NDIA’S EXCHANGE RATE POLICY, FOREIGN EXCHANGE RESERVES AND CAPITAL ACCOUNT CONVERTIBILITY tational trade scenario marked tion and trade "openness" in recent Inthe fast changing inter y increasing globali Variable. With rapidly increasing integration of global financial markets and increased capital mobility across the ‘world, exposure to exchange rate risks has also increased. ‘As the Mexican crisis in 1992, East Asian meltdown in 1997, Russian crisis in 1998 and the experience of Argentina jn 2002 have clearly shown, exchange rate changes can play havoe with the economies. Accordingly, economists have shown a renewed interest in issues relating to exchange rate regime, anda large body of theoretical and empirical literature ‘on the subject has emerged. Economists are once again debating which exchange rate regime is the best and how ‘should exchange rates be managed. In India, capital account liberalisation has also emerged as an important issue of debate. In this chapter, we shall discuss: © Choice of exchange rate regime, i.e., the choice between fixed, flexible and intermediate exchange rate regimes Exchange rate management in India «© Foreign exchange reserves in India ‘© The issue of capital account convertibility CHOICE OF EXCHANGE RATE REGIME The peo polar (or extreme) cases of exchange rate regimes are: (i) the fixed exchange rate regime, and Gi) the fully floating (or market-determined) exchange rate regime. Between these two extremes, one can think of @ number of intermediate regimes which combine the important features of these two regimes in different ways. The supporters of the fixed exchange rate regime argue that it provides credibility, transparency, very low inflation and, financial stability. Countries for which pegged exchange rates seem to be appropriate are small economies with a dominant trading partner that maintains @ reasonably stable ‘monetary policy. The international experience also reveals si that a large number of small economies have pegged thir sev pange rate regimes. For instance, small Caribbean island ‘economies, some small Central American countries ang Some Pacific island economies peg to the US dollar. Aftican countries like Lesotho, Namibia and Swaziland peg to the South African Rand. Countries like Nepal and Bhutan peg their currency to the Indian rupee. ‘The other extreme is the fully floating exchange rate regime. In this case, there is no government (or central bank) intervention and the currency's value is determined by the free play of demand and supply forces. The chief merit of flexible or floating exchange rate is the simplicity ofits operative mechanism. The supporters of this exchange rate regime argue that it is much easier to change one price, namely the exchange rate, than to alter thousands or millions of individual prices, when an economy needs to enhance (or reduce) its international price competitiveness in the interest of balance of payments adjustment. In the new international trading environment in which the entire emphasis is on ‘opening up’ all trade and restrictions of any kind are being frowned upon, there is an increasing pressure on the developing countries to adopt a fully floating exchange rate regime, However, most of these countries have resisted these pressures as free float carries the risk of volatility which could unsettle the entire extemal sector of these economies via speculative market activities and large-scale capital outflows and can thus have disastrous effects on the domestic sector as well Between the two extremes of *hard pegs’ and ‘full float’, there is a large spectrum of exchange rate systems that combine features of these two regimes in various degrees. All of them can be conveniently clubbed into, what can be called, ‘intermediate exchange rate regimes.’ For @ substantially long period of time, many countries followed a ‘fixed but adjustable” exchange rate regime in which countries pegged their nominal exchange rates but altered them through devaluation if such an action was ‘Some countries opted for a tight band, some for crawling peg and some others for crawling band. Most countries in the present-day world are following intermediate regimes —_ Scanned with CamScannertific features, no targets for the change market inter rate movements, iy that exchang (not fired or ps Id be able to interve Patesifmovements are believed to level of tal Accoun hich submited its Report on fly 44 au Exchange rate policy for India aimed sy eal effective exchange rate broadly withiy around neutral level. This is essentially . According to A. tf devloingcconomes today ng ones Bal policy on account of, at least, ° Firstly, today’s developed ec, In their history as fast as several of the Asian ve done, the most important example being of Over the last quarter century. There is no Tecord of hundreds of million of people coming Poverty line in just one generation. And, the fate policies have been an important element of policy spectrum which enabled this most of the exports of the developing countries ared commodities’ which are extremely to cost and pricing. Since exchange rate is an factor in determining the price competitiveness in onal markets, it plays an important role in determining ic competitiveness of a developing country. It is that central bank intervention and sterilisation’ supply can have financial costs. However, the the real economy of misaligned exchange rates quite possible in the case of a fully floating te regime), in terms of lost growth and jobs, can INGE RATE MANAGEMENT IN INDIA ‘the last six-and-a-half decades since Independence, ge rate system in India has transited from a fixed Tate regime where the Indian rupee was pegged sterling on account of historic links with @ basket-peg during the 1970s and 1980s and fo the present form of market-determined ge rate regime since March 1993. System (1947-1971) s e, India followed oe of the IMF whereby the rupee's exter! Po Ked at 4.15 grains of fine gold. In ‘and Capital Account Convertibtty sis are cits: the exchange rate was pegged ster BPRS ar ccs a8 pegged to pound sterling September po round sterling (or & 4.76 per US dollar) in sett this femained unchanged upto June 1966 ound ater eee was devalued by 36.5 per cent to & 21 per the ranetting (or 1 US $ = © 7.50), This exchange rate of we Leman constant till 1971 when the Bretton the 42 atem collapsed with the suspension of convertibili of the dollar by the USA. rere pee when the Penged Regime (1971-1992) India pegged its currency to the US dollar (from gust mt = December 1991) and to the pound sterling vm Bae 7 Feline Dressure on the pound string vis--vls major tastes tmiemeits: being pegged to the sterling, this led to misalignment of the Tupee vis-a-vis other currencies. Moreover, the importance of UK in India’s trade had declined Over the years. To overcome the weaknesses associated With a single currency peg, the Indian rupee, effective September 1975, was delinked from the pound and pegged {10 a basket of currencies of India’s major trading partners. This system remained in vogue tll 1992. During this period, Le., 1975 to 1992, the exchange rate of rupee was, officially determined by the Reserve Bank of India within a nominal band of +/-5 per cent of the weighted basket of currencies of India's major trading partners. By the late 1980s and the early 1990s, it was recognised that both macroeconomic policy and structural factors had contributed to a misalignment in the exchange rate. Devaluation by many of India’s competitors (despite their Jower inflation than in India) had aggravated the misalignment. For instance, China and Indonesia depreciated their currency against the US dollar more than India, despite lower inflation, ‘over the period end-December 1980 to end-December 1989, Asa result, India’s export competitiveness suffered a setback. In fact, Suresh Tendulkar has alleged that the period from 1947 to 1993 was one in which, except for occasional ‘and dramatic episodes of devaluation (as in 1949 and 1966), there was no active use of changes in the nominal exchange rate as a tool of macroeconomic management. Indeed, for most of this period, the exchange rate was overvaltied. This overvalued exchange rate provided cheap foreign exchange for priority uses (particularly by the government), discriminated against exports, and generated excess demand for imports restricted by quantitative restrictions. According to Tendulkar, the absence o correction for exchange rate overvaluation and its bias against exports led to an export stagnation while boosting forimports. "The options of exchange rate adjustment and the aggressive use of trade ae to promote exports ‘were not seriously considered.’ Scanned with CamScanner516 Indian Economy ‘The Period Since 1991 A two-step downward adjustment of 18-19 per cent in the exchange rate of the Indian rupee was made on July 1 and 3, 1991 with a view to placing it at an appropriate level in line with the inflation differential with major trading Partners in an effort to maintain the competitiveness of exports. This provided the necessary impetus for allowing, greater exchange rate flexibility. It was felt that small and frequent changes in the exchange rate that would be signalled by market forces would be a better alternative to large and delayed corrections necessitated by a basket-pegged regime. ‘The transition to a market based system was sequenced on the basis of the Report of the High Level Committee on Balance of Payments chaired by C. Rangarajan, The first step in this transition was the introduction of partial convertibility of rupee in 1992-93 Budget known as liberalised exchange rate management system (LERMS). This was followed by market- determined exchange rate regime in 1993. Liberalised Exchange Rate Management System. The Finance Minister announced the liberalised exchange rate management system (LERMS) in the Budget for 1992- 93, This system introduced partial convertibility of rupee, Under this system, a dual exchange rate was fixed under ‘which 40 per cent of foreign exchange earnings were to be surrendered atthe official exchange rate while the remaining 60 per cent were to be converted at a market-determined rate. The foreign exchange surrendered at official rate was to be used for the import of essential items (like crude oil, "petroleum products, fertilisers, life-saving drugs, etc.) and the foreign exchange converted at the market price was to bbe used to finance all other imports. Since the official ‘exchange rate was lower than the market rate, this system meant taxing the exporters to subsidise the government's bulk imports. The implicit export tax was between 8-12 per ‘and was highly resented by exporters. Market-determined Exchange Rate Regime (1993 Present Day). The LERMS was essentially a transitional ism and provided a fuir degree of stability. There ‘also a healthy build-up of reserves. As a result, there 4 smooth changeover to a regime under which the rates were unified effective March I, 1993. Since the day-to-day movements in exchange rates have Jargely market-determined. “The objective of exchange ‘management has been to ensure that the external value ‘the rupee is realistic and credible as evidenced by a ‘current account deficit and manageable foreign situation. Subject to this predominant objective, rate policy is guided by the need to reduce volatility, prevent the emergence of destabilising ies, help maintain adequate level of reserves, and ‘an orderly foreign exchange market.”’ This shows that the market-determined exchange rate regime be, in followed by India since 1993 is a ‘managed float’ regime ime, Under the unified exchange rate regime adopted inthe 1993-94 Budget, the 60:40 ratio was extended t0 100 pep cent conversion. This 100 per cent conversion was extend for: (i) almost the entire merchandise trade transacting (ie., export and import of goods); and (ii) all receipts whether on current or capital account of balance of payments, but not all payments. Side-by-side, the official RBI rae alsy stayed on for the conversion of items not permitted under the unified market rate, ie., more than half a dozen of invisible items of current account as well as capital accoun, In addition, various exchange control norms of the Reserve Bank remained in operation all along, albeit with some relaxation of provisions, This shows thatthe 1993-94 Budge introduced full convertibility on trade account, In February 1994, the Reserve Bank undertook several steps towards achieving current account convertibility’ when it announced relaxations in payment restrictions for a number of invisible transactions and liberalisation of exchange control regulations upto a specified limit relating to: (a) Exchange Eamets’ Foreign Currency (EEFC) Accounts; (b) basic travel quota; (c) studies abroad; (d) gift remittances; (e) donations; and (A payments of certain services rendered by foreign parties, Current account convertibility was finally achieved in August 1994 when the Reserve Bank further liberalised payments and accepted obligations under Article VIII of the IMF, ‘under which India is committed to foresake the use of exchange restrictions on current international transactions as an instrument in managing the balance of payments. The experience with the market-determined exchange rate system has been satisfactory. For most of the period since 1993, the foreign exchange market was characterised by orderly conditions, excepting a few episodes of volatility. The nominal exchange rate of the rupee vis-a-vis the US dollar was around ® 31.37 per dollar over the period March 1993 to August 1995, The average exchange rate for the five year period 2003-04 to 2007-08 was 43.1 per dolla and it depreciated to an average of & 51.1 per US dollar over the five year period 2009-10 to 2013-14, Average exchange rate of the rupee for the year 2020-21 was & 74.22 per dolla while exchange rate at end-March 2021 was $ 1 = € 73.50. THE MANAGEMENT OF FOREIGN EXCHANGE RESERVES Foreign Exchange Reserves: Rationale for Accumulation and the Question of Adequacy Under the Bretton Woods system, foreign exchang’ eserves were used by the monetary authorities mainly Scanned with CamScannerradia’s Exchange Rate Polley, Foreign Exchang sp extra value oftheir respective currencies at he eer te breakdown of te Breton Wods ere rly 1970s, counties sated adopting exible {em int regimes. Under a perfectly flexible exchange oe ren exchange reser play only a marginal aPC er, as noted earlier, most of the countries adopted woe Hower’ exchange rate regimes which require i, cental banks in the foreign exchange market iserviae 10 time, Therefore, holding of adequate foreign fo nge reserves. Becomes imperative. The need for excaining adequate foreign exchange reserves has mreased over time with the acceleration in the pace of icepeonand enlargement of rs border capital flows ser nighly volte in tare, The main sbjetves of folding reserves can De stated as follows: (i) maintaining ili oe in monetary and exchange rate policies: fencing the capacity to inervene i foreign exchange CGrkets; (i) Timing external vulnerability so as to absorb “juring times of crisis; (iv) providing confidence to sarki that external obligations can always be met; and (1 reducing volatility in foreign exchange markets.® ‘The question that needs to be addressed here is: what isthe appropriate size of reserve holdings for a country to ssa the above objectives? The size depends on the {following five hey factors — size of the economy, current Jecount vulnerability, capital account vulnerability, ‘exchange rate flexibility and opportunity costs. ‘As far asthe practical approach to the determination afreserve adequacy is concerned, traditionally the adequacy was determined by a simple rule of thumb: i. the stock afreserves should be equivalent to a few months of impor’ However, the financial crises in the 1990s highlighted the limitations of this approach. It is now being increasingly recognised that focussing only on current account transactions is insufficient as it is the capital account transactions that are now more important. Among various components of capital account transactions, short-term external debt has gained, snce in determining reserve ‘adequacy, From the perspective of crisis prevention, resetves to short-term debt ratio has emerged as a benchmark t9 determine the adequacy of reserves. It has been suggested that empirical assessment of reserve adequacy should be so defined that the country can meet its extemal repayment ‘obligations without additional borrowing for one yea the socalled Guidotti Rule (proposed by Pablo E, Guidott in 1999). ve Reserves and Capital Account Convertibility si7 endeavoured to reflect the ‘liquidity risks’ associated with ao avetrypes of flows and other sequements: The policy for averve management is built upon a host of identifiable fectors and other contingencies, including, infer alia, the five of the current account deficit and short-term Aiabilities {including current repayment obligations on long: feo Joans); the possible variability in portfolio investment® and other type of capital flows; the unanticipated presst°e ‘on the Perce of payments arising out of external shocks: and movements in repatriable foreign currency deposits of non- melden Indians. A sufficiently high level of reserve’ is necessary to ensure that even if there is protonged meeting, reserves can cover the ‘liquidity of risk’ 0” ‘all accounts over a fairly long period. During recent period, the strong build-up of reserves bas been associated with the Reserve Bank's sttempe *® prevent the rupee from appreciating 00 fast. Because of the Peet of capital inflows from various sources, the Indien eonomy has been flooded with dollars. These dollars art tot being adequately absorbed in the economy because of Tiuggish imports and capital controls, The swelling tide of dollars has lified the rpee substantially. This as the authoritic® coved as they feel that a strong rupee would adversely weet the competitiveness of Indian exporters severely. SO, ‘he Reserve Bank has intervened excessively in the foreign tachange market from time to time to prevent rupes from tppreciating too fast. With this end in view, it bought ‘ears from the market and sold rupees in return. The dollars that were thus purchased added to the foreign fexchange reserves of the country. TIus, the rising foreign exchange reserves are closely linked to the exchange rate management policy of the Reserve Bank of India. The extra rupees that have been released into the economy @s a ‘consequence of this policy have a potential of creating inflationary pressures in the economy or they can create ripples in the stock, bond and real estate markets. To avoid this possibility, the Reserve Bank has been selling some of the government securities it holds to suck out the rupees it hhas released in the economy. This entire process — purchasing dollars, releasing rupees and then sucking them out through sales of government securities — is called ‘sterilisation’ (or sterilised intervention). This has ai ee of Reserve Bank's policy over the last s. However, critics argue that this policy has now reached its limits as the amount of marketable government securities with the Reserve Bank has considerably shrunk. India’s Foreign Exchange Reserves India’s foreign exchan; ; we reserves have i Considerably inthe post-1991 period — from US $8 bil i arch 1991 to § $77 billion at end-March 2021, Scanned with CamScanner2 Indian Economy Tndia has now the fourth largest foreign exchange reserves in the world after China, Japan and Switzerland, ‘While foreign exchange reserves at end-March 1991 ‘were enough to cover imports of just about ten days, they ‘were enough to cover as much as 17.4 months of imports in 2020-21. Alongwith an improvement in the import cover, ‘other indicators on the adequacy of reserves have also Jmproved. For instance, the rato of foreign exchange reserves toeextemal debt rose from 7.0 per cent as at end-March 1991 to 138 per cent in 2007-08 and stood at 85.5 per cent as at cend-March 2020 and further to 101.2 per cent at end March 2021. The ratio of reserves to short-term debt rose from 68.3 per cent as at end-March 1991 to 571 per cent ‘as at end-March 2021. However, in this context, the following points: 1. A substantial pat of the build-up of foreign exchange reserves since 1991 has been due to NRI deposits and foreign institutional investor (FHI) investments. As correctly pointed outby C.P. Chandrasekhar, these kinds of investments rarely, ifever at all, finance new investments in the domestic ‘economy. These are also typical inflows that would be reversed in case of any sign of uncertainty leading to fast ‘erosion of foreign exchange reserves.’ 2. The Reserve Bank has been claiming that reserve accumulation in recent years has been due to higher remittances, quicker repatriation of export proceeds and non-debt inflows. In other words, the rise in foreign exchange reserves is driven by ‘fundamental factors’ and is not a response to ‘arbitrage’ motives. However, large NRI deposits and FIL investments suggest that arbitrage has played an ‘important role in building up foreign exchange reserves. Arbitrage is being done by NRIs, corporate treasuries through short-term external commercial borrowings that are invested in India, foreign institutional investors who are investing in Indian debt and banks which are bringing in short-term capital. These are all being driven by: (i) the difference domestic and international rates; and (ii) the tion that the rupee would remain stable or appreciate . The problem with arbitrage flows is that they are, very nature, fickle, A rise in international interest (which could be caused by a decline in global liquidity) rrise in the dollar’s value can squeeze the arbitrage Jeading, in turn, t0 a reversal of flows. 3, As correctly pointed out by Jayati Ghosh, while the ‘norease in inflows represents the fact that India now s to be a better destination to foreign investors other developing countries, the fact that it is translating into a build-up of foreign exchange reserves ‘because it means that such inflows are not is necessary to consider increased investment: within the economy, contrioarmeagn currency holdings reflect an excess of fay over ex ante investment and Suggest an Ting well below potential, and an enormous the use of resources.|” contributing t© ex ate ‘economy operat slack in terms of 1 THE ISSUE OF CAPITAL ACCOUNT CONVERTIBILITY ‘The Case For and Against Capital Account Convertibility Capital account liberalisation has been viewed by many economists as an important component ofthe overall opening tpof global trade and financial markets. Therefore alongwith Tetoval of restrictions on merchandise trade and current ‘account convertibility, they have advocated full capital count convertibility as well. The arguments put forward in favour of full capital account convertibility areas follows: 1. Liberal capital account leads to faster economic growth, 2, Developing countries need external capital to sustain an excess of investment over domestic saving and an open capital account can attract foreign capital. Iti also argued that such capital flows can have favourable ‘spillover effects also in the form of technology, skills, and introduction of new products as well as positive externalities in terms of higher efficiency of domestic financial markets resulting in improved resource allocation and efficient financial intermediation by domestic financial institutions. 3, Since effective implementation of capital controls becomes more and more difficult in a globalised economy, this de facto situation should be recognised de jure by litng controis on capital account transactions. 4, Full capital account convertibility will foree governments to behave more responsibly on fiscal balances Unsustainable deficits would frighten investors, leading to capital flight from the country — and this danger would force governments to act more responsibly in controlling fiscal deficits. However, none of these arguments stands to close scrutiny. As far as the first argument is concemed, A.V: ‘Rajwade has pointed out that chere is no conclusive evidence 40 suggest that a liberal capital account leads to faster economic growth. On the other hand, there are clear risks in liberalising the capital account. Therefore, for judging te desirability or otherwise of capital account convertibility, ‘one must carefully weigh the ‘risks’ as against the ‘rewards’. While rewards are uncertain, risks are very obvious a8 liberal capital account can amplify and prolong a crisis. Scanned with CamScanner& As far as the second argument js con ned, Rajwade sary link between increased ows and full convertibility on capital account ze capital inflows without the currency anwertble even on the current account, This shows rn the point of view of the foreign investor what that there is no 1 that fro ae inant economic and industrial performance of the mer and nor capital account convertibility ‘The third argument is a ‘non-argument’ — one cannot jsify (or egalse) a wrong just because it exists, For itt, one knows that there is widespread coruption in fia Similarly, there are thefts and robberies and other vr nes in violation of the laws, “Can this be an argument for Tuting coruption or thet"! Obviously no ‘As far as the argument that full capital account convertibility will fore the governments to act more tesponsibly on the fiscal front is concemed, Rajwade points ‘ut that such optimism is not borne out by empirical evidence. Moreover, in a democratic country, it is for the citizens to discipline the political masters and they should not depend fn a hundred odd currency and bond dealers, focussed on Short-term trading profits, to do so at an enormous cost to the real economy. ‘As the above discussion shows, the arguments in favour of full capital account convertibility do not stand a close scrutiny, On the other hand, the case against full capital account convertibility is quite strong. This rests on the various risks associated with capital account liberalisation like potential macroeconomic instability arising from the volatility of short-term capital movements; the risk of large capital outflows and associated negative externalities; export ital scarce developing countries; and weakening the ability of authorities to tax domestic financial activities. The experience of Mexico in 1994, East ‘Asian countries in 1997, Russia in 1998, Brazil in 1998-95 and Argentina in 2001 as highlighted the risk of capita) sccount liberalisation. For instance, the East Asian countries in 1980s and 1990s to open up removed most ofthe restrictions steps led to massive capital rajor part of these inflows 12 which were extremely ‘and speculation. Failure of Beare cecpanies x Thailand 80 banat tele commis A on uo ae pias , ative ais to abandon their earlier exchange forcing the Tal authorities and allowing the babt to rate system of ‘This floating of the baht led to its float on July 2, 1997. Piisee Gai. egxicet the innit rn te css Tang dolar The contagion fect oF ' had undertaken several steps their capital accounts and had on their financial markets. These were in the form of ‘hot money vulnerable (0 ange Rate Policy, Foreig licy, Foreign Exchange Reserves and Capital Account Convertibilty 519 ‘was felt in other countries of Southeast and East Asian region as well particularly Indonesia, Philippines and South Korea. There was a large-scale reversal of short-term flows from these countries. Short-term flows to Asia declined from net inflows of US $ 69 billion in 1996 to net outflow of US § 104 billion in 1997, ‘As is clear from the above, if the domestic economy does not perform well for any reason whatsoever, there is a tendency for money to flow abroad. Thus, the benefits of ‘outflows are negatively correlated to the health of the domestic economy. Under full capital account convertibility, if an economy does not perform well (or if some other economies perform much better), there will be massive capital outflows from the economy. Thus, an already “bad situation would tum ‘worse’. While few individual investors ‘would benefit, the country would lose. “The risk-reward relationship of liberal outflows by residents is pot acceptable as it will benefit only the few, and that too when the many, if not most, are in misery.”!? India’s Approach to Capital Account Convertibility ‘On account of the dangers of full capital account convertibility and the unhappy experience of other countries who opted for such convertibility, the Reserve Bank of India opted for a gradualist and phased capital account liberalisation programme. It started off by opting first for current account liberalisation in stages. By August 1994, this process was completed with India accepting obligations under Article VIII of the IMF's Articles of Agreement. Subsequently, capital account transactions were gradually liberalised. Restrictions on inflows were relaxed first. While liberalising the inflows, there was an emphasis on encouraging foreign direct investment and portfolio investment which were progressively liberalised. Liberalisation of commercial borrowings was also undertaken but focus here was ‘concentrated on liberalisation of long-term borrowings while short-term debt-creating inflows were discouraged. Recently, ‘with consolidation in the extemal sector, restrictions on outflows have also been liberalised. ‘The framework of Reserve Bank's approach to capital account convertibility was provided by Report of the Committee on Capital Account Convertibility (Chairman: §.S. Tarapore) submitted in May 1997. For the purpose of its Report, the Committee defined capital account ‘convertibility (CAC) as the freedom to convert local financial ‘assets into foreign financial assets and vice versa at market determined rates of exchange. It can be, and is, coexistent with restrictions other than on external payments. It also «does not preclude the imposition of monetary/fiscal measures relating to foreign exchange transactions which are of @ prudential nature, The Committee did not recommend Scanned with CamScannerom Indian Economy unlimited opening up of capital account, but preferred a phased liberalisation of controls on outflows and inflows over a three-year period (ending 1999-2000). Even at the ‘end of the three-year period, capital account was not to be fully open and some flows, especially debt would continue to be managed. The three crucial preconditions laid down by the Committee for attaining CAC were (i) fiscal consolidation, (ii) a mandated inflation target, and (iii) strengthening of the financial sector. As a prerequisite for CAC, the Committee had laid down that the current ‘account deficit should not exceed 1.6 per cent of GDP and the combined fiscal deficit of Centre and States should be around 3.5 per cent of GDP. In addition, the Committee stressed that important macroeconomic indicators should also be assessed on an ongoing basis. Important Capital Account Liberalisation Measures “The purpose and the spirit of measures undertaken in India since 1997-98 to open up the capital account have ‘been broadly in line with the recommendations of the Report of the above-mentioned Committee, while the time-table itself has assumed lesser significance. Important capital account liberalisation measures undertaken in India during recent years are as follows: 1, All deposit schemes for NRIs have been made fully convertible. 2. NRIs will be free to repatriate in foreign currency their current earnings in India such as rent, dividend, pension, interest and the like based on appropriate certification. 3, Indian citizens have been permitted to maintain foreign currency accounts out of foreign exchange earned/ retained from travel expenses, 4, Both, listed Indian companies and resident individuals have been permitted to invest abroad in companies listed in recognised overseas stock exchanges, and having at least 10 per cent shareholding in a company listed on a recognised stock exchange in India, on Jenuary 1 of the year of investment. 5. Indian companies are allowed to access ADRs! GDRs (American Depository Receipts/Global Depository Receipts) markets through an automatic route without approval of the Ministry of Finance subject to specified norms and post-issue reporting requirements. 6. FDI is allowed upto 100 per cent on the automatic, ‘route in most sectors subject to sectoral rules/regulations applicable. 7. Indian parties are allowed to make direct investment in a joint venture/wholly owned subsidiary outside India without prior approval of the Reserve Bank/Governmen, subject to certain conditions 8. Investment in overseas financial sector is also permitted subject to certain terms and conditions 9, A person resident in India being an individual ig permitted to acquire foreign securities by way of gi, inheritance ot under cashless Employees Stock Option Scheme (ESOP). In addition, employees or directors of the Indian office/branch/subsidiary of a foreign company or an Indian company are permitted to acquire ESOPs against remittance without any monetary limit 10. Indian corporates who have set up overseas offices have been allowed to acquire immovable property outside India for their business as well as staff residential purpose, 11. ADs (Authorised Dealers) in India are permitted to borrow in foreign currency subject to certain conditions, 12, Mutual Funds have been permitted on application, after obtaining necessary permission from SEBI, to invest in ADRS/GDRs of Indian companies and rated debt instrument in overseas market. Recently, they have also been permitted to invest in equity of overseas company, subject to conditions applicable to corporates/individuals. 13, General permission has been granted to registered foreign institutional investors to purchase shares/convertible debentures of an Indian company through offer/private placement subject to specified ceiling. 14, The Reserve Bank has allowed the resident Indians to remit up to $ 25,000 a calendar year for any current ot capital account transaction, or a combination of both (this limit has been raised in a phased manner to $ 2,00,000). This provision enables resident Indians not only to open and operate foreign currency accounts outside India, but also t0 use the money remitted to those accounts to acquire financial ot immovable assets without prior approval from Reserve Bank. 15.As per guidelines issued on January 12, 2005, (0 transfer of shares in an existing Indian company has beet allowed under automatic route except in certain cases: (ii) conversion of ECB/loan into equity has been allowed under the automatic route provided the activity is under the automatic route and the foreign equity afters conversion falls within the sectoral cap; and (if) conversion of preference shares into equity has been allowed under the automatic route provided the increase in foreign equity participation is within the sectoral cap in the relevant se=10® and the activity is under the automatic route. 16, On June 25, 2012, RBI announced the following measures for capital account liberalisation: (i) Indian Scanned with CamScanneries in manufacturing and infrastructure sectors and cor foreign exchange carnings were allowed to avail of past commercial borrowing for repayment of outstanding ei leans towards capital expenditure andioe fresh Rupee Fira expenditure under the approval route, The overall Sing for such external commercial borrowings would be Us 10 billion; (if) The then Prevailing limit for investment ty SEBI registered foreign institutional investors in Goverment securities (G-Sees) was enhanced by a further anount ofS billion (this raised the overall Limit for FIL investment in G-Sees from US $ 15 billion to US § 20 tion). In order to broad-base the non-resident investor tus for G-Sees, it was also decided to allow long-term iestrs like Sovereign Wealth Funds (SWFs), multilateral agencies, endowment funds, insurance funds, pension funds and foreign central banks registered with SEBI, to alsy invest in G-s The above di have been an the capital iscussion shows that a number of steps nounced in the post-199] Period to liberalise pening up of capital accounts and making currencies fully onvertible, Indeed, as pointed out by Rajwade, “If financial tablty, which the money men keep emphasising, is the lective, itis best to forego, out of the impossible trinity, 1 capital flows but not managed exchange rates or 2 ident monetary policy, Indeed, volatile exchange d's Exchange Rate Policy, Foreign Exchange Reserves and Capital Account Convertibitity rates are an impediment to economy! On the subj rates, we perhaps net from the IMF."!4 321 greater globalisation of the real ject of capital flows and exchange ed fo learn much more from China than ee eee NOTES ee OTE ee 13, 14, oo0 Cae Bank of India, Report on Currency and Finance 2002-03 (Mumbai, 2004), p. 198 Feyotsivade, “Risks and Rewards of Capital Account Converbilty”, Economic and Political Weekly, January 6,2007, pp. 33.4 The meaning of ‘sterilisation’ is, Management”). Suresh D. Tendulkar, “India in the World Trading System: A Quantiatve Assessment’ in TN, Srinivasan and Suresh D. Pendaleon penetrating India with the World Economy (New Debi, 2003), P. 16, Reserve Bank of p. X17, Current account convertibility is defined sell foreign exchange for the following ‘India, Report on Currency and Finance 1998-99, as the freedom to buy or Reserve Bank of India, Report on Currency and Finance 2002-03, ©p. cit, p. 187, CP. Chandrasekhar, “Openi 27, 2004, p. 117. ds . . 2003, p. 103, |. AN, Rajwade, op cit, p, 30 “Hot money’ refers to. short ‘interns jal capil se Co WHA ove about in oa matket for maximising returns on investments Rajwade, op. cit, p. 33, AN. Rajwads, “Liberal Capital Flows”, » Econom Weekly, May 26, 2012, p, 20 ene oe neta Scanned with CamScanner