Throwback to 1991? Not really

The measures introduced by the Reserve Bank and the Government in the recent period to deal with the problems on the external sector have raised a public debate. Some have feared that it marks a return to the pre-Gulf-Crisis days in the early 1990s, both in terms of economic conditions and policy measures.

The Prime Minister and Finance Minister have reassured the nation that it is not so, and what we see now is only a temporary deviation from the liberal policies initiated in the 1990s. The truth is somewhere between the two extreme views.

To understand the debate, one may divide the issue into two parts: economic conditions in 1990-92 and 2012-13 and the policy stance then and now.

From the table it is clear that we are far better off than in 1991-92 in the real sector. But there are some worrisome features on the external side that should be a matter of concern. The debt-service ratio and the level of reserves are vastly better than they were in 1991-92.

Policy Stance

Doubts have been raised as to whether the country is going back to the era of administrative controls and arbitrary powers of government and the central bank after more than a decade of economic reforms that are still in the process of evolution.

The restrictions imposed on gold imports and capital flows to foreign countries have to be understood as transitional arrangements to tide over the current crisis.

Critics will do well to remember that, necessitated by circumstances, President Nixon announced on August 15, 1971, the delinking of dollar from gold and the imposition of wage and price controls. And US had been considered all along as the paragon of a free economy and the capitalist system!

The depreciation of the rupee, crossing the level of Rs 62, has raised questions on the minds of some about the efficacy of measures. There are lags involved in policy implementation.

It is good to know that RBI has agreed to the suggestions to remove interest rate restrictions on the Foreign Currency Non-Resident Accounts and exempt all the incremental accretions to the NRI deposit schemes from CRR and SLR. (“Knight in shining armour”, Business Line , July 16).

It will take some time for the banks to decide on the interest rates and canvass with the NRIs. We may expect the benefits in a month or so.

However, I wish the interest rates on NRI deposits were completely freed from regulation and all incremental deposits exempted from CRR and SLR, instead of being made applicable to only deposits of 3-5 years, the ceiling on interest rate being 400 basis points above LIBOR for FCNR deposits.

Our banks are well versed in international banking and the system is mature enough not to go overboard in fixing deposit rates. Arbitrage and run on the NRI deposits seen during the Gulf Crisis may not recur.

One estimate of the wealth of 25 million NRIs is $100 billion. Banks can easily tap a large proportion with attractive interest rates, given the near-zero return in the West.

Regarding capital outflows, the RBI could have been less harsh in prescribing limits on investments abroad.

Checking volatility

In the long run, they will be a source of strength to current account due to dividends received. They amounted to $2 billion last year. There should be no grievance on the reduction in the limit to remittances from $2,00,000 to $75,000. Such remittances have been small in the recent years. There is a suspicion that the steep depreciation in the last few months has encouraged arbitrageurs to send money abroad with a view to bringing them back taking, advantage of the increase in the value of the underlying amount.

Although they may be mutually cancelling in terms of forex, the timings of inflows and outflows create volatility in exchange rates.

This tendency is likely to gain further strength and accelerate during election time with the recycling of money taken abroad illegally.

Swapping (not selling) of gold for dollars, suggested by David Gornall, Chairman of London Bullion Market Association, could improve matters considerably through substantial dollar inflows at nominal cost.

The impact of the measures to constrain liquidity has seen a collateral damage in the government securities market. Short-term papers earn an yield above 11 per cent. There is an inverted yield curve.

The damage to government finances needs to be contained. It will require another article to spell out the measures.

(The author is a Mumbai-based economic consultant.)

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