Tarapore for curbs on capital inflow

Former RBI deputy governor and author of capital account convertibility roadmap S S Tarapore today favoured imposing reserve requirements to impound a portion of capital when the scale of overseas inflow was unmanageable.

The impounded amount will not earn interest and can deter overseas investors from bringing capital in large doses.

"About 10 per cent of it (capital) may be impounded as a reserve requirement with RBI for 12 months," he said at a function to unveil Dun & Bradstreet's publication, India's Top Banks 2008. It (reserve requirement) should apply to all capital inflows. A selective approach would be a standing invitation to evasion.

While RBI should be in readiness to use such a measure at a short notice, it appeared unlikely to be needed in 2008-09, he added. India has witnessed a huge flow of capital, especially portfolio investment.

India's forex reserves, as on February 15, 2008, amounted to $301 billion, about $110 billion higher than a year ago. In the middle of this decade, Thailand had imposed unremunerative reserve requirements of 30 per cent on most capital inflows, which were to be deposited with the central bank for a year.

Turning to RBI's operations to sterlise excess liquidity on account of a large flow, Tarapore said: "At the present time, it is not totally clear as to what would be the intensity of capital flows in the ensuing year and, therefore, it will be desirable not to undertake any jerky sterilisation operations."

The present limit under the Market Stabilisation Scheme bonds (MSS) is Rs 2,50,000 crore. This at the peak will imply an interest burden of Rs 17,500 crore. The present MSS outstanding, as on February 15, 2008, amounted to Rs 1,77,000 crore.

He said one option would be to calibrate the sterilisation to the capital inflow. This is best achieved by imposing, in the April 2008 Policy, a 10 per cent incremental cash reserve ratio which would impound cash balances only to the extent liabilities of the banks rise, he said.

"It will be best to smoothen liquidity by reducing the MSS outstandings, whenever possible, which would then give the RBI fire power to use the MSS in case there is lumpiness in the capital inflows."