It is useful to revisit the events of the mid-’90s. In 1993-94, India embarked on liberalisation of portfolio inflows. From near-zero levels, portfolio inflows rose sharply to $307 million in the 2nd quarter of 1993-94, and to $2,283 million in the 4th quarter. This marked the beginning of a capital surge into India. From 1992-93 to 1993-94, net capital inflows rose sharply from $2.9 billion to $9.6 billion. Faced with the capital surge, the RBI chose to prevent the rupee from appreciating. The rupee-dollar rate was kept largely fixed during this episode. Between July 1993 and December 1993, the USD was fixed at Rs 31.42. In January 1994, it moved to Rs 31.37. The purchases of dollars by the RBI led to a rise in net foreign assets. Faced with high growth in reserve money, the RBI raised the CRR in order to reduce money supply growth. The CRR became one of the main instruments of squeezing money out of the system. So, on June 11, 1994, it was raised from 14 per cent to 14.5 per cent. On July 9, 1994, the CRR was again raised, to 14.75. On August 6, 1994, the CRR was again raised to 15 per cent. Further, on October 29, 1994, the CRR for Foreign Currency Non-Resident (FCNR) Accounts was raised from 0 per cent to 7.5 per cent. On January 21, 1995, the CRR for FCNR accounts was raised further to 15 per cent.

As a result of these steps, while reserve money growth continued at 30 per cent, broad money growth was brought down. However, owing to the strong measures taken, bank-lending rates rose above 20 per cent. Industrial growth fell sharply in a few months and was limited to single digit numbers for nearly a decade. Since inflation created a political urgency, policy-makers could not wait for monetary tightening to play out. Several severe measures taken in quick succession, leading to a sharp and sudden tightening of credit, pushed industry into a recession.

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