been prepared on the basis of documentary records and oral evidence provided by eminent central bankers and policy makers. Drawing on this repository of information, the volume provides a perspective on the developments and challenges over the reference period, that is, 1997–2008, which encompassed the Asian financial crisis and the initial phase of the global financial crisis in its ambit. During this period, India experienced high growth coupled with macroeconomic and financial stability, even as strong capital inflows posed significant challenges for exchange rate and monetary management.
Against this backdrop, a number of institutional and structural reforms were put in place by the RBI in coordination with the government. Important among them were the institution of the Liquidity Adjustment Facility (LAF), introduction of the Market Stabilisation Scheme (MSS) and prohibition of the RBI’s participation in primary auctions of government securities as part of fiscal responsibility legislation. Sector-specific refinancing facilities were phased out to enable liquidity management at a system level under the LAF. Amendment to the RBI Act in June 2006 removed the floor and ceiling on the cash reserve ratio (CRR) and the RBI was prohibited from payment of interest on CRR balances. Amendment to the Banking Regulation Act came into force in January 2007 which removed the floor rate of 25 per cent of the statutory liquidity ratio (SLR). All these reforms enhanced the flexibility and effectiveness of monetary policy considerably.
13 - Financial Inclusion
- Tirthankar Roy, London School of Economics and Political Science
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Summary
Introduction
The Banking Regulation Act, 1949, or the BR Act, vested sweeping powers with the Reserve Bank to regulate banking companies, essentially to protect the ‘interests of depositors’. Customer service, however, was a neglected field in banking, especially after the nationalisation of banks, as the number of bank branches and clients increased manifold.
The Reserve Bank recognised the problem early, but service quality continued to be a matter of concern. It was common in the 1970s for a customer to wait for twenty to thirty minutes to withdraw cash from the account or to make repeated visits to the branch to have the passbook updated. It took two days to get a cheque book, six hours to get a demand draft and at least one week to get a local cheque and four to six weeks to get an outstation cheque cleared. The Bank constituted a committee in 1990 to look into the causes of the persistence of poor customer service in banks. The recommendations of the committee included an extension of business hours for non-cash transactions, uninterrupted service at the counters, introduction of ‘may I help you’ desks, and a customer complaint book, among other measures.
The onset of the financial sector reforms in the 1990s gave greater operational freedom to banks. This, together with the introduction of technology, led to general improvement in services. New channels of delivery of service meant that the time taken for delivery of service was reduced. Increased competition, with the entry of new private banks in 1994–95, reinforced the tendency. But the entry of new players did not serve consumer interest significantly better than before. In the rural areas, often a single bank served a large number of people so that the benefits of competition remained limited. Further, the legal processes for establishing customer rights and entitlements were unaffordable in time and money.
As competition depressed interest income, there was pressure on banks to increase their non-interest income, and new charges were levied on the customer, such as the penalty for not maintaining a minimum balance in deposit accounts, using the service at a non-home branch, and premature loan repayment. The entry of ‘new generation’ banks (fully computerised from the start) and the adoption of new technology by all banks led to new problems.
14 - Communication Policy
- Tirthankar Roy, London School of Economics and Political Science
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- The Reserve Bank of India
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- 10 January 2023
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- 11 May 2023, pp 596-613
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Summary
Introduction
In keeping with international trends, the Reserve Bank made significant changes to make its communication policy more transparent during the reference period. Global trends, together with domestic factors, such as liberalisation, increasing reliance on market-based instruments and the opening of financial markets, led the Bank to disseminate more information to stakeholders and to the public and at the same time avoid disrupting financial markets. While maintaining transparency, quality and timeliness, the Bank sought to achieve clarity on its own roles and responsibilities, manage expectations, promote two-way flow of information, collect statistics and conduct research.
Over the years, the communication strategy was strengthened. At the beginning of the reference period, existing communication channels consisted of periodic publications of monthly monetary and credit information reviews, Reserve Bank of India (RBI) Monthly Bulletins, Annual Reports, speeches of senior executives, circulars and notifications, data series, pamphlets and other reports to make information available to bankers, academics and general public. The launch of its own website in 1996 marked the beginning of electronic dissemination of information. Internally, the Governor’s New Year Letters, RBI newsletters, in-house magazines, monthly demi-official letters to the Governor by Regional Directors, internal manuals, and conferences of Regional Directors served well to disseminate information and communicate to the staff.
During the reference period, the communication policy became more transparent, interactive and receptive to feedback (also see Box 14.1). The communication process engaged market participants. Draft reports, circulars and notifications were placed on the website, and comments on these were invited from the public before the reports became final. The Technical Advisory Committee for Monetary Policy (TACMP) created a platform for greater interaction with the outsiders in the process of monetary policy formulation. At the same time, data dissemination improved, partly by adhering to the International Monetary Fund (IMF) standards. Increased interactions with media followed the announcement of the monetary policy. The Bank responded to media reports more than before. The speeches of the executives became more comprehensive and transparent in content and reach.
The Bank’s communication policy had two components, external and internal. External communication was conducted by means of press releases, speeches, publications, notifications, circulars, frequently asked questions (FAQs), advertisements, media interviews and the website, and focused on areas such as the macroeconomic situation, monetary and fiscal policies, banking, financial markets, payment systems and external sector developments.
10 - Regulation of the Financial System – Part I: Commercial Banks
- Tirthankar Roy, London School of Economics and Political Science
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Summary
Introduction
In keeping with the financial market reforms, the period covered in this study saw the Reserve Bank move away from development banking, which focused on channelling credit to desired fields, towards managing competition, new entry and corporate governance of institutions. This chapter, or Part I of Chapter 10, describes changes in the regulation of commercial banks. Part II deals with the regulation of other financial institutions. The supervisory function will be covered in Chapter 11.
The next section outlines the broad pattern of reforms in the regulation of banks. Subsequent sections deal with prudential norms; private sector banks; governance issues; public sector banks; foreign banks; rehabilitation of weak banks, amalgamations and mergers; branch licensing; customer identification; deregulation of credit regime, mortgage debt and global crisis; and miscellaneous regulatory issues. The concluding section considers what was achieved and what was left unfinished during the reference period.
Broad Patterns of Regulatory Reform
In March 1997, there were four categories of commercial banks: the public sector, the old private sector, the new private sector and foreign banks. Their asset shares were 83 per cent, 7 per cent, 2 per cent and 8 per cent, respectively. The dominance of the public sector declined markedly by the end of the reference period.
From several years before the reference period, regulatory practices were beginning to change to give these banks more freedom of operation and allow them to become more efficient market players. These efforts strengthened in 1997 and 1998. In 1997, an in-house working group reviewed the guidelines and instructions issued by the Department of Banking Operations and Development (DBOD). In April 1998, a further review by Deputy Governor S. P. Talwar indicated that more areas of micro-management should be left to the banks, with a greater focus on monitoring compliance. On 3 June 1998, in a meeting between Governor Jalan and the Deputy Governors, it was decided to delegate freedom to banks in many areas. And in April 2000, the Governor had a meeting with the chief executive officers (CEOs) of major commercial banks to discuss autonomy.
Structural reforms were undertaken at the same time with the same broad aim to allow banks more freedom while improving corporate governance.
Index
- Tirthankar Roy, London School of Economics and Political Science
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- The Reserve Bank of India
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Contents
- Tirthankar Roy, London School of Economics and Political Science
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- The Reserve Bank of India
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Photographs
- Tirthankar Roy, London School of Economics and Political Science
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- The Reserve Bank of India
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List of Abbreviations
- Tirthankar Roy, London School of Economics and Political Science
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Preface
- Tirthankar Roy, London School of Economics and Political Science
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Summary
The Reserve Bank of India Volume 5 covers the eleven-year period of 1997–2008. This is an institutional history of the RBI and thus records developments in policies and operations in its major functional areas. The time period covered in this volume is unique as it was flanked by two major crises in the international economy. The RBI not only responded to the underlying developments and challenges but also took upon itself the remarkable role of the leader in initiating reform measures in several critical areas. These included rationalising and strengthening of monetary policy operating instruments, namely institution of the Liquidity Adjustment Facility (LAF) and the Market Stabilisation Scheme (MSS), establishment of financial market institutions (for example, Clearing Corporation of India Ltd.) and building up of payment system infrastructure (for example, Real Time Gross Settlement System, Delivery versus Payment, Negotiated Dealing System, Electronic Clearing Service, and so on), putting in place firm and sound legal structure for providing flexibility yet ensuring clear outcome and accountability (for example, Foreign Exchange Management Act, 1999, Government Securities Act, 2006, Payment and Settlement Systems Act, 2007, and so on), consolidating and strengthening the banking and non-banking sectors, improving the rural credit system and the financial inclusion. Thus, one may say that much of the plumbing was done during this period on which the present-day modern system stands. In the process, however, this volume documents the evolution of the RBI itself.
Another distinguishing feature of this period was that it was characterised by a stable relationship between the government and the RBI though some differences surfaced during the latter part in such policy areas as monetary management, exchange rate and reserve management, and the quality of capital flows without having any bearing on the macro-economic stability.
The journey of preparation of this Volume 5 had been a fascinating one. It was prepared by a team of consultants under the guidance of the author Professor Tirthankar Roy of London School of Economics. The focus had been on capturing the core areas of public policy interface of the RBI with the functions of other non-core service departments kept to the minimum.
4 - Foreign Exchange Market and Management of the Capital Account
- Tirthankar Roy, London School of Economics and Political Science
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Summary
Introduction
Between 1997 and 2008, the Indian foreign exchange (or forex) market underwent a major transformation in terms of the scale of turnover, players, institutional arrangements, and instruments. Although the Indian rupee had become convertible on current account in 1994, some of the current account transactions were still subjected to limits. These were either removed or relaxed subsequently and brought under a new legal framework, the Foreign Exchange Management Act (FEMA), 1999, which replaced the earlier, and far more restrictive, Foreign Exchange Regulation Act (FERA) 1973. Authorised dealers (ADs) were provided with more flexibility to undertake forex operations and greater freedom to manage risks.
The liberalisation of the capital account, by contrast, was a more gradual process and marked by cautious optimism. The period witnessed ‘effective’ full capital account convertibility for non-resident Indians (NRIs) and the introduction of limited liberalisation measures for capital transactions of residents. The underlying aim was to open up the forex market in line with the ongoing reforms. That expectation was so well fulfilled that the resultant transition posed problems for capital account management. Between 2001 and 2008, capital inflows occurred on a scale beyond the absorbing capacity of the economy, forcing the Reserve Bank to explore ways in which the ‘problem of plenty’ could be handled (Table 4.1).
In terms of the powers conferred by FEMA, the Reserve Bank is responsible for development and regulation of the forex market as well as management of the capital account. The measures that were taken to further open up the market during 1997–2008 necessitated changes in the legal framework and introduction of a large number of specific regulatory measures on the part of the Bank. The focus of the present chapter is on these measures.
The rest of the chapter has two main sections, dealing with the forex market and management of the capital account.
Foreign Exchange Market
Until the late 1990s, the Indian forex market was relatively shallow and had an uneven flow of demand and supply. Most transactions were spot and trade based. Transactions emanating from market expectations were rare because arbitrage opportunities between onshore and offshore financial asset markets were not freely allowed to be exploited.
15 - Organisational Change
- Tirthankar Roy, London School of Economics and Political Science
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Summary
Introduction
During the period under reference, globalisation, rapid economic growth, advances in information technology (IT), new responsibilities and increasing public scrutiny of its policies and functions posed enormous challenges to the Reserve Bank’s organisational set-up. At the same time, there was a fall in staff size. The Bank addressed new challenges by trying to upgrade the skills, technical expertise and professionalism of its employees, by means of in-house and external training, and strategic changes in placement and recruitment policy. Employee welfare measures received special attention, and efforts were undertaken to make the Bank’s compensation package competitive and attract talented individuals to its service. Mechanisation and computerisation, especially in the operational departments, were accorded top priority. A few new regional offices were opened after the formation of new states. And new departments were carved out to address emerging challenges. The system of internal inspection and audit was changed to adopt a risk-based approach of surveillance. Alongside, accounting norms were strengthened, and annual accounts of the Bank became more transparent in terms of dissemination of information relating to the composition of the balance sheet, valuation practices, changes in accounting practices, and different sources of income and expenditure.
The present chapter outlines these changes. The chapter is divided into ten main topics: the boards and committees, central and regional offices, new departments, human resource and staff matters, IT, rationalisation of systems and procedures, audit, inspection, balance sheet and ownership of institutions.
Boards and Committees
The Central Board of Directors carries out the general superintendence and provides direction to the affairs of the Bank. The Board is appointed by the Government of India in keeping with the provisions of Reserve Bank of India (RBI) Act. There are official and non-official Directors. While the former comprises the Governor and the Deputy Governors, the latter consists of Directors nominated by the government. Of these, ten are drawn from various fields, one is a government official and four are nominated from the local boards. There are four local boards – Western, Eastern, Northern and Southern. These boards are set up to advise the Central Board on local matters, to represent territorial and economic interests of local cooperatives and banks, and to perform such other functions as delegated by the Central Board from time to time.
1 - Introduction: Managing Liberalisation
- Tirthankar Roy, London School of Economics and Political Science
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Summary
This volume of the history of the Reserve Bank of India (RBI) covers events during the eleven financial years from 1997–98 to 2007–08 (the ‘reference period’). Over this period, the Reserve Bank faced several major external shocks and had to function in a rapidly changing economic environment within India. While the economic liberalisation process had begun in the early 1990s, key institutional and financial market reforms occurred, and integration of the Indian economy with the world economy accelerated, during the reference period.
The Bank shaped the transition, and adapted to it, by adjusting its approach to containing inflation and maintaining financial stability, focusing on financial market institutions and infrastructure, taking legal and other steps to achieve operational autonomy, making improvements in organisational capability and communication practices. It also worked not only to improve customer service in banks and the rural credit system but also to enhance financial inclusion. In all these efforts, the Bank relied on its own expertise as well as that available outside the organisation.
This is an institutional history. It thus records developments in policies and operations of the Bank in its functional areas and documents the evolution of the organisation itself. While the details of policies, operations and organisational changes appear in subsequent chapters, this introductory chapter presents a compact account of these developments during the reference period. The chapter begins with a brief review of the macroeconomic trends and political situation, followed by a review of the major areas of activity of the Bank during the reference period, and a brief chapter outline.
Backdrop
The beginning of the reference period witnessed several stressful events. The Asian currency and financial crisis (1997) posed major challenges for the policy environment in India. In the aftermath of the nuclear tests in Pokhran in May 1998, several Western nations imposed sanctions on India, leading to the partial suspension of multilateral lending, downgrading by international rating agencies and reduction in investment by foreign institutional investors.
Despite these shocks, the reference period saw robust growth of the Indian economy. Continuing from previous years, the corporate sector responded to increasing openness and global competition by improving productivity. All relevant financial parameters relating to solvency, liquidity and profitability improved.