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The long road to convertibility

The long road to convertibility
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First Published: Mon, Aug 13 2007. 12 36 AM IST
Updated: Mon, Aug 13 2007. 12 36 AM IST
Last week Jinny and Johnny were engrossed in a discussion about capital account convertibility. Jinny is of the view that regulating the flow of capital is like regulating the flow of traffic on the road. Too many procedural “red lights” can act as a hindrance to capital movement. However, you can’t fully dispense with all the red lights. Moving towards fuller capital account convertibility is like building flyovers for capital movement with appropriate check posts. Here’s the concluding portion of the chat between Jinny and Johnny on convertibility.
Johnny: But why are we moving in phases? Can’t we build flyovers for capital movement at one go?
Jinny: Building flyovers overnight will not help if your roads continue to have potholes. Our financial system still has many potholes that we need to take care of. The first committee on capital account convertibility (1997) had set out many signposts such as gross fiscal deficit to be 3.5% of gross domestic product (GDP), inflation rate to be within the 3-5% range, gross non-performing assets (NPAs) to be 5% of total advances, cash reserve ratio (CRR) to be 3% for moving towards capital account convertibility over a three-year period ending March 2000. Except for NPAs, we have missed the targets in many respects. Fiscal deficit is still above the target. Inflation has been above the indicated range. CRR is also on the rise. But it’s not as if we have not made any progress since the first committee submitted its report. In fact, there has been liberalization in capital account transactions step by step so that the market could adjust to the changes without any difficulty.
Johnny: What kind of signposts has the second committee on convertibility placed for achieving the targets?
Jinny: Well, the second committee in its report has set out a broad framework for sequencing and timing of further capital account liberalization. The government’s fiscal health no doubt continues to be a cause of concern. The committee has emphasized that there should be more transparency in disclosing the actual liabilities of both the Union and state governments. It is felt that there are many liabilities like small savings and unfunded pension liabilities that are not reflected in the figures of fiscal deficit.
The committee talks about a new indicator—public sector borrowing requirements—that will more accurately reflect the dependence of the government on market borrowings. The committee recommends that a revenue surplus of 1% of GDP be created by 2010-11 for meeting the Union government’s repayment obligations. A good fiscal condition, of course, remains the first precondition for achieving fuller capital account convertibility.
Johnny: You mean to say that the fiscal health of the government remains one of the roadblocks to capital account convertibility?
Jinny: Yes, but there are many other roadblocks. For instance, the committee is concerned about the health of the banking system. It has been observed that at present the banking sector is fragmented by the presence of different categories of banks. Different categories of banks have different strengths and weaknesses. A weak bank in the chain can make the entire system vulnerable. The committee favours consolidation in the banking sector. The emphasis is on creating strong and professionally managed banks, not just large banks.
Johnny: Well, it would be great if we achieve all the targets by 2011. But what practical difference will fuller convertibility make in our lives?
Jinny: Fuller capital account convertibility will provide resident individuals, like you and me, freedom of choice. Just a year ago, a resident individual was permitted to remit only $25,000 per calendar year for any permissible current or capital account transaction or a combination of both. This limit was raised to $50,000 in December 2006. The Reserve Bank of India has further raised it to $100,000. If the recommendations of the committee on fuller capital account convertibility are followed, then this limit will be further enhanced to $200,000 by 2011. Don’t you think that it will make a lot of difference?
Johnny: Freedom to remit $200,000 in a year? I don’t know whether I would be able to earn that much money even in the next 10 years. Anyway, Jinny, I hope that by the time the capital account “flyover” is ready, people like me who now ride on bullock carts have at least a bicycle to ride.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at realsimple@livemint.com
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First Published: Mon, Aug 13 2007. 12 36 AM IST