ABSTRACT

During the post-independence period until the early 1990s, the financial system in India was characterised by a heavily regulated framework such as interest rate controls, a directed credit programme and strict entry rules to the financial markets. In addition, money and capital markets were underdeveloped, and the budget deficit of the central government was automatically monetised by the Reserve Bank of India (RBI). Against this background, a macroeconomic crisis arose in the early 1990s. Due to a deficiency in the tax system and a significant proportion of unplanned expenditure in the fiscal sector, the budget deficit became persistent. Furthermore, India had to rely on foreign debt in order to fill the saving-investment gap in the face of a declining trend of external assistance flows in the 1970s. The accelerating fiscal deficits led to a higher rate of inflation and a balance of payments crisis occurred in 1991. Since then, the government has launched a gradual financial reform programme as an integral part of its stabilisation policies. This chapter starts with a brief overview of the current main regulations imposed

on commercial banks. Then, the development of the financial markets in the preand post-financial reform periods will be discussed, including the government securities market, the credit market, the money market, the stock market and the foreign exchange market. The impact of the liberalisation in the financial sector on the conduct and effectiveness of monetary policy will then be investigated. Concluding remarks summarise the major effects of the financial reforms on the real and financial sectors.