The Hindu Business Line : Whither transparency?

Large government balances with the RBI, quietly allowing sub-accounts and participatory notes to ensure continued FII flows and directional shifts in the liquidity, are recent developments on which there has been only silence. The Reserve Bank of India needs to re-examine the framework and the institutional processes of policy-making.

At least three developments and ideas have surfaced in the last four weeks or so that cause concern from the standpoint of transparency.

The first one is in the context of the Budget. Among others, one of the developments left unexplained is the Centre's accumulation of large balances with the Reserve Bank of India. It would be unfortunate if this is considered a temporary aberration. It cannot be a reflection of fiscal rectitude. The action implies that the government is postponing expenditure, a practice adopted by some States in the recent past.

This goes against the grain of public economics wherein the state has a role to play not only in protecting the citizens from external aggression and internal law and order problems but also in promoting their welfare, and in the Indian case developmental activities as well.

LOSS FOR SOCIETY

The societal loss in postponing developmental/welfare activities could be large. Accumulation would imply costs in terms of returns on activities foregone or in terms of the interest income that would have accrued had the balances been lodged in interest-bearing instruments. The Government has not explained the rationale of such cash accumulation. It cannot be that the Government is preparing itself to spending large sums on some infrastructure projects in the near future. Such a step if taken to the extreme would have implications for liquidity management.

The second instance is more worrisome. There appears to be a quiet agreement in the official quarters on allowing sub-accounts and perhaps participatory notes (PNs) to ensure continued buoyancy in foreign institutional investments despite the caution given by the RBI and by several scholars.

The reasons for convergence of official opinion on this issue have not been spelt out. Has it got to do with the stock market price boom which is supposed to be the barometer of investor confidence and which no official agency dares to be sceptical about even when economic logic (including international codes) points otherwise?

CASE FOR CONVERTIBILITY

Or, is there a short-to-medium-term objective of making India an attractive destination — the so-called financial hub of Asia? This, however, cannot be done unless there is capital account convertibility. The Prime Minister, while releasing in Mumbai recently the third volume of the History of the Reserve Bank of India for the period 1967-1981, asked the Ministry of Finance and the RBI to revisit the subject of CAC.

Management of abundant external reserves has posed serious problems for the RBI. The apex bank is forced to bear large opportunity costs on the one hand and is exposed to high foreign exchange risks on the other. The latter also heightens the uncertainty about the RBI's ability to optimise its profits. The Government, on the other hand, would like the RBI to continue to give as much budgetary support as before.

Against this backdrop, it is no wonder that the RBI has acted with rare alacrity in appointing yet another committee with a member composition not very different from the one that studied the subject earlier in the 1990s.

The revisit means that the committee would have to spend its energies in building a framework that distinguishes temporary flows from permanent flows and that underlines the critical minimum level of reserves that would always be with the RBI under all possible scenarios of net flows. To elaborate, assumptions, for example, about speculative attacks and contagion effects and economic uncertainties would have to be built into some of the scenarios. But in all the scenarios, the assumptions of `sound' macroeconomic policies (fiscal, monetary and exchange rate policies) and coordinated and well-timed responses of policy makers to changing economic circumstances would be made simply because that facilitates the committee to arrive at what could be regarded as the sustainable level of international reserves. No one, however, can claim with an air of certainty that a scenario or a set of scenarios would be the credible one.

NO SERIOUS CONSTRAINTS

From most accounts, the pre-conditions to convertibility are no longer serious constraints. The international financial architecture is so fashioned that recurrence of major financial crises of the kind seen in the 1990s would be highly improbable, given the emphasis on crisis-prevention that includes observance of international standards and codes. In this context, the widely perceived orderliness in India's financial markets should help policymakers to decide in favour of convertibility that any way is not irreversible. Already there is an impression that more than the RBI the Government is in favour of capital account convertibility. If this is correct, then why should there be a committee at all?

The third case of opacity relates to the issue of liquidity management. The directional shifts in the liquidity position from surplus to crunch reflect large credit demand, large government cash balance accumulation, internal debt policies and sharp inflows of foreign capital. The directional shifts would imply that liquidity smoothening through the year is an art that is yet to be mastered. It is not a question of correcting the present crunch situation with the RBI, banks and government officials huddling together to address the problem before the end of March.

The over-reliance on the repo mechanism for liquidity management requires to be given a real hard look. This begs the question about the fundamentals of the monetary policy framework in which daily liquidity adjustment plays a central role in emerging economies.

CRITICAL QUESTIONS

But where bank financing rather than market financing is dominant, it is useful to seek answers to a number of critical questions.

Is the exercise of liquidity requirements that is undertaken daily adequate?

Is it enough to look at data on inflows and outflows that are generated by domestic operations and foreign exchange operations?

Is it handicapped by deficiency of any information, say the daily trial balance sheet of the Bank?

Is the demand for reserves thoroughly examined?

Is it in sync with the supply of reserves?

Is there an under-identification problem?

Are the conventional policy instruments adequate to take care of the problem?

Is liquidity smoothening less critical than soft interest rates?

Would not liquidity smoothening take care of interest rate as well as exchange rate volatilities?

It is certain that notwithstanding the measures that would be taken by the end of March, the RBI would need to re-examine the framework and the institutional processes of policy-making — subjects on which we shall focus on.

(The author, a former Executive Director of the Reserve Bank of India, can be accessed on asurivasudevan@hotmail.com)