RBI for years on has lost several billions of foreign exchange reserves in arresting the Rupee fall though in vain. The central bank has decided that the Indian industry does not want a devaluation of the currency and a mere 7-10 per cent slow depreciation in the currency would be satisfactory as this would lead to a more realistic level. But is this form of thinking correct especially at a time when dollar denominated exports have underperformed and trade deficit today is at a high of around $9 billion. A notionally competitive Rupee is one aspect of good trade performance. In such situations RBI should be the sole regulator of the exchange value and should not be roped in by political lobbies.

But a look at today's events will show that RBI is faced with situations of wars and the government falling on which it has no control thus adding a hurdle to their endeavour to ensure stable financial markets. RBI’s role gets complicated when faced with complicated tasks of maintaining a stable Rupee and simultaneously ensuring soft interest rates. Any hike in interest rates will adversely affect the government’s borrowing programme. The only option is foreign currency flows will reduce the pressure on the Rupee. This is provided the foreign fund managers are comfortable with the political situation and judge the government’s intentions in the right earnest.

Towards CAC
Relaxation in guidelines on ADRs/GDRs and allowing Indian companies to use US$100 million from ADR/GDR funds for acquisition abroad is a stepping stone for the Rupee to become convertible on the capital account. Removing the criteria of a three year track record will make more companies tap this route. The government announced these relaxation with good intentions but they have come at a time when global markets are fast moving and mega mergers and amalgamations worth billions of dollars are taking place the worldover resulting in Indian companies standing no chance with mere offerings of $100 million. Thus, at this juncture the dream of Indian companies becoming MNCs is a far cry. The government realising that the forex reserves were drying up announced the external commercial borrowings (ECB) programme which later started putting pressure as there was a drain on the forex reserves which was later replaced by the GDR programme. Pre-conditions attached only saw core companies remain outside the scheme. Itwas only in 1996-97 when the foreign exchange reserves started to show an improvement that the government took bold initiatives and relaxed the guidelines. But then they were faced with a bigger problem of demand recession which proved a dampner for raising equity abroad as excess capacities existed in the economy.

What went wrong here
Why did this happen especially at a time when growth was picking up and forex reserves were fairly comfortable? Tight monetary policy, stringent pre-conditions attached to the ADR/GDR route, high interest rates and decline in both public and private investments was a grave mistake. This all resulted in Indian companies being denied to borrow cheap overseas funds. Public limited companies were worst affected as they were forced to borrow from the domestic market at high interest rates burdening them with equal high interest liabilities. The government also reduced plan outlays which forced forced public companies to heavily depend on market borrowings to meet their capital investments. What was the fallout of all this? More public companies became red facing huge debt burdens only because of the shortsighted policies of the government.

Here again that the government gave its age-old justifications that a tight budgetary outlay was being allocated to curb fiscal deficit and to bring about monetary harmony in the economy which would help curtail its high external debt burden of around $90 billion. But as usual the government failed in its efforts and domestic debt shot up and the country lost the opportunity of raising cheap overseas funds.

World scenario
Today the industrialists are euphoric about the liberalised guidelines as this provides the Indian companies an opportunity to become global players. Today the worldover stockmarkets are volatile and Indian companies have yet to penetrate listing on world stockmarkets. World MNCs would like to guard the interests of their own companies and would like to ensure maximum penetration in the overseas market even in the field of Information Technology where India has a clear edge. If the government has to succeed it will have to loosen their grip on the domestic money market and try and reduce the interest rates in which a beginning has been made -- a one per cent reduction was announced in the PF rates which will cool off the tight monetary conditions prevailing in the economy. But with further cuts in interest rates likely it will no longer be attractive for an Indian entrepreneur to tap overseas markets as world interest rates would work out to be the same as in the domestic market. Thus, expanding thebequitybase would not be an attractive option for an Indian entrepreneur through the ADR/GDR route. This should have been done way back in 1995-96 when interest rates were high at 16-18 per cent. Today there is no danger of a run on forex reserves as they are quite comfortable at $40 billion and even if there is a sudden panic on Indian paper floated overseas there is no major cause for concern.

Today government is still hesitant about moving towards capital account convertibility as it has not completed it’s homework despite the fact the Indian economy is fairly stable politically, growth is picking up in most sectors and there are no major volatile shocks being experienced in the economy. Why then the delay ? Dilly dallying on the part of the government will once again see India losing out on this golden opportunity of improving its world rating.

But there are many complications involved in the process and unless and until the government is sure of the possibilities, it should not take a hasty decision which would prove to be expensive in the long run. Today foreign companies are allowed to be listed on the Indian bourses. This could possibly mean that the Indian Rupee is being allowed to be exported for the first time. A foreign company raising money in India can raise only Rupee funds. If they have a manufacturing unit then the intention is quite clear what if they are a non-production based company what do they do with the Rupee funds if they are not allowed to take them out of the country. Well all these are steps in the direction of Indian Rupee moving towards capital account convertibility (CAC).

External environment
Currently, a lot of ground work is being done for foreign companies to get listed on the Indian bourses. India has liberalised its regime of inward flow of currencies. But, the same cannot be said about outflows. But the encouragement to expand foreign listings on the Indian stockmarkets is a clear signal that a move towards CAC is on the cards. Freeing FDI and encouraging Indian companies to raise equity abroad should provide some cushion in case there is an outflow of funds.

When the report was framed under the chairmanship of SS Tarapore there were plenty of challenging tasks ahead of them. But, today India has liberalised which will make it easy for the Rupee to move towards CAC. The gold regime has been liberalised, derivatives has been ushered and FDI nd FIIs have been allowed in more sectors. Reducing procedural hurdles and making investments hassle free is being given top most priority with respect to ADRs/GDRs. The report on CAC set a three year time frame starting from 1997-98 to move towards full convertibility. But, the Asian crisis spiked any discussion on the issue which resulted in the process getting delayed. Today for foreign nationals CAC exists. But, the crux of the issue was to allow some flexibility for the Indian residents in effecting outward remittances.

But what is necessary at the moment is for the government to keep a check on the fiscal deficit and have a strong financial system in place so as to take a greater strain of the larger currency inflows. Unless and until these conditions are not in place it will take a while till we see Rupee fully convertible both on the current as well as capital account. Looking at the Asian crisis what is required is to have a proper sequencing of reforms and have overseas based financial sector wherein deficits are firmly in check. The government needs to wake up to this reality and not delay the matter as lags affect the credibility of a system. Indian markets are used to shocks and an entry will put things in place. Banks and stocksmarkets underwent many shocks like entry of private players, FII role being enhanced and finally what happened the system absorbed the shocks and reacted positively. Fundamentals have to be in place and if a market requires proof and although RBI is conservative at present, it will reactfavourably in the future and eventually put CAC in place.

Today with globalisation and integration the buzzwords, dismantling economic barriers of course with adequate safeguards CAC is considered to be a sine qua non for effective economic management in the new millennium. What needs to be guarded is activities of the currency speculators and other unscrupulous players who distort the smooth working of the markets with speculation and rumours becoming major factors influencing the market. Today India is quite comfortable with its forex reserves, there is a control on inflation, financial sector reforms are in place, there exists a stringent fiscal policy and exchange policy is quite flexible. There cannot be a flight of capital as all is not in liquid form and a major part of it will be invested. But what Indian finance ministers have to look into is how to manage the capital inflows that will find their way into the developing countries. Unless and until well utilised at the right time they can create overheating in the economy which would be a difficultsituation if not handled in an organised manner.

But the chief architect of the report Tarapore himself is not very confident about the financial sector of the economy and does not trust the fiscal stability. He firmly believes that the Indian financial system will have to cross many more hurdles before CAC can be ushered in. Many argue that a wait and watch approach to put things in place will only result in India losing out.

Need for infrastructure finance
At present, there is a dire need for funds to finance several infrastructure projects which are a main foundation for future investments. Speculators and motivators will always exist and we cannot afford to waste our precious time to keep them at bay. The Asian crisis was triggered by unrestricted large inflow of foreign funds in largely unregulated and immature markets in Asia. These funds were inter alia utilised for unproductive activities, real estate boom and for creating other long-term assets. As a result,when the crisis really developed as a result of the sudden outflow of funds it led to devaluation, disruption in the growth process and social pain as assets were sold dirt cheap in distress sales. In the aftermath of the crisis many economists have voiced very strongly against CAC. It is also argued that many companies had huge funds which they invested in these Asian countries only for speculative purposes with the sole intention of destabilising these economies which triggered the crisis.

To avoid such shocks in the future what should be done is to allow only the amount of currency to be traded that is actually used up to finance global trade and services. Today it is estimated that around USD 2 trillion is moving around in various currencies and only a small part is being used up which is where the entire problem lies as it is here that speculation creeps in. Volumes in the forex markets are so large that they say that currency trading is around 20 times of world trade. The question is not of trading volumes but is it really required. True currency trading is required for world trade but unnecessary currency trading is fraught with risk. A new code to monitor speculative funds is what is required which will reduce the shocks in the future. There has to be fair amount of transparency and disclosure practices which will make the system more healthy. A better practice to bring about stability is not to monitor currency stability but to curb short-term capital inflows which could play animportant role in preventing a crisis in the future.

Despite India today having a fairly high forex kitty and CPI at lows there are many other indicators that are flashing red for which India has to take a precautious note.

Looking at the above criteria it is natural that at this stage India is still not ready to fully take on CAC. Short-term solutions are not the answer especially with the financial system still groping with high levels of non-performing assets, capital inflows practically drying up and the IMF quota already stretched to the maximum.

So the need of the hour is to have a change in the conservative nature and thinking of our banking and financial policies and restructure out macro economic policies before we opt for CAC. It will take a while for things to be put in place and once a domestic financial architecture and macro policies are put in place CAC can flow in as a natural process. Volatility and speculation once again hit the India forex markets with the Rupee seeing an all time low of 44.70 against the US$. That's when the RBI moved in to check the Rupee fall and played heavily with the forex reserves to get Rupee back to 44. 10/20 mark. A 50 per cent surcharge on import finance and a 25 per cent surcharge on overdue export bills which would be phased out as early as possible to some extent would help correct the distortions. However essentials and government related imports have been left out from surcharge. RBI has assured the banking and exporter community that it would meet any temporary demand/supply dollar imbalances which arisedue to leads and lags in the system.