Tarapore Panel Favours Full Convertibility By 2000

THE TERMS: 3.5% gross fiscal deficit l 3-5% inflation l Deregulation of interest rates l 3% cash reserve ratio

The S S Tarapore committee, appointed by the Reserve Bank of India, has recommended full convertibility of the rupee on the capital account by 1999-2000.

The committee, headed by former RBI deputy governor S S Tarapore, has suggested that full convertibility (freedom to convert local financial assets into foreign financial assets and vice versa at a market-determined exchange rate) should be achieved in three phases commencing this year, and the process should be subject to fulfilment of certain crucial preconditions and signposts.

 

The key preconditions for achieving full capital account convertibility are fiscal consolidation by reducing the gross fiscal deficit to 3.5 per cent of the gross domestic product (GDP), adherence to a Parliament-mandated average inflation target of 3-5 per cent, strengthening of the financial system through total deregulation of interest rates, reduction in the cash reserve ratio for banks to 3 per cent and a sharp reduction in non-performing assets of banks to 5 per cent of the total advances.

The Reserve Bank on February 28, 1997, had appointed the Tarapore committee on the basis of the announcement made by finance minister P Chidambaram in the Union budget. The committee, formed with the objective of looking into the progressive liberalisation of capital account transactions, submitted its report on May 30. The report was made public yesterday.

If and when implemented, the recommendations of the Tarapore committee will impart unprecedented autonomy to RBI, speed up financial sector reforms, put in place a more transparent exchange rate policy, usher in a guideline-based system of monitoring balance of payments as well as foreign exchange reserves and introduce greater fiscal discipline (RBI to eschew from taking part in primary issues of government borrowing, and transfer of RBI profits to the Centre and PSU disinvestment proceeds to be used for creating a consolidated sinking fund).

The committee has also made a strong case for liberalising the overall policy regime on gold. Banks and financial institutions fulfilling well-defined criteria may be allowed to participate in gold markets in India and abroad and deal in gold products, the committee has said.

Recognising that there are certain weaknesses in the system and that the preconditions can be achieved over a period of time, the committee has recommended that the first phase of the convertibility should commence in the current financial year (1997-98). The second phase should begin in 1998-99, to be followed by the third and final phase in 1999- 2000.

In the first phase, Indian joint ventures/wholly-owned subsidiaries have been recommended to be allowed to invest up to $50 million in ventures abroad at the level of authorised dealers, the committee has recommended. The existing requirement of repatriation of the amount of investment by way of dividend within a period of five years may be removed, it has said.

The committee has further said that setting up of ventures abroad should be allowed to any entity and not restricted to exporters and exchange earners. Exporters and exchange earners may be allowed 100 per cent retention of earnings in EEFC accounts with cheque writing facility in phase-I, the committee has said. Individual residents may be allowed to invest in assets in financial market abroad up to $25,000 in phase-I with progressive increase to $50,000 in phase-II and $100,000 in phase-III.

Similar limits may be allowed for non-residents out of their non-repatriable assets in India, the committee has recommended. The committee has said that Indian investors registered with the Securities & Exchange Board of India (Sebi) may be allowed to send funds for investments abroad subject to overall limits of $500 million in phase-I, $1 billion in phase-II and $2 billion in phase-III.

Banks may be allowed liberal limits for borrowing and lending abroad, the committee has suggested. Borrowings may be subject to an overall limit of 50 per cent of unimpaired tier-one capital in phase-I, 75 per cent in phase-II and 100 per cent in phase-III, with a sub-limit on short-term borrowings, the committee has said.

The committee has said that foreign direct and portfolio investment and disinvestment should be governed by comprehensive and transparent guidelines, and prior RBI approval at various stages may be dispensed with, subject to reporting by ADs. All non-residents may be treated on par for the purposes of such investments, it is recommended.

The committee feels that foreign institutional investors (FIIs), non-residents and non-resident banks should be allowed into the forward markets and all India financial institutions should be made authorised dealers. The committee has said that currency futures be introduced with screen-based trading and efficient settlement systems.

As a precondition to CAC, the committee feels that there should be a reduction in the Centres gross fiscal deficit (GFD) to GDP ratio from a budgeted 4.5 per cent in 1997-98 to 4 per cent in 1998-99, and further to 3.5 per cent in 1999-2000. This should be accompanied by the states deficit as also a reduction in the quasi fiscal deficit.

Target 2000

Full capital account convertibility by the year 2000

Reduction of gross fiscal deficit from 4.5 per cent to 3.5 per cent

Average effective CRR to be reduced from 9.3 per cent to 3 per cent

NPAs to be reduced from 13.7 per cent to 5 per cent of total bank advances

Individuals allowed to invest $1,00,000 in the financial markets abroad

Sebi registered Indian investors allowed to invest upto $2 billion overseas

Banks allowed to borrow and lend upto 100 per cent of Tier-1 capital

Setting own house in order

Formation of a consolidated sinking fund (CSF)

Disinvestment proceeds and RBI dividends to go into the CSF

Government to set up its own public debt office

RBI to withdraw from primary government borrowing programmes

Parliament to give the RBI mandate to manage inflation between 3-5 per cent

Interest rates to be fully deregulated

Moratorium to be imposed on weak banks; credit expansion to be capped, to invest only in gilts

Debt service ratio to be brought down from 25 per cent to 20 per cent

Net foreign assets to currency

ratio to be not more than 40 per cent

Opening up vistas

Indian JVs/wholly owned subsidiaries allowed to invest upto $50 million overseas, by March 1998

Repatriation requirement of investment amount within five years to be scrapped

Exchange earners to be allowed to retain 100 per cent earnings in EEFC accounts, with cheque facility

Prior RBI approval dispensed with for foreign direct and portfolio investment and disinvestments

Banks and FIs allowed to play in local and overseas gold markets

FIIs, NRIs, non resident banks allowed into the forward exchange markets

Financial institutions allowed to be full fledged authorised dealers

Dissent on investments in overseas markets

Two members of the Tarapore Committee A V Rajwade and S S Bhalla had divergent views on the issue of residents investing in assets in financial markets abroad.

This seems to be the only issue on which any of the committee members had conflicting views. Committee sources told Business Standard that since there was total unanimity on the remaining issues, the secretariat decided against appending a dissent note as is the tradition. Instead, the dissenting members views were incorporated in the main report.

While A V Rajwade is not in favour of permitting financial outflows by resident individuals, resident corporates and non-resident individuals out of their non-repatriable assets until the preconditions set for the first phase of CAC are met, the views of S S Bhalla are to the contrary. Bhalla holds that the macro-economic situation is exceptionally strong and large capital inflows are likely to continue. Better macro and exchange rate management would be facilitated if individual residents were allowed outflows with significantly larger limits, says Bhalla.