Get the answer of: What is Monetary Liberalisation?
However, monetary liberalisation is often regarded as the key to success in LDCs. Monetary liberalisation basically means the release of ceilings on interest rates so that they may rise as high as the demand for funds would pull them. This strategy was followed in South Korea.
This strategy encouraged saving and investment. As A.P. Thirlwall has put it, “Monetary policy to encourage saving largely takes the form of the development of financial intermediaries which can encourage those with a productive surplus to save by eliminating the risk of lending directly to investors, and of the development of branch banking which can help tap small savings”. Monetary policy can also encourage saving by tapping the unorganised sector which lends mainly for consumption purposes (as is observed in most villages in India).
A well-developed financial system and especially financial intermediation conduces to growth by ensuring not only an efficient allocation of capital among competing uses but also that saving is used for investment purposes.
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The capacity to save largely depends on the existence of well-developed saving institutions like banks, post offices, insurance, companies that guarantees saving will lead to investment (and not hoarding) and that the return on the investment will be maximised.
In fact, an organised money market can ensure that savings take the form of acquisition of physical assets. In most LDCs, the development of banking and credit mechanisms has always acted as a stimulus to saving and investment.
Historically, the growth of the money economy has often been a powerful stimulus to the development of banking and credit mechanisms. In fact, the development of a national banking system, comprising a central bank, a commercial banking system and a network of development banks is a pre-requisite of development planning.
In LDCs like India the developmental role of the central bank is more important that it’s conventional (stabilisation) role. In such countries the central banks take the lead in developing other financial institutions, especially institutions to provide long-term loan finance for development and to provide a market for government securities.
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Other functions of the central bank include:
(1) The maintenance of a high level of demand to help the economy achieve capacity growth; and
(2) The application of selective credit controls, if necessary, in the interest of developing particular sectors of the economy.
In developing countries, the central bank finds it difficult to ensure economic stability (i.e., full employment of resources and price level stability) for two reasons:
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(1) the credit control instruments are not very effective and
(2) variability of export earnings and the volatility of overseas investment which often cause income fluctuations.
In developing countries, the commercial banking system also encourages thrift and allocates saving in the most socially productive manner. Moreover, by creating credit it equates saving and investment and provides the means by which growth is financed.
In such countries, monetary policy permits the economic system to expand in response to continual opportunities for growth provided by technical progress. In India, rapid expansion of bank branches after nationalisation of top 14 commercial banks in 1969 and in 1980 has tapped small savings from rural areas which would otherwise go waste.
Development banks like the Industrial Development Bank of India (IDBI) also have a role in financing development. They have various purposes; to provide long-term finances for industry, especially where there is difficulty in raising finance through the so-called leading sectors of the economy.
For instance cumulative sanctions and disbursements of financial assistance to industrial concerns by all financial institutions upto 1995 amounted to Rs 2 57 727 crores and Rs 1, 72,678 crores, respectively. Some development banks invest directly, others guarantee loans floated by private industry. The stress is on assistance to specific sectors of the economy where the risks of investment may be higher than what the ordinary commercial banking system is willing to accept.
Finally development banks have also a role to play in stimulating the capital markets. This they do by selling their own stocks and bonds by helping enterprises float or place their securities, and by selling from their own portfolio of investments.
Monetary policy which causes inflation may also lead to forced savings by curtailing real consumption (not consumption expenditure) of the community. Thus, inflation is a form of concealed taxation. In this sense, monetary policy is just a substitute of fiscal policy.
No doubt, fiscal policy may also raise the level of saving. However, saving raised by fiscal policy is essentially involuntary in nature except to the extent that fiscal policy pursued encourages increased production and leads to an increase in national income which, in its turn, generates its own saving, it marginal propensity to save is positive.