Business Standard

The external sector

WORLD MONEY

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A.V. Rajwade Mumbai
Today marks an important development in the recent history of India's external sector: the Asian Development Bank is launching a rupee bond issue "" the first ever by a foreign issuer.
Even otherwise, one can hardly remember a period of a few weeks in which so many important pronouncements and regulatory changes have taken place.
But before looking at some of these, consider the speech at the National Institute of Bank Management conference last month, delivered by Anne Krueger of the International Monetary Fund (IMF) on the subject of capital account convertibility.
She argued that "...it is not possible to have trade liberalisation without relatively free capital flows "" at least, not over an extended period. Opening trade without opening capital markets runs a high risk either of under- or over-invoicing as export and import activity is used as a cover for capital exports."
Even Krueger's employer did not consider, until a couple of decades ago, that a liberal capital account was necessary for trade liberalisation or otherwise; current account convertibility was considered enough.
Again, as for the under- or over-invoicing argument, it is like saying that people should not lock doors because thefts take place even if doors are locked.
This apart, the example Krueger approvingly cites, of a country benefiting from a liberal capital account, is the US "" a country whose currency is the world's reserve currency and, therefore, its experience of hardly any relevance to anybody else.
Curiously, a few paragraphs down, she forgets the earlier, laudatory references to the US when she cautions that "large unsustainable fiscal deficits and open capital markets make uncomfortable bedfellows" "" exactly what America is suffering from right now. Many other incongruities could be quoted from one of the more sloppy addresses by a senior IMF official.
The Reserve Bank of India (RBI) in its report on currency and finance argues that "while controls may be potentially inefficient, there is considerable merit in using a regulatory mechanism for moderating the ebb and flow in capital movements...there may be a case for retaining the freedom to re-impose controls or tighten regulations as long as the vulnerability to highly speculative or motivated attack on the currency exists, since market corrections may be more destabilising to the economy."
As it goes on to point out, "the beneficial effects of capital account liberalisation on growth are ambiguous. There is no evidence that countries without capital controls have grown faster, invested more, or experienced lower inflation (Rodrik, 1998)."
Any doubters only need to look at China where the currency is not convertible even on current account and which has a growth rate for 25 years that no western country has ever matched.
The unfortunate part is that too many of us accept at face value the virtues of flexible/volatile exchange rates advocated often by some self-serving westerners. It is worth repeating that the principal beneficiaries of volatile exchange rates are currency traders, and that such volatility adds to the risk of cross-border transactions, impeding globalisation.
Turning now to some other issues, the authorities should be complemented on a quick review of the earlier, highly restrictive external commercial borrowing policy announced in November.
The Report on Reserves is also welcome as far as it goes. One would, however, like to make a few comments that could hopefully be taken care of in subsequent reports:
  • One has doubts about whether the short-term credit is adequately reflected in "table 4" of the International Investment Portfolio of India;
  • In the same table, one is not clear whether the number against portfolio investment is on a mark-to-market basis or on the basis of net inflows. If it's the latter, then the utility of the number is open to question;
  • Again, one supposes that "other investments" under the liabilities listed in the same table, comprise external loans. Inasmuch because the data would be used by external analysts, it would have been useful to give also the present value of the loan liabilities.
Let me now turn to the $ 25,000 a year remittance facility allowed to resident Indians. A couple of banks were prompt to come out with foreign currency deposit schemes. The question is whether individuals should take advantage thereof.
My recommendation, for what it is worth, would be to do so to the extent of a portion of one's savings. To be sure, the mid-term scenario for the exchange rate is quite bullish for the rupee. The interest differential is also in favour of the Indian currency despite the above-market rates offered on Indian resident deposits abroad.
This really shows how far we have come on the external front. At one time, domestic banks were offering above-market rates for non-residents' foreign currency deposits; now it is the banks abroad who are offering to pay above-market rates for deposits of resident Indians.
If I still recommend some dollar savings, it is first for diversification, and second, as a hedge against the possibility of continued fiscal profligacy, at some time debasing the currency.
Remember, should that happen, the RBI could well withdraw the $ 25,000 facility. In financial markets, long-term benefits often accrue from decisions taken when there were no obvious temptations to take them.
Since the RBI seems to be in a liberalising mood, is it not the time to review the restrictions on rebooking of cancelled forward contracts/swaps brought in when the circumstances were quite different?
avrco@vsnl.com


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First Published: Feb 23 2004 | 12:00 AM IST

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