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Creeping convertibility, RBI's gameplan

Tamal Bandyopadhyay

WWho is playing the role of Santa Claus this Christmas? Ask this question to a corporate chief (domestic or transnational), a commercial banker and a treasury manager and there will be only one answer: Reserve Bank of India governor Bimal Jalan.

Last Saturday, he offered enough goodies to all the players in the financial markets. He allowed corporations to rebook cancelled forward contracts - a facility that was banned a few years back in the wake of the East Asian currency crisis; multinationals to take forward cover without any RBI permission for their India exposure through the foreign direct investment route since 1993; and Indian banks to invest as much as they want in the overseas money market and debt instruments.

Then, there were relaxations in terms of allowing banks to offer limitless foreign currency rupee swaps to corporations and permitting exporters and importers to book forward contracts without any documentary evidence as proof of transactions. Besides, foreign banks operating in India can now take decisions on what extent they want to hedge their tier-I capital deployed here.

On the face of it, all these relaxations ensure better risk management by corporations and offer market players greater manoeuvrability. But take a second look at these measures in relation to the RBI's ongoing relaxations on the foreign exchange front and a clear pattern will emerge. Jalan is re-writing the chapters of India's foreign exchange manual.

The governor's game plan clearly is creeping convertibility. With every incremental flow of greenback into the markets and consequent increase in the country's forex kitty, he is relaxing rules and taking a quiet march to capital account convertibility.

This despite the fact that two well-known economists much admired by Jalan - Paul Krugman and Jagdish Bhagwati - being in favour of temporarily or permanently giving up the capital account convertibility.

The S S Tarapore Committee on Capital Account Convertibility (CAC) in May 1997 had charted out a three-stage CAC to be completed by 1999-2000. The committee had indicated certain signposts for capital account convertibility. The three most important of them are: fiscal consolidation, a mandated inflation target and strengthening of the financial system.

The committee had recommended a reduction in gross fiscal deficit from 4.5 per cent to 3.5 per cent in 1999-2000 and a mandated rate of inflation for the period 1997-98 to 1999-2000 at 3 to 5 per cent.

In the financial sector, the focus was on mainly two parameters: banks' cash reserve ratio and non-performing assets. The recommendations were to reduce gross NPAs as a percentage of total advances from 13.7 per cent in 1996-97 to 9 per cent by 1998-99 and to 5 per cent by 1999-2000. The average effective CRR should come down from 9.3 per cent in April 1997 to 3 per cent by 1999-2000, it had said.

The point to note is that none of the core conditions of the Tarapore panel have been met but the RBI has gone ahead charting its own course. Even in 2002-03, banks' CRR is much higher than what Tarapore had recommended and so are gross NPAs not to speak of the fiscal deficit. In essence, RBI's approach is not clinical but sequential.

In the run-up to full convertibility, the committee had charted out a phased liberalisation of capital inflows and outflows:

• Allowing Indian joint ventures/ wholly-owned subsidiaries to invest up to $ 50 million abroad;

• Removal of existing requirement of repatriation of the amount of investment by way of dividend within in five years;

• Allowing exporters/exchange earners to keep 100 per cent of their forex earnings in the exchange earners foreign currency accounts;

• Permitting individual residents to invest in financial assets abroad up to $ 25,000 and gradually raising the limit to $ 50,000 and $ 1,00,000;

• Allowing mutual funds to invest in securities abroad within an overall limit of $ 500 million in phase I, $1 billion in phase II and $2 billion in phase III;

  Giving banks greater freedom to borrow and deploy funds outside India in stages;

• Allowing foreign institutional investors' portfolio funds to be invested and repatriated without prior RBI scrutiny;

• Allowing FIIs, non-resident Indians and foreign banks full access to forward cover for their Indian assets;

• Permitting banks and financial institutions to participate in gold markets aboard; and

• Withdrawing the Reserve Bank from playing the role of the government's merchant banker.

  Let's take a look at the measures that the Reserve Bank has taken over the last few months to emphasise its commitment of convertibility to individuals, corporations, banks and other market players:

• Overseas funds are allowed to hedge their entire foreign currency exposures arising from investments in Indian equities instead of just 15 per cent earlier.

• Indian banks were initially allowed to invest up to 50 per cent of their equity capital or $ 25 million -whichever is higher - in overseas money market or debt instruments. Now this limit too has been removed and it is up to the board of the individual banks to decide on how much they want to invest abroad.

• Indian residents are allowed to open domestic accounts to deposit foreign currency obtained abroad through payments received for services provided, honorariums or gifts and residual travel money. There is no ceiling on the amount.

• Indian firms can borrow up to $ 50 million from global sources without government approval and prepay foreign loans ahead of schedule.

• Individuals can now get up to $ 500 without filling any form or submission of any documents.

• Remittance of foreign exchange for medical treatment up to $ 50,000 is allowed without submission of any documents.

• Remittance of foreign exchange for travel and education or gifting of funds up to $ 5,000 has also been freed.

• Individual professionals can now retain up to 100 per cent of his foreign exchange earning in EEFC accounts.

• Repatriable status accorded to all non-resident depositors except balances in NRO accounts.

• Capital transfers for NRIs up to $ 1,00,000 out of sale of immovable property as also inheritances and legacies, permitted.

• Limits for Indian direct investments under the automatic route has been doubled to $ 100 million.

• Software exporters are encouraged by permitting them to receive 25 per cent of the value of their exports in the form of equity of start-up companies.

• Two-way fungibility of ADRs/GDRs were operationalised to bring about alignment in the prices of Indian stocks in the domestic vis-à-vis international markets.

• Corporates have also been accorded greater freedom to raise (up to $ 50 million) and pre-pay foreign currency borrowings (up to $ 100 million).

• Corporates have also been accorded greater freedom to raise short-term suppliers/buyers credit for imports (up to $ 20 million).

• FIIs are allowed to trade in exchange traded derivatives.

• Corporations are free to rebook cancelled contracts.

• Swap and open position limits available to banks have been raised to enable them to offer finer rates to the customers.

• Finally, RBI is also actively considering introducing rupee-based currency options.

There is still a long way to go. For instance, banks have been allowed to deploy money overseas without any restrictions but only in debt and money market instruments and not in equities.

Similarly, the cap on $ 500 million for mutual funds to take overseas exposure may sound too little. Nobody is allowed to punt on the rupee and RBI is still policing the forex market, albeit in a subtle way.

But the Reserve Bank seems to be more concerned about "effective convertibility". For all practical purposes, rupee is now virtually convertible on capital account for individuals.

As far as business is concerned, all "flow" transactions are convertible; it is only the "stock" - the assets - that is left out. They are allowed to take positions and hedge their investments.

The road to convertibility, in India, is a calculated gradual transition path starting in the early '90s when the High Level Committee on Balance of Payments, chaired by C Rangarajan, recommended the introduction of a market-determined exchange rate regime.

The Liberalised Exchange Rate Management system was instituted in March 1992 as a transitional phase before the convergence of the dual rates on March 1, 1993. The current account convertibility was achieved in August 1994 by accepting Article VIII of the Articles of Agreement of the International Monetary Fund.

At the next stage, a 14-member Sodhani panel, an expert group on foreign exchange was set up in November 1994. The group's report in 1995 helped develop, deepen and widen the forex market through introduction of various products.

The Tarapore Committee on Capital Account Convertibility in 1997 was the third and final stage on forex liberalisation.

The East Asian currency crisis and the sanctions in the wake of the Pokhran blast had put up some initial roadblocks but now it seems to be back on the central bank's priority list. The RBI push will become stronger once the $ 4.23 billion Resurgent India Bonds are redeemed next year.

These bonds were raised in 1998-99 to combat the impact of sanctions. Analysts also feel that the Reserve Bank may target a $100 billion worth of forex chest before taking the final plunge into the dollarisation of the Indian economy. The forex kitty of the country is now above $ 68 billion (as on December 13) and rising by over $ 750 million every week.

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