The Role of Fiscal and Monetary Policies in Sustaining Growth With Stability in India*

• Date: 01 December 2008
• DOI: http://doi.org/10.1111/j.1748-3131.2008.00106.x
• Published date: 01 December 2008
• Author: Rakesh MOHAN

doi: 10.1111/j.1748-3131.2008.00106.x

Asian Economic Policy Review

(2008) 3, 209–236

© 2008 The Author

Journal Compilation © 2008 Japan Center for Economic Research

209

Blackwell Publishing LtdOxford, UKAEPRAsian Economic Policy Review1832-81051748-3131

© 2008 The AuthorsJournal Compilation © 2008 Japan Center for Economic ResearchXXXOriginal ArticleXXXXXXRakesh Mohan

The Role of Fiscal and Monetary Policies in

Sustaining Growth With Stability in India*

Rakesh MOHAN†

Reserve Bank of India

The performance of the Indian economy in recent years has attracted increasing international interest.

This paper focuses on the role of fiscal and monetary policies in the evolution of the Indian economy over

the years, with particular attention being given to the reforms undertaken in these policies since the early

1990s. The coordination of fiscal and monetary policies has been crucial in the sequencing of the

economic reform process carried out since the early 1990s. Monetary policy aims to maintain a judicious

balance between price stability and economic growth. With the opening up of the Indian economy and

the spread of financial sector reforms aimed at functional autonomy, prudential strengthening, operational

efficiency, and competitiveness of banks, considerations of financial stability have assumed greater importance

in recent years alongside the increasing openness of the Indian economy. The biggest challenge facing

the conduct of fiscal and monetary policy in India is to continue the accelerated growth process while

maintaining price and financial stability. Therefore, the self-imposed rule-based fiscal correction at both

the national and subnational levels has to be consolidated and carried forward. The existence of a high

level of fiscal deficit also contributes to the persistence of an interest rate differential with the rest of

the world, which then also constrains progress toward full capital account convertibility. The success

achieved in revenue buoyancy through tax rationalization and compliance has to be strengthened further.

Key wo rds

economic reform, fiscal policy, growth, India, monetary policy, price stability.

JEL codes

E5, E6, O53

The performance of the Indian economy in recent years has attracted increasing international

interest. The Sixth Asian Economic Review Conference is therefore a timely one to take

stock of what has happened and to also deepen our understanding of the policies and

processes that have led to the current trends. This paper focuses on the role of fiscal and

monetary policies in the evolution of the Indian economy over the years, with particular

attention being given to the reforms undertaken in these policies since the early 1990s

1. Macroeconomic Overview

An interesting feature of the record of economic growth in India is that it has experienced

a sustained slow acceleration in growth since independence. Growth has been accelerating

gradually since the 1950s, except for an interregnum between 1965 and 1980 (Table 1).

1

Thus,

*The assistance of R. K. Pattnaik, M. D. Patra, B. M. Misra, Muneesh Kapur, and Indranil Bhattacharyya

in the preparation of this paper is gratefully acknowledged. This paper has benefited immensely

from the comments of the discussants (Takatoshi Ito and Chalongphob Sussangkarn) and those of

the participants of the Sixth Asian Economic Review Conference.

†Correspondence: Rakesh Mohan, Deputy Governor, Reserve Bank of India, Central Office, Shahid

Bhagat Singh Road, Mumbai 400 001, India. Email: rakeshmohan@rbi.org.in

Role of Fiscal and Monetary Policies in India

Rakesh Mohan

© 2008 The Author

210

Journal Compilation © 2008 Japan Center for Economic Research

Tab le 1

Macroeconomic indicators at a glance (percentage)

1950–1951

to 1964–1965

1965–1966

to 1980–1981 1980s 1990–1991

1991–1992

to 1996–1997

1997–1998

to 2002–2003

2003–2004

to 2007–2008

1. Real GDP growth 4.1 3.2 5.6 5.3 5.7 5.2 8.7

Agriculture and allied 2.9 2.1 4.4 4.0 3.7 0.9 4.4

Industry 6.7 4.2 6.4 5.7 7.0 4.1 8.4

Manufacturing 6.6 3.9 5.8 4.8 7.5 3.9 9.1

Services 4.9 4.2 6.3 5.9 6.4 7.8 10.3

2. Real GDCF/GDP 13.5 19.2 20.2 24.4 22.5 24.1 31.4‡

3. ICOR 3.3 6.0 3.6 4.6 4.0 4.6 3.6‡

4. Nominal GDCF/GDP 11.8 16.7 20.8 26.0 23.9 24.5 33.0‡

5. GDS/GDP 10.3 15.9 19.0 22.8 22.7 24.1 32.7‡

6. Saving–investment gap/GDP (5–4) –1.5 –0.7 –1.8 –3.2 –1.2 –0.4 –0.3‡

7. M3 growth 6.4 15.6 17.2 15.1 17.5 15.9 17.6†

8. SCB’s non-food credit growth Na 17.8 17.8 12.4 16.2 15.3 25.7†

9. Growth in investments in government securities 8.0 17.7 19.4 18.2 21.5 22.0 12.8†

10. WPI inflation (average) 3.8 9.0 8.0 10.3 9.6 4.6 5.5

Note: †Adjusted for the mergers and conversions in the banking system. Variation for 2005–2006 is taken over April 1, 2005. ‡Data pertain to 2003–2004

to 2006–2007. GDP, gross domestic product; GDCF, gross domestic capital formation; GDS, gross domestic savings; ICOR, incremental capital output ratio;

SCB, scheduled commercial banks.