The Indian financial sector underwent a tectonic shift 50 years ago this week, when the Indira Gandhi government nationalised the 14 biggest commercial lenders on 20 July 1969.
Historical background –
- India was buffeted by economic as well as political shocks. There were two wars—with China in 1962 and Pakistan in 1965—that put immense pressure on public finances.
- Two successive years of drought had not only led to food shortages, but also compromised national security because of the dependence on American food shipments to keep hunger at bay.
- Fiscal retrenchment through a three-year plan holiday had hurt aggregate demand as public investment was cut.
- Many other countries in Asia had switched to more market-oriented policies in the preceding years, even within the overall industrial policy framework.
- However, Indira Gandhi swung the other way with the support of the Left. Bank nationalisation was one of her responses to the economic and political challenges of the time.
Justification of nationalisation –
Indira Gandhi told the Lok Sabha on 29 July 1969 that the “purpose of nationalisation is to promote rapid growth in agriculture, small industries and export, to encourage new entrepreneurs and to develop all backward areas“. This was part of the overall political strategy to squeeze big business houses that backed her opponents, as well as build a new political base.
Impact of bank nationalisation –
- The impact of bank nationalisation can be thought about in terms of three core areas: deposits, lending, and interest rates.
- The one positive impact of bank nationalisation was that financial savings rose as lenders opened new branches in areas that were unbanked.
- Gross domestic savings almost doubled as a percentage of national income in the 1970s. A growing part of this was sucked up by the government itself through increases in the statutory liquidity ratio.
- Banks were asked to push funds towards sectors that the government wanted to target for growth.
- Credit planning also meant that the interest rate structure became incredibly complex. There were different rates of interest for different types of loans. The Indian central bank eventually ended up managing hundreds of interest rates.
- The legendary R.K. Talwar resigned as chairman of State Bank of India in 1976 rather than bend under political pressure.
Remnants of nationalisation –
- The political control of bank lending continued even after the 1991 reforms—and the bad loan mess that has weighed down on the Indian economy since 2012 is at least partly explained by the credit bubble that grew under political patronage from New Delhi.
- The fact that successive governments continue to maintain a tight grip on the banking sector shows the political importance of having control over the credit spigots in the economy.
Bank nationalisation was the pivot of a broader political economy strategy followed in the 1970s—a decade when economic growth barely outpaced population growth. Average incomes stagnated. It was a lost decade for India. Bank nationalisation succeeded in specific areas such as financial deepening because of the rapid spread of branches, but it eventually did more harm than good.
Source – Livemint