Roadmap or rocky road?

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The Tarapore Committee II


While the second Tarapore Committee's roadmap towards fuller capital account convertibility is well-designed, it has been criticised as subject to too many implicit hurdles. How well its recommendations work will depend on whether the central bank and the Government take forward the bold and comprehensive effort or opt for conservatism, says S. VENKITARAMANAN.

The Tarapore Committee (II) has completed its work of drawing up a roadmap towards fuller capital account convertibility (FCAC), a goal set before the RBI and the Finance Ministry by the Prime Minister in March 2006. The broad thrust of the panel's report is to make the relaxations in capital account transactions considerably more liberal in three phases. Particular stress has been laid on the opening up of external commercial borrowing (ECB) limits for corporates, to take advantage of the larger pool of resources available globally. It is also significant that individual residents will have the freedom to move abroad up to $100,000 in the final phase. So, too, the Committee votes in favour of non-residents of all types, not only NRIs, being permitted to invest in the Indian capital market. A similar relaxation is proposed in respect of foreign entities in the Indian debt market, but subject to certain safeguards.

While the roadmap is well-designed, it has been criticised as subject to too many implicit hurdles. For instance, as a commitment of the FCAC, the Committee recommends that the country achieve its target ratio of fiscal deficit to GDP. In fact, it suggests a further rigidity in these requirements by focussing on gross borrowing of the governments instead of net borrowals. I do not quite follow the logic of this requirement, unless it be that the Government should be in the pink of fiscal health for FCAC to be risk-free.

However, experience of the Asian crisis showed that even countries in good fiscal health were not immune to forex crises facts cited by the panel itself. The Committee has laid down a number of "concomitants" for FCAC that involve a tightening of fiscal targets viz., that instead of focussing just on Government borrowing, the entire public sector borrowing requirements should be brought under the scanner.

In these days when public-private partnerships are becoming the flavour of the season, this requirement would put a constraint on the proposed expansion of infrastructure investments using public-private partnerships. That is obviously a matter that the Government and the planners will examine before reaching a final decision on the suggestion to target public sector borrowing requirements.

Protecting the economy

What is perhaps important to reduce the vulnerability of the economy to risks arising from FCAC is that sovereign borrowing in the global markets, especially at the short-term end, should be restricted. Other than that, fiscal constraints shall not necessarily figure in a roadmap towards FCAC, as they do not necessarily lead to current account deficits. But this is perhaps part of the ideology of the Committee, which seeks to restrict the presence of the state


state in economic activity as a part of its roadmap.

Of a piece with this general ideology is the requirement that the state should get out of the banking sector to the extent possible in order to render the financial system more efficient. Indeed, the Committee goes to the extent of saying that business houses should be allowed to own new banks. How relevant this recommendation is to the general concept of capital account convertibility (CAC) escapes me.

Just because business houses own banks in India, does the path of CAC become smoother? That there is considerable scope for conflict of interests when business houses own and manage banks was made clear in India in the period before nationalisation. Even the US or the UK do not consciously encourage business-houses in owning banks. It is a different question that business-houses such as GM or GE have non-banking finance companies. That is allowed in India also.

Dissenting voices

The Tarapore Committee (II) has received two notes of dissent from its members, Mr A.V. Rajwade and Dr Surjit S.Bhalla. While Mr Rajwade's comments are primarily on the risks of increasing the limits on individual capital remittances, Dr Bhalla's comments are on certain perceived inconsistencies and contradictions in the report. One would have expected Dr Tarapore to have given a proper response to these comments in the report itself. But there is no such reference. Dr Bhalla comments on banning Participatory Notes (PNs) as a vehicle of investment by foreign entities in the Indian capital market. PNs have become popular particularly because of the transaction costs involved in other forms of investments. Further, a Committee set up by the Ministry of Finance under the Chairmanship of Dr Ashok Lahiri, Chief Economic Adviser to the Government, has, on the contrary, favoured the continuance of PNs.

There is merit in the suggestion that instead of banning PNs, the efforts of the Committee would have been better directed to find out what are the impediments to inward investments that make PNs the preferred role.

At any rate, the attitude of the Committee, which was designed to make capital movement less restricted and which finally ends up banning one preferred route of inward flows, is rather contradictory. The FCAC Committee would have done better to examine the issues at greater length and given consideration to the questions raised by Dr Bhalla.

Exchange rate policy

While there is a great deal of merit in many of the Tarapore Committee (II)'s specific recommendations, it is difficult to agree with the suggestion regarding exchange rate policy. The Committee suggests that the RBI should focus its attention on the band of 5 per cent of the REER. One does not know the full implications of this proposal, but from what Dr Bhalla indicates in his note of dissent, it amounts to prescribing that the RBI intervene if the rupee goes beyond a fixed rate.

Perhaps, I have misunderstood the FCAC Committee's recommendation. But it is pertinent to point out that the RBI's exchange rate management policy has generally received appreciation from impartial observers. The central bank, however, tends to allow the rupee to appreciate, especially in comparison with partners such as China and the Asean economies.

The impact of such appreciation on the competitiveness of Indian exports has to be seriously considered in setting exchange rate policy guidelines. Surely, the RBI and the Central Government would not be found wanting in their determination to follow the Chinese example, at least in this respect.

Better safe than sorry?

The Tarapore Committee (II) is a bold and comprehensive effort. It is inevitable that such an exercise should elicit controversy. If the Committee had not spelt out the operational implications of its proposals, it would have been criticised as irresponsible. And some of the adverse comments on the effort of the Committee as too much of a prescription of minutiae do not capture the crusading spirit of Dr Tarapore, an experienced central banker, who knows whereof he speaks.

The question is what happens to the proffered roadmap. Will the RBI and the Centre be content with setting up another Task Force to examine the FCAC Committee recommendations!

Or will they do a workmanlike job of examining the proposals and come to a decision? It is true that the Committee itself is informed by a spirit of `better be safe than sorry'. If conservatism wins, what was intended to be a roadmap may end up a road full of potholes!

(This article was published in the Business Line print edition dated September 11, 2006)
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