The Hindu Business Line : Harnessing the forex wealth

The latest Monetary Policy has taken the first steps to use the foreign exchange riches and these moves will further globalise the Indian economy and speed up its integration into the global market.

The $200-billion foreign exchange reserve continues to confound the Government — shoring up the value of the rupee against the dollar and eroding the competitiveness of Indian exports in international markets. Now, there has been a subtle yet significant change in the focus of the Reserve Bank of India in its latest Annual Policy Statement for 2007-08 — from the recurrent theme of inflation targeting to the imperative to harnessing this huge foreign exchange corpus.

This shift in focus is welcome on two counts. One, it is high time the huge potential that the foreign exchange offers was fully tapped. Two, from experience it has been observed that results of monetary measures come with a time lag, especially vis-à-vis inflation-targeting.

Financially Excluded

This is because a chunk of the population, well over 50 per cent, still remains financially excluded. So, an increase in interest rates that makes funds dearer has no bearing for a large number of people. Equally, monetary measures are expected to yield results from large segments of urban and semi-urban economy, albeit slowly. Inflation has to be combated by de-bottlenecking the supply-side constraints, from the other front. On both these counts, the apex bank and the Government had initiated steps and the results are just beginning to show. So, sustaining inflation-targeting measures may have at best been a placebo, if it did not have side-effects that would curb the inherent growth of the economy.

The latest policy statement announces specific measures to liberalise the foreign exchange inflows and outflows in order to better deploy the vast resources. The move to reduce by 50 basis points the ceiling interest rate on FCNR(B) deposits to LIBOR minus 75 basis points is just one. The ceiling interest rate on NR(E)RA deposits has been reduced by 50 basis points to LIBOR/SWAP rates. Also, the overseas investment limit (total financial commitment) for Indian companies has been enhanced to 300 per cent of their net worth. Listed Indian companies' limit for portfolio investment in listed overseas companies has been enhanced to 35 per cent of net worth.

The aggregate ceiling on overseas investment by mutual funds has been raised to $4 billion. Prepayment of External Commercial Borrowings (ECBs) without RBI approval has been increased to $400 million. Raising the limit for individuals for any permitted current or capital account transaction from $50,000 to $100,000 per financial year is another highlight of the announcement. These moves will further globalise the Indian economy and speed up its integration into the global market.

There can be no doubt that the two-pronged attack on deposits held in foreign exchange, the FCNR (B) accounts and rupee denominated accounts NR(E)RA, would choke the flow into NRI accounts. In fact, the Government has found NRI deposits the perfect tool to regulate and moderate foreign funds inflow. Through conducive policy initiatives the Government had tweaked the corpus of net NRI deposits to $3,642 million in 2003-04 before throttling it to an outflow (negative flow) of $964 million in 2004-05 before it surged back to $2,789 million in 2005-06. There can be no doubt that the current policy moves will restrain its growth in the coming year.

But it is to be seen if the largesse offered to the public, institutions and companies will be exploited fully. No doubt, there will be increased demand for dollars along with greater foreign investments, as well as bids to acquire good foreign companies. But it will all be governed by the risks and opportunities in the global market. And that is bound to temper the flight of dollars from India into the international markets.

Heightened inflows, outflows

Reflecting the global confidence in the Indian economy, there has been spectacular growth in foreign institutional and foreign direct investments. While there can be no doubt that the new initiatives will foster greater outflow from the foreign exchange reserves, it will also be tempered by increasing opportunities in the domestic market. However, given the huge reserves on hand, even this heightened outflow may not dent the $200-billion corpus significantly.

The slow but inexorable growth from $500 million in 1991 to $200 billion in 2007 has created some nagging problems that the Government can do without. But it is up to the Government to convert these problems into opportunities. Some preliminary initiatives have been announced in the Annual Statement. Caution must be accompanied by some out-of-the-box thinking so as to move away from the safe, time-tested though low-yielding US securities to the relatively riskier path of high-yielding market related returns.

No doubt the trustees of the wealth, the Finance Ministry and the Reserve Bank of India, have a difficult task before them: Treading the fine line between risk and return.

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