RBI: Red Brigade of India Indian Express, 30 March 2006 - Ila Patnaik In case you thought it was only the JNU Students Union that opposes globalisation, here is a surprise for you. After the Prime Minister's statement that India should move towards full capital account convertibility, the Employees Union of the Reserve Bank of India issued a statement opposing the move. What is the RBI staff afraid of? Why should RBI employees be opposed to India adopting capital account convertiblity? What do they have to lose? The reasons for the support anti-globalisers have got from this august body are not too difficult to comprehend. The answer lies in the annual report of the RBI (2003-04) Table 14.8. It shows that out of the 24,994 employees of the RBI, the largest number among them -- 7,286 employees work in the Department of Currency Management. In addition, 1,259 employees work in the Foreign Exchange Department. On paper, the rupee is convertible on the current account and the exchange rate of the rupee has been a market determined exchange rate since 1993. But 8,545 people continue to be employed in foreign exchange management. Today there are a number of controls on capital flows and foreign exchange movement. Capital account convertibility will mean dismantling this last bastion of control raj in India. Bureaucrats in the the ministries of industry and commerce did not like it when liberalisation eliminated their license-permit raj. Why should the babus in the RBI like it any better? The RBI staff would lose work on two fronts. One, they will not be trading on currency markets as full capital account convertibility can work properly only if the rupee is allowed to float. Two, households and firms of India will manage their own assets, with hundreds and thousands of portfolios scattered across the world, catering to their own preferences and needs. This will replace the present public sector framework for risk management done by RBI staff running one giant foreign currency reserves portfolio. At a lecture at the Reserve Bank of India on March 24, Harvard President and former US Treasury Secretary, Larry Summers, noted that India has excess foreign exchange reserves to the tune of 15 percent of GDP. The opportunity cost of holding these reserves in low yield securities, is, according to Summers, more than 1 percent of GDP and greater than the public spending on health. Last year Planning Commission Deputy Chairman Montek Singh Ahluwalia had started a public debate about using India's excess foreign exchange reserves. In mid 2004 when he raised this issue the level of reserves was USD 110 billion. Yet, despite the understanding that the level of reserves was excessive, more were acquired and today they stand at USD 130 billion. It is clear that for the last 5 years at least, the level of foreign exchange reserves in India have been far beyond what is required as 'insurance'. Reserve adequacy can be measured in a number of ways. The "Greenspan Guidotti rule", quoted by Larry Summers, requires reserves to be enough for a year's requirements taking into account various risks in the world economy. One can alternatively use months of imports or short term debt servicing as measures of reserve requirements. India satified all these requirements many years ago but reserves continued to grow. Many people believe that a build up of reserves takes place when foreign capital comes into the country, or when the country exports more than it imports. Wrong. It takes place when the RBI buys dollars in the foreign exchange market. If the RBI does not step forward to buy dollars, there is no further reserve accumulation. What happens is a movement in the price of the currency - a movement depending on the demand and supply of rupees and dollars in the market. The build up of reserves takes place to the extent that the RBI tries to manipulate the exchange rate. If it chooses to keep the exchange rate fixed, or in a band around a chosen level, it buys and sells in the market. In other words, the costly policy of building reserves is a direct consequence of the exchange rate policy of the government. There is no consensus that rupee appreciation is bad, but let us for the moment assume that that is what the government wants. The question then is how to achieve it without ending up with costly reserves. Prime Minister Manmohan Singh's suggestion of putting India on the path to full capital account convertibility (CAC) will solve two problems - that of the RBI having to intervene heavily and pile up reserves if it wants to prevent rupee appreciation, and that of India's foreign assets earning low returns. Under CAC, households and firms in India would buy dollars to hold assets abroad. Instead of the RBI having to enter the market for foreign exchange and purchase dollars when they start getting cheap due to capital inflows, millions of investors would see the opportunity and step in and buy assets abroad. This would reduce the pressure on the rupee to appreciate. Some recent easing of restrictions such as allowing households to hold bank deposits of USD 25,000 abroad, pre-payment of external debt, allowing outbound FDI by Indian companies have been done when the pressure on the rupee to appreciate was high. Full convertibility will achieve this as well. How it will be different from what we have today is that there will be ups and downs in the exchange rate beyond RBI's control. Second, CAC would address the problem Larry Summers refered to -- of holding India's foreign assets in low yielding securities. When millions of firms and households hold assets, they maximise returns. India's foreign portfolio will contain bonds and shares of companies and governments all over the world. When RBI holds foreign exchange reserves these are held mainly in highly liquid securities, typically low risk, low return government bonds, or as India moves away towards other currencies, euro and yen denominated bonds. India got rid of the control raj in industry. India got rid of the control raj in trade. Both were opposed by vested interests who earned rents from the controls. It is time for India to get rid of the control raj on capital flows. ------------------------------------------------ Back up to Ila Patnaik's media page