GS Paper III

News Excerpt:

The Reserve Bank of India (RBI), which was established on April 1, 1935, is responsible for monetary stability, currency management, inflation targeting, regulating the banking system, and setting interest rates.

Early years of RBI:

• Legislation to set up the Reserve Bank of India was enacted in March 1934, and the provisions relating to the constitution of the bank, issue of share capital, and establishment of central and local boards became operative from January 1, 1935.
• The first Governor of the RBI was the Australian Sir Osborne Arkell Smith, who was also one of the two managing governors of the Imperial Bank of India. 
• Sir C D Deshmukh was the first Indian to become Governor.
• Following Partition, it was agreed that the RBI would cease to be Pakistan's currency authority and that Indian notes would cease to be legal tender in Pakistan.

The reforms of 1991:

• A sharp increase in oil prices in 1990 led to an acute economic crisis, making the balance of payments situation unmanageable, depleting foreign exchange reserves along with massive capital outflows, and pushing India close to default.
• The RBI transferred more than 46 tonnes of gold from its reserves to the Bank of England to borrow forex to manage immediate liquidity problems.
• Full convertibility of the rupee on trade accounts was allowed, giving more flexibility to trade.
• Banking reforms were announced, lenders' setting of interest rates was deregulated, and new private bank licences were issued between 1991 and 1995.

2008 crisis and after:

• India escaped the 2008-09 global financial crisis through a combination of management, structure, and luck. 
• Pre-crisis, Governor Y V Reddy's policies against capital inflows, especially to the real estate sector, and against rapid foreign bank expansion were timely. 
  • Post-crisis management was excellent and appropriately measured.
• Under Subbarao, the RBI opted for a liberal accommodative policy to salvage economic growth.
• Raghuram Rajan announced plans to - 
• Internationalise the rupee.
• Float inflation bonds linked to the consumer price index.
• Steps to boost exports and increase inflows.
• Plans to review the monetary policy process.
• Gave banks the freedom to open branches without having to approach the RBI for licences.

Demonetisation of 2016:

• In 2016, the government announced the demonetisation of the Mahatma Gandhi Series' Rs 500 and Rs 1000 notes. 
• It also announced the issuance of new Rs 500 and Rs 2000 notes in exchange for the demonetised notes.
• The sudden withdrawal of notes created a liquidity shortage in the country. There were long queues outside banks, and people faced immense hardships across the country. 
• It also roiled the economy - demand fell, businesses faced a crisis, and GDP growth declined close to 1.5 per cent. 
• Many small units reported huge losses even after nine months. The pace of remonetisation was slow.
• Managing the situation was one of the biggest challenges faced by the RBI. At stake was the bank's credibility.

Monetary Policy Committee (MPC), asset quality review:

• The Monetary Policy Committee (MPC) decides on interest rates.
• The RBI has utilised the Insolvency and Bankruptcy Code (IBC) to address the huge debt pile of some of the biggest defaulters.
• It has drawn up two lists of 40 corporates with debts of around Rs 4 lakh crore that are in various stages of resolution in National Company Law Tribunals.

COVID-19 pandemic:

• As demand crashed, production cuts, job losses, and growth declined. 
• RBI opted for an accommodative monetary policy. 
• The repo rate, the main policy rate, was brought down to 4% to kickstart growth. 
• The liberal policy spiked inflation, forcing the RBI to raise rates by 250 basis points to 6.5% now.
• However, the pandemic aided the RBI in boosting the digitisation of payments. The launch of UPI revolutionised payments in the banking system.