NEWS
INTERVIEW
SPECIALS
CHAT
ARCHIVES

A sleepy outfit like the RBI cannot handle full convertibility of the rupee

A strange thing happened last week. Business newspapers went ga-ga, as they tend to do from time to time, over a report on capital convertibility prepared by a former deputy governor of the Reserve Bank of India. The report made front page news in most newspapers but the business papers really went to town on it.

But the stock market did not, nor did the money market, though they should have reacted most positively. The stock market did not budge an inch, neither did the money market. They ignored the report totally, as if they did not know what it was all about -- which is unlikely -- or simply did not care.

Since the markets do not lie, there must be a very good reason for their strange behaviour. In fact, newspapers too have taken a cue from the markets and have now forgotten all about it. Within a week of publication, the Tarapore report, for it was prepared by a committee headed by Tarapore, is as dead as dodo.

Why did the report fall flat in the market? First, let us see what it recommends. It recommends total convertibility of the rupee in the next three years, which implies that any Indian will be able to open a foreign account -- even an account in Switzerland or Cayman Islands -- no questions asked, and will be able to transfer dollars or pounds or what have you without a chit from the RBI.

Corporates will be able to buy companies abroad and also invest in foreign bonds or shares. They, like other Indians, will be able to purchase real estate in New York or London, just as Londoners and Yankees will be able to do here. In other words, the dollars or pounds you earn, will be your dollars or pounds, not the government's. For the last fifty years, all foreign exchange belonged to the government, not to any individual, though he may have earned it through exports. For the first time, what you earn, you keep.

This is a big change. Why did the markets not react to such a revolutionary change?

There may be several reasons. First, things do not happen just because the government says they should happen. Second, where is the guarantee that full convertibility will open the doors to prosperity, as the government claims? And third, governments come and go in India, and so do finance ministers. Who knows what may happen to the report once this government goes?

There are also other reasons. Recent history about full convertibility is none too reassuring. Look what happened in Mexico, a country far richer than India, with five times the latter's per capita income. For some reason, probably goaded by its powerful neighbour, the United States, Mexico went fully global five years ago. Things were not too bad to start with, until the Mexicans realised they had an open door to goodies in the West.

They went on a wild spending spree and purchased Rolls Royces and Mercedes by the hundred. Rolls Royce company even had to open an office in Mexico to cater to its new customers. The Mexicans also opened bank accounts in Switzerland -- a country they know very well -- and transferred their cash there. Within a year, Mexico's foreign reserves came crashing down from $20 billion to $2 billion.

Foreign investors including foreign portfolio managers fled Mexico, taking their money with them. The peso collapsed and with that, the economy. Factory after factory closed down and thousands of workers lost their jobs. The Rolls Royce company wound up its branch and went back to London.

There is not much difference between Mexicans and Indians. They even look alike. Both hold numbered accounts in Switzerland. Indians are supposed to have salted away as much as $150 billion in Swiss and other banks. This is equivalent to one and a half times India's foreign debt and six to seven times its foreign reserves.

What happened in Mexico can certainly happen in India. It is said that interest rates in India will come down after capital convertibility and this should help Indian industry. But interest rates have nothing to do with it. If as much as $150 billion have been kept outside India until now, when interest rates in India are twice the level in London or New York, just imagine what will happen when the rates slump.

Then there is the Reserve Bank itself. You need a strong regulator when you free your currency, and when millions or probably billions of dollars rush in and out of the country at the touch of a button. Can the Reserve Bank, an inept organisation, keep an eye on so much cash? Remember it did not even know that Bhansali had decamped with hundreds of millions, until it became a big story in the papers. Can such a sleepy organisation cope with full convertibility of the rupee and all it implies?

The markets have decided it will not, which is why they refused to take the report seriously. I entirely agree. There are a great many things we have to put right before we can even think of convertibility.