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The Rediff Business Interview/S S Tarapore

'Markets will punish India if its fundamentals are weak'

S S Tarapore was chairman of the Committee on Capital Account Convertibility, which report was submitted to the Reserve Bank of India in June 1997. Among the many recommendations, was the introduction of CAC in a phased manner and stringent monetary norms. Yet, the recent currencies crises in the Southeast Asian markets have put a question mark on the future of convertibility.

In an exclusive interview to A K Diwanji, Tarapore, a former deputy governor of the Reserve Bank of India, spoke of the Southeast Asian problems and defended the committee's recommendations. Excerpts:

In your report, you had said that CAC should be introduced in three phases, starting immediately. However, with the political crisis, that seems highly implausible. So what should, or can, be done now?

The pace of implementation of the measures on Capital Account Convertibility should be determined by the performance vis-a-vis the preconditions. A fair degree of compliance has been achieved so far on the precondition. It is often not appreciated that a number of the measures recommended for 1997-98 have already been implemented. I am of the view that measures can continue to be implemented, albeit cautiously, taking into account the performance vis-a-vis the preconditions.

What would you attribute the fall of the rupee to? What level will it reach? What will be the impact of a rupee at Rs 40 to 42 per dollar?

In a world of fluctuating exchange rates a variation in the exchange rate of the rupee is inevitable. It is not meaningful to make forecasts of the level of the rupee at a future date that is best left to punters. But form the viewpoint of analysts, we can talk of a right level of the rupee only when we know what would happen to other currencies and what would happen to the fundamentals of the Indian economy. Broadly speaking, the present exchange rate would perhaps show that a good part of the Real Effective Exchange Rate adjustment has taken place; we need to await publication of the numbers for the recent period.

The RBI has put in place certain measures (postponing the cash reserve ratio cuts, hiking short-term interest rates) to curb the rupee's fall. But will these not make it difficult for the present sluggish economy to pick up?

An effective policy would warrant that forex intervention by the central bank is buttressed by money policy action and that is what has indeed been done. It should be noted that the the RBI's measures have raised the short-term interest rates which were unduly low. You just cannot afford to have Indian short-term interest rates as low as they were prior to the recent increase.

If India's laws today permitted CAC, then following the crisis in Southeast Asia, the Indian currency too would have been hammered. In light of the Asian experience, do you think now is the right time for introducing CAC? What precautions would you suggest?

It is totally erroneous to attribute the Southeast Asian problems to CAC. India would have problems if its fundamentals were weak. The precaution I would suggest is that we must ensure that there is no slippage in the preconditions for CAC. If our macro economic fundamentals are weak we will be punished by markets whether or not we have CAC.

In the report, you have recommended fiscal deficit at 3 to 4 per cent and low inflation before introducing CAC. But economists blame the obsession with containing the deficit and inflation as reasons for the economic slowdown. Don't you think the CAC report will thus be a curb on high growth?

It is a question of getting the basic analysis right. Reducing the fiscal deficit of the Central Government to 3.5 per cent of GDP by the year 2000 and having a mandated average inflation rate of 3-5 per cent over three years are not easy preconditions to achieve. Let us not believe that fiscal profligacy and unbridled inflation are the paths to prosperity. The recommendations of the CAC Committee are quite consistent with the attainment of the country's growth potential.

The CAC panel studied examples worldwide, but these countries are those with high social development. India still has high illiteracy and poverty. So how relevant are the examples?

Relatively high illiteracy and poverty are no excuses for imprudent macro economic policies.

In your opinion, which country is India most likely to imitate in going in for CAC?

India does not need to imitate any other country in evolving its programme of CAC. We have to have our own roadmap. Incidentally, no other country has chalked out such a comprehensive and consistent roadmap.

Would not CAC contribute to rupee volatility? You have recommended a fluctuation band, but is it not better to let the market decide?

The committee has recommended a market determined exchange rate with a monitoring band with reference to the neutral REER. To combat undue volatility, the committee has outlined a framework of intervention, viz, that the Reserve bank would ordinarily not intervene within the band and ordinarily intervene outside the bank.

If, however, there is a volatility, the Reserve Bank could intervene within the Band and per contra it may not intervene outside the band. As such, the committee recommended a flexible approach to exchange rate management while at the same time providing some broad guidelines for operating a policy which would be understood by the market.

A former RBI governor has expressed doubts at the panel suggestion that the RBI should not enter the government's primary market. What do you think?

What the committee has recommended is that the Reserve Bank should concentrate on providing liquidity or draining out liquidity through its operations in the secondary market. In fact that is how central banks the world over impact on the security market.

You have insisted that India will not go the Mexico way. Earlier, many economists had said that the Southeast Asian countries would never behave like the Latin American countries. Today, would you still insist that India will stay unaffected from regional crisis?

It would be imprudent to claim that there is no such a thing as a contagion effect. What is being emphasised is the India's external payments position reflects strong fundamentals -- a very low current account deficit, a moderate external debt-GDP ratio and a sharply falling debt-service ratio. These factors minimise the impact of the South East Asian crisis on India.

What would you say to allay the fears of those who fear a capital flight from India after the CAC comes in, especially since our perennial political crises always cast a shadow over our economic prospects and growth?

The issue of the capital flight has to be properly understood in a milieu of CAC. It needs to be appreciated that CAC does not reverse a capital flight; what it does it that it facilitates the emergence of policies that would cut at the root cause of capital flight.

What is the worst case scenario that might happen to India which allowed CAC? And the best case picture?

CAC has to be viewed as a system of reward for good macro economic management and punishment for bad macro economic management.

Interviews