ECONOMICS - II PROJECT

WINTER SEMESTER 2018

Submitted By:

Sumant Meena (217055)

&

Himanshu Cheeta (217089)

 Structural Reforms In Industry, Banking and Finance

SYNOPSIS

The year 1991 marked an important watershed in the economic history of post- Independent
India. The country went through a severe economic crisis triggered by a serious balance of
payments situation. The crisis was converted into an opportunity to introduce some fundamental
changes in the content and approach to economic policy. While the process of reform was rapid
in the early years, it tapered off only to be resumed in the late 1990s. There was, however,
continuity in economic policy during those years under different governments.

This paper tracks the story of Indian Financial Sector Reforms and the Impact of India’s
Economic Reforms. It tracks the story of Indian Financial Sector reforms in terms of a number of
segments such as banking, debt markets, forex markets and other like non-banking financial
companies. This apart, as an offshoot of the financial sector reform, changes in the monetary
policy are discussed. In this light, the paper looks at various performance indicators of different
segments of the Indian Sector. In general, it is found that here has been an improvement in
efficiency competitiveness and health of all the segments of the Indian financial sector. The
paper raises some issues for the future of this sector.

This paper also focuses on the impact of India’s economic reforms on industrial structure and
productivity, it reveals a disappointing overall performance in both output and growth and
employment. This however is not the result of exogenous factor, but the consequence of the type
of policies being followed under economic reforms. If mistakes were made in the past they need
to be corrected. But efforts should be made to ensure that demand is high enough for more output
to be produced more people to be employed, poverty to be reduced. The purpose of this study is
to detail the structural reform process undertaken by India and to evaluate its results.
 BACKGROUND

The Indian economy, in the first three decades of Independence, grew at an average annual rate
of about 3.5 per cent. In the 1980s, the growth rate picked up. In fact, in the second half of the
1980s, the average rate of growth was close to 5.6 per cent. Nevertheless, the 1980s ended with
some serious problems as far as the country was concerned. The fiscal deficit was getting out of
control and the balance of payments situation was coming under increasing strain. On the fiscal
side, the major problem was the growing fiscal deficit. In the 1970s and 1980s, the fiscal deficit
of India was something of the order of 6 percent. By 1991, the fiscal deficit of the Government
of India alone had touched 8.3 per cent. Interest payments became the largest single item of
expenditure in the Government of India's budget, and were equivalent to four per cent of the
GDP in 1990-91.1

A growing fiscal deficit affects the economy in a number of ways. It has implications in terms of
the crowding-out effect it may have in relation to private investments. But even from a narrow
fiscal point of view, the growing fiscal deficit and the increasing debt results in a larger share of
the revenue receipts being pre-empted for the payment of interest, and a consequent decline in
the allocation of resources for developmental purposes. Apart from the interest burden becoming
large, the growing size of debt also resulted in the distortion of the financial system, in as much
as banks and other institutions were required to contribute a certain percentage of their deposit
liabilities, in the form of investment in government securities at rates of interest that were below
market-determined rates of interest.

On the balance of payments side, the current account deficit of India touched about 3.2 per cent
of the GDP in 1990-91. This may not look like a very high level of deficit compared to the level
of current account deficit that some of the fast-growing economies have incurred. Nevertheless,
given the large size of India's GDP, 3.2 per cent of that GDP, in absolute terms, was quite high.
Of course, the immediate trigger was the Iraqi- Kuwait war, which resulted in an abnormal
increase in oil prices. Being a net importer of oil, the burden was so large-in one year the bill

1
The Indian Economy Since Independence. (n.d.). Retrieved March 15, 2019, from
http://home.fau.edu/sghosh/web/images/India talk.pdf
increased from $ 3.7 billion to $ 6.0 billion that India had to draw down the bulk of the foreign
exchange reserves in order to meet increased oil cost.2 This drawing down of the reserves, in
turn, resulted in a downgrading with respect to the rating of the country which had further impact
upon raising the funds for the financing of the current account deficit So a vicious cycle was set
in motion the drawing down of the reserves, down grading of the rating and inability to finance
the deficit. All of this resulted in a very serious balance of payments situation. In substance
despite the very strong growth that the Indian economy registered in the second half of the
1980s, it entered the 1990s with an unsustainable level of fiscal deficit and balance of payments
deficit.

The response to this particular crisis was to put in place a set of policies aimed at stabilization
and structural reform. The stabilization policies were aimed at correcting the weaknesses that had
developed on the fiscal and the balance of payments fronts while the structural reforms were
aimed at removing some of the rigidities that had entered into various segments of the Indian
economy. Obviously, structural reforms could not be introduced unless a degree of stabilization
was achieved. Equally, stabilization by itself would not be adequate unless structural reforms
were introduced to prevent the recurrence of such problems. That was why India put in place,
simultaneously a set of policies aimed at both stabilization and structural reform. The reforms
were also a response to an increasing recognition that the overall pace of economic development
had fallen short of not only the aspirations of the people but also the objective potential of the
economy.

CONTENT OF REFORM

The structural reforms introduced in the early nineties broadly covered the areas of industrial
licensing, foreign trade, foreign investment, exchange rate management and the financial sector.
There were changes in each of the areas.
India, since the days planning was introduced, had practised a system of industrial licensing
under which a license was required before setting up any large unit. This practice had roots in the

2
(n.d.). Retrieved March 15, 2019, from https://rbi.org.in/scripts/AnnualReportPublications.aspx?Id=166
belief that resources could be best allocated by a planning authority and that licensing was the
best way to manage limited resources. Over years, it became obvious that such a system was
inefficient and led only to corruption and creation of rent. One early step that was undertaken as
part of the structural reform process was to do away with licensing. The elimination of barriers to
entry and expansion was well received and had very little opposition.3

Import substitution constituted a major plank of India's foreign trade policy. This was primarily
due to the highly pessimistic view taken on the potential for export earnings. A further impetus
to the inward orientation was provided by the existence of a vast domestic market. The inward
looking industrialization process did result in high rates of industrial growth between 1956 and
1966. However, as inefficiencies crept into the system, the economy turned into an increasingly
high cost one. This also led to a "technological lag" and resulted in poor export performance. As
part of the structural reforms a bold initiative was taken to reduce the tariff rates and dismantle
quantitative controls over imports. The peak tariff rates which were as high as 200 per cent have
been brought down to 40 per cent and the dispersion has also been reduced. There are still some
quantitative controls which remain and these were to be phased out during 1999-2000. The tariff
rates are being brought down in stages, as some caution in this regard has become necessary in
order to enable the Indian industries which had been set up behind high protective tariff walls to
adjust to the changed situation.

The policy towards foreign investment has undergone a sea change. Prior to 1991, the policy
towards foreign investment was restrictive and at best permissive. While it welcomed foreign
investment, in most cases it was limited to 40 per cent. Majority ownership was an exception
rather than the rule. This policy was given up and foreign investors were given the freedom
to own majority share holding. A Foreign Investment Promotion Board was set up to be
proactive with respect to foreign investment. While foreign individuals are not allowed to invest
in Indian stock markets, recognized institutional investors are allowed to invest in the stock

3
Ahluwalia, M. S. (1994). India's Economic Reforms. Retrieved March 15, 2019, from
http://planningcommission.nic.in/aboutus/speech/spemsa/msa012.pdf
market. Portfolio investors have the freedom to sell the shares at any time and repatriate the
funds. Thus a fundamental change in the approach to private capital flows occurred after 1991.4

Along with the change in the policies in foreign trade and foreign investment, a significant
change occurred with respect to exchange rate management. From a managed floating system
under which the exchange rate was officially determined, the regime has passed through several
phases to reach a market based system under which the exchange rate is determined by forces
of demand and supply. Current account transactions have been freed of exchange control
regulations and controls over several transactions on capital account have been eased while the
central bank of the country intervenes in the foreign exchange market, it does so primarily to
prevent volatility and instability.

The financial sector underwent a major change. The financial sector in India is dominated by the
public sector. Most of the banks as well as the insurance institutions are state-owned. Broadly
speaking, reforms in the financial sector are aimed at Indian banks conforming to international
prudential standards and simultaneously imparting a greater element of competition in the
financial system. The administered structure of interest rates has been dismantled with freedom
given to banks to fix the rates of interest on deposits and loans. New private sector banks have
been licensed. Foreign banks even prior to 1990 had been allowed to operate branches in India.
The regulation of the capital market also received considerable attention in order to provide
greater protection to investors. The financial sector reforms have been reviewed more than once
by a committee.

It is worth recalling at this stage that in the fifties and sixties the dominant view in the literature
on development economics was that government had an important role toplay and that it should
undertake activities that would compensate for "market failure" Market failure was perceived as
the inability of markets to allocate optimally resources over time, that is, for investment because
of the "myopic" nature of markets. The literature also emphasized the importance of economies
of co-ordination that aggregate planning could achieve. It is this line of reasoning that led most

4
Srinivasan, T. N.. (1998). Indian Economic Reforms: Background, Rationale, Achievements, and Future Prospects,
Retrieved March 16, 2019, from
https://www.researchgate.net/publication/2508978_Indian_Economic_Reforms_Background_Rationale
developing countries to formulate economy wide plans. However, four decades of development
experience has shown that there can be "government failure" as well. The regulatory state in
many countries has resulted not only in economic losses due to misallocation of resources arising
from faulty investment decisions but also in diversion of resources to rent seeking activities
because of the very regulations themselves. In fact, if there is a lesson to be drawn from the
development record of the last four decades it is that there can be both "government failure" and
"market failure" and that the critical issue is not so much the presence or absence of state
intervention but the extent and quality of that intervention. The New Economic Policy in India
builds on this experience.

There is a common thread running through the various policy measures introduced since 1991.
The objective is simple and that is to improve the efficiency of the system. The regulatory
mechanism involving multitudes of controls has fragmented capacity and reduced competition
even in the private sector. The thrust of New Economic Policy is towards creating a more
competitive environment in the economy as a means to improving the productivity and
efficiency of the system. This is to be achieved by removing the barriers to entry and the
restrictions on the growth of firms. While the Industrial Policy seeks to bring about a greater
competitive environment domestically, the trade policy seeks to improve the international
competitiveness subject to the protection offered by the tariffs which are itself coming down.
The private sector is being given a larger space to operate in as much as some of the areas
reserved exclusively earlier for the public sector are now allowed for the private sector. In these
areas, the public sector will have to compete with private sector, even though the public sector
may continue to play the dominant role. What is sought to be achieved is an improvement in the
functioning of the various entities whether they be in the private or public sector.

Taken together these reform measures in the various areas constitute an important break in
India's economic policy. However there are many areas where reforms have made little progress.
A major concern has been with respect to loss making public sector units and how to deal with
them. Public sector reforms in general have not received adequate attention. The rigidities in the
labour market continue. The process of privatization has also been slow, because of the lack of
required consensus.
 PERFORMANCE SINCE LIBERALIZATION

Performance since Liberalization Judged by the standard criteria of growth rates in national
income and per capita income, the Indian economy has done well since liberalization. Between
1992-93 and 1998-99 the average annual growth rate was 6.55 per cent. This is even higher than
the previous high of 6.04 per cent achieved between 1985-86 and 1989-90. The average annual
per capita income growth rate between 1992-93 and 1998-99 has been 4.7 per cent as compared
with a growth rate of 3.4 per cent in the eighties. Thus, there has been a significant step up in
terms of the per capita income growth rate. The average growth rate of industrial production and
agricultural production since 1992-93 has been 6.4 per cent and 3.1 per cent respectively. The
gross domestic savings rate of the economy on an average during the nineties has remained at 24
per cent. The inflation rate has shown a perceptible decline in the recent period. The average
inflation rate in the current year as measured by the wholesale price index has been 3 per cent.
The foreign exchange reserves of the country had shown a perceptible improvement from $ 5.8
billion in 1991 to $32.5 billion by March 1999.5

Another important factor to note is the reasonable stability of the Indian economy at the time of
the recent East Asian crisis. Even in fiscal 1997-98, the growth rate of the economy was
maintained at 5.1 per cent. The exchange rate of the rupee in relation to the dollar suffered a
minimal decline. The foreign exchange reserves continued to increase during the period.

One of the major objectives of the stabilization policy was to bring about a reduction in the fiscal
deficit. For various reasons already indicated, the decline in the fiscal deficit is extremely
important. The Central Government did succeed in bringing down its fiscal deficit by almost 2
percentage points between 1990-91 and 1996-97. The ability to bring down the fiscal deficit of
the Government of India below 5 per cent of the GDP has proved to be difficult. The overall
fiscal deficit of the Centre and the States taken together continue to remain a little over 8 per cent
of the GDP.6

5
D. S. (2012). Indian Economyafter Liberalisation Performance and Challenges(1st ed.). Daryaganj, New Delhi:
SSDN & DISTRIBUTORS. From
https://www.academia.edu/2504452/Indian_Economy_after_Liberalisation_Performance_and_Challenges
6
India's fiscal deficits: A short history. (2017, March 17). Retrieved March 16, 2019, from
https://www.rediff.com/business/column/column-indias-fiscal-deficits-a-short-history/20170317.htm
In relation to the external sector, the country has been successful in keeping the current account
deficit at a reasonable level. As mentioned earlier, the current account deficit peaked to 3.2 per
cent of the GDP in 1990-91. In recent years, it has remained below 1.5 per cent of the GDP.
Exports grew very strongly during the years 1993-94 to 1995-96. The average annual growth rate
was 20 per cent in dollar terms.7 However, for a number of reasons, both internal and external,
export growth rate slackened thereafter. But in the current fiscal year during the first nine months
of the year, exports have grown in dollar terms by 12.9 per cent.

SOME CONSENSUS

The liberalization process has come in for criticism from two opposite ends. There are those who
feel that the process has been slow and not sufficiently comprehensive. At the other end, there
are critics who view the reform process as misconceived, ignoring the basic requirements of the
people. There are four aspects of these criticisms which deserve attention.

A major criticism of the opponents of the liberalization process is that the higher growth rate
achieved has made no dent on poverty and unemployment. They rely basically on National
Sample Survey data on consumption expenditures. Estimates of the percentage of people below
poverty line based on various National Sample Survey rounds show that the combined rural and
urban ratio came down from 44.48 per cent in 1983 to 38.86 per cent in 1987-88 and further to
35.07 per cent in 1993-94. However, based on a thin sample as against large sample, one
estimate shows a rise in the poverty ratio to 43.01 per cent in 1998. This is a disturbing trend.
Another analyst relying on the thin sample shows that between 1993-94 and 1997, while the rural
poverty ratio came down to 35.78 per cent, the urban poverty ratio has come down to 29.99 per
cent. Obviously there are some methodological issues involved. There are misgivings on using
the thin sample for arriving at the poverty ratio. All the same one has to enquire as to why a step
up in growth rate has not resulted in making an impact on poverty and unemployment. Part of the
reason may lie in the slower rate of growth of agricultural production of 2.6 per cent in the
nineties as against 4.11 per cent in the eighties.

7
B. K., S. M., & Suresh, A. K. (2015). Cyclicality of Social Sector Expenditures: Evidence from Indian States.
Retrieved March 17, 2019, from https://rbi.org.in/scripts/bs_viewcontent.aspx?Id=3050.
Employment figures indicate that between 1990-91 and 1997-98, overall employment grew at an
average rate of one per cent with the employment in the organized and unorganized sectors
growing at 0.6 per cent and 1.1 per cent respectively Part of the explanation for this phenomenon
lies in the rigidities in the labour market which induce preference for capital in relation to labour
contrary to the pattern of factor endowments in the country. It is here, one has to take a lesson
from the experiences of Europe and the United States. Unemployment has remained stubbornly
high in Europe, where the rigidities in the labour market are high, whereas a flexible labour
market has enabled the United States to reduce the unemployment ratio.

One of the major planks of the liberalization policy has been to reduce the fiscal deficit. There
has been some success in this area but not to the desired extent However, some are critical of the
fact that whatever reduction that had been brought was almost by reducing capital expenditures
Total expenditures as a proportion of GDP came down by 3.1 percentage points between 1990-
91 and 1997-98. This was achieved by a reduction in capital expenditures as proportion of GDP
by 2.1 percentage points and revenue expenditures by 0.9 percentage points.8 The revenue to
GDP ratio has remained unaltered at the pre-reform level despite significant tax reform measures
introduced. Without doubt the best way of reducing fiscal deficit is by reducing revenue deficit.
But unfortunately revenue expenditures have kept increasing. Wages and salaries have continued
to rise. Subsidies after an initial drop have remained at the same level as percentage of GDP. In
fact, at state levels implicit subsidies have increased enormously because of the supply of various
services such as electricity and water for irrigation below cost. The fiscal deficit can be contained
at a reasonable level only by widening the tax base and thereby raising the ratio of revenue to
taxes and by limiting revenue expenditures both on account of establishment expenditure and
subsidies. In a developing economy like India, where a significant proportion of people remain
poor, subsidies are an essential component of government expenditures. However, they need to
be targeted appropriately, so that they accrue only to low income households. Hard decisions
become inevitable

Yet another area of concern of the critics is that enough attention is not being paid to social
infrastructure areas. Literacy levels have risen in India. Nevertheless, they remain well below

8
ECONOMY AND THE PLAN : AN OVERVIEW. (n.d.). Retrieved March 18, 2019, from
http://planningcommission.gov.in/reports/genrep/arep9099/ar98-99.htm
what has been achieved by many of the Asian countries. Basic health facilities have not reached
every one. But the fault for this situation cannot be laid at the doors of liberalization. In fact, the
very purpose of liberalization is to reduce the role of the state as an entrepreneur and direct
investor and expand its role in areas such as social infrastructure, where state alone can play a
dominant role. As has been somewhat paradoxically remarked "more market does not mean less
government but only different government". The need for expanded state intervention in areas of
education, health and sanitation cannot be under estimated. In fact, it is an efficient economy
which will generate the necessary surplus which will enable the state to fulfill its socio-economic
obligations. It is also to be noted that better education and health are a function of not only levels
of expenditures but also the efficiency with which such expenditures are incurred.

The fourth area of concern has been the growing disparities in income among states. Differences
in growth rates among states have become more pronounced after liberalization. During the
seven-year period 1984-85 to 1991, the highest growth was 62.7 per cent and the lowest was 17
A percent. In the post-liberalization period, the highest growth was 85.4 per cent while the
lowest was 10.1 per cent. Some of the most highly populous states have registered very low
growth rates in the post-liberalization period. Tax devolution formulas as well as Planning
Commission allocations of grants and loans are heavily weighted in favour of population and the
inverse of per capita income. Nevertheless, the populous states have grown weakly in the last
seven-year period and this has in fact contributed to the increase in the overall poverty ratio also.
In fact, many of these states have not been actively involved in the liberalization process. If the
regional disparities have grown, it 1s also a reflection of the quality of governance.

SECOND GENERATION REFORMS

Analysts and policy-makers are talking today of second generation reforms. This implies the
deepening of the reform process wherever it has been initiated earlier and bringing within its
scope new areas. The motivation is the same and that is to increase the efficiency and
productivity of the economy. The need is to adopt a coherent and consistent set of measures to
enable Indian enterprises to compete both at home and abroad.
The direction of reform in the foreign trade area has gained further momentum with progressive
reduction in tariff and the removal of quantitative controls. The WTO commitments are being
implemented. It is equally necessary for the industrially advanced countries to create an
environment in which world trade can grow. They must also keep to their part of commitments
to WTO. India, along with other developing countries, has rightly taken the stand that trade
negotiations must not be mixed with other issues such as labour standards for which other
international fora exist for discussion and enforcement.

The foreign investment policy has been further liberalized. The Government of India recently
allowed foreign direct investment through the automatic route over the entire spectrum of
industries with the exception of a short negative list which will be subject to Foreign Investment
Promotion Board clearance. Foreign direct investors as well as portfolio investors enjoy full
freedom of repatriation.

India has accepted Article VIII commitment of IMF which implied full current account
convertibility. On capital account, full convertibility exists for foreign investors and non-resident
Indian depositors. We have adopted a cautious policy on capital account. At the same time, we
have allowed greater freedom for Indian entrepreneurs to borrow or to raise funds through other
means like issue of GDRS. However, prior permission is required. Short-term external debt is
being kept at a minimum. Capital account liberalization is not a discrete event. It can be done in
stages along with the strengthening of the domestic financial markets.

Improving the performance of the financial sector has been an integral part of the reform process.
The banking system in India is progressively compelled to conform to the international
prudential standards. The capital adequacy ratio was increased above the normal 8 per cent level
to reach 9 per cent by 31 March 2000. A greater element of competition has been injected
through the licensing of new banks in the private sector and by the operations of foreign banks.
There are at present 45 foreign banks with 189 branches operating in India. One of the foreign
banks is the Development Bank of Singapore.9 As is true of the banking system in many
countries, the rapid branch expansion and spectacular growth in deposits had resulted in a high
level of non-performing assets. The gross non-performing assets of public sector banks as a

9
Kamath, G. B. (n.d.). The intellectual capital performance of the Indian banking sector. Retrieved March 18, 2019,
from https://www.emeraldinsight.com/doi/abs/10.1108/14691930710715088.
proportion of total advances as at the end of March 1999 was 15.9 per cent. After taking into
account the provisions, the net non-performing assets constituted 8.13 per cent. This is still high.

There are three banks identified as weak banks which have net non-performing assets in the
range of 11-20 per cent. Banks and government as the owner are seized of this matter. While
government has been willing to pump capital (total amount injected so far is Rs. 204.5 billion),
this is obviously not a permanent solution. Alternative mechanisms such as Asset Reconstruction
companies are being thought of. The legal framework for recovery of loans from banks has been
weak Apart from setting up separate Debt Recovery Tribunals, the laws themselves are under
scrutiny for speedy recovery of dues. The supervisory system in relation to banks has been
strengthened through on site inspection which has been the traditional mode of supervision in
India, and off site surveillance through submission of periodic reports.10 Technology up-
gradation in banks which has gathered speed, should facilitate off site surveillance. The Reserve
Bank of India has constituted a Board for Financial Supervision within the Bank to pay exclusive
attention to supervision.

One issue in financial sector reforms that has remained controversial has been with respect to
government ownership of banks Earlier the Bank Nationalisation Act was amended to enable
government holding to come down to 51 per cent. Several banks had taken advantage of this
change. Eight banks so far had gone to the capital market to raise funds from the public. For
example, in the case of Bank of Baroda and State Bank of India the private ownership constitutes
33.4 per cent and 38.5 per cent of the total capital respectively. The critical question is whether
government should give up the majority ownership.11 A recent committee on the Financial Sector
has recommended that government share should be brought down to 33 per cent. My successor at
the Reserve Bank of India had also indicated that there was a strong case for raising the
legislative ceiling for market participation in the equity of public sector banks.

Financial sector reform is a continuous process. However, it acquired a special urgency and
importance in India in the wake of the economic crisis of 1991. Recent events elsewhere in the
world have shown why a sound and safe financial system is essential, if the growth process is not

10
Ahluwalia, M. S. (1994). India's Economic Reforms. Retrieved March 15, 2019, from
http://planningcommission.nic.in/aboutus/speech/spemsa/msa012.pdf
11
Mohan, R. (2005). Financial Sector Reforms in India: Policies and Performance Analysis. Economic and Political
Weekly, 40(12), 1106-1121. Retrieved from http://www.jstor.org/stable/4416358
to be derailed. While the first phase of reforms focused on removing the external constraints
bearing on the functioning of banks and introducing internationally accepted prudential
standards, the second phase must stress on the organizational effectiveness of banks.

One area which requires close attention on the part of policy-makers is infrastructure which can
emerge as a consistent over growth, if adequate attention is not paid. Future infrastructural
investment needs are expected to be large because of the demand created by economic growth,
rising population, rapid urbanization as well as the need to make up for the backlog
Infrastructure productivity will determine how India will cope with increasing pace of
urbanization, globalization and technological innovations in manufacturing.

The financing requirements of infra structure as a whole are massive. For this massive magnitude
of investment to materialize, a definitive, transparent and concrete policy framework has to be
put in place. Such a framework should focus on increased commercialization of infrastructure
services, appropriate legal, regulatory and administrative frameworks to support both foreign and
domestic private sector involvement, and the introduction of new and innovative financial
products for infrastructure funding. In order to achieve the desired levels of investments, both
public and private, in the infrastructure sectors, it is essential that the issues of appropriate
pricing and cost recovery are tackled at the earliest with transparent and explicit subsidization,
where needed. Even in the changed milieu, the public sector enterprises will continue to shoulder
the major burden of providing critical infra- structure services. The process of deregulation and
privatization of infrastructure services must be supplemented by the establishment of statutory
and regulatory authorities for ensuring fair competition among public and private operators, and
protecting consumer interests, public safety, and environmental concerns

The setting up of an independent Telecommunications Regulatory Authority of India (TRAI) is a

step in a right direction. Similarly, several state governments have also set up independent
authorities to determine electricity tariffs. The improvement of the performance of the power
sector is an urgent need. This can happen only if the pricing is appropriate and there is an
independent authority to fix the tariffs. In all of these areas there could be some element of cross
subsidization. What is necessary is to ensure that, taken as a whole, the cost is fully recovered.
Reforms in the infrastructure areas which mainly include power, transport and communications
must receive the highest priority in the coming years. Reforms in these areas are also linked with
the reforms for improving the performance of public sector organizations because the public
sector continues to dominate these areas.

The Indian economy has done well in the post-liberalization period. The country has moved to a
high growth path. Objective conditions exist for the economy to grow at a sustained rate of seven
per cent. A more competitive environment has emerged which should lead to increased
efficiency. The Indian economy has also shown its resiliency at the time of the East Asian crisis.
The impact of the crisis on India was minimal. But the post liberalization experience has also
revealed certain weaknesses. The slow growth in agriculture and the consequent impact of a
slower decline in poverty reduction are areas of concern. The restructuring of the fiscal system as
well as the policy of disinvestment are meant to enlarge the pool of resources available to the
government to enable it to pay more attention to social infrastructure. A sound financial system
is an essential prerequisite for sustained economic growth. Recent East Asian experience only
underscores this need; a weak financial system can hamper the growth process. The sustained
growth of India also requires that adequate attention is paid to the development of physical
infrastructure. The financial needs for such a rapid expansion are heavy. Enough funds will flow
in, only if we have a transparent and independent regulatory authority.

The liberalization programme to be successful must ensure that the benefits accrue to all sections
of society and that it commands the acceptance of a wide constituency Efficiency and equity
should not be posed as opposing considerations. They must be weaved together to produce a
coherent pattern.

In purchasing power parity terms, India ranks as the fifth largest economy. The world is
becoming increasingly interdependent. Technology has played a major role in this regard. There
are both opportunities and risks in this development. International co- operation can help to
minimize such risks. A bold initiative is necessary in this regard. At the same time each country
must try to maximize the gains from the changing world scenario. The outside world must
perceive the growth potential of a country like India which has pursued its policies within the
framework of democratic polity and a society open to new ideas.
 Table 1
Selected Macroeconomic Indicators, India 1980-81 to 1989-90

Item 1980- 1981- 1982- 1983- 1984- 1985- 1986- 1987- 1988- 1989- Average
81 82 83 84 85 86 87 88 89 90
1 GDPA at Factor cost Annual 7.2 6.1 3.1 8.2 3.8 4.1 4.3 10.6 6.9 6.9 5.9
(At constant Prices) Growth
Rate (%)
2 Rate of Gross 22.7 21.2 20.0 19.4 18.5 20.7 19.6 22.0 23.4 23.2 21.1
Domestic Capital
Formation (at
constant prices)
3 Gross Domestic 21.2 19.8 19.0 18.9 18.2 19.8 18.7 20.9 21.4 22.4 20.0
Savings Rate
4 Industrial Production Annual - 9.3 3.2 6.7 8.6 8.7 9.2 7.3 8.7 8.6 7.81
Growth
Rate (%)
5 Agricultural Annual 15.1 7.0 -4.0 13.2 -0.6 1.4 -3.6 0.1 21.4 2.1 4.11
Production Growth
Rate (%)
6 Food grains Annual 19.9 2.6 -3.6 18.4 -4.3 5.0 -5.7 -2.5 21.7 0.7 3.59
Production Growth
Rate (%)
7 Wholesale Price Index Annual 18.2 9.3 4.9 7.5 6.5 4.4 5.8 8.1 7.5 7.5 7.91
(from 1982-88 Growth
onwards Case: 1981- Rate (%)
82)
8 Consumer Price Index Annual 11.4 12.5 7.8 12.6 6.3 6.8 8.7 8.8 9.4 6.1 9.04
(industrial workers) Growth
(From 1984-85 Rate (%)
onwards base
1982=100
9 Exports (US $ Million) Annual 7.1 2.6 4.6 3.7 4.5 -9.9 9.4 24.1 15.6 18.9 8.06
Growth
Rate (%)
10 Imports (US $ Million) Annual 40.5 -4.4 -2.5 3.5 -5.9 11.5 -2.1 9.1 13.6 8.8 7.21
Growth
Rate (%)
11 Foreign Exchange US $ 6823 4390 4896 5649 5952 6520 6574 6223 4802 3962 -
Reserves Million

12 Current A/c deficit as Annual -1.6 -1.8 -1.8 -1.6 -1.2 -2.3 -2.0 -1.9 -2.9 -2.5 -1.96
% GDP Growth
Rate (%)
13 Foreign Investment as Annual 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.01
% GDP Growth
Rate (%)

Sources: Various issues of

1: Reserve Bank of India. Handbook of Statistics on Indian Economy
2. Economic Survey, Govt. of India.
3. Reserve Bank of India, Annual Report
4. Reserve Bank of India. ‘Report on Currency and Finance’
 Table 2
Selected Macroeconomic Indicators, India 1990-91 to 1998-99

Item 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 Average

1 GDPA at Factor cost (At Annual 5.4 0.8 5.3 6.2 7.8 7.2 7.5 5.1 6.8 5.8
constant Prices) Growth Rate
(%)
2 Rate of Gross Domestic 25.9 21.7 22.3 22.3 26.9 27.3 27.4 26.9 25.1 25.1
Capital Formation (at
constant prices)
3 Gross Domestic Savings 24.3 22.9 22.0 22.7 25.6 25.3 26.1 24.7 22.3 24.0
Rate
4 Industrial Production Annual 8.2 0.6 2.3 6.0 9.4 12.1 7.1 4.2 4.0 6.0
Growth Rate
(%)
5 Agricultural Production Annual 3.8 -2.0 4.2 3.8 5.0 -2.7 9.3 -5.6 7.6 2.6
Growth Rate
(%)
6 Food grains Production Annual 3.3 -4.2 4.7 4.1 3.9 -6.3 10.1 -3.2 5.8 2.0
Growth Rate
(%)
7 Wholesale Price Index (from Annual 10.3 13.7 10.1 8.4 10.9 7.7 6.4 4.8 6.9 8.8
1982-88 onwards Case: Growth Rate
1981-82) (%)
8 Consumer Price Index Annual 11.6 13.5 9.6 7.5 10.1 10.2 9.3 7.0 13.1 10.2
(industrial workers) (From Growth Rate
1984-85 onwards base (%)
1982=100
9 Exports (US $ Million) Annual 9.2 -1.5 3.8 20.0 18.4 20.8 5.3 4.6 -3.8 8.5
Growth Rate
(%)
10 Imports (US $ Million) Annual 13.5 19.4 12.7 6.5 22.9 28.0 6.7 6.0 0.09 12.9
Growth Rate
(%)
11 Foreign Exchange Reserves US $ Million 5834 9220 9832 19254 25186 21687 26423 29367 32490 -

12 Current A/c deficit as % Annual -1.6 -1.8 -1.8 -1.6 -1.2 -2.3 -2.0 -1.9 -2.9 -1.96
GDP Growth Rate
(%)
13 Foreign Investment as % Annual 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.01
GDP Growth Rate
(%)

Sources: Various issues of

1: Reserve Bank of India. Handbook of Statistics on Indian Economy
2. Economic Survey, Govt. of India.
3. Reserve Bank of India, Annual Report
4. Report on Currency and Finance, Reserve Bank of India
Figure 1 Figure 2

Figure 3 Figure 4
Figure 5 Figure 6

Figure 7 Figure 8

Figure 9 Figure 10
 Figure 11 Figure 12

Figure 13 Figure 14

Figure 15 Figure 16
 Appendix
BANKING SECTOR REFORMS, 1992-1997

India's financial sector reforms were an integral part of the economic reform package introducted
in 1991. The reform package comprised two sets of measure, one part dealing with stabilization
and the other with structural reform. Stabilization policies were intended to correct the
imbalances on the fiscal and the balance of payments areas and, so to say, to put the house in
order in the short run. The structural reform measures were aimed at accelerating economic
growth over the medium term by removing the rigidities that had crept into the system. These
two sets of measure were complementary since structural reforms could not be introduced unless
a degree of stabilization had been achieved and stabilization by itselt would not be adequate to
prevent the recurrence of crises. Reforms relating to the banking sector constituted an important
part of structural reforms.

The financial sector reforms took into account two factors. First, since the nationalization of
banks, there had been a considerable expansion in banking facilities However, serious concerns
had been ex- pressed on the quality and efficiency of the services rendered and more particularly
on the viability and profitability of the public sector banks. Two, several steps had been taken in
the eighties in order to make the banking system more responsive to the needs of the
customers and also to improve its efficiency. However, these steps were considered inadequate
and were not sufficiently far reaching. A Committee under the chairmanship of M. Narasimham
was set up and a logically consistent set of recommendations made by the Committee provided
intellectual support to the various measures adopted. While the recommendations of the
Committee were broadly kept in mind, the progress and content of the
financial sector reforms were conditioned by the events as they unfolded in the real and financial
sectors and the emerging perceptions relating to reforms.
 BACKGROUND

The nationalization of the 14 major commercial banks in 1969 was an important landmark in the
evolution of the banking system in our country. Six banks were further nationalized in 1980. The
major impact of nationalization was the spectacular expansion in the coverage of the banking
system. The total number of commercial bank branches increased from 8,262 in 1969 to 60,190
in 1991. Apart from this impressive increase in the number of branches, more than 50 percent of
the bank branches were located in the rural areas. The period also saw a rapid increase in bank
deposits and credit. The share of public sector banks in the total business of banking system was
85 per cent. With respect to credit dispensation, the significant factor was the mandatory
requirement to provide 40 per cent of the net bank credit to priority sectors. The priority sector as
defined was a composite of sectors such as agriculture and small-scale industry and classes of
borrowers such as weaker sections. The priority sector credit as a percentage of total net
bank credit of the public sector banks stood at 41 percent in 1991.

The performance of banks and other financial institutions is normally judged by the twin criteria
of allocational efficiency and operational efficiency. Allocational efficiency determines how well
the available funds are distributed among competing demands. Allocational efficiency did
assume importance in the banking system in the seventies and eighties. But efficiency was
judged largely in terms of social policy considerations. Credit allocation became a by-product of
planning and licensing. Operational efficiency results from the organizational effectiveness of
institutions. Ultimately, it must get translated into the profitability of the institutions as well as
better service to customers. It is this operational efficiency that was not given the necessary
thrust in the seventies and eighties. This was due both to the structural weaknesses of banks in
the context of the mammoth expansion in a short period of time and policy directions. Gross
profits (surplus before provision) of banks had been steadily declining and in 1989-90 such
profits constituted only 1.10 per cent of working funds In fact, profits after provisioning were at
a level providing cause for serious concern. In fact, several banks did not even make necessary
gross profits for adequate provisioning. This is apart from the fact that the norms adopted for
provisioning at that time were themselves not very strict.
The late eighties and early nineties were also a period in which there was a great concern all over
the world in improving the soundness of the banks. The Basle Committee norms for provisioning
and capital adequacy came to be widely accepted towards the end of the Eighties. The capital
structure of Indian banks and more particularly of public sector banks was weak. The balance
sheets of the commercial banks also did not reveal the true picture, as there was inadequate
provisioning and no uniform definition of non-performing assets.

From the mid-eighties, a number of policy measures were introduced in order to strengthen the
public sector banks. While the system of administrative structure of interest rates continued,
some degree of flexibility was given to banks in fixing the interest rates on large loans. Attempts
were made to give greater freedom to banks in determining the deposit rate. But these efforts had
to be abandoned, as the banks were not ready for such a change. Recognizing the
fairly large expansion in the staff in commercial banks, steps were initiated to restrict further
expansion. Some banks were clearly over staffed even judged by the average of the banking
system which itself was high. The health code that was introduced to classify loans according to
quality was a precursor to prudential norms Attempts at computerization ran into severe
problems, even though the Eighties saw the initial first steps. In fact, the resistance to
computerization was pervasive and could be overcome only over a period of years. The balance
sheet of the performance of the banking system, as it was in 1991, was thus mixed, strong in
achieving in socio-economic goals and in general widening the credit coverage but weak as far
as viability was concerned.

CONTENT OF REFORMS

It may be useful to look at the various measures that were introduced as part of Banking Sector
Reform into three broad categories:
1. Policy frame work relating to external environment;
2. Improvement in financial health; and
3. Institutional strengthening.
 1. Policy Frame Work

The external factors having a bearing on the functioning of the banking system related to the
administered structure of interest rates, high levels of pre-emptions in the form of reserve
requirements and mandatory credit allocation to certain sectors. Easing of these external
constraints constituted an important part of the reform agenda.

The administered structure of interest rate was dismantled in various steps over a period of time.
By the end of 1997, banks were free to determine the interest rate on all domestic bank deposits
as well as on loans except for small loans up to Rs. 2 lakhs and credit for export. This
deregulation of interest rate also meant that the government had to borrow at more or less
market determined interest rates. This facilitated the introduction of Treasury Bills of various
maturities and paved the way for the use of open market operations as an instrument of monetary
and credit control. The "repos" market also emerged as a consequence

The high levels of fiscal and monetized deficits had led to a situation in which the pre-emptions
in the form of Cash Reserve Requirements (CRR) and Statutory Liquidity Ratio (SLR) had to be
kept at very high levels A significant aspect of the reform process was to reduce both types of
reserve requirements which would have the effect at improving the profitability of banks through
an expansion in the lendable resources. The CRR which stood at 15 per cent in 1992 had been
reduced to 9.75 per cent by November 1997. Reduction in CRR was not a matter of simple fiat.
It had to be calibrated carefully The reductions in CRR and SLR could have moved faster, had
fiscal deficit been confined to lower levels. In fact the fiscal deficit of the
Central Government after coming down from 8.3 per cent in 1990-91 to 5.7 per cent in 1992-93,
went up again subsequently.

The mandatory priority sector credit at 40 per cent of net bank credit was not altered. However,
the changes in the interest rate regime reduced the element of cross- subsidization that was
inherent in the system. The scope of priority sector was also widened.
 2. Improvements in Financial Health

As mentioned earlier the profitability of the commercial banks was low and the level of
non-performing assets quite high. The first step that was necessary to improve he financial health
of banks was to introduce prudential norms more or less in keeping with international thinking.
Prudential norms were intended to serve two purposes: first, they would bring out the true
position of a bank's loans portfolio and second they would help to arrest further deterioration in
the quality of loans. Prudential norms related to income recognition, asset classification,
provisioning for bad and doubtful debts and capital adequacy. A proper definition of income was
essential in order to ensure that banks took into account income which was actually realised. A
clear definition of what constituted a "non-performing" asset was given. Without going into
details, the prudential norms were steadily tightened over a period of time. In fact the process is
still continuing so that ultimately the Indian standards would be exactly the same as the
international standards. One important element in the new norms related to capital adequacy.
Banks were required to have capital equivalent to 8 per cent of risk-weighted
assets. The effective implementation of this norm required that the government bring in
additional capital in the case of public sector banks. Over a five year period, the government
contributed additional capital to the tune of Rs.16,000 crore. However, to avoid cash out flow
from the government, these funds were required to be invested in special bonds. While there
were alternative ways of restructuring the banks, this method was considered the most
appropriate at that time. Introduction of capital adequacy norms would not have meant much if
the government had not come forward to augment the capital base of the public sector banks.

3. Institutional Strengthening

An important aspect of the banking sector reform was to strengthen the institutional base of the
banking system. These included a variety of measures such as the licensing of new banks in
private sector, enabling the public sector banks to go to the market and augment their capital
base, creation of Debt Recovery Tribunals to deal with loans owed to the commercial banks and
the creation of an institutional agency like Ombudsmen to settle the grievances of bank
customers. The concept of local area bank with limited territorial jurisdiction was also mooted,
even though no concrete action could be taken during this period. The basic purpose behind
strengthening the institutional infrastructure was to create a more competitive environment in the
economy. The licensing policy relating to opening of branches by foreign banks was also eased
during this period.

With the introduction of prudential norms and greater freedom given to banks, the need for a
strong supervisory system also became necessary. The Reserve Bank of India had, over years,
built up a system of super- vision over banks which relied heavily on on-sight inspection. In the
context of the compelling need to improve the supervisory system, the Reserve Bank of India
brought about institutional changes within itself. A separate Board for Financial Supervision was
created to concentrate exclusively on supervisory issues. The Board was also assisted by an
Advisory Council comprising of eminent persons in the areas of Law and Finance. The Board for
Financial Supervision itself included four members from the Board of RBI who had specialised
in accounting, law, economics and management. On-sight inspection was supplemented by off-
sight surveillance which required information to be supplied by commercial banks periodically in
certain formats. Commercial Banks in turn had to bring about a number of changes in their
institutional set-up. A greater emphasis on internal control systems became essential.

SOME ISSUE AND CONTROVERSIES

The path of financial sector reforms was not smooth. It had to steer its course in the midst
of many controversies and arguments. While some felt that the financial sector reform process
was not proceeding fast, there were others who were fundamentally opposed to the basic
premises of financial sector reforms. The need to carry conviction with all had the effect of
slowing the process. Another factor which slowed the process was the securities scam and the
prolonged inquiry into the associated events. Since in the minds of some at least the scam was
related to the liberalization process, it was necessary to remove various misconceptions. For
example, ready forward transactions came under a cloud because of the manner in which such
transactions were made use of by the banks during the scam. However ready-
forward transactions are common world over for meeting short term liquidity requirements. It
ready forward transactions were totally abolished the creation of several markets including an
active "repos" market in government securities would not have been possible Besides, the
energies of many financial institutions were absorbed in answering many issues raised in the
inquiry relating to the scam and thereby preventing full attention to reforms. The introduction of
prudential norms and the need for banks to make adequate provisions resulted in the balance
sheets of public sector banks showing loss. While this was inevitable when an important change
such as enhanced provisioning was being introduced, it also created a general sense of loss of
credibility and this had to be taken into account while sequencing various measures. Legislative
changes, which were required to support the reforms were becoming increasingly difficult after
1993. Therefore some of the desired changes had to be adjusted within the parameters and
structure of existing laws.

INTEREST RATE AND RESERVE

Requirements:
While this is not the place to discuss in any detail monetary policy measures, it may be noted that
the changes introduced in the interest rate and reserve requirement regimes were intended to give
greater autonomy to banks in the disposition of their funds, while at the same time recognising
that interest rate and reserve requirement were important policy instruments of the central bank.
With respect to interest rate, the objective was to influence the general level of interest rate
through the various policy instruments available to the Reserve Bank and leave the structure to
be determined by the market The steps that were taken to modify the interest rate regime during
this period were really intermediate measures. The CRR had remained at a high level for long
and the objective was to bring it down so that banks would remain competitive in relation to
other financial institutions. However the steering of the CRR on a downward path was not
simply a matter of arithmetic. It had to be done in conjunction with other changes including the
development of alternative instruments of control. For example even though the Monetary Policy
for the second half of 1997-98 had intended to take the CRR further down to eight per cent, it
had to be postponed because of exchange rate management considerations. Nevertheless there
was a substantial reduction in CRR over a six year period and other instruments of monetary
control were being simultaneously developed. Changes in the interest rate regime were a
necessary part of the effort to widen the various money and financial markets. A well
functioning Government Securities market is a prerequisite for the use of open market operations
as an instrument of monetary control. Interest rates, even though they went up initially to higher
levels –and this happened particularly at the time of turbulence in the foreign exchange market-
they came down subsequently. The effective rate on Government Securities taking into
account all maturities steadily dropped from 1995-96. The Commercial banks were also passing
through a learning experience with the freedom to given to them to fix the interest
rate.

PRUDENTIAL NORMS

The need for introducing prudential norms is no longer a matter for debate and argument. We
need to fall in line with the international practices not only because our banking and financial
system is more integrated with the rest of the world but also because these norms are inherently
sound. Some had argued that in view of the very high levels of CRR and SLR, there was no need
for additional prudential requirements. These arguments arise out of an inadequate appreciation
of the respective purposes of reserve requirements and prudential norms. We did not compel the
Indian banks to conform immediately to Basle standards because that could have created a crisis
of confidence. While the ultimate objective was clear, we decided to follow a step-by-step
approach. This was also made known to banks. It has been argued that the introduction of
prudential norms had made banks credit-shy. They had shown a strong preference for investment
in government securities because of the zero risk attached to such securities. In almost all the
countries, in the initial years after the introduction of prudential norms, there has been a down
sizing of the loan portfolio. This however does not constitute an argument against the
introduction of prudential norms Management of risk is key to the soundness and stability of
banks. The introduction of capital adequacy requirement imposed a heavy burden on the
government. It will be difficult for the government to be continually injecting capital into public
sector banks. The answer to expanding the loan portfolio which is inevitable and desirable in an
expanding economy lies in better risk management and improving the internal control systems.
The additional capital which banks would require in order to support a larger asset portfolio will
have to come from the market. When there is some degree of market participation, it imposes a
certain discipline on the banks.
The extent of access to the private capital market that should be permitted in relation to public
sector banks has been a matter of discussion. Even the latest legislative change does not permit
ownership of government to go below 51 per cent. This was decided on pragmatic
considerations. Law also does not permit disinvestment by public sector banks. Therefore, the
dilution of the stake of the government in percentage terms in the total capital can only come by
raising additional capital from the market. Even to raise resources from the capital market that
would be equal to 49 per cent of the total capital would be large and therefore the issue
of government ownership going below 51 percent was deferred. Raising resources from
the capital market and giving representation to the private share holders on the boards of the
banks have had a salutary effect on the functioning of such banks. The issue of how
to combine autonomy with accountability is a larger one and needs to be addressed in relation
not only to public sector banks but all public sector organizations.

ORGANIZATIONAL STRUCTURE

Government took the view that it was not necessary to undertake a far reaching restructuring of
all the public sector banks into international banks, national banks and regional banks because
this would have taken the focus away from some of the important issues like introduction of
prudential norms that needed immediate attention. The benefits of such restructuring were also
not clear. One aspect of the restructuring of banks related to the handling of non-performing
assets. A recommendation had been made to set up separate asset recovery companies to which
the bad and doubtfulness debts of banks could be transferred and such companies would be
exclusively concerned with recovery. However this suggestion was not implemented, for the
reason that it would be better to re-capitalise banks and compel the banks which had lent to
become responsible for their recovery as well. The setting up of separate recovery companies
would have made a difference only if such companies had been supported by suitable changes in
Jaw to speed up recovery. The organizational and management structure of such companies
would also have to be different. In fact, even the creation of separate Debt Recovery Tribunals
had run into constitutional problems.
One question that is being raised from time to time is whether the financial sector reforms
neglected special considerations relating to rural credit. The contention that rural credit was
ignored during this period was a mistaken impression. In this context the point has been made
that the RBI stopped making allocation out of the LTO fund to NABARD and other
developmental financial institutions. While this is true, it would be incorrect to draw the
inference that adequate funds were not made available for rural credit. The General Line of
Credit from the Reserve Bank to NABARD was substantially increased during this period. Also
the capital base of NABARD was expanded with the Reserve Bank of India making the major
contribution. Besides a programme to recapitalise Regional Rural Banks was introduced so that
the capital base of these banks could be strengthened. However, the problems faced by Regional
Rural Banks were endemic and chronic. Several solutions were suggested including the merger
of RRBS with the sponsor banks but an agreed solution proved elusive.

SYSTEM OF SUPERVISION

The very process of banking sector reform required that the supervisory system was adequately
expanded and strengthened. Introduction of prudential norms was not enough; its implementation
had to be monitored closely. The supervisory system within the Reserve Bank underwent two
important changes, one relating to the focus of supervision and the other with respect to
institutional arrangements. A thorough review was made with the help of a committee on what
the objectives, focus and periodicity of supervision should be. Several changes were introduced
in the methodology of supervision. The role and functions of external auditors were more clearly
defined. A system of offsite surveillance was also contemplated. The institutional arrangements
relating to supervision within the Reserve Bank underwent a change in number of ways. Apart
from creating a separate department for supervision, the Board for Financial Supervision with an
advisory council was setup. It has been argued that the supervisory functions should have been
totally separated from RBI with a separate independent authority set up for that purpose. In
relation to the role of central bank in banking supervision, there are several models available in
the world, ranging from total separation to in-house arrangements. There is no conclusive
evidence that countries with total separation of supervision from central banks have had a better
record in controlling bank failures While the need for a separate arrangement for supervision was
clearly recognized, any arrangement other than what was initiated would have required either a
separate enactment or drastic changes in the Reserve Bank of India Act. It was decided to
experiment with an arrangement which could be effective and which could operate within the
existing legal frame work. The new arrangement while retaining the overall control of the
Reserve Bank ensured that supervision would be performed as a distinct and special function. A
similar arrangement was in vogue in Bank of England until 1998. However what could be the
best institutional arrangement with respect to supervision was not a closed issue.

Financial sector reform is a continuous process. However, it acquired a special urgency and
importance in the wake of the economic crisis of 1991. Even recent events elsewhere in the
world have shown why a sound and safe financial system is essential, if the growth process is not
to be derailed Significant changes in the banking sector were made during the period 1992-1997.
They constitute a solid foundation. But as the saying goes, we have miles to go. Even as we
make further changes to reform the banking sector ultimately the aim should be to create a
dynamic financial system which can on its own respond to the changing environment and also
correct its mistakes.