Views of RBI governor-designate, Bimal Jalan, on capital flows as mentioned in his recent book,India's Economic Policy: Preparing for the 21st century

A fundamental point is that a large trade or current account deficit cannot persist for more than a few years, and in any case cannot be financed by private capital flows from abroad. Despite the large volume of such flows globally, most of the domestic savings of capital surplus countries are in fact invested domestically.

It is difficult to prescribe an upper limit for the level of sustainable current account deficit; however, there is hardly any country which has been able to sustain a deficit of more than 3 per cent to 4 per cent over a number of years (the exceptions are countries which are supported by large flows of bilateral aids for political reasons)...For India, considering the low ratio of trade-to-GDP, a sustainable current account deficit is likely to be no higher than 1.5 to 2.0 per cent of GDP for the forseeable future.

The best form of private capital flows is direct investment in plants and factories. Such investments are less likely to be withdrawn, even though the annual volume of fresh inflows may fluctuate. However, it is important to ensure that such flows are not of a "tariff jumping" variety. A reduction in domestic protection and tariff levels, therefore, has to be an integral part of the policies for attracting direct investment.

The worst form of capital flows is short-term debt capital (of less than one-year maturity) denominated in a foreign currency. As in the case of Mexican "tesobonos" short-term assets are likely to be withdrawn in crisis.Long-term commercial debt, while useful for investment financing, should be kept within the prudential limit of debt servicing capacity. For India, a safe rule is that for any length of time debt servicing on all external debts should not exceed 20 to 25 per cent of receipt from exports and services.

A developing country wishing to attract portfolio capital is well advised to maintain a high level of external reserves. A good rule is that foreign exchange reserves should be at least twice as high as the total stock of portfolio and short term investment in a panic, this should provide sufficient resources to cover withdrawals of capital as well as payments for debt service and imports. In fact if reserves increase pari passu with an increase in portfolio investment, a panic is unlikely to occur. Panics are self-fulfilling, in the sense that once markets expect a payment crisis, the crisis will occur as all investors rush to withdraw funds.

Industrial countries which have opened financial markets can manage with lower levels of reserves of safety net arrangements among there central banks and the mutual facilities to borrow in foreign markets. Developing countries do not have adequate access to such arrangements.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.