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Is India prepared for CAC?
India will first have to put in place its macro economic policies and clean up the fiscal mess before moving onto CAC. Sanjeev Sanyal, Regional Economist, Deutsche Bank gives his views on CAC to Jayashree Jakhade of Financial Express Think Tank. Excerpts:
India opened up its economy way back in the 1990s. But liberalisation measures are not a part of the capital account convertibility (CAC). It is a broader agenda of globalisation. This way there is wider scope for exposure for the Indian investor as well as Indian companies both with regards to investments and in equity in international markets. For India to move on to full CAC there will have to be a lot that the government will have to do. Firstly, it will have to clear up its fiscal deficit mess and make it more qualitatively productive. Secondly, it will have to further reform the financial system in order to be able to take the shock of capital account volatility. In both these aspects India is still not prepared. Today the Indian financial systems lack the necessary infrastructure to take on the pressure of greater volume of currency flows. Unless and until we can withstand these shocks of outflows and inflows it is unreasonable to move on to CAC.The above conditions should be fairly in place and the government and RBI should have some amount of testing time before taking the major leap. To avoid a currency crisis like the Asian one, India will have to be very cautious and see to it that there is a proper sequencing of reforms in the first place so that there is no major volatility in the long run. For India to attain a high GDP and sustained growth -- which are the prerequisites for moving on to CAC -- what we should really focus on is not just on attaining a high GDP but on sustainability. Focus should be on how growth is generated, what is the investment - saving gap which should be tried and narrowed which is not happening at the moment, what is the type of capital flows -- is it FDI or portfolio investment -- and what is the real effective exchange rate (REER) which would give us a feel of the inflation rate prevailing in the economy which would help in international comparison of the rates. The Rupee has been holding steady for the past coupleof months. The recent volatility is not very significant as it was only in a one per cent traded band and it should be looked at as an adjustment for dollar strength against other world currencies. With RBI following a REER rather than a nominal rate, it has become very effective in controlling the rate of depreciation along the lines of the inflation rate. Accordingly, if India has to become competitive and strengthen its world rating and competitiveness it would have put in place a broader set of reforms focussing primarily on infrastructure, finance, the legal system, labour laws which would help improve the present working. Unless these are not in place moving on to CAC is not advisable. RBI today is playing an important role and is monitoring the currency in line with inflation rises which is an international practice. With India improving its external standing, with the forex reserves quite comfortable and with higher expectations of FDI inflows it is likely that the Rupee will see a 44.50 level towards December-end. RBI will not allow volatility in the market and the Rupee will remain a fairly stable currency in the future .
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