The Role of the Reserve Bank of India in Economic Policy: A Balance Sheet Approach

Recent literature on monetary policy issues sometimes criticizes the Reserve Bank of India’s tolerance regarding inflation, sometimes praises its “gradualism” when having to deal with macroeconomic objectives. Scholars tend likewise to take a stand on the issue of the desired hierarchy of objectives assigned to central banks and the “optimal” monetary regime, though remaining surprisingly silent on major structural questions. By tracking changes in the RBI’s balance sheet, this paper shows that following the 1991-liberalization reforms, the central bank has ceased to finance the expansion of the domestic economy involving itself instead in the task of integrating India’s financial system to a larger globalized financial market. Systematic accumulation of FX reserves, which is the policy response adopted to cope with large international capital inflows and the condition to succeed that integration, raises the question of the costs and risks the Indian financial system incurs in, at a time when major international currencies suffer from persistent macro imbalances.