This refers to your editorial "Do away with PNS" (ET,Nov18). As suggested this is the best opportune time to introduce ban on Participatory Notes(PNs) and minimise the problems connected with the excess overflows of foreign exchange .By doing away with PNs, both captal market and forex market can expect some order apart from having some checks on outflows of illegal funds. The forex inflows are welcome for economy's growth,but this should not be a conduit for exploiting loopholes to indulge in illegal transactions.
Some of the approaches to tackle excess inflows can be introduction of forex inflows stabilisation fund wherein excess funds can be contributed by the forex earners provision of incentives to use liberally forex earnings for acquisition of business opportunities abroad, by discouraging flows coming in a camouflaged manner etc. This is also the time to give a boost to the infrastructure development where imports of capital goods and technology are needed.
Dr T.V.Gopalakrishnan
(This appeared in ET 20/11/09)
Friday, November 20, 2009
Monday, November 16, 2009
Forex Inflows
Time has come to have a new approach to manage forex inflows and put them into optimum use and at the same time insulating the economy from inflationary and other adverse consequences.
It is heartening that the economy attracts foreign funds and the flows continue to be increasing day by day although they also bring some adversaries to the economy in general in the form of inflationary conditions and forex market in particular by way of rupee appreciation with attendant consequences upsetting the calculations of exporters, authorities in managing the exchange rate, sudden upsurge in money supply and liquidity, volatility in capital market and build-up of reserves more than the requirements. While there cannot be any dispute on the need to have foreign funds to support the fast growing economy and manage huge fiscal deficit, the fact remains that absorption of huge foreign 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 as a comparatively well managed economy, has been and continues to be a challenge.
The forex reserves which stood at less than $1 billion in 1991 and induced introduction of economic liberalization measures, has crossed $280 billion as at end of September 2009 and continue to accumulate further. The excess inflows experienced in 2007 seem to be back again necessitating to review the measures to contain their impact. The influx of funds by way of FDI and portfolio investments alone have exceeded $22 billion dollars this fiscal and rupee has appreciated around more than 12 % as on date. Exports have not picked up and cannot be expected to improve considerably in the context of less than anticipated economic recovery in advanced nations.
Management of capital flows due to unprecedented heavy injection of liquidity by Federal reserves, European Central Bank and bank of England to tide over the global financial crisis has its own impact on various central banks including India forcing them to build up reserves. Capital flight to India due to interest rate differential, stability in the financial system and general confidence in the ability of our economy to perform better will definitely attract funds and will turn out to be a major concern to policy makers.
Flight of capital and accumulation of reserves add money supply in the system and cause inflation and inflationary expectations. While availability of funds for speculative build of assets and investments has to be curbed and at the same time sufficient liquidity to take care of productive investments, consumption needs, payment and settlement system has to be ensured, the challenges faced by the authorities in finding an equilibrium are something formidable.
In this context the approach to the problem of flow of foreign funds beyond the absorbing capacity of the economy needs a re look and traditional way of handling the situation has to be changed. The conventional system of intervening in forex market by RBI and using sterilization method to negate the effects of intervention have their own macro economic costs.
Taking into consideration the vastness of the country, huge population still living below the poverty line, inadequate availability of physical, social and financial infrastructure, aspirations and ability and availability of people to attain any bench mark levels of growth envisaged despite constraints and expectations of international community that this country can 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 real situation will prove to be slightly abnormal and naturally calls for an abnormal solution.
Apart from the normal measures like encouraging outflows of foreign exchange 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 can be considered. Other solution can be in the form of creating a Foreign Exchange Inflows Stabilisation Fund .
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 to the economy and the exchequer 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 transferred to an account styled “Exchange Inflows Stabilisation Fund” without involving rupee exchange. The Account can be maintained at RBI.
Banks, exporters, investors, importers and institutional forex earners etc having excess foreign exchange and do not require them urgently can invest such excesses in this fund for a small compensation and incentive if required. Such a fund if created and encouraged even if at a small cost to the exchequer will obviate the need for immediate conversion of forex into rupees and consequent measures of sterilization.
For the contributors towards this fund, this can facilitate as a deposit account under their command and funds can be utilized as and when the need arises. This fund kept at the disposal of RBI can be utilized by the Government for exclusive development of infrastructure requiring foreign exchange and the present controversy as to whether the Forex Reserves built up by RBI can be utilized by the Government for developmental purpose can be ended with conviction.
Main advantage of such a fund is that it eliminates rupee supply and consequent ripple effects. The Government can consider compensating by way of suitable incentives to those who contribute towards this fund. The compensation can be paid in Indian rupees or foreign exchange. Exchange rate can be protected through hedging as is done at present in forex transactions.
In case the fund accumulates over a period which is bound to be the case, those who require foreign funds can be allowed as they raise External Commercial Borrowings at a specified exchange and interest rate. The funds can be made available exclusively in forex for development of infrastructure by way of import of technology, skilled manpower, materials research and development.
The costs /sacrifice involved to develop, maintain and manage such a fund may prove to be highly beneficial when compared to the present costs and risks involved to maintain financial stability, exchange rate stability, favorable 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 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 innovative approach and perhaps Foreign Exchange Inflows Stabilisation Fund may be the solution.
It is heartening that the economy attracts foreign funds and the flows continue to be increasing day by day although they also bring some adversaries to the economy in general in the form of inflationary conditions and forex market in particular by way of rupee appreciation with attendant consequences upsetting the calculations of exporters, authorities in managing the exchange rate, sudden upsurge in money supply and liquidity, volatility in capital market and build-up of reserves more than the requirements. While there cannot be any dispute on the need to have foreign funds to support the fast growing economy and manage huge fiscal deficit, the fact remains that absorption of huge foreign 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 as a comparatively well managed economy, has been and continues to be a challenge.
The forex reserves which stood at less than $1 billion in 1991 and induced introduction of economic liberalization measures, has crossed $280 billion as at end of September 2009 and continue to accumulate further. The excess inflows experienced in 2007 seem to be back again necessitating to review the measures to contain their impact. The influx of funds by way of FDI and portfolio investments alone have exceeded $22 billion dollars this fiscal and rupee has appreciated around more than 12 % as on date. Exports have not picked up and cannot be expected to improve considerably in the context of less than anticipated economic recovery in advanced nations.
Management of capital flows due to unprecedented heavy injection of liquidity by Federal reserves, European Central Bank and bank of England to tide over the global financial crisis has its own impact on various central banks including India forcing them to build up reserves. Capital flight to India due to interest rate differential, stability in the financial system and general confidence in the ability of our economy to perform better will definitely attract funds and will turn out to be a major concern to policy makers.
Flight of capital and accumulation of reserves add money supply in the system and cause inflation and inflationary expectations. While availability of funds for speculative build of assets and investments has to be curbed and at the same time sufficient liquidity to take care of productive investments, consumption needs, payment and settlement system has to be ensured, the challenges faced by the authorities in finding an equilibrium are something formidable.
In this context the approach to the problem of flow of foreign funds beyond the absorbing capacity of the economy needs a re look and traditional way of handling the situation has to be changed. The conventional system of intervening in forex market by RBI and using sterilization method to negate the effects of intervention have their own macro economic costs.
Taking into consideration the vastness of the country, huge population still living below the poverty line, inadequate availability of physical, social and financial infrastructure, aspirations and ability and availability of people to attain any bench mark levels of growth envisaged despite constraints and expectations of international community that this country can 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 real situation will prove to be slightly abnormal and naturally calls for an abnormal solution.
Apart from the normal measures like encouraging outflows of foreign exchange 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 can be considered. Other solution can be in the form of creating a Foreign Exchange Inflows Stabilisation Fund .
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 to the economy and the exchequer 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 transferred to an account styled “Exchange Inflows Stabilisation Fund” without involving rupee exchange. The Account can be maintained at RBI.
Banks, exporters, investors, importers and institutional forex earners etc having excess foreign exchange and do not require them urgently can invest such excesses in this fund for a small compensation and incentive if required. Such a fund if created and encouraged even if at a small cost to the exchequer will obviate the need for immediate conversion of forex into rupees and consequent measures of sterilization.
For the contributors towards this fund, this can facilitate as a deposit account under their command and funds can be utilized as and when the need arises. This fund kept at the disposal of RBI can be utilized by the Government for exclusive development of infrastructure requiring foreign exchange and the present controversy as to whether the Forex Reserves built up by RBI can be utilized by the Government for developmental purpose can be ended with conviction.
Main advantage of such a fund is that it eliminates rupee supply and consequent ripple effects. The Government can consider compensating by way of suitable incentives to those who contribute towards this fund. The compensation can be paid in Indian rupees or foreign exchange. Exchange rate can be protected through hedging as is done at present in forex transactions.
In case the fund accumulates over a period which is bound to be the case, those who require foreign funds can be allowed as they raise External Commercial Borrowings at a specified exchange and interest rate. The funds can be made available exclusively in forex for development of infrastructure by way of import of technology, skilled manpower, materials research and development.
The costs /sacrifice involved to develop, maintain and manage such a fund may prove to be highly beneficial when compared to the present costs and risks involved to maintain financial stability, exchange rate stability, favorable 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 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 innovative approach and perhaps Foreign Exchange Inflows Stabilisation Fund may be the solution.
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