The way RBI lays its monetary policy it is difficult to judge its performance in a well defined benchmark. The first problem is to assess requirement (demand) of credit in the economy. Secondly if demand is estimated then the "adequate" credit may vary as per the perception and aversion to the risk. Third, credit extended "to support growth" may have a time-varying relationship with GDP growth. All this will depend upon the efficient banking system, as it the delivery channel, also upon the availability of the funds from the non-banking source and corporate behaviour in raising finances for projects. Measuring the "adequate" level of credit is, therefore, not an easy task. For example, results in Banerjee and Duflo (2004) suggest that during the second half of the 1990s, many small firms in India were severely credit constrained. While credit extended in the economy may not be "adequate" from these firms' perspective, the same may not hold from the point of view of the banking sector or the central bank. But during that time non-banking financial source of credit also starts growing and the gap between them narrowed down in worldwide. This was also consistent with our country also. Although during the 1970s and 1980s the credit channel was thought to be the only effective channel for monetary policy transmission, the inefficiency in the directed lending programmes did not necessarily lead to growth. While economic reforms opened up other channels, the increased efficiency in the banking sector led to a closer association between credit growth and GDP growth.A broader interpretation of the objectives of monetary policy in India, however, includes price stability and GDP growth. We therefore examine performance with respect to these two variables.
The period 1970-71 to 2004-05 has been divided into four phases:
1970-71 to 1984-85 (Pre-MT),
1985-86 to 1992-93 (MT: Phase 1)
1993-94 to 1997-98 (MT: Phase 2)
1998-99 to 2004-05 (MIA).
Performance under different monetary policy
Annual average
Period
Inflation
GDP growth
Pre-MT (1970-71 to 1984-85)
8.4
3.8
MT (1985-86 to 1997-98)
8.1
5.7
Phase 1 (1985-86 to 1992-93)
8.4
5.2
Phase 2 (1993-94 to 1997-98)
7.6
6.6
MIA (1998-99 to 2004-05)
5
6
The above picture clearly depicts inflation in India has fallen gradually with the increase in GDP growth rate. As the prices were not market-determined and were often kept steady artificially with budget support, the problem of controlling price rises was not relevant. Thus, apparently, the MIA in India has served its purpose well. However, first, better performance under the later framework does not prove that it is the change of the framework or monetary policy alone that has caused the better performance. Performance with respect to both inflation and growth under a particular framework is the result of many other policies. Second, the performance comparison should ideally take place in a ceteris paribus condition.
Role of monetary policy in the observed performance
We now attempt to assess the extent of role of monetary policy in India in bringing about the changes in economic performance. We can analyse the role of shocks other than monetary policy shocks to inflation in India. The main shocks were the supply shock. Indian economy experienced three high inflation episodes, viz, 1972-75, 1979-81 and 1990-95, leading to double digit inflation rates.
International Oil Shock (1972-75, 1979-81)
Fiscal profligacy and the balance of payments crisis (1990-1995) (even Gulf War)
The Indian experience seems to be supportive of the existence of positive supply shocks as well. For example, studies like Poddar (2004) have found evidence that the liberalisation process in India had resulted in greater domestic competition, increasing firms' efficiency and increased ability to export. This increase in efficiency was achieved by combinations of monetary, fiscal, competition and administrative policies and not by monetary policies alone.
Monetary policy in India so far had largely been discretionary. The discretionary policies, at least during the 1990s, were unavoidable due to the structural changes that were required to transform a command and control economy to a market-based one. Despite crucial differences in a few areas, the monetary policy framework in India has assimilated many of the best international practices. The RBI's overall performance in transparency and data dissemination were also satisfactory. Its performance in assessing the outlook - in full view of public knowledge - had also been good and this perhaps helped to guide expectations of economic agents along the desired trajectory.
Ahluwalia M S (2002): "Economic reforms in India since 1991: has gradualism worked?"
Journal of Economic Perspectives, 16, 67-88.
Arif R R (1996): Money demand stability: myth or reality - an econometric analysis,
Development Research Group Study No 13, Reserve Bank of India.
Balakrishnan P (2005): "Macroeconomic policy and economic growth in the 1990s",
Economic and Political Weekly, XXXX, 3969-3977.
