BA LLB 2nd semester economics notes pdf :Give a critical evaluation of the financial sector reforms in India in the post-1991 period

The initiation of financial reforms in the country during the early 1990s was to a large extent conditioned by the analysis and recommendations of various committees/working groups set up to address specific issues. The process has been marked by ‘gradualism’ with measures being undertaken after extensive consultations with experts and market participants.

Reform measures introduced across sectors as well as within each sector were planned in such a way so as to reinforce each other. Attempts Were made to simultaneously strengthen commercial decision-making and market forces in an increasingly competitive framework. At the same time, the process did not lose sight of the social responsibilities of the financial sector. However, for fulfilling such objectives, rather than using administrative fiat or coercive, attempts were made to provide operational flexibility and incentives so that the desired ends are attended through the broad interplay of market forces.

Despite several changes in government, there has not been any reversal of direction in the financial sector reform process over the last 15 years. As pointed by Governor Reddy, the approach towards financial sector reforms in India is based on panchasutra or five principles:
(i) Cautious and appropriate sequencing of reform measures.
(ii) Introduction of norms that are mutually reinforcing.                                                                          (iii) Introduction of complementary reforms across sectors (most importantly, monetary, fiscal, and external sectors).
iv) Development of financial institutions.
(v) Development of financial markets.

                                                         Policy Reforms

Commercial banking constitutes the largest segment of the Indian financial system. Despite the general approach of the financial sector process to establish regulatory convergence among institutions involved in broadly similar activities, given the large systemic implications of the commercial banks, many of the regulatory and supervisory norms were initiated first for commercial banks and were late extended to other types of financial intermediaries.

After the nationalization of major banks in two waves, starting in 1969, the Indian banking system became predominantly government-owned by the early 1990s. Banking sector reform essentially consisted of a two-pronged approach. While nudging the Indian banking system to better health through the introduction of international best practices in prudential regulation and supervision early in the reform cycle, the idea was to increase competition in the system gradually.

Unlike in other emerging market countries, many of which had the presence of government-owned banks and financial institutions, banking reform has not involved large-scale privatization of such banks. The approach, instead first involved recapitalization of banks from government resources to bring them to appropriate capitalization standards. In the second phase, instead of privatization, an increase in capitalization has been done through diversification of ownership to private investors up to a limit of 49 percent, thereby keeping majority ownership and control with the government. With such widening of ownership, most of these banks have been publicly listed; this was designed to introduce greater market discipline in bank management and greater transparency through enhanced disclosure norms. The phased introduction of new private sector banks, the expansion in the number of foreign bank branches, provided for new competition.

Debt Market Reforms

Major reforms have been carried out in the government securities (G-Sec.) debt market: In fact, it is probably correct to say that a functioning G-Sec debt market was really initiated in the 1990s. The system had to essentially move from a strategy of pre-emption of recourse from banks at administered interest rates and through monetization to a more market-oriented system. Prescription of a “statutory liquidity ratio” (SLR), i.e., the ratio at which banks are required to invest in approved securities, though originally devised as a prudential measure, was used as the main instrument of pre-emption of bank resources in the pre-reform period. The high SLR requirement created a captive market for government securities, which were issued at low administered interest rates. After the initiation of reforms, this ratio has been reduced in phases to the statutory minimum level of 25%. Over the past few years, numerous steps have been taken to broaden and deepen the Government securities market and to raise the levels of transparency. Automatic monetization of the Government’s deficit has been phased out and the market borrowing of the Central Government is presently undertaken through a system of auctions at market-related rates.




Forex Market-Reforms

The Indian forex exchange market had been heavily controlled since the 1950s, along with increasing trade controls designed to foster import substitution. Consequently, both the current and capital accounts were closed and foreign exchange was made available by the RBI through a complex licensing system. The task facing Indian in the early 1990s was therefore to gradually move from total control to a functioning forex market. The move towards a market-based exchange rate regime in 1993 and the subsequent adoption of current account convertibility were the key measures in reforming the Indian foreign exchange market. Reforms in the foreign exchange market focused on market development with prudential safeguards without destabilizing the market. Authorized Dealers of foreign exchange have been allowed to carry on a large range of activities. Banks have been given large autonomy to undertake foreign exchange market a large number of products have been introduced and entry of newer players has been allowed in the market.