Changes in the monetary policy after chakrabarty commitee report

1. CHANGES IN MONETARY
POLICY AFTER
CHAKRAVARTY COMMITTEE
REPORT
Submitted by-
Baivab Nag-17MB4008

2. MONETARY POLICY
■ Monetary policy is the process by which the monetary authority of a country, typically
the central bank or the currency board controls either the cost of very short term
borrowing and monetary base often targeting an inflation rate or interest rate to
ensure price stability and general trust in the currency.
■ Further goals of a monetary policy are usually to contribute to the stability of GDP, to
achieve and maintain low unemployment, and to maintain predictable exchange rate
with other countries.

3. Problems in Monetary Policy Before
Chakravarty Committee Report Submission
■ During the 1970s and early 1980s, the Indian economy had numerous issues relating to
the functioning of the monetary system.
■ The government borrowing program was increasing rapidly.
■ These increasing requirements from the government could be met by-
– Increasing credit from the to the government
– Increasing the Statutory Liquidity Ratio that was meant to be maintained by the
banks.
 As a result, the reserves of the government were increasing and this led to an increase
in the Money Supply which in turn, resulted in inflationary pressures in the economy.
These were the most prominent reasons for the appointment of the Chakravarty
Committee for reviewing the monetary system

4. Formation of Chakravarty Committee
In December 1982, Dr. Manmohan Singh, the then Governor of the RBI, appointed a Committee under
the Chairmanship of Prof. Sukhamoy Chakravarty to review the functioning of the monetary system in
India.The Committee was assigned major terms of reference as follows:
■ (a)To critically review the structure and operation of the monetary system in the context of the
basic objectives of planned development.
■ “(b)To assess the interaction between monetary policy and public debt management in so far as
they have a bearing on the effectiveness of monetary policy.
■ “(c)To evaluate the various instruments of monetary and credit policy in terms of their impact on
the credit system and on the economy. In this context, links among the banking sector, the non-
banking financial institutions and the unorganised sector could be assessed.
■ “(d)To recommend measures for improvement in the formulation and operation of monetary and
credit policies and to suggest specific areas where the various policy instruments need
strengthening.
■ “(e)To make such other recommendations as the Committee may deem relevant to the effective
operation of monetary and credit policy.
The Committee submitted its report in 1985.

5. ChakravartyCommittee’s Findings
For the efficiency of the monetary system, there should be no mismatch between the responsibility of
the RBI to supervise and control the monetary system and its authority in this regard.The Committee
has, thus, hinted at the undue interference of the government in the monetary management of the RBI.
The Committee observes that till now the Indian monetary system has not succeeded in attaining its
major social objectives satisfactorily for the following reasons:
■ (a) Excessive fiscal deficits;
■ (b)Unduly large credit of the banking system to the government;
■ (c) Reserve Bank’s main concentration on supporting public borrowings at cheaper rates rather than
taking relevant action for the effective monetary management: monetary tools like the Statutory
Liquidity Requirements (SLR) and interest policy being used to facilitate a large public debt from the
banking sector.

6. Chakravarty Committee’s Findings(cont.)
In the context of the present working of the monetary system in India, the Committee has made the
following noteworthy observations:
■ 1.The growth of money supply (М3) has greatly exceeded the growth in output during the period
1971-1984.The money supply (M3) has increased on an average at the rate of 17.2 per cent per
annum, while the output (NNP at factor cost) has increased just at the rate of 3.7 per cent; the
wholesale price index 1 as registered a 9.8 per cent rise per annum.
■ 2.The government’s resort to RBI’s credit has increased excessively.This has caused a phenomenal
expansion in reserve money adversely affecting the conduct of monetary policy since 1970.
■ 3.The government borrows at a much lower rate than the prevailing market rates by resorting to
the RBI and the captive market of the banks.
■ 4.The system of administered interest rates is typical of the Indian monetary system.
■ 5.Yields on treasury bills at 4.6% discount rates are very low.
■ 6. Concessional rates of interest seem to have permitted the rise of economically non-viable
projects.
■ 7.The currency-deposit ratio has steadily declined from 1.53 in March 1951 to 0.3 in March 1984.

7. The Committee’s Recommendations:
■ 1. Reduction in the growth of reserve money during the Seventh Plan period and the years to follow.
■ 2.The Reserve Bank should adopt monetary planning by assuming money supply growth rate
targets year by year along with the operation of the country s five-year plans. It should also prepare
a credit budget for this growth and allocation of credit.
■ 3. Relative price stability is to be maintained by not allowing the annual price rise to go beyond 4 per
cent. “It would be desirable, in the Indian context, to assign to the monetary authority a major role
in promoting price stability, and also to accord price stability a dominant position in the spectrum of
objectives pursued by the monetary authority.”
■ 4. Money supply growth target should be determined in view of the expanded growth rate in GNP,
the real income elasticity of demand for money, and a permissible price rise of, say 4 per cent per
annum.
■ 5.There is need for an upward revision of the administered interest rates.Yields on treasury bills and
the government securities must be enhanced corresponding to the prevailing market rates of
interest on other financial assets.

8. The Committee’s
Recommendations(cont.):■ 6. Ceiling on call-rates should be removed.
■ 7. Long-term deposits and loans must yield a minimum of 3 per cent real rate of returns.
■ 8.There should be only two concessional lending rates applicable to bank credit provided to the
specified priority sector borrowers, one of which should be equivalent to the basic (minimum)
lending rate and the other somewhat lower than it. Banks should have freedom to fix their other
lending rates.
■ 9. Banks should be assisted by the Reserve Bank by extending larger refinance and bills discounting
facilities.
■ 10. Bill markets should be strengthened by removing impediments like payment of stamp duty,
difficulty in obtaining supplies of stamp paper, administrative rigidities, etc.
■ 11. It is a misconception to assign to the trade sector a low priority for bank finance in comparison to
the industrial sector in the present stage of development in Indian economy. Hence, the trade sector
must be given due recognition and should not be starved of bank credit.
■ 12.The demand for money function in Indian economy needs detailed investigation. Universities,
scholars and the Reserve Bank should undertake intensive research works in this regard.

9. Criticisms
The committee was criticized heavily as it was believed that the recommendations would not be able to
curb money supply due to the following reasons:
■ The committee recommended a range rather than an actual target for the annual grown of Money
Supply, M. People opined that this provision is likely to be interpreted liberally by the government
and the RBI would concur, hence defeating the purpose. Further flexibility was provided with its
system of 'Monetary targeting with feedback'.This would render the target for growth of Money
Supply short lived and would dilute further any monetary discipline they wished to achieve.
■ The committee had recommended that each of the nominal rates to be administered based on the
target real interest and the short term/long term rate of growth of price inflation.The underlying
assumption seems to be that thereby actual real 'r' will turn out to be equal to the target real 'r'.
Clearly, this would be so only if Ṗ = Ṗe. Error free prediction of Ṗ is not easily realize.Also, the RBI's
price expectations may diverge much from the public's price expectations.
■ It should have been relatively easier for the RBI to fix the nominal rates on theTerm deposits for one
year and five years and above and also the basic lending rate for banks. Managing the market for
government securities so as to maintain a certain chose interest rate structure and ensure enough
voluntary demand for government bonds and bills would not be that easy.
■ The committee linked the treasury bills with short term Ṗe and all other rates of interest with long
term Ṗe without giving any reason for the same.
■ The committee gave no recommendation on how and when the nominal rates of interest should be
revised

10. THANKYOU