Home >Opinion >Columns >Opinion | The 1969 bank nationalization did India more harm than good
Photo: HT
Photo: HT

Opinion | The 1969 bank nationalization did India more harm than good

It was the pivot of a political economy strategy of the 1970s—when economic growth barely outpaced population growth

The Indian financial sector underwent a tectonic shift 50 years ago this week, when the Indira Gandhi government nationalized the 14 biggest commercial lenders on 20 July 1969. The second volume of the official history of the Reserve Bank of India describes bank nationalization as the single-most important economic policy decision taken by any government after 1947. Central bank historians say that in terms of the impact, even the economic reforms of 1991 pale in comparison.

The landmark decision came at the end of a troubled decade. 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.

The 1966 devaluation of the rupee was an economic success, but also a lightning rod for political anger. The Congress party had already suffered electoral setbacks in the 1967 elections. It was headed for a split. The Naxalites were growing in strength. However, the devaluation had helped improve the balance of payments while the Green Revolution began to ease the food constraints.

India was at a crossroads. Many other countries in Asia had switched to more market-oriented policies in the preceding years, even within the overall industrial policy framework. Their growth would accelerate over the next two decades. In India, there had been some tentative moves in that direction during the short tenure of Lal Bahadur Shastri. However, Indira Gandhi swung the other way with the support of the Left. Bank nationalization was one of her responses to the economic and political challenges of the time.

The impact of bank nationalization can be thought about in terms of three core areas: deposits, lending and interest rates. The one positive impact of bank nationalization 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. P.N. Dhar writes in his memoirs that V.K. Krishna Menon made the startling claim in a private meeting with top officials before nationalization that the government would not have to worry about mobilizing funds once banks were nationalized.

Banks were asked to push funds towards sectors that the government wanted to target for growth. Indira Gandhi told the Lok Sabha on 29 July 1969 that the “purpose of nationalization 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.

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. This mind- boggling structure was brought down only after the 1991 reforms, with the central bank managing the pivotal repo rate, while commercial lending rates were to be decided by banks themselves.

The subsequent political economy was perverse. Indira Gandhi said in a Lok Sabha debate on bank nationalization: “We have no intention to set up a monolithic agency to run all these banks. While we must strengthen the machinery at the Centre, there will be autonomy for each bank and the boards will have well-defined powers. We will give directions but these will be on policy and general issues, not on specific loans to specific parties. We shall be vigilant about the dangers of too much interference—whether it is motivated by political or other considerations."

There are no prizes for guessing how long that promise held. The legendary R.K. Talwar would resign as chairman of State Bank of India in 1976 rather than bend under political pressure. 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 nationalization 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. There is no doubt that exogenous shocks, such as rising energy prices or failed monsoons, played a part in the stagnation, but economic policy also hurt. Bank nationalization succeeded in specific areas such as financial deepening because of the rapid spread of branches, but it eventually did more harm than good.

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics. Read Niranjan’s previous Mint columns at www.livemint.com/cafeeconomics

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