Explained: In Fact – Team Manmohan and deregulation of interest rates

The fifth part of Express Economic History Series.

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Manmohan Singh, who had had a long stint in the Finance Ministry and the Planning Commission, recalled over three decades later that he had no idea of what monetary policy was then.

In 1982, a little after he came to what was then Bombay as RBI Governor, Manmohan Singh kicked off an exercise that would lead to one of the biggest reforms in the Indian financial and monetary system: interest rate deregulation. Those were the years of ‘fiscal imbalances’ — large borrowings by the government to finance spending and boost growth, without adequate revenues — with RBI providing credit. This had a fallout in high inflation, an increase in reserve requirements, making it mandatory for banks to buy and hold more government bonds and securities, and set aside more cash. At one stage, the level of preemption or resources of banks that had to be earmarked for meeting this norm was 50%, making it extremely difficult for RBI to pursue an independent monetary policy.

RBI pursued the issue with the government, but the country’s biggest borrower showed little restraint. Manmohan Singh, who had had a long stint in the Finance Ministry and the Planning Commission, recalled over three decades later that he had no idea of what monetary policy was then. So he brought in Prof Sukhamoy Chakravarty, the man Paul Samuelson had described as an “economist’s economist”.
Chakravarty and Singh had taught at Delhi School of Economics at the same time. When Singh was in the Ministry, Chakravarty was at the Planning Commission, and headed the PM’s Economic Advisory Council. Joining him on the committee was deputy governor C Rangarajan, who had come to RBI during I G Patel’s time. Rangarajan had written about fiscal deficit, and both Singh and he recognised the need to check it.

Singh had in mind the clear articulation of the objectives of monetary policy, a better understanding of the effectiveness and impact of both fiscal and monetary policy, the use of these policies to attain national goals, and the implications of a growing number of financial instruments on monetary policies. This was a time when the government decided interest rates, with several slabs.

The panel, which submitted its report during the tenure of Singh’s successor, R N Malhotra, made the point that monetary policy should promote price stability, financial savings, and an efficient payments system besides, of course, helping the government raise resources adequately.

It also made a strong case for better coordination between monetary and fiscal policy, a new interest rate structure with greater leeway for banks to decide rates — with the maximum lending rate pegged at 3% above the maximum nominal deposit rate to ensure decent margins — measures for a positive real rate of return to depositors, and a change in rates for government securities and their maturities.

It also set a target for monetary expansion at 14%, and said the policy should aim to keep the average annual increase in the Wholesale Price Index to 4% or less. A standout recommendation was the proposal to deregulate interest rates on both deposits and lending. In short, it was the Chakravarty Committee that drew the outlines of how monetary policy ought to be formulated.

The panel fell short of recommending a complete dismantling of administered rates. But a conscious effort was made to cut the number of slabs. To Rangarajan, the man who gave it all credibility was Chakravarty. In 1986-87, and the year after that, the government began to implement some of these recommendations — which have now come to be recognised as the building blocks of a modern monetary policy. Perhaps fittingly, in 2013, it was Prime Minister Manmohan Singh who called for a more modern monetary policy framework in the globalised economy — leading to the Urjit Patel Committee report. The mantra of the 4% inflation target remains.

shaji.vikraman@expressindia.com