Defects of the Indian Money Market and the Reforms Since the 1980s

Despite its size, the Indian money market — particularly before the reforms of the 1980s and 1990s — suffered from several structural weaknesses that limited how effectively it could serve the economy and how smoothly RBI policy could transmit through it.

Defects of the Indian money market:

• Existence of an unorganised sector — indigenous bankers and moneylenders continued to meet a real share of short-term credit demand, especially in rural areas, operating with interest rates and practices that RBI regulation could not directly reach.
• Lack of integration between the organised and unorganised sectors — funds and interest-rate signals did not flow smoothly between the two segments, weakening the reach of monetary policy.
• Multiplicity of interest rates — because the market was fragmented across institutions and instruments, interest rates for essentially similar short-term borrowing could differ considerably from one segment to another.
• Seasonal shortage of funds — demand for short-term credit rose sharply during the busy (harvest/festival) season, straining liquidity at predictable times of year.
• Absence of a well-developed bill market — the use of commercial bills as a financing instrument remained limited compared to more mature money markets, restricting an efficient channel for trade credit.
• Narrow range of instruments and participants — for much of independent India's early decades, the money market relied heavily on the call money market and ad hoc RBI accommodation, with few standardised instruments available to non-bank participants.

Reforms since the 1980s. Recommendations from expert committees — chiefly the Chakravarty Committee and the Vaghul Committee — led to a sustained programme of money market reform from the mid-1980s through the 1990s and beyond:

• New instruments introduced: Certificates of Deposit (1989) and Commercial Paper (1990) were introduced to widen the range of short-term instruments available to both borrowers and investors; Treasury Bills were issued across a wider range of standard maturities (91/182/364 days).
• New institutions set up: the Discount and Finance House of India (DFHI) was established in 1988 to develop a secondary market in money market instruments, improving their liquidity.
• Money Market Mutual Funds (MMMFs) were permitted, letting small investors indirectly access money market returns that were earlier available mainly to large institutions.
• Repo and reverse repo operations were introduced and progressively developed as the RBI's principal short-term liquidity-management tools, giving the central bank a precise, market-based way to inject or absorb liquidity. …