That forgotten goal

Twelve years after introducing current account convertibility (in his role then as finance minister), Prime Minister Manmohan Singh has done well to re-focus attention on the next step, capital convertibility for the rupee. In doing so, he has indirectly underlined how patchy has been the country's progress in macro-economic management, in the nine years since the Tarapore Committee laid out the road map for full convertibility, in May 1997. That committee said the rupee should be made fully convertible in 2000, by which time the fiscal deficit should be no more than 3 per cent, and the inflation rate between 3 and 5 per cent. Just re-stating those targets today is a powerful comment.

The 3 per cent fiscal target has been pushed back by nine years, to 2009, and while inflation rates in recent years have been mostly within the range specified by Tarapore, that is partly because oil prices have not been raised. The Tarapore Committee also argued that the Reserve Bank should move to specific inflation targeting, as the better central banks do, but this is not yet a stated goal in India and the RBI still believes in pursuing multiple objectives. Also, the RBI does not yet have the full freedom to operate in a manner that will allow it to target inflation rates as the key variable, heedless of what happens to the currency or to the rate of economic growth.

Another area highlighted by Tarapore as requiring corrective action was the financial health of banks. This got decidedly better after banks adjusted to the Basel I norms of 1998, but there has been no further progress on the capital adequacy ratio (CAR) in the last three years. Basel II next year will pose fresh challenges as its fresh accounting norms will drop Indian banks' CAR from 12.9 per cent to 11.3 per cent. This is still comfortable, but there are too many weak banks in the system, and the finance minister's sensible goal of achieving consolidation in this sector has been stymied so far by the Left, and others. In any case, many banks will have to raise fresh capital in the coming year, and this should be encouraged.

The Tarapore time-table went out of the window when the Asian currency crisis hit in late 1997, and since then the climate of international opinion has moved towards the view that capital account convertibility is not important. Since some important emerging markets suffered episodic crises (like Turkey and Brazil), caution levels also went up. Still, the best-managed economies are those that have capital account convertibility, and it is a goal worth achieving as an index of economic freedom. The point here is that capital account convertibility does not come in one magical step, overnight. It is a series of small steps taken over a period of time, with each step being a test of the system and its resilience to unexpected developments. The government and the RBI have already taken some steps (Indians can now invest abroad in a limited way, companies have much greater freedom to buy assets overseas, and so on), but there is some distance to go. The finance ministry or the RBI should therefore list the steps to be taken in a fresh three-year time frame, so that full capital account convertibility is achieved within the life of this government.