The Hindu : Convertibility — wish and reality

Online edition of India's National Newspaper
Saturday, Jan 18, 2003

Business

Business - News Analysis

Convertibility — wish and reality

By C. R. L. Narasimhan

The latest relaxations of exchange control regulations only reinforce the gradualist stance. When it advents capital account convertibility will be for all.

The two immediate reactions to the Finance Minister's proposals to liberalise the exchange control regime are noteworthy: that they were intended to benefit the non-resident Indian community. Second, that they bring capital account convertibility much closer. Both the inferences are valid only up to a point.

The announcement was made at a well-attended, highly publicised meeting of overseas Indians in Delhi. It was at the same venue that the Prime Minister had announced the granting of dual citizenship for certain categories of non-residents. When Jaswant Singh's turn came, he dwelt on easing capital account rules substantially but did not quite usher in a full capital account convertibility regime. Nor are the relaxation measures intended to benefit the non-resident Indian community only. When full capital account convertibility does come about — for the moment no date has been fixed — there obviously cannot be any preferential treatment for any category such as non-resident Indians. The liberalisation package announced at the forum for non-resident Indians was intended for a much larger audience, including resident and non-resident Indians as well as foreigners.

How close are we to capital account convertibility? It will be useful to remember that capital account convertibility implies a state where there is absolute freedom to shift assets and liabilities between currencies including the rupee. There will be minimal restrictions on the movement of capital to and from India. There will be no special discrimination against those not having a resident status.

To a large extent foreigners will have easy access to not just the capital market but to the property market. A company such as Microsoft can tap the Indian debt market. A resident Indian can buy government securities/debt instruments as well as equities trading on an international exchange. Very often capital account convertibility is confused with full convertibility of the rupee. The rupee has always been convertible against major currencies. Even when it was pegged to the dollar.

The Finance Minister's January 10 package is therefore more in the nature of liberalising the exchange control rules, one more step maybe but not a sweeping abandonment of the controls regime. Incidentally even the most liberal exchange regimes admit of some controls. The transformation now taking place in India is significant in that it signals a certain willingness to allow resident individuals to invest abroad to a greater extent than ever before. Earlier corporates and mutual funds were given the permission and now they get additional leeway. But it is the permission being given to individuals to buy equities that seemingly suggested the onset of capital account convertibility. The other ingredients of Mr. Singh's package measures such as doing with the limits for remittances under ESOP (stock options), certain types of loans to exporters appear procedural but relaxation of overseas investment norms sounds exciting.

Two points are relevant here. The relaxation has come with caveats. Second, are the new proposals workable or relevant at the current state of the economy? An individual resident in India can buy shares of a well-known company quoted on an approved stock exchange abroad but that company should have a certain presence through its subsidiary/associates in the Indian stock markets.

There are other quantitative ceilings as well but it is the stipulation of reciprocity that that to be better understood. It will prune down the list of eligible companies in which investment can be made. There could be other practical problems that may stand in the way of individual investments flowing freely towards overseas stock exchanges. For instance, it is not going to be easy for any individual to study the movements of particular eligible scrip and then put his money at the right time. In fact the nuances of investing abroad are different from investing in India. Besides, the present juncture is hardly propitious for such activities even by the more knowledgeable fund managers of mutual funds.

The equity markets abroad have not yet recovered from the crash induced by the bursting of the technology bubble. A spate of corporate scandals in America has considerably muted even the most optimistic investor interests. Besides, interest rates are at record lows. Debt instruments, including bonds, yield very little. To top it all there will be a foreign exchange risk which will have to be adequately understood and managed by the investors in India. One key variable has been the movement of the rupee against the dollar. The rupee appreciation will have to be taken into account in any investment decision.

The latest round of relaxation on the exchange front may have been prompted by the healthy and rising forex reserves (nearly $71 billion last week). However, it is highly unlikely that there will be a sizable dent on the reserves due to the operation of these measures. It will be useful to examine in greater detail the implications of the unprecedented accumulation of reserves that has been going on recently. There has to be awareness on what constitutes an appropriate level of reserves. Then perhaps ways of relaxing the exchange controls further can be contemplated. At no stage however the concerns of the macro economy be overlooked.

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Convertibility — wish and reality