Convert the Capital !
Whenever I turn the pages of my passport, which of course is blue Indian one, I stop at a particular page. Now days when passports have latest RFID tags and biometric data, mine has this second last page where Foreign exchange transactions have to be recorded. I am sure most of the Indian passports, like mine, have this page blank. It serves nothing except to remind us of our old times when we had tough current account convertibility norms. There was limit to amount of Indian Rupees that could be converted to foreign exchange for travel and other such related expenses. Of course we have come a long way from then. We have a huge foreign exchange reserve(154.209bn US $ as on April 7, 2006). There is no limit to Indian currency that one can convert to foreign exchange for purpose of travel, educational, medicinal expense, etc. The current account is totally convertible.
The capital account is still not fully convertible. Recently the issue gained focus when Prime Minister & Finance Minister of India said that India is very close to capital account convertibility. When this happens then there would be no restrictions on converting domestic currency (Rs) to foreign currency and vice versa. Indians can convert their savings in rupees to some other foreign currency according to the return opportunities. They can also invest in shares and assets abroad (at present the limit is US $ 25,000 per year). Same is true for Indian companies; they can raise capital from abroad and invest in assets there.
So what is the debate over capital account convertibility? Is India mature and ready for it? Capital account convertibility, one of favourite and pet topic of international financial institutions like IMF, has always been aggressively pushed by them.
There are many benefits associated with capital account convertibility like cheap capital for investment and hence developmental activity, better investment and risk hedging options, imports becoming cheaper, etc.
The disadvantages can be easily summed up by the East Asian and Mexican crisis. They are perfect example of how capital account convertibility can go wrong. Of course we have one of the best central bank of world, Reserve bank of India. But is that enough? What essentially follows the regime of full capital account convertibility is Banks and other financial institutions starts to invest in risky assets or takes high exposure of short tem debts. A little change in currency rates can lead to a debilitating blow in such case.
The securities scam of 1992 for the first time highlighted how far Indian banks can collude in scams. With passing of years it was thought that both our banks and monitoring bodies have matured. But this proved to be short-lived and false with the recent IPO scandal which displayed glaring systemic weakness and exploitation of these by our financial institutions. With the propensity of Indian banks to go any length for profits and absence of mature regulatory and monitory bodies, can one be sure of the banks in the full capital account convertibility regime? The answer might well be the answer to India being ready for full capital account convertibility.
26 Comments:
At 6:46 AM, Abhinav said…
quite informative... i do not know much abt "capital account convertibility" but ur post is a good start.
At 8:11 AM, Y said…
Informative post Satya. And CAC is also a phenomenon of the inexorable forces of globalisation. It more feels like a situation that if you do, u are damned ; if u dont then also u r damned.
At 8:36 AM, Y said…
Satya, explain a thing. R dollar reserves a prerequisite for CAC? Is so why?
At 8:36 AM, greensatya said…
Abhinav - Glad it was helpful
Sher - Yeah, CAC is all about globalisation. In the utopian world CAC would be the best thing.
When our PM and FM pitches for CAC then they might know better about Indian situation. But I still can't seem to trust our banks and with rising inflation. Hope the credit policy to be announced tomorrow will have some steps to check inflation.
At 8:50 AM, greensatya said…
Sher - Yeah 'dollar or better forex reserve' is prerequisite for both current and capital account convertibility. Although no one can be sure of the level of reserve.
Our RBI manages the inflow and outflow of current and capital account out of this forex. So yeah it is essential. It also acts as cushion and security for unforeseen situations.
Let's just say after capital account convertibility, India Inc has lot of dollar exposure and suddenly the exchange rate fluctuation happens. This would make those who have large exposure to perish instantly. But if RBI has forex it will immediately control the exchange rate. This also is one of the disadvantage of CAC. It is always better to have market controlled exchange rate.
At 9:03 AM, Y said…
How is this? Market controlled exchange rate. I think if CAC is implemented that is as close to market exchange rate. And even now RBI determines the rate. Its not full float.
At 9:15 AM, greensatya said…
Sher - If CAC happens then it will be market controlled exchange rate. But if CAC is implemented without the necessary prerequisites then RBI will have to interfere and manipulate the exchange rate. The prerequisite are given in report of 'Tarapore committee,1997' as Fiscal deficit(less),inflation (less), deregulated interest regime, etc.
CAC does always leads to few situations when a nation can't afford to have full market controlled exchange rate.
But even then Forex is needed to manage the outflow. Where will you get your dollar from? This reserve also creates investor confidence. The exchange rate fluctuation also happens due to intangibles as investor confidence.
Well now in India, it is almost market controlled. RBI does not interfere unless some extreme situation happens. Compare this with Chinese and Japanese policy.
At 9:32 AM, Y said…
Ok, get it.
I'll have to quip in again. All human constructs are full of falicies. :))
There seems to be this layer. First of G7 countries. And then a layer comprising of us mortals. And CAC can be used if a situation demands to kill us so that the top layer saves themselves. Not save but get an extension.
At 9:37 AM, greensatya said…
Sher - CAC has its own advantages and disadvantages. I will try to put up a post just containing the advantages and dis-advantages. But as the East Asian crisis proved it is risky . But if our fundamentals are strong we can go for CAC. Infact as of now, if you sum up various relaxations, we are more than 50% capital account convertible.
The question is can India handle 100% CAC ?
At 5:52 PM, killer is i said…
Hey, trust me, i have NOOOOOOOOOOO idea about these things. I knw i shud knw something about it but i guess my knowledge is way too weak. Thanx for information satya, though i have to get my basics clear to understand wat really u want to say. I guess my political knowledge is poor.
At 7:35 PM, greensatya said…
Killer - You are welcome.
Papiha - Hmm, that could be one trigger. Let's see how it goes
At 10:14 AM, Anonymous said…
shaivi- That was gud ....but i wud like to add one more thng n that is the critical role that has to b played by a well capitalised, well managed & well regulated financial systemwhich has all along been stressed by the indian authorities has come into sharper focus.Further,the dangers from a highly leveraged corporate strucuture without propere norms for corporate governance are better appreciated.needless to say fiscal position has to be taken into account.
At 1:42 PM, Freeze said…
I'm lost. As usual.
*sigh*
At 9:12 PM, greensatya said…
Shaivi - You pointed out correctly. There has to be well regulated and well managed Financial system and then only CAC can be achieved. And true for Fiscal discipline and norms for corporate governance. I think we are doing more or less in the area of corporate governance by atleast the big names in India.
Freeze - No problem. Getting lost is the first step for finding the way.
At 12:47 AM, Koi Pahailee said…
hmm :)
good pt there.
I wanna say is that this post made me think about my country.
(pls no Indi Pak rivalry here)
but green, if you know the history, State Bank of Pakistan is 1000% a star (although very small reserve as compared to India). My point is that the total reserves were $777million in Oct 1999 (when Nawaz Sharif fled) and are now around 15 bn (i.e. in 5-6 years.) We are no more taking loans from IMF and WB like we were uptil 1999. The banking sector has grown like 400%, with all credit expansion etc in all all sectors.
And a 100 more things to add here.
But I know that we have a long way to go. Cant even think of current account convretibility.
This is what your post made me think. Somewhere back in time, these sad pathetic democratic governments (Nawaz and Bhutto) have hurt us so bad that we cannot recover it seems.
I feel sad.
At 8:47 AM, Y said…
Koi, I think its misplaced to base your opinion of central banks performance on the amt of reserves it controls. Even if Nawaz Sharif was there the reserves wud have risen to 15 b $. And so is with India. We are more globally connected than ever. And since we are talking about reserves..it is something which inherently has to do with globalisation.
So I dont think its a metric of performance but a metric of globalisation. Is it good or bad..god knows. What do u say Satya?
At 10:23 AM, greensatya said…
Koi & Sher,
Interesting discussion here. Let me add to it. Increase in forex reserves is definitely due to increasing globalisation of both Pakistan and India. The notable component being the remittance done by Non residents of each country. The other important component being money invested in stock exchanges by FIIs.
Karachi stock exchange has been quite impressive. It is one of the fastest increasing sensex in Asia. I am not sure which one is fastest but Karachi stock exchange is in the big league.
All these factors make up the forex reserve. But we also run trade deficit. I am sure for Pakistan as well import is more than export. And both of us have to buy crude oil. So if nothing is being done then the forex reserve will be depleted. But if a level is maintained then the credit goes to the Central banks of respective countries.
Till the time we have no CAC, it is the central bank which manages the portfolio of nation. They assidously maintain it to sustain a level which creats investor confidence and ward off Balance of Payment crisis.
So the Central bank of Pakistan's performance is definitely reflected by the forex reserve. And as Sher said the forex is coming to both of us from globalisation.
Koi, I have read the reports that Pakistan is doing good Financially. I think we should be happy, for it will lead to the all round development of the region which is in favour of both India and Pakistan.
At 12:38 AM, Koi Pahailee said…
Sher,
I was reflecting upon the fact that the envornment for business and investment was worst in Nawaz's and Benazir's times. And Musharaf's regime has been the best i have seen in my life time (So far) in terms of economic growth. I shudder at the thought of where we would have been in the 'oil-price-hike' times, had those 'democratic govt. been in power. You know, when Nawaz fled, Pak was on verge of bankruptcy and did not have enough money to pay teh next loan installement due to IMF/WB!
Green
Good analysis there. I mean in terms of reflecting on why forex reserves are reflection of performance of central bank. I dint think of that and for a moment, i was lost reading SHER's opinion. But let me ask, what is CAC?
At 1:06 AM, Koi Pahailee said…
And i know this is not the place but SHER, what have u done to your blog??
its gone??
At 4:55 PM, Y said…
Koi,
Cant comment on Pakistan. But just take the case of India. And I think it can be extrapolated on Pakistan and vice versa. There r two things here:
1) Govts more than ever are open to reforms across the spectrum of nations. I think theres a systemic pressure on all developing countries to reform or to be left out. So no matter a Vajpayee or a Manmohan Singh or a dumb like me, we all had to reform. In case of Pakistan a Nawaz Sharif or a Bhutto or an Imran Khan they all wud have done reforms too.
2) The world as a whole is seeing economic growth which has been unprecedented. We are all on the boat thats witnessing high tides:). India is today enjoying 8% annual growth. Thats a good number considering a GDP of 650 billion $. Business environ is rocking. Living in Bangalore everyday I hear the Intels, the IBMs the microsofts of the world announce major investments. They praise the government. Our healthy fiscal situation relative to the past and other countries. Yeah its all there.
But is it happening because of the govt policies/ central bank. No way all these MNCs come to India despite the Govt and the Central bank. Its the MNCs which are driving the growth the reforms in all countries. They are the LCD. Least common denominator. All reforms, growth are in some way stemming from their expansion.
This is the truth of India's growth and probably of Pakistan's.
I think if u were the Pakistan President or I were the Indian PM...the growth wud have been the same, coz we both wud be riding the high tides together.
At 11:58 PM, Koi Pahailee said…
but but but...
the blog??
its gone!
At 12:04 AM, greensatya said…
Papiha - I didn't edit your response !
Koi & Sher - That was a good discussion.
At 6:56 AM, Raj said…
Hey. Sorry for being away for so long but you should really write something about yourself rather than SBI and stuff. Its been long since you did that last. The blog is called "My Journey" :)
At 9:13 AM, Koi Pahailee said…
i second raj
and no explanation of how this blog is really about u...cuz it isnt
At 11:39 AM, greensatya said…
Raj - I don't have such happening life as to write about it. If I decide to write only about me then I will have to stop blogging.
Koi - Yeah this blog is about whatever crap comes in my mind.
At 10:22 PM, greensatya said…
Muruks - You have correctly pointed out one more benefit of CAC. But this has to be complemented with some regulatory framework or any such government would take huge risk exposure. Anything going wrong might bankrupt the particular government.
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