INTRODUCTION

The Reserve Bank of India was established on April 1, 1935 by the Reserve Bank of India
Act, 1934. Initially, the RBI was privately owned, but after nationalisation in 1949, it came to
be fully owned by the Government of India.

The fact that RBI was set up as per the recommendation of a commission that was finally called after
a sufficient amount of preliminary study by various other commissions also speaks volumes about
the role that this ‘central bank’ was intended to play. ‘The question of a central banking institution
for India had been under examination both by Royal Commissions and by the Legislature long before
the Hilton-Young Commission recommended in 1926 that India’s financial structure should be
completed by the creation of a central bank.’1 The Reserve Bank of India was conceptualised on the
outlook, working style and guidelines presented to the commission by the visionary Dr. Ambedkar.
Historically the economic governance requirements focussed primarily on currency and exchange,
than banking or rather, central banking. Back then, currency and banking were quite disconnected
terms. ‘It was proposed at that time to amalgamate the three Presidency Banks into one strong
institution. The central banking functions envisaged for the new institution were not only those of
note issue and ‘banker to the Government’, as in earlier proposals, but also maintenance of the gold
standard, promoting gold circulation as well as measuring and dealing with requirements of trade
for foreign remittances. The new bank was to perform commercial banking functions as well, as the
Presidency Banks had been doing till then.’2 In 1921, the three Presidency Banks got amalgamated
into the Imperial Bank.

‘The Preamble of the Reserve Bank of India describes the basic functions of the Reserve
Bank as:

"...to regulate the issue of Bank Notes and keeping of reserves with a view to securing
monetary stability in India and generally to operate the currency and credit system of the
country to its advantage."’3 This description implies a vast spectrum of functions as well as
powers that have been conferred upon the RBI.

Initially, when the bank began its operations, it performed the functions transferred to it from
the erstwhile Controller of Currency and the Imperial Bank of India—the management of
Government accounts and public debt and the augmentation of banking facilities across the
country. The RBI started as a mere banker to the Government, but its roles and functions
have undergone a good deal of changes with changes in the economic scenario. The
predominant factors that contribute to the consistent change in the role of RBI are
globalisation, external economic conditions such as recession on the world economy, internal
economic conditions, politics- national as well as international, etc.

1
ML Tannan, Tannan’s Banking Law and Practice in India, Reserve Bank of India as Central Bank,p. 333.
2
History of the Reserve Bank of India, RBI website, http://rbidocs.rbi.org.in/rdocs/content/PDFs/89634.pdf
3
Reserve Bank of India website, http://www.rbi.org.in/scripts/AboutusDisplay.aspx#EP1
This paper deals with the changing role of RBI, which is at the helm of affairs in the Indian
economy, since its inception to the current date.

GLOBALISATION AND THE RBI

1951-1967.

MONITORY POLICY MAKING-

Monitory policy defines the function of a central Bank. The Reserve Bank of India was in
charge of quite a large number of developmental initiatives for the growth of independent
India. RBI had to take the responsibility for “deepening the financial sector of the
economy”4and thus it had to keep monitory policy in a wider ambit as compared to most
traditional central banks. It was only because RBI’s own initiatives and plan development of
that the monitory policy changed substantially during this period.

Monitory policy continuously focussed on the short term seasonal pressures and the proposed
targets of the five year plans acted as a backdrop through which the former responsibility was
to be discharged. However, in order to overcome these short term challenges, the Bank did
not forget the bigger picture. “But the practical necessities of decision-making under multiple
constraints often led to the adoption, sometimes against the better judgement of its officers if
not always of the Bank, of measures which created bigger problems in the longer term than
the more immediate ones they helped to resolve. As the logic of decision-making became

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endogenized in the form of precedents and institutional evolution, the course was set for
departures which however small or partial in the beginning, exercised over a period of time a
tangible influence on the overall effectiveness of the Bank's monetary policy.”5

ENVIRONMENT TO FORMULATE MONITORY POLICIES-DEFICIT FINANCING-

The monitory policies are also likely to be affected by a factor called deficit financing.
“Deficit financing, defined narrowly as the change in the government's indebtedness to the
Reserve Bank of India, has been an important part of plan financing in India, and a key
element in determining the environment for monetary policy.”6 This has been found true to
quite an extent in the first 3 five year plans. Starting with the first plan, the total outlay in the
public sector was Rs 1960 crores. Out of this amount, Rs. 260 crores were lent by the Bank to
the Government. In the existing backdrop of low inflation rates during the first plan, the
government resorted to deficit financing, by changing its indebtedness to the RBI by a quarter
of the total outlay in the public sector(Rs. 4672 crores) during the second five year plan, that
is, Rs. 1170 crores. During the third five year plan, it seemed that the Government had learnt
a partial lesson from the previous two year plans. The figures in the third plan were
somewhat like this- A total outlay of 8577 crores and 13.2 % of it, that is, Rs. 1133 crores
represented the deficit. Overall, after the first 3 five year plans, it has been found that, out of a
total outlay of Rs. 6628 crores in the public sector, Rs 626 crores were accounted for by the
Bank.

Initially, when this concept of deficit financing started developing, both the Indian policy
makers and the Reserve Bank of India were supportive of it. The RBI was of the view that,
deficit financing helped the Government to accomplish goals that could not be supported by
the existing resources and would require some additional supply of money. However, quite
ironically, from the start of the first five year plan itself, the Reserve bank of India had been
quite modest and submissive in its overall role. There were several reasons behind such an
attitude of the Reserve Bank of India. The developments in this attitude of the RBI emerged
“clearly in the course of the visit to Bombay in February 1958 of Per Jacobson, the Managing
Director of the IMF. The latter's discussions at the Bank revealed that while not altogether
unsympathetic towards India's development problems and efforts, he was sceptical about the
policy of deficit financing and doubtful that it would give the government any substantial
command over additional real resources for investment.”7 Gradually, the Bank, in an attempt
to judge the impact of deficit financing on Indian economy, took into consideration various
factors that would also determine the scope of operation of the monitory policy chalked out
mainly to bring about the stabilization of prices. These factors included- “the availability of
wage goods, chiefly foodgrains, as a major influence upon the extent to which any given

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Volume II, Deficit Financing and the Environment for monitory policy

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Volume II, Deficit Financing and the Environment for monitory policy
level of deficit financing or public investment affected domestic prices. Generally speaking,
the Bank also expected the relatively small role played by bank money in overall money
supply and the substantial leakages of currency from the banking system to mitigate the
inflationary impact of the expansion of its credit to the government.”8

DEFICIT FINANCING and MONITORY CONTROL:

The activities, including public investments impose certain mammoth responsibilities on the
reserve Bank of India. The Bank assumed roles like, banker to the Indian Government and
the manager of its loans, which in turn affected the operation of the monitory policies. In this
scenario, initially, the Bank was calm and reserved and was keeping itself on an observant
stance. However, gradually in the mid-1950s, the RBI started indulging itself more into the
requirements(mainly financial) of the public sector. Thus, since then , the Bank became more
and more vocal about the reservations it carried regarding the financial policies of the
Government and, subsequently, its advice started carrying importance to the Government.

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CURRENT ROLE OF THE RBI

One of the most pivotal functions of the central bank of any country is framing of the
monetary policy, both short term as well as long term, for the economic governance of
the country. ‘Monetary policy is the macroeconomic policy laid down by the central
bank to control money supply in the economy. It involves management of money
supply and interest rate and is the demand side economic policy used by the
government of a country to achieve macroeconomic objectives like inflation,
consumption, growth and liquidity.’9 In the Indian context, the monetary policy
framed by the RBI aims at managing the money market in quantitative terms in order
that it meets the demands of the various sectors of the economy, and increasing the
growth rate of the national economy.

Another crucial tool used by the central bank is the fiscal policy. A fiscal policy,
unlike monetary policy, concerns itself with government spending and revenue
collection in order to influence and regulate the macroeconomic productivity levels.

IN THE TENURE OF RAGHURAM RAJAN AS GOVERNOR:

After assuming office of the 23rd Governor of RBI, Dr. Raghuram Rajan issued a
statement wherein he acknowledged the current precarious condition of the Indian
economy caused primarily by global financial markets, and went on to articulate his
plans and intentions to propel the Indian economy on a favourable path.

He emphasised on the main function of RBI as stipulated by the Preamble of the RBI
Act, 1934, of creating and maintaining monetary stability in the economy, by
particularly dealing with the value of the Indian Rupee and the incessant problem of
inflation. He has ordered committees to be formed to come up with recommendations
for formulating the monetary policy framework. This suggests to us that the mandate
of the RBI, by virtue of which it constitutes committees, which involve not only
officers of the central bank, but also external experts, both national and international,
has become very wide in the recent years. Also considerable is the fact that the
recommendations of these committees are only advisory in nature, the final call being
reserved with the Reserve Bank, implying that the central bank has gained a highly
concentrated autonomy regarding economic policy decisions.

Secondly, Mr. Rajan focussed on that role of the RBI, which is becoming increasingly
significant in the wake of an open, liberalised economy and volatility in the global
economy—the RBI’s developmental role. Technically being an instrumentality of the
state, the RBI has a duty of socialist action as its important and indispensable role.
With this in mind, Rajan iterated that he would focus on poverty alleviation and

9
Economic Times, Definition of Monetary Policy, http://economictimes.indiatimes.com/definition/monetary-
policy
growth harmoniously, by increasing access to finance for the poor, rural small and
medium scale industries. This will serve a dual purpose, the other being growth
increment through smaller industries at a time of stymied growth rate of larger
industries.

The RBI can also be seen to be going in for decentralisation of its mandate. (domestic
banks will no more have to approach the RBI for opening new branches). This
situation allows us to analogise this power of RBI with the power of delegated
legislation, available to the government and other public authorities by provision of
the Constitution.
CONCLUSION

Recently, Prime Minister Manmohan Singh was quoted as saying that ‘The Reserve Bank has
served our country with great distinction. But, I venture to think that the best is yet to
come’10. This makes evident the profundity of faith reposed by the Government of the
country on the Reserve Bank of India.

10
PM Wants RBI to Re-think Monetary Policy, Business Line, Aug 17, 2013 issue.