Page 267 - DECO502_INDIAN_ECONOMIC_POLICY_ENGLISH

Unit 20: Indian Financial System: Money Market and Monetary Policy

monetary policy. Monetary policy, or any policy for that matter, has to be evaluated by examining Notes
whether its objectives have been achieved over time. As mentioned above, on the recommendation of
the Chakravarty Committee, the RBI had adopted ‘price stability’, i.e., controlling inflation, as the
‘dominant objective of the monetary policy’, while at the same time, maintaining an adequate liquidity
in the economy. The question arises here is : Price stability at what rate of inflation ? This question
arises because some inflation is inevitable in a growing economy like India. It is, perhaps, in view of
this fact that the Chakravarty Committee had recommendation price stability at 4 percent rate of
inflation. Even other economists have suggested, on empirical basis, that a 3-5 percent annual inflation
is desirable for a developing economy.
Examined against the price stability objective, India’s monetary policy appears to be only partially
successful. Instead of looking at annual variation in the inflation rate, let us look at decennial rate of
inflation to examine the effectiveness of monetary policy.
In India, inflationary pressure started building up during the 1960s, due to the Chinese war in 1962,
the Pakistan war in 1965, and near-famine conditions in 1965-66. As a result, inflationary pressure
started mounting from 1962-63, and inflation rate shot up to 13.9% in 1966-67. The decennial average
rate of the 1960s was worked out at 6.4 percent.
The things were much worse in the 1970s. The inflation rate during the 1970s was much higher — the
highest rate during the period was 25.2 percent in 1974-75. This has been the highest rate of inflation
in India so far. The decennial average inflation rate was 9 percent, due mainly, to the failure of the
kharif crop and rise in oil prices. Incidentally, these aspects fall outside the scope of monetary controls.
During the 1980s, things improved marginally. The decennial rate of inflation declined from 9 percent
in the 1970s to 8 percent in the 1980s, with the highest inflation rate of 18.2 percent in 1980-81. However,
there was an upsurge of inflationary pressure during the first five years of 1990s. The average rate of
inflation during the period from 1990-91 to 1995-96 was worked out at 10.6 percent. Thereafter,
however, the inflation rate declined considerably. The inflation rate varied between 3.4 percent in
2002-03 and 6.4 percent in 2004-05. The annual average rate of inflation during the period from 1995-
96 to 2006-07 works out to be 5 percent. This was quite close to the economically and socially desirable
rate of inflation.
If one compares the high rate of inflation (varying between 6% and 10%), one would conclude that
during the entire period from 1960-61 to 1995-96, i.e., during a period of 35 years, the monetary
policy was unsuccessful in achieving its objectives. Although inflation rate was quite within the
desirable limit 4-5% during the period from 1995-96 to 2006-07, it can hardly be attributed to the
monetary policy. The lower rate of inflation was mainly due to high growth rate— 7-9 percent. The
only point that goes in favour of the monetary policy is the fact that things might be much worse in
the absence of monetary controls adopted by the RBI. What is alarming is the fact that, in spite of all
monetary measures, inflation rate shot up to about 12 percent—to be precise, 11.98 percent—in June-
July 2008. However, had RBI not adopted a monetary policy with prime objective of price stabilization,
inflation rate could have been much higher.
It may be added at the end that inflation rate has been within the desirable limit (5%) during the
period from 1995-96 to 2006-07, which can be attributed to the monetary policy. It may be argued that
the lower rate of inflation was mainly due to high growth rate. But then maintaining a reasonably
high growth rate was also the second most important objective of the monetary policy. It may be this
be concluded that monetary policy of India has been only fairly successful.
Self-Assessment

1. Choose the correct option:
(i) For implementing a comprehensive Khadi Reform Programme, a financial aid of $ I million
over a period of three years has recently been tied up with?
(a) International Monetary Fund (b) International Development Agency
(c) Asian Development Bank (d) International Finance Corporation

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