It is heartening that the economy attracts foreign funds and the flows continue to be increasing day by day although they disturb the sleep of many particularly the exporters and various policy making authorities. $7 billion are reported to have come in, during September alone upsetting the calculations of authorities in managing the exchange rate, sudden upsurge in money supply and liquidity, sharp movements in sensex and heavy build-up of reserves. While there cannot be any dispute on the need to have foreign funds to support the fast growing economy, the fact remains that absorption of huge funds without causing damage to the well controlled inflation, well managed financial system consisting of various types of markets, institutions and instruments and the international image meticulously developed over a period has been and continues to be a challenge. The forex reserves which stood at less than $1 billion in 1991 and induced introduction of liberalization measures, has crossed $250 billion as at end September 2007 and continue to accumulate further. Build-up of reserves adds money supply in the system and causes inflationary expectations. The need to contain money supply and at the same time maintaining adequate flow of funds to the productive sectors particularly agriculture and industry has always been the major concern of authorities. Availability of funds for speculative investments in capital market and real sector has to be curbed. Sufficient liquidity to take care of retail, consumption needs and payment and settlement system has to be well maintained. These multi- tasks have to be handled professionally and skillfully keeping the expectations of all stakeholders domestically and internationally in tact and satisfying them.
Is it an insurmountable problem? Taking into consideration the vastness of the country, huge population still living below the poverty lines, inadequate availability of physical, social and financial infrastructure, aspirations and ability of the people to attain any bench mark levels of growth envisaged and expectations of international community that this country would be the super economic power in future, the massive flow of funds should be viewed as a God –given opportunity to perform and deliver. No doubt, the present situation is slightly abnormal and as such naturally calls for an abnormal solution.
Apart from the normal measures like encouraging outflows through travels, remittances, imports of goods particularly those which can mitigate inflationary expectations, other measures to contain inflows through some incentives akin to those offered to attract inflows when the situation demanded during forex crisis during 1990s without impinching on the sentiments of investors can be considered. Other solution can be in the form of creating a Foreign Exchange Inflows Stabilisation Fund through a Special Purpose Vehicle exclusively instituted for this purpose. As it is, Reserve Bank intervenes in the forex market and effects purchases and sales of foreign exchange to moderate the exchange rate fluctuations. This necessarily involves injection and absorption of rupees to maintain /soften the liquidity. To neutralize the impact of purchase/sale of foreign exchange and consequent money supply and liquidity in the market, sterilization is done using government securities for sale / purchase. The whole exercise involves a cost and creates an element of uncertainty and speculation in different markets in the financial system. All these can be to a great extent minimized if surplus of foreign exchange or a portion of it can be surrendered to the Special Purpose Vehicle and made part of the Exchange Inflows Stabilisation Fund without involving rupee exchange. For the contributor towards this fund, this can facilitate as a deposit account withdrawable on demand. This fund can be utilized for exclusive development of infrastructure requiring foreign exchange. In case the fund accumulates, those who require foreign funds can be allowed as they raise External Commercial Borrowings at a specified exchange and interest rate. Main advantage of such a fund is that it eliminates rupee supply and consequent ripple effects. The cost involved creating such a fund and the disadvantages perhaps faced by those who contribute to this fund will more than offset the problems and costs now faced by the economy because of heavy inflows and adverse chain effects. The Government can consider compensating by way of suitable incentives to those who contribute towards this fund. This solution may initially appear to be irrational but may prove to be a boon in the long run for all stakeholders particularly the government and the economy.
To elaborate further on this fund, banks /parties receiving foreign funds and who can afford to contribute identified surplus without expecting in exchange rupee funds on the spot should be encouraged to deposit such surpluses with a special purpose vehicle exclusively set-up to manage the fund. This fund can be akin to India Develop Fund Where deposit was received for a specified period . The contributors to the fund now suggested can be compensated by way of interest or some incentive or both in rupee terms. Exchange rate risk at the time of return of the funds on demand or on maturity can be hedged through derivatives both at contributors’ and special purpose vehicle’s level. The funds accumulated can be made available to utilize exclusively in foex for development of infrastructure by way of import of technology, skilled manpower, materials research and development. The setting up of such a fund without involving rupee exchange though initially appears to be conceptually difficult, it cannot be ruled out as impossible. It is like Security Transaction Tax which was initially objected to but has come to stay fetching good revenue to the Government and without inflationary implications as the levies cannot be passed to general consumers as happens in the case of VAT and other levies. The costs /sacrifice involved to develop, maintain and manage such a fund may turn out to be highly beneficial when compared to the present costs and risks involved to maintain financial stability, favourable inflationary conditions and the credibility among the international community to continue to attract investments in India. The fact remains that economy needs billions of dollars for various developmental needs particularly heavy particularly heavy physical infrastructure of international standards to sustain and register further growth of GDP. The momentum now attained and the confidence level built-up both at national and international level have to be maintained at any cost to make the economy really a super power. It may call for some innovativeness and perhaps Foreign Exchange Inflows Stabilisation Fund may be the solution.
Is it an insurmountable problem? Taking into consideration the vastness of the country, huge population still living below the poverty lines, inadequate availability of physical, social and financial infrastructure, aspirations and ability of the people to attain any bench mark levels of growth envisaged and expectations of international community that this country would be the super economic power in future, the massive flow of funds should be viewed as a God –given opportunity to perform and deliver. No doubt, the present situation is slightly abnormal and as such naturally calls for an abnormal solution.
Apart from the normal measures like encouraging outflows through travels, remittances, imports of goods particularly those which can mitigate inflationary expectations, other measures to contain inflows through some incentives akin to those offered to attract inflows when the situation demanded during forex crisis during 1990s without impinching on the sentiments of investors can be considered. Other solution can be in the form of creating a Foreign Exchange Inflows Stabilisation Fund through a Special Purpose Vehicle exclusively instituted for this purpose. As it is, Reserve Bank intervenes in the forex market and effects purchases and sales of foreign exchange to moderate the exchange rate fluctuations. This necessarily involves injection and absorption of rupees to maintain /soften the liquidity. To neutralize the impact of purchase/sale of foreign exchange and consequent money supply and liquidity in the market, sterilization is done using government securities for sale / purchase. The whole exercise involves a cost and creates an element of uncertainty and speculation in different markets in the financial system. All these can be to a great extent minimized if surplus of foreign exchange or a portion of it can be surrendered to the Special Purpose Vehicle and made part of the Exchange Inflows Stabilisation Fund without involving rupee exchange. For the contributor towards this fund, this can facilitate as a deposit account withdrawable on demand. This fund can be utilized for exclusive development of infrastructure requiring foreign exchange. In case the fund accumulates, those who require foreign funds can be allowed as they raise External Commercial Borrowings at a specified exchange and interest rate. Main advantage of such a fund is that it eliminates rupee supply and consequent ripple effects. The cost involved creating such a fund and the disadvantages perhaps faced by those who contribute to this fund will more than offset the problems and costs now faced by the economy because of heavy inflows and adverse chain effects. The Government can consider compensating by way of suitable incentives to those who contribute towards this fund. This solution may initially appear to be irrational but may prove to be a boon in the long run for all stakeholders particularly the government and the economy.
To elaborate further on this fund, banks /parties receiving foreign funds and who can afford to contribute identified surplus without expecting in exchange rupee funds on the spot should be encouraged to deposit such surpluses with a special purpose vehicle exclusively set-up to manage the fund. This fund can be akin to India Develop Fund Where deposit was received for a specified period . The contributors to the fund now suggested can be compensated by way of interest or some incentive or both in rupee terms. Exchange rate risk at the time of return of the funds on demand or on maturity can be hedged through derivatives both at contributors’ and special purpose vehicle’s level. The funds accumulated can be made available to utilize exclusively in foex for development of infrastructure by way of import of technology, skilled manpower, materials research and development. The setting up of such a fund without involving rupee exchange though initially appears to be conceptually difficult, it cannot be ruled out as impossible. It is like Security Transaction Tax which was initially objected to but has come to stay fetching good revenue to the Government and without inflationary implications as the levies cannot be passed to general consumers as happens in the case of VAT and other levies. The costs /sacrifice involved to develop, maintain and manage such a fund may turn out to be highly beneficial when compared to the present costs and risks involved to maintain financial stability, favourable inflationary conditions and the credibility among the international community to continue to attract investments in India. The fact remains that economy needs billions of dollars for various developmental needs particularly heavy particularly heavy physical infrastructure of international standards to sustain and register further growth of GDP. The momentum now attained and the confidence level built-up both at national and international level have to be maintained at any cost to make the economy really a super power. It may call for some innovativeness and perhaps Foreign Exchange Inflows Stabilisation Fund may be the solution.
4 comments:
Excellent Article!!
The idea is excellent. Just a few thoughts on this.
While setting up the Fund itself is an ingenious thought, we should also find a way to mandate usage of this Fund for depositing surplus forex. Unless there is a mandate that ensures that this surplus will go into this Fund, we may not be able to effect the required control over currency inflows and therefore its impact on the exchange rate.
So despite the Fund the central bank may need to continue to purchase/sell foreign exchange and therefore sell/purchase government bonds to keep exchange rate and inflation respectively in check. Therefore either there has to be a mandate or a strong enough incentive.
Good Points !
I have the following comments:
I came across a stunning report that was published in 2003 by Goldman Sachs, that says clearly why currency appreciation in the BRIC countries cannot be stopped. Given the fact that the predictions from the report have been accurate till now, it is not unreasonable to assume that currency appreciation will remain a fact of life for the next 2 decades. The report is located at:
http://www.goldmansachs.com/insight/research/reports/99.pdf
So you have a tricky situation as far as the fund is concerned: nobody will contribute unless mandated by a regulation, and if you decide to pass regulations anyway to control the exchange rate, there are more direct ways to do it.
From what I think, RBI must have foreseen the 39 rupee dollar in 2002-2003 and implemented this fund then. Its too late now ?
The report is located
here
Post a Comment