estimates reaction functions for the RBI that can be used to place its policy actions in international comparative perspective. It asks whether and how the reaction function changed with the shift to inflation targeting. Sections 5 and 6 then look at how the behavior of macroeconomic and financial variables, including inflation expectations and passthrough, changed if at all with the shift to IT. Section 7 looks at the RBI’s response to the Covid-19 pandemic, after which Section 8 concludes.

# **2. India’s monetary policy framework**<sup>**2**</sup>

India’s monetary policy framework has evolved over recent decades (for a summary see Appendix Table A1). In the first two decades following independence, there was no formal framework for monetary policy. Policy regulated credit availability with an eye toward the needs of the current five-year plan.<sup>3</sup> With enactment of the Banking Regulation Act in 1949, banks were required to maintain a Statutory Liquidity Ratio in the form of gold, cash and approved securities. Other policy instruments included the discount rate (bank rate), reserve requirements and open market operations.

The monetary policy framework in place from the end of the 1960s, when the major banks were nationalized, through the mid-1980s is often described as one of “credit planning,” during which policy operated via Statutory Liquidity Ratio (SLR) and the Cash Reserve Ratio (CRR), <mark>a specified minimum fraction of total customer deposits that commercial banks must hold in cash or as deposits with the central bank.</mark> The SLR was used to finance the budget deficit, the CRR to neutralize the effect of deficit financing on inflation.<sup>4</sup> Deposits at and credit supplied by public sector banks expanded rapidly, resulting in a rapid increase in the broad money supply: the money stock increased by 17.5 percent a year during the 1970s and first half of the 1980, compared to less than 10 percent in the previous decade. Since the period featured modest economic growth (about 4 percent a year), this resulted in relatively high inflation (averaging 8.8 percent). Das (2020) contends that traditional monetary policy instruments, such as bank rate and open market operations, proved inadequate for regulating credit growth, money supply, and inflation owing to fiscal dominance.<sup>5</sup> From the mid-1980s through the late 1990s, the Reserve Bank employed a “monetary targeting with feedback” framework, in which the broad money supply was set in line with projected GDP growth

> 2 This section draws on Mohan and Ray (2018), Das (2020), and Hutchison et al (2013). See also Mohan and Kapur (2009) and Patra and Kapur (2012) for discussions of the evolution of monetary policy in India. Dua (2020) provides a discussion of the inflation targeting framework, and Patnaik and Pandey (2020) compare features of India’s inflation targeting framework with that of other countries.

> 3 Monetization of the budget deficit by the RBI increased after the second five year plan, leading to an increase in SLR to 25 percent from 20 percent .

> 4 The SLR was raised from 25 percent of bank’s Net Demand and Time Liabilities (NDTL) in 1969 to 37 percent by July 1985, while the CRR was raised from 3 percent of banks’ NDTL in 1969 to 9 percent by 1985.

5 Recall that the RBI was not independent and was expected to finance the budget deficit with no questions asked. As Ghate and Kletzer put it, “Fiscal dominance and financial repression have been hallmarks of Indian monetary policy for decades. The Reserve Bank of India was designated as the banker for the government and authorized to grant advances to the Government of India in the Reserve Bank of India Act of 1934. These advances became _ad hoc_ 3-month Treasury Bills continuously held by the RBI in a process of automatic monetization of government debt. The RBI simply funded the public sector budget deficit through periods of rising public debt and inflation until the 1990s. In 1997, the authorization to issue such _ad hoc_ Treasury Bills ended and replaced by a system of Ways and Means advances. The RBI continues in its debt management role for the Government of India. In 2006, RBI’s participation in the primary market for government debt ceased, and India completed the transition to market determined yields on government bonds.” 3