Industrial Policy, 1991

INTRODUCTION
The industrial policies pursued till 1990 enabled India to develop a vast and
diversified industrial structure. India attained self–sufficiency in a wide range of
consumer goods. But the industrial growth was not rapid enough to generate
sufficient employment, to reduce regional disparities and to alleviate poverty. It
was felt that government controls and regulations had put shackles on the growth
of different segments of Indian Industry. Lack of adequate competition resulted in
inadaquate emphasis on the reduction of costs, up-gradation of technology and
improvement of quality standards. It is to reorient and accelerate industrial
development with emphasis on the productivity, growth and quality improvement
to achieve international competitiveness that the Industrial Policy of 1991 was
announced.

Objectives of IP, 1991:

IP, 1991 has the following objects:
� to build on the gains already made
� to correct the distortions or weaknesses that have crept in
� to maintain a sustained growth in productivity and employment, and
� to attain the international competitiveness.

Elements of IP, 1991:

To achieve these objectives, IP, 1991 introduced changes with respect to:
� Industrial licensing
� Foreign investment
� Foreign technology agreements
� Public sector policy and the
� MRTP Act.

1. INDUSTRIAL DELICENSING:
Till the 1990s, licensing was compulsory for almost every industry, which was not
reserved for the public sector. This licensing system was applicable to all
industrial enterprises having investment in fixed assets (which include land,
buildings, plant & machinery) above a certain limit. With progressive liberalization
and deregulation of the economy, industrial license is required in very few cases.
Industrial licenses are regulated under the Industries (Development and
Regulation) Act 1951. At present, industrial license is required only for the
following:

i. Industries retained under compulsory licensing (five industries are

reserved under this category).
 Notes on Business Environment By Dr. Anupama Rajput

ii. Manufacture of items reserved for small scale sector by larger units: An
industrial undertaking is defined as small scale unit if the capital investment does
not exceed Rs. 10 million (approximately $ 222,222). The Government has
reserved certain items for exclusive manufacture in the small-scale sector. Non
small-scale units can manufacture items reserved for the small-scale sector if
they undertake an obligation to export 50% of the production after obtaining an
industrial license.
iii. When the proposed location attracts locational restriction: Industrial
undertakings to be located within 25 kms of the standard urban area limit of 23
cities having a population of 1 million as per 1991 census require an industrial
license.

Thus, excluding these, investors are free to set up a new industrial enterprise,
expand an industrial enterprise substantially, change the location of an existing
industrial enterprise and manufacture a new product through an already
established industrial enterprise. The objective of industrial delicencing would be
to enable business enterprises to respond to the fast changing external
conditions. Entrepreneurs will be free to make investment decisions on the basis
of their own commercial judgment. This will facilitate the technological dynamism
and international competitiveness. Further industries will have freedom to take
advantage of ‘economies of scale’ as well as ‘economies of scope’ in the current
industrial policy environment.

2. Removal of Threshold Limits on Asset Size of Companies through

amendment of MRTP Act, 1969:
An important objective of India’s earlier industrial policies was to prevent
emergence of private monopolies and concentration of economic power in a few
individuals. Accordingly, Monopolies and Restrictive Trade Practices (MRTP)
Act, 1969 was enacted and MRTP Commission was set up as a permanent body
to periodically review industrial ownership, advice the government to prevent
concentration of economic power, investigate monopolistic trade practices and
inquire into restrictive trade practices, which are prejudicial to public interest.
An MRTP firm was mainly defined in terms of asset size. An MRTP company had
to obtain prior approval of the government for setting up a new enterprise as well
as for expansion. However, MRTP Act was applicable only to private sector
companies.

Since 1991 MRTP Act has been restructured and pre-entry restrictions have
been removed with regard to prior approval of the government for the
establishment of a new undertaking, expansion, amalgamation, merger, take
over, and appointment of directors of companies. The asset restriction and
market share for defining an MRTP firm has been done away with. MRTP Act is
now applicable to both private and public sector enterprises and financial
institutions. Today only restrictive trade practices of companies are monitored
and controlled. The MRTP act has been replaced by the Competition Act, 2002.
This law aims at upholding competition in the Indian market. The competition

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commission has been established in 2003 which mainly control the practice that
have an adverse impact on competition.

3. Public Sector De-Reservation and Privatization through Dis-Investment

Till 1991, Public Sector was assigned a pre-eminent position in Indian Industry to
enable it to achieve “commanding heights of the economy” under the Industrial
Policy Resolution (IPR),1956. Accordingly, areas of strategic importance and
core sectors were exclusively reserved for public sector enterprises. Public
enterprises were accorded preference even in areas where private investments
were possible.

Since 1991, the public sector policy consists of:

i) Reduction in the number of industries reserved for public sector: Now
only two industries (atomic energy and railway transport) are reserved for the
Public Sector. They are known as “Annexure I” industries (Ministry of Commerce
and Industry, 2001). The essence of government’s Public Sector Undertakings
(PSUs) policy since 1991 has been that government should not operate any
commercial enterprises. The policy emphasized to bring down government equity
in all non-strategic PSUs to 26 percent or lower, restructure or revive potentially
viable PSUs, close down PSUs, which cannot be revived and fully protect the
interests of workers. Government’s withdrawal from non-core sectors is indicated
on considerations of long-term efficient use of capital, growing financial un-
viability and the compulsions for these PSUs to operate in an increasingly
competitive and market oriented environment (Disinvestment Commission,
1997).
ii) Implementation of Memorandum of Understanding (MOU): As a part of
the measures to improve the performance of public enterprises, more and more
of public sector units have been brought under the purview of Memorandum of
Understanding (MoU) system. A memorandum of understanding is a
performance contract, a freely negotiated document between the Government
and a specific public enterprise.
iii) Referral to BIFR: Many sick public sector units have been referred to the
Board for Industrial and Financial Reconstruction (BIFR) for rehabilitation or,
where necessary, for winding up.
iv) Manpower Rationalization: In order to make manpower rationalization
Voluntary Retirement Scheme (VRS) has been introduced in a number of PSEs
to shed the surplus manpower.
v) Private Equity Participation: PSEs have been allowed to raise equity
finance from the capital market. This has provided a market pressure on PSEs to
improve their performance.
vi) Disinvestment and Privatization: Disinvestment and privatization of
existing PSEs has been adopted to improve corporate efficiency, financial
performance and competition amongst PSEs. It involves transfer of Government
holding in PSEs to the private shareholders.

4. Foreign Investment Policy:

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The foreign investment policy was reformed and accordingly foreign investment
was actively sought. Both foreign direct investment and portfolio flows have been
encouraged in the post-reform period with some positive results in both cases.
The important foreign investment policy measures are as follows:

i) Repeal of FERA, 1973: FERA, 1973 has been repealed and Foreign
Exchange Management Act (FEMA) has come into force with effect from June
2000 (RBI, 2003). Investment and returns can be freely repatriated except where
the approval is subject to specific conditions such as lock-in period on original
investment, dividend cap, foreign exchange neutrality, etc. as specified in the
sector specific policies.
ii) Dilution of Restrictions on Foreign Direct Investment (FDI): FDI is allowed
in all sectors including the services sector except atomic energy and railway
transport. FDI in small scale industries is allowed up to 24% equity. Use of brand
names/trade marks is allowed. Further, FDI up to 100% is allowed under the
automatic route in all activities/sectors except the following, which require prior
approval of the Government:-
- Sectors prohibited for FDI
- Activities/items that require an industrial license
- Proposals in which the foreign collaborator has an existing financial/technical
collaboration in India in the same field
- Proposals for acquisitions of shares in an existing Indian company in financial
service sector and where Securities and Exchange Board of India (substantial
acquisition of shares and takeovers) regulations, 1997 is attracted
- All proposals falling outside notified sectoral policy/CAPS under sectors in
which FDI is not permitted.

5. Foreign Technology Agreements (FTA)

The automatic approvals for technology agreement are allowed to industries
within specified parameters. Indian companies are free to negotiate the terms of
technology transfer with their foreign counterparts according to their own
commercial judgment. Companies can make remittances for technical services
fees, know-how and royalty subject to the terms approved by RBI.

6. Dilution of Protection to SSI and Emphasis on Competitiveness

Since 1991, the protective emphasis of SSI policy has undergone dilution. The
number of products reserved exclusively for purchase from small industry by the
government has been reduced to 358 items from 409 items. Measures have
been adopted to improve technology and export capabilities of SSIs. The overall
promotion orientation of SSI has shifted from protection towards competitiveness.

IMPACT OF INDUSTRIAL POLICY, 1991

The all-round changes introduced in the industrial policy framework have given
a new direction to the future industrialization of the country. There are
encouraging trends on diverse fronts. Industrial growth was 1.7 per cent in 1991-
92 to 9.2 percent in 2007-08.

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the industrial structure is much more balanced

The impact of industrial reforms is reflected in multiple increase in investment
envisaged, both domestic and foreign. This is due to encouraging response from
the private sector. There has been dramatic increase in FDI since 1991. The
foreign investment as a percentage of total GDP has increased from 0.5 percent
in 1990-91 to 5.7 percent in 2006.

Investments in infrastructure sector such as power generation have surged from

players of various sizes in different states.
The capital goods have grown at an accelerated pace, over a high base attained
in the previous years, which augurs well for the required industrial capacity
addition.

SUMMARY
The primary objective of Industrial Policy of 1991 is to achieve international
competitiveness, in addition to that of IPR 1956. To achieve these objectives the
policy introduced far reaching changes with respect to licensing, foreign
investment and technology, MRTP Act, competition policy, public sector
enterprises, etc. The scope for private sector, both domestic and foreign, is
widened dramatically; licensing is virtually scrapped; threshold limit on assets of
large undertakings is removed; mergers, acquisitions and amalgamations are
allowed, financial performance of public sector is accorded prominence, and
retrenchment and redeployment of labor wherever necessary to improve
industrial efficiency is encouraged. These reforms have started yielding positive
results. Industry has reached double digit growth and the growth is likely to get
further momentum. There is a spurt in domestic and foreign investments across
the industry. The public sector restructuring has also been initiated. However,
nothing much has been done to allow the exit of inefficient units.

Liberalization, Privatization and Globalization (LPG)

Liberalization
In common parlance, liberalization is the loosening up of controls, which the
government exercises on economic forces. It means the reduction of
government regulation on economic activity and allowing greater use of market
forces in the economic processes. The main aim of the liberalization was to
dismantle the excessive regulatory framework that curtailed the freedom of
enterprise and free the large private corporate sector from bureaucratic controls.
The liberalization process in India was initiated following a balance of payments
crisis in 1990–91. The major components of liberalization are as follows:

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Industrial Sector Reforms: This reform sought to remove the barriers

preventing entry of new firms and the limits to growth in the size of existing firms.
The strategies are:

(i) Abolition of industrial licensing as an instrument of control over private

investment.
(ii) Abolition of the restriction on investment by large industrial groups.
(iii) Drastic reduction in the list of industries reserved for the public sector.
(iv) Elimination of price control on several industrial items.
(v) Reduction of the list of items reserved for production in the small-scale
sector.
(vi) Opening the economy to FDI

Trade Sector Reforms: The objective of the trade reform is to encourage free
flow of imports
and exports to the maximum possible extent. This involves:
(i) Elimination of quantitative import licensing.
(ii) Reduction in import tariff levels.
(iii) Abolition of subsidies on exports
(iv) Adoption of a flexible exchange rate regime.

Financial Sector reforms: The financial sector reforms aimed at profit oriented
financial services and the better functioning of the money and capital markets.
The three major sub-divisions are:
• Reforms in the banking sector: The efforts are liberalisation of interest
rate controls and controls over bank credit allocation, introduction of
prudential norms and improved supervisory standards, liberalisation of
entry for private banks and introduction of minority private share holding in
public sector banks.
• Reforms in the capital market: The major elements are elimination of
government control over the issue of capital, attract foreign portfolio
capital, establishment of an independent regulator for the securities
market and opening the mutual funds sector for private mutual funds.
• Reforms in insurance: Insurance sector is being opened to new private
sector insurers but with a capital of 26 per cent in foreign equity.

Fiscal reforms: The fiscal reforms are aimed at reducing the financial burden of
the state and improve the stability of the nation. The specific strategies adopted
are:
(i) Reducing the fiscal deficit of both the central and state governments.
(ii) Tax reforms at the central and state government levels including moderation
of rates of tax, simplification and introduction of VAT principles in domestic
indirect taxation by the central government and more recently by state
governments also.

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(iii) Sale of minority equity in public sector organisations to mobilise resources for
the budget.
(iv) Adoption of a general strategy for public-private partnership in developing
infrastructure.
(v) Efforts to open up the following sectors under varying regulatory structures:
power, telecommunications, roads. post, airports and. most recently, railways

- Dismantling the regime of industrial licensing and controls.

- Removal of Threshold Limits on Asset Size of Companies through amendment
of MRTP Act, 1969:
- Public Sector De-Reservation and Privatization through Dis-Investment
- Freer Foreign Investment
- Greater Freedom for Foreign Technology Agreements (FTA)
- Dilution of Protection to SSI and Emphasis on Competitiveness

Privatization
Privatization has to be viewed in two ways: In a narrow sense, it implies the
induction of private ownership in a public sector undertaking. In a broader sense,
it implies the enlargement of the scope of the private sector in the growth of the
economy. The basic purpose is to limit the areas of the public sector and to
extend the areas of private sector operation including heavy industries and
infrastructure. Privatization is, therefore, a process of involving the private sector
in the ownership or operation of a state owned or public sector undertaking.
Privatization is, therefore, a process of involving the private sector in the
ownership or operation of a state owned or public sector undertaking. It can take
three forms: (i) Ownership measures; (ii) Organizational measures; and (iii)
Operational measures.

(i) Ownership measures involve the transfer of government ownership in the

public sector enterprises (i.e. PSEs) to the private sector. In India it has taken
three forms:

a) Total decentralization implies 100 per cent transfer of ownership of a public

enterprise to private sector.
b) Joint Venture implies partial transfer of a public enterprise to the private
sector.
c) Liquidation implies the complete sale of enterprises.

(ii) Organizational measures include a variety of measures to a limited state

control. It includes:
a) A holding company is designed to taking top-level major decisions with
sufficient degree of autonomy for the operating companies in its hold in their day-
to- day operations.
b) Leasing: In this arrangement, the government agrees to transfer the use of
assets of a public enterprise to a private bidder for a specified period

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c) Restructuring involving the changes in the financial structure or activities of

business of PSEs.

(iii) Operational measures involve the transformation in organization structure

so as to provide the sufficient degree of autonomy to the operators of the
enterprise or develop a system of incentives that raise its efficiency and
productivity. The basic purpose of operational measures is to infuse the spirit of
private enterprise. In India it is in the form of: a) MOU between government and
management of PSEs; b) Granting of operational freedom to the managers.
c) Provision of incentives for workers and executives consistent with increase in
efficiency and productivity; d) development of proper criteria for the investment
planning e) permission to public enterprise to raise resources from the capital
market

Impact of Privatization on the Performance of Public Sector Enterprises

(PSEs):
The market-oriented reforms since 1980’s have brought a commendable change
in the performance of PSEs in India. The reduced budgetary allocation
accompanied by a greater managerial autonomy and a growing competition has
instill a greater amount of cost consciousness amongst PSEs. The changes in
the market conditions and corporate governance had ensured greater
accountability.
The ratio of net profit to capital employed has been 3.5% on average during 80’s
which fell to 3% during early period of reforms. This ratio has witnessed an
increasing trend over the last decade. It stood at 12.26% in 2006-07.

There is the sharp decline in number of loss making PSEs and their losses. The
number of loss making units has declined from 92 in 1983-84 to 59 in 2006-07.
the profits earned and dividend paid by PSEs is steadily improving.

The reform process especially of loss-making units have to be further

strengthen as the number of loss making is still on the higher side

GLOBALISATION
Globalization is primarily an economic phenomenon that involves the increasing
interaction, or integration, of national economic systems through the growth in
international trade, investment and capital flows. A rapid increase in cross border
social, cultural and technological exchange is part of the phenomenon of
globalization.

It has four parameters:

(i) Reduction of trade barriers so as to permit free flow of capital and services
across national frontiers;
(ii) Creation of an environment in which free flow of capital can take place;
(iii) Creation of an environment permitting free flow of technology among nation-
states; and

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(iv) Creation of an environment in which free movement of labour can take place
in different countries of the world.

In other words unhindered trade flows, capital flows, technology flows and labor
flows are important components of globalization.

Measures of Globalization of Indian Economy:

To pursue the objective of globalization, the following measures have been
taken:

i. Reduction of import duties: There has been a considerable reduction in

import duties. By 1990 import duties were 300 percent or more for several items
and above 200 percent for many items. Peak rates were progressively reduced
to 10%.

ii. Reduction of restrictions on Imports: The import control regime earlier

applicable to imports of raw materials, other inputs, production and capital goods
has been virtually dismantled. Today, all raw materials, other inputs and capital
goods, can be freely imported except for a relatively small negative list.

iii. Encouragement of foreign investment: The government has taken a

number of measures to encourage foreign investment. The main measures
taken in this regard are:

• Approval for automatic direct investment upto 100 per cent foreign equity

iv. Encouragement to foreign technology agreement: The Industrial

Policy of 1991 undertook the following measures:
• Automatic permission will be given for foreign technology agreements in
high priority industries
• No permission will be necessary for hiring of foreign technicians and
foreign testing of indigenously developed technologies.

Impact of Liberalization:
Indian economy has been undergoing significant changes in all the sectors in
recent years. The impact of LPG on the Indian economy are wide and could be
seen from several angles such as internal and external trade, production,
consumption and distribution, overall and sector wise performance, social,
economical, political and cultural impacts, and macro and micro level impacts.

• Growth of GDP:
Annual growth in GDP per capita has accelerated from just 1¼ per cent in the
three decades after Independence to 7½ per cent currently, a rate of growth that
will double average income in a decade. Potential output growth is currently
estimated to be 8½ per cent annually and India is now the third largest economy

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in the world. Increased economic growth has helped reduce poverty, which has
begun to fall in absolute terms.

• By 2006, the average share of imports and exports in GDP had risen to
24%, up from 6% in 1985.
• Inflows of foreign direct investment increased to 2% of GDP from less than
0.1% of GDP in 1990,
• The net national saving rate between 2001 and 2007, has now reached
almost 23% of GDP,
• The combined fiscal deficit of central and state governments has been
reduced from 10% of GDP in 2002 to just over 6% of GDP by 2006, with
the ratio of debt to GDP falling from 82% in 2004 to 75% by March 2007.
• GDP per capita is now rising by 7½ per cent annually, a rate that leads to
its doubling in a decade
• Faster growth has resulted in India becoming the third largest economy in
the world (after the United States and China and just ahead of Japan) in
2006, when measured at purchasing power parities, accounting for nearly
7% of world GDP.
• with increased openness and rapid growth in exports of merchandise and
IT-related services, its share in world trade in goods and services had
risen to slightly over one per cent in 2005, when measured at market
exchange rates.
• The current account has been largely financed by foreign direct
investment. Such a benign outcome has been helped by increased
domestic saving including the recent fiscal consolidation.
• Increased growth since the mid-1980s has helped to substantially reduce
the national poverty rate to less than 20% of the population in 2008.

Major Issues and Challenges:

1) Reduction of Local Trade Barriers through the creation of Special

Economic Zones

2) Taxation policies need to be reformed in terms of further simplification of

tax structure, reduction of levels and dispersion of import tariffs.

3) Reducing bottlenecks in infrastructure with greater private participation in

areas such as Electricity generation where public enterprises are still
dominant and demand consistently outstrips supply, representing a major
constraint on growth (factors such as cross-subsidization, state dictated
pricing policy).

4) Reforms in Labor Market: The reduction in the stringency of

employment protection laws and consolidation of complex structure of
labor laws is needed to increase employment opportunities, improve
labor wage and social security provided by the business. It will also

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facilitate the movement of labor out of agriculture to more productive

areas.

5) Minimize barriers to competition: It is important to ensure that the

competitive environment is created for firms to operate which are still
highly concentrated. The reservation of specific product for SMEs needs
to be further revised.

6) Modern bankruptcy law: At present there exists a difficult and lengthy

process to restructure or close insolvent or bankrupt companies. The
modern bankruptcy law that reduces the role of the courts is required to
restructure the business in the present dynamic environment.

7) Public Sector Reforms involving greater privatizing of sectors where the

government share of output is larger (banking, insurance, coal and
electricity)

8) Reforms in Financial Sector: Progressive Deregulation in terms of

freedom on asset liability management of banks, reduction of foreign
investment in bank, improvement of bond market.

9) Fiscal Reforms in terms of re-organization of public spending by

reducing outlays on subsidies and better targeting them to reach poor
people, simplification of direct and indirect of taxation procedures (in
terms of reduction of tax exemptions, levels of indirect taxes) and fiscal
discipline among states are essential.

Conclusion:
Market-oriented reforms – which started in the mid-1980s and were followed by
more fundamental reforms since the early 1990s and renewed in the 2000s –
have lifted the Indian economy on to a significantly higher growth path, helping to
reduce poverty. In order to further raise the sustainable and inclusive growth
further reforms are required in terms of reducing restrictions in labor and product
markets; improving infrastructure, human capital formation and general public
services; and reducing tax distortions.

Monetary and Fiscal Policies in India

Meaning
Monetary policy (MP) is the deliberate effort by the central bank (i.e.
RBI in India) to influence economic activity by variations in the money
supply, availability of credit or interest and exchange rates consistent
with specific national objectives. It is the management of money
supply and interest rates by central banks to influence prices and

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employment. It is also described as money and credit policy as ti

concerns itself with supply of money and credit to the economy.
(Note: MP is the statement that used to be announced twice in the year (i.e.
October and April referred to as busy and lean season policy respectively till
1998-99. But with decrease in the share of agriculture credit RBI has started
making annual policy statement in April with a review in October.)

Monetary Policy can be

Expansionary Policy Contractionary Policy

Increase in SS of money and credit Decrease in money SS and credit

Impact of MP:
Monetary policy is an important part of regulatory framework. It has a profound
impact on business firms. Changes in money supply affect aggregate demand,
and the general price level. The availability of credit affects liquidity and business
investments. The business managers have to keep a close watch over the
changes in the monetary policy. It influences money supply and availability and
cost of credit in the economy. These in turn influence the savings, investment
and consumer expenditure in the economy. The monetary policy through its
implication on the demand and supply of credit can influence the business and
industry in a big way.

Instruments of MP in India
MP is implemented through the instruments that can be classified as Direct
instruments or Indirect instruments.
Instruments of Monetary Policy

Direct Indirect (market based)

one-to-one correspondence first would affect

between the instrument dd and ss of bank’s reserves, price of
and its objective money and then the desired objective is met
Examples Examples
(CRR,SLR, administered ‘r’ (Open Market operations, Repo)

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directed lendings, moral suasion)

The term “direct” refers to the one-to-one correspondence between the

instrument (such as a credit ceiling) and the policy objective (such as a specific
amount of domestic credit outstanding). Direct instruments operate by setting or
limiting either prices (interest rates) or quantities (amounts of credit outstanding)
through regulations. Indirect instruments act through the market by, i.e. in the
first instance, adjusting the underlying demand for, and supply of, bank reserves
and then would affect the price and quantities of credit outstanding.

 The direct instruments include cash reserve ratio (CRR), liquidity

reserve ratios, directed credit and administered interest rates. The direct
instruments include cash reserve ratio (CRR), liquidity reserve ratios,
directed credit and administered interest rates.
CRR specifies the amount of reserves, banks need to maintain as cash or with
the central bank as percentage of their liabilities (deposits). (at present it 5.5%)
Statutory Liquidity Ratio (SLR) in India, specifies the amount of money banks
must invest in Government securities (and bonds of PSUs) as proportion of their
deposits. (at present it is 24%).
Directed credit prgramme is used to channelise flow of credit to
preferred/priority sectors. Administered interest rates are used to control lending
and deposit rates directly.

 The indirect instruments consist of the repos (repurchase agreements),

Open market operations (OMO), refinance facility, discounting facilities

OMO are, broadly defined, the purchase or sale of financial instruments by the
central bank, in either the primary market (open market- type operations) or the
secondary market (full-fledged open market operations. It is resorted to when the
central bank attempts to change the liquidity condition for a longer term.

Repo/Reverse Repo: It is a transaction in which two parties agree to sell and

repurchase the same security. Under such an agreement the seller sells
specified securities with an agreement to repurchase the same at a mutually
decided future date and a price. The present repo rate is 7.5% and reverse repo
is 6%.

(Notes:The Repo/Reverse repo transactions can only be done at Mumbai

between parties approved by RBI and in securities as approved by RBI (Treasury
Bills, Central/State Govt securities).
Notes:
Uses of Repo
-It helps banks to invest surplus cash
-It helps investor achieve money market returns with sovereign risk.
-It helps borrower to raise funds at better rates

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-An SLR surplus and CRR deficit bank can use the Repo deals as a convenient
way of adjusting SLR/CRR positions simultaneously.

-RBI uses Repo and Reverse repo as instruments for liquidity adjustment in the
system.

Refinance facility, discounting facilities involves refinance of eligible

export credits) and discount window facility (rediscounting of bills or
borrowings from RBI by banks)

Objectives of MP in India
Price stability (or controlling inflation) and maintaining economic growth are the
most commonly pursued objectives by central banks across the world. In view of
large-scale financial crises that occurred in a number of countries in the 1990’s
(notably in Mexico, South Asia, Brazil and Argentina), achieving financial stability
to pre-empt such crisis or to protect the national economy from the ill effects of
such crisis occurring in another country has become an additional objective of
monetary policy.

1. Price stability:
Price stability is the prime concern of developing countries like India. A high
degree of inflation has adverse effects on the economy. It raises the cost of
living, makes exports costlier, reduces incentive to save, and encourages non-
productive investment. Since the price rise is closely linked to the money and
credit supply, therefore MP is used to achieve price stability. The increase in
money ss raises demand of goods and services and exerts upward pressure on
prices and vice-versa. The RBI through its monetary instruments can change the
availability of money and credit supply or cost of funds and thus would price
stability.

2. Economic Growth:
The adequate finance is the pre-requisite of fast economic growth. The
expansion of credit and money supply helps in rapid development and
diversification of the economy. However, the excessive expansion leads to price
instability and may endanger the financial stability of the economy.

3. Financial Stability:
The primary function of financial system is to facilitate the smooth and efficient
flow of funds from savers to user of funds. The financial instability means the
contagious or systemic risk on financial system of the economy. Financial
markets are different from real market as the herd mentality catches up fast
making market more volatile. In India RBI ensures financial stability through
- regulations / supervision of financial entities called preventive
measures.
- Safety measures such provisioning norms, capital adequacy norms
etc.

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- Liquidity maintenance through its monetary instruments to avoid

disruptions and disorderly failures eg recently fall in CRR, SLR repo
rates are egs of providing liquidity to provide financial stability in the
market.

4. Exchange Rate Stability:

India has moved towards the floating exchange rate policy since 1993 whereby
market forces determine the exchange rate. As a policy the exchange rate is
market determined but RBI intervenes to avoid the situation of excessive
appreciation or depreciation of rupee against the foreign currency. For instance
to prevent depreciation of rupee RBI releases more dollars and vice versa to
prevent appreciation of rupee.

All the objectives may not be complementary to each other and so

depending upon the circumstances the emphasis keep on changing.

Monetary Policy: Recent Trends

i. Earlier MP was conducted with a view of expansion of broad money supply as
a target. The desired rate of growth of money ss was kept in view of expected
GDP growth and level of inflation. But with reform process it is simply not
determined in the light of GDP growth and level of inflation but also exchange
rate and capital flows.
ii. Indirect instruments has replaced direct instruments so repo has been used
more extensively by RBI.
iii. The MP has been disentangled from fiscal policy to a large extent as the
increased fiscal deficit is financed by market determined interest rates.
iv. Interest rate deregulation has occurred.

Fiscal Policy (FP) See notes

Conclusion: MP and FP are complementary to each other:

MP and FP are complementary instruments of the general economic policy of the

government. They have to be considered in conjunction with each other to
achieve desired level of growth and stability.FP influences demand pressure via
both government spending and changes in the private disposable income via
taxation and subsidies system. In this way fiscal policy affect demand and
inflation pressure. For example if govt. increases its spending all other things
equal monetary policy needs to be tighter so that slow growth in the private
demand can make room for additional govt. demand without adversely affecting
the price. (Shown as below)

Higher Govt exp High govt. exp

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 Notes on Business Environment By Dr. Anupama Rajput

Crowds out pvt. Productive Invest. monetization of deficit

Price Rise price rise

ContractionaryMP contractionary MP

Similarly large monetized fiscal deficit leads to excess liquidity in the system and thus
contractionary MP has to be followed to mop up excess liquidity to bring about monetary
stability.

The FP also determines the foreign reserve position of a country. The higher fiscal deficit
reduces the sovereign rating in the international market and can negatively affect the
foreign reserve position. MP has to be designed to stabilize foreign exchange reserve of
the country.

High Govt. exp.

Lower international rating

lower attraction to foreign investors

MP to attract foreign investment.

The credibility of MP is also important factor that determines the fiscal position. The
independent monetary policy prevents the monetization of govt. debt to a certain level.

Thus fiscal policy affects the success of MP in various ways and the efficiency of MP is
also dependent upon the efficient and effective FP.

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