Fears Of Flight
difference to export under-invoicing, is a case in point. Consider the reasons cited by the Deputy Governor for capital flight. He enumerated four reasons fears of currency depreciation, high domestic interest rates, negative or low real interest rates at home and taxes on financial intermediation. Of these, the first is no longer a valid fear and the fourth is less of a problem with tax rates coming down. On the second and the third reasons, one is not entirely convinced about their validity as reasons for capital flight. For example, is the real rate of interest relevant? Or should one consider the rates of return in the capital market?
Dr Reddy also had various comments to make about the hawala market. The withering away of the hawala market and a transition to complete market determined exchange rates is a precondition mentioned by the Tarapore Committee for capital account convertibility. Unfortunately, the Tarapore Committee attributed the existence of the hawala entirely to the phenomenon of gold smuggling. While gold smuggling contributes to the hawala, as Dr Reddy correctly pointed out, the hawala also owes its existence to quantitative restrictions on imports of consumer goods and procedural bottlenecks that make it difficult to acquire foreign exchange through legal channels. In other words, one needs to add to the Tarapore Committees recommendations in the sense that imports of consumer goods should be on open general licence (OGL), at reasonable rates of duty. On procedures, the outdated Foreign Exchange Regulation Act (FERA) needs to be replaced by a more reasonable Foreign Exchange Management Act (FEMA), so that routine foreign
exchange transactions do not become illegal. More pertinently, the Deputy Governor pointed out that the balance of payments problem is not one of managing excess outflows, but one of managing excess inflows. These have an inflationary impact, and if the Reserve Bank tries to sterilize inflows, there is upward pressure on interest rates. This is yet another reason to introduce capital account convertibility sooner, rather than later.