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Raising our policy sights

Why Indian policymaking must aim for capital account convertibility.

Updated: May 15, 2015 12:01:01 am
raghuram rajan, rbi, reserve bank of india, ninth plan, indian agriculture, eighth plan, investment rates, india columns, indian express columns, indian express The RBI governor Raghuram Rajan has raised our sights by saying we should aim at capital account convertibility.

By: Yoginder K Alagh

We see again the possibility of higher growth. In a book on the future of Indian agriculture, I had reiterated my preconditions for a growth rate of 7 per cent-plus. Investment rates have to go up to 34 per cent-plus, factor productivity, around 3 per cent in the past, has to rise to 5 per cent. Trade shares have to rise to spur productivity growth. The RBI governor has underpinned all this and raised our sights by saying we should aim at capital account convertibility.

In the final versions of the Eighth Plan and the Ninth Plan, we had stated that capital account convertibility was the lasting objective of that stage of the reform process. We had said that by that time, in large measure for foreigners investing in India, the rupee was convertible, so they could repatriate capital and earnings almost without restrictions. But this was, and is, not so for Indians. Indeed, this creates a major handicap for Indian multinationals. Operating on a global plane, they have to get all kinds of clearances because they are Indian companies, while their competitors do not have these handicaps. This is much like negative protection, only now, it is on the capital account.

Negative protection, which we had documented in the 1980s, arose when, in a partially liberalised economy, you were globally efficient in a real sense. But since your global competitor did not have to buy inputs from protected industries, even when he was relatively inefficient in real terms, he was at an advantage in money cost. In long-term costs, which include capital costs, you may be more efficient, but your competitor will score over you in financial costs and have the advantage of greater agility. So the RBI governor is right.


In 1997-98, then Finance Minister P. Chidambaram announced the Plan document as a macro policy objective in his budget speech. At that stage, we had laid down a broad timeline. There were three preconditions to work on for capital

account convertibility. The first was a low inflation rate. We are almost there now, although food inflation remains a thorn. The second was high exchange reserves. That is now passé. The third was dynamic exports. Questions remain there, but globally, in terms of comparisons in the recent period, we are all right. The Taraporewala Committee (1997 version) worked out the details of these three conditions, which I felt were important. So now, almost a decade

and a half later, we should start making timetables with different phases built in and set up a credible monitoring mechanism. That should be the Niti Aayog’s big job. If prices are to be kept stable, the RBI must manage debt as an instrument of policy, and not the finance ministry.

While details have to be worked out, it is not sufficient to have an annual inflation rate of 5 to 6 per cent. For the rupee to be globally acceptable for transaction and holding purposes, its value has, at worst, to be competitive with other global currencies — and, at best, stable. It is only then that others apart from the diaspora will also hold rupees.

Our exchange reserves are a source of strength and, given prudent monetary policy, it is extremely unlikely that there will be an isolated run on the rupee. On exports, there are two criteria. There have to be at least three to five speciality exports on a required scale. Software and gem polishing are examples. There also has to be a cafeteria out of which a selection by global markets would always leave us winners. We are almost, but not fully, there. Stable wages and improved infrastructure are critical, including market development strategies.

The writer is chancellor, Central University of Gujarat.


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