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Indian Economic Policy

Notes monetary actions. In spite of advances made in the forecasting techniques, reliable forecasting
of macroeconomic variables remains an enigma. In this regard, it is interesting to quote Stephen
McNees.
“How can forecasters go wrong ? They may not predict’ disturbances (the Gulf War, for example);
they may misread the current state of the economy and hence base their forecasts on a wrong
picture of the present situation; and they may misjudge the timings and the vigour of the
government’s monetary and fiscal responses to booms or recessions. The fact is that forecasting
has not reached perfection, particularly at major turning points in the economy,....”
Because of the low degree of reliability of forecasting, prediction of the outcome of a policy
action and hence formulation of an appropriate monetary policy has remained an extremely
difficult task. This point has been adequately evidenced by unpredictability of recession in the
US economy and inflation in India, both in 2008. An inappropriate policy based on guesswork
is bound to be unsatisfactorily effective. There is a large empirical evidence to support this
point of view.
(iii) Growth of Non-banking Financial Intermediaries : Apart from the above limitations of the
monetary policy, the structural change in the financial market due to rapid growth of non-
banking financial intermediaries has reduced the scope of effectiveness of this policy. The
proliferation of non-banking financial intermediaries including industrial financial corporations,
industrial development banks, mutual saving funds, insurance companies, chits and funds,
and so on, have reduced the share of the commercial banks in the total credit. Although financial
intermediaries cannot create credit through the process of credit multiplier, their huge share in
the financial operations reduces the effectiveness of monetary policy which works through the
banking finance.
(iv) Underdeveloped Money and Capital Markets : In addition to the factors discussed above, the
effectiveness of monetary policy in the less developed countries is reduced considerably because
of the underdeveloped character of their money and capital markets. The money and capital
markets are fragmented, while effective working of monetary policy requires a fairly developed
money market and that money market and the sub-markets of the capital market are interactive
and work interdependently.

Monetary Policy of India
We have discussed above the meaning, scope, instruments and working mechanism of monetary
policy in a general framework and have also used examples of monetary measures adopted by the
RBI. In this section, we take a look at India’s monetary policy including its objectives, instruments
and targets.
The RBI, the central monetary authority of India, has been changing the objectives and their priorities
of its monetary policy from time to time in accordance with the needs of the country. The RBI has, in
fact, managed monetary affairs of the country, especially the control, regulation and allocation of
bank credit as and when required by the needs of the country. However, RBI’s monetary policy has
not been found to be working very effectively. The reason was that the RBI was severely constrained
by the growing deficit financing by the Government of India. A comprehensive knowledge of India’s
recent monetary policy and its working can be had from the Chakravarty Committee Report, the
writings of C. Rangarajan, a former Governor of RBI and Rakesh Mohan, Deputy Governor of RBI.

Monetary Policy Objectives
As already noted above, monetary policy being an organ of the overall economic policy, its objectives
could not be different from or be in conflict with the overall objectives of other economic policies of
the country. The three major objectives of India’s overall economic policy have been (i) economic
growth, (ii) social justice, i.e., an equitable distribution of income, and (iii) price stability. Of these
objectives, growth and price stability have been in general the objectives of India’s monetary policy. Of
these two objectives, however, Chakravarty Committee considered promoting price stability as ‘the
dominant objective of the monetary policy’ (Report). For, in the Committee’s opinion, “It is price

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