The Reserve Bank of India (RBI) governor Bimal Jalan today made a strong pitch for a conservative economic policy with greater safety walls and regulated capital flows.
The governor was speaking at the high level central bank governors' symposium on International Financial Architecture, in London.
As the lead speaker at the symposium, Jalan put forth India's experience in external sector management, and propagated that each country ought "to build its own safety walls by providing for higher reserves, more realistic policies to regulate capital flows and careful monitoring of exchange rates". Flexibility in exchange rates was essential, but so was the ability to intervene, if and when necessary, he argued.
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Jalan in his speech also pleaded for larger voting power for developing countries, arguing for greater voice to all member countries rather than for a handful of industrial countries.
"It is one of the ironies of the last 40 years that although developing countries as a group have grown much faster than the developed countries and their relative economic strength in terms of output and trade has increased substantially, their actual voting power in Bretton Woods institutions has tended to decline," he argued.
Referring to the international financial scene of the '90s, Jalan acknowledged the gains as well as crises mainly on account of volatility in capital flows and exchange rates in recent times. He established that the international financial environment had become uncertain and unpredictable during the period than in the previous half-century.
India had not been affected by the Asian currency crises. RBI governor stated to the world banking community that since then India had increased its foreign exchange reserves several times over and was now adequately placed to take care of all reversible capital flows as well as current account deficits. India's foreign exchange reserves are today more than that required under the conservative "Guidotti rule", he stated. The Guidotti rule suggests reserves coverage for one year's capital account liabilities.
India's short-term debt is very low and the central bank's forward liabilities had been reduced to less than one per cent of reserves. "This has gained us the confidence of the markets which has been more than evident even during the recent period of uncertainties," he pointed out.
It is the responsibility of the country to cope with the burden of instability and volatility, stated Jalan, as he listed three fundamental requirements drawn from the Indian experience for preventing a financial crisis. These were careful monitoring and management of exchange rates without a fixed target; a policy to build a high level of foreign exchange reserves taking into account anticipated current account deficits and "liquidity at risk" arising from unanticipated capital movements; and a judicious policy for management of the capital account.
Jalan argued against utilising short-term banking capital for financing investments and growth, adding that foreign direct investment and portfolio investment should thus be encouraged.
However, this he said came at a cost, because foreign investors were quick in reversing the flow of foreign direct investment and portfolio investment.