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CERTIFICATE

This is to certify that Minal Garud (Roll No. 11053) has submitted this report relating to Capital Account Convertibility as a partial fulfillment of the course, entitled Business Environment I for the Masters Programme in International Business (2002-2004) of the Symbiosis Institute of International Business-Pune.

[Academic Coordinator]

INDEX INDEX.............................................................................................2 Executive Summary .......................................................................3 Introduction....................................................................................5 Advantages Of CAC.......................................................................8 Developing countries Perspective..................................................9 Disadvantages of CAC.................................................................12 Factors Influencing CAC...............................................................13 Inflation Rate ................................................................................13 Financial Sector Reform...............................................................14 Current Account Balance..............................................................15 Foreign Exchange Reserves........................................................16 Strategy Towards CAC.................................................................17 Preconditions of TATAPORE Committee.....................................18 History Of CAC in India.................................................................19 Current Trends of India:................................................................21 Conclusion....................................................................................29 Bibliography..................................................................................30

Executive Summary
The Indian economy has seen a radical change during the last decade. From a regime of fixed exchange and regulated interest rates, tight control on foreign direct investment (FDI) and a complete absence of foreign portfolio investment, it has transformed itself into a favored destination for FDI and portfolio investment. Even in the late 1970s India continued to shelter its economy even when Latin America was opening itself to commercial borrowings and the East Asia economies changed their policies to attract private international portfolio capital. This changed with liberalization in the 1990s when Indian policy makers embarked on a conscious strategy to integrate the economy with global financial markets The role of volatile private capital flows across borders has been debated widely in other countries, but the impact of such flows on the Indian economy is yet to be evaluated Today, private flows have replaced official assistance as the main source of meeting the current account deficit. The increase in FDI and portfolio inflows has had a wide-ranging impact on the economy. These flows have begun to dominate the Reserve Banks monetary policy and protecting the economy from the consequences of these flows has been the hallmark of the nineties. They also account for sharp increase in Indias foreign exchange reserves, currently estimated to be above US $ 70 billion. However, these flows have not proved to be an unmixed blessing. Some authors have argued (Ahuluwalia, 2002) that India has gained substantially from the liberalisation of capital account and given the controls on residents and strict limits on debt creating inflows, Indian economy is not vulnerable to shocks from such inflows and outflows. The fact that India has escaped any serious capital flight is often cited as evidence. This report looks at the benefits and Cost of Capital Account Convertibility, and tries to evaluate present status of Indian

achievements as

far as Recommendation of Tarapore Preconditions are

concerned. It also critically looks the experience of developing countries in CAC. It also critically evaluates the Strategy for moving towards the full capital account Convertibility and concludes that Capital account convertibility is not destination but a journey where the path has no fixed laid down rules.

Introduction
When we talk of convertibility we mean the ease of conversion of a currency to be exchanged for another currency. Convertibility can be differentiated as current account and the capital account. When people have the freedom to switch over from one currency to another for the purpose of buying goods and services, then we say that current a/c convertibility is in force. On the other hand, if people are allowed to change currency in order to buy capital assets such as bonds, shares and property, then the nation has capital account convertibility (CAC) in force.

Major Components of Balance of Payments: 1) Current account 2) Capital account The current account transactions are classified into two broad categories: Merchandise / Visible Invisible 1. Travel 2. Transportation 3. Insurance 4. Investment income 5. Government 6. Miscellaneous 7. Transfer payments-official 8. Transfer payments-private The capital account transactions are classified into three main categories: Private capital: All the loans and borrowings did by the private agencies like FDIs etc. These transactions are further divided into two categories viz. 1. Long term: All the loans and borrowings whose maturity period is more than one year. 2. Short term: All the loans and borrowings whose maturity period is less than one year.

Banking capital: All the purchasing and selling of the fixed assets and liabilities did by the central and co-operative bank that is authorized to deal in the foreign currency.

Official capital: These are the transactions did by the government. These are further divided into three categories. 1. Loans 2. Amortization 3. Miscellaneous

Advantages Of CAC
A large number of different arguments have been advanced for capital account liberalisation. 1. CAC maximizes efficiency in the worlds use of capital, a scarce resource. Capital account liberalization reduces interest rate differentials across currencies and countries, and thereby reduces international differences in the cost of capital. As a consequence, investment becomes more efficient. This argument is identical to standard arguments on the gains from free trade in goods and services. 2. CAC gives individuals freedom to dispose of their income and wealth as they see fit. In a liberal democracy, property owners should be free to dispose of their assets as and where they wish, provided that this does to involve illegal activities or tax avoidance or evasion. In particular, capital market controls prevent Individuals from diversifying their asset portfolios. Abolition of controls facilitates risk reduction. 3.Monetary policy- As capital markets are forward looking, the possibility of large inward or outward capital flows imposes an element of constraint on government policies, requiring that these be feasible over the longer term. This discipline is a means for obtaining commitment to sound policies from governments, which may be subject to short term electoral or other political pressures. 4. Financial market discipline intense capital mobility puts greater burdens on a country to ensure that its financial system is well supervised and regulated. If countries are to compete in free international capital markets, they will be required to conform to international standards with regard to reporting and to financial regulation.

Developing countries Perspective


The 1990s were marked by two major events in international financial markets in the context of emerging market economies. 1) One was the rapid increase in international private capital flows, 2) The occurrence of financial crises, beginning first with Mexico in December 1994 and its accompanying contagion effects and the recent crisis in East Asia and Russia. The two events are related in that a surge in capital flows was followed by sudden reversals leading to a financial crisis in the receiving country, accompanied by problems in the region because of herding behavior in international markets. Many believe that an open account is an invitation to a crisis and are of the opinion that a closed capital account will avert disaster. One of the most persuasive arguments for capital account liberalization is that globalization has come to stay and that developing countries need to be part of the growing financial integration of countries around the globe in world financial markets. Liberalization in the industrialized countries was a response to the changing realities of the world economy and proceeded in the general background of a move towards flexible exchange rates in 1973. Significant developments in the world economy spurred this process and created the compulsions to liberalize. A situation arose in which domestic banks in industrialized countries faced competition from international financial markets and governments had to face the risk of evasion of restrictions on the capital account as the growth of offshore banks provided alternative opportunities for meeting the needs of global nature of business. The growth in communications, computers and electronically based payment technology have reduced the cost of collecting, processing and executing transactions which further fostered the process of liberalization. It led to the development of more sophisticated financial

products, which have expanded hedging, and investment opportunities and transactions that transcend international boundaries. The process of liberalization accelerated in the 1980s and 1990s and as of June 1995, all industrial countries had eliminated controls on both inflows and outflows of capital. The forces, which led to liberalization in the industrialized world, are increasingly relevant for developing countries too. Compulsions for liberalization are generated by the financial intermediation possibilities offered by offshore centers as an alternative to heavily regulated and still developing financial onshore markets. They offer attractive opportunities to those countries in need of investment finance to sustain high rates of growth. There is also the recognition that globalization has come to stay because of the increased internationalization of business opportunities and the development in information and transaction technologies. It is also accepted that if countries are convertible on the current account, capital controls are porous and ineffective. With increasing financial integration of the developing countries with financial markets in the industrialized world, opening the capital account becomes unavoidable, as a country cannot remain isolated. If countries do not plan for an orderly integration with the world economy, the world will integrate with them in a manner which gives them no control over events. Thus, the question is not whether a country should or should-not move to capital account convertibility but whether an orderly or a disorderly transition is desired. It has made it easier for countries to finance budget deficits and current account positions, and has improved the investment, funding and hedging opportunities of the private sector. This should in theory lead to inter-temporal consumption smoothing. The costs of this process are because financial integration still has to go a long way till we observe the law of one price.

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Interest rate differentials cause large and sometimes speculative movements of capital. This has in the case of some countries heightened credit, liquidity and moral hazard risks facing financial authorities, increasing the need for international solutions to problems of prudential stability. The experience of countries that liberalized the capital account starting from a weak initial base and inadequate conditions, end up in a financial crisis. Costs of liberalization also include the risk of capital flow reversals and herding behavior in international financial markets. The experience has also raised concerns about international financial stability in the absence of prudential regulations and restrictions. Today it is recognized that although a liberalized capital account has certain benefits for developing countries it also has certain costs, therefore making liberalization a more complicated procedure. The costs of liberalization are acknowledged but their existence cannot reverse the globalization process.

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Disadvantages of CAC
1. Macroeconomic Policy: Capital domestic account interest liberalisation rate. This is complicates just the the conduct of of the macroeconomic policy, essentially by constraining the level of the counterpart macroeconomic discipline argument advanced as a benefit from liberalisation. 2. Exchange Rate Management: Many developing countries are committed to pegged exchange rate regimes. The viability of this type of regime is underpinned by capital account controls. The Asian Crisis has shifted the majority view in the Economics profession towards a strong preference for floating rate regimes, but that transition requires a degree of central bank independence, which can currently only be an aspiration in many developing countries. 3. Taxation: A characteristic of many poor developing countries is that they have a relatively narrow tax base. Capital market liberalisation has the potential to further reduce the tax base. This is first because it is difficult to tax overseas earnings, and this makes it attractive to countries to prohibit the export of domestic capital 4 There is empirical evidence that countries with capital controls tend to exhibit relatively high inflation resulting in lower real interest rates, and hence real service costs, on domestic debt. Capital account liberalisation therefore entails either increases in explicit tax rates or reductions in government expenditure

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Factors Influencing CAC


Fiscal Consolidation Consolidating the states fiscal position has been a key component of successful efforts to liberalize the capital account. This not only helps ensure macroeconomic stability but also enhances the credibility of policy by easing debt-servicing obligations. Large fiscal deficits may keep interest rates high and thus contribute to interest rate differentials that induce large inflows of more volatile, short-term capital. In itself, fiscal consolidation and Balance is not enough to prevent crises (Thailand, Malaysia, Indonesia), but it has been a necessary component of liberalization (Argentina, Chile, Uganda) and its absence can lead to instability (Brazil).

Inflation Rate
Among central bankers there is an increasing belief that an inflation rate in the low, single-digit range is a desirable objective of policy. The achievement of this policy will require central banks to have greater independence and insulation from populist pressures. With an increasingly integrated world economy and low inflation rates in the industrial countries, it is necessary for developing countries to break inflationary expectations and achieve inflation rates not far out of line with those in the industrial countries. High rates of inflation are destabilizing and require high nominal and real rates of interest, which have negative real effects and could reinforce capital inflows (Brazil). Conversely, artificially maintained low interest rates could induce large net outflows of capital.

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Financial Sector Reform


A central component of any policy directed at promoting capital account liberalization is the reform and restructuring of the financial sector to avert inefficient allocations of capital. In an environment of liberalized capital flows, weaknesses of the financial system can cause macroeconomic instability and crises (Thailand, Indonesia, Kenya). The choice is therefore between a careful reform of the financial system before or during the process of liberalization, and emergency reforms after a crisis. Banking systems remain weak in many developing countries, burdened either by interest rate controls or mandated lending to favored groups or firms. In addition, many systems have very high reserve requirements relative to international levels. Reducing these requirements diminishes the effectiveness of monetary policy in the absence of indirect policy tools. Thus, the development of indirect tools such as open market operations and interest rates should become a key objective of policy. Reform must also encompass improved accounting standards, increased monitoring and surveillance of bank risk exposure, and prudential standards that conform to international standards (Basle Committee). Monetary Policy The development and deepening of financial markets following reform, also changes the context in which monetary policy is conducted. A move from direct monetary policy controls to indirect controls is desirable, as it avoids distortions in financial intermediation and is more flexible for policy purposes. In addition, the development of indirect controls also enables the central bank to more effectively carry out sterilization operations in capital inflow episodes. Appreciation of the exchange rate due to capital inflows diverts investment away from the tradable sector. Sterilization is needed to deal with this or it can be combined with other instruments such as reserve requirements, taxes or a partial liberalization of outflows.

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Exchange Rate Policy Exchange rate policy becomes even more central to policymaking concerns with moves towards capital account convertibility. Authorities must decide on the optimal degree of exchange rate flexibility with an aim to prevent either unsustainable appreciations of the real exchange rate that can undermine competitiveness or expensive interest rate defenses of fixed rates and/or costly sterilization operations. The balance between these considerations is complex, although there is a general belief that exchange rate regimes have to be more flexible under capital account convertibility.

Current Account Balance


Current account deficits are commonly found in developing countries, reflecting the use of global savings to achieve desired levels of growth and investment. Experience suggests that prudent limits must be set on expanding deficits. The counterpart of current account deficits are expanding external liabilities, and as the deficit rises debt servicing begins to account for an increasing proportion of external earnings that could be otherwise used to increase imports. Thus, high current account deficits may constrain growth by retarding imports as well as leading to fears of contraction and/or crisis.

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Foreign Exchange Reserves


With capital account convertibility, the level of international reserves becomes a key consideration for policymakers. Reserves help to cushion the impact of cyclical changes in the balance of payments and help offset unanticipated shocks, which can lead to reversals of capital flows. Reserves also help sustain confidence in both domestic policy and exchange rate policy. The optimal level of reserves is of course contingent on a country specific circumstances, including its balance of payments, exchange rate regime and access to international finance. Indicators of reserve adequacy should be derived from measures of import cover and debt servicing. Another important ratio to monitor is the ratio of short-term debt and portfolio stocks to reserves to guard against sudden depreciation.

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Strategy Towards CAC


Country experiences suggest that there are three strategies for opening the capital account and that it is practical and feasible to be at different points along the spectrum leading to a fully convertible capital account. 1). The opening up of the capital account based on distinctions between residents and non-residents (an approach followed by India30 and South Africa). In both these cases the assumption seems to be that outflow of capital by residents can cause a crisis since opening up is more cautious for the resident sector. There is some basis for this. In the 1994 Mexican crisis domestic residents moved out of Tesobonos first setting a signal for FIIs. However, as country experiences shows that FIIs are equally likely to exit from a country based on their perceptions about the economy ii. Opening first the inflow side and later liberalizing outflows (same as (i) but the opening up is not restricted between residents and non-residents. After liberalization of inflows and outflows, management of the open capital account with the aid of price instruments (when required) that are designed to alter the maturity structure of inflows and their impact on monetary and exchange rate policy (an approach followed by Chile, Colombia and Malaysia). The experience of these three economies points to the importance of overall supportive policies to make these controls work. iii. A big bang approach that simultaneously liberalizes controls on inflows and outflows (an approach followed by Argentina, Peru and Kenya). The country experiences suggests that either option (i) or (ii) is Preferable for most developing countries. Each country has to decide on the degree of capital account convertibility based on its own conditions. If a country decides on a given degree of CAC, over time it should move towards greater openness consistent with its overall reform process.

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Preconditions of TATAPORE Committee


Financial Sector Reforms a) Interest rate deregulation b) Strengthening of financial Sector c) Reduction of CRR and SLR to 3% and 25% respectively. d) Reduction of NPA to 5% by 2000 Fiscal Consolidation a) Mandated rate of Inflation should be an average of 3%-5% b) Reduction of GFD/GDP ratio from budgeted 4.5%(97-98)to 3.5% Exchange rate Policy a) Credible and transparent policy b) Forward exchange rate markets to reflect interest rate differentials. c) Adequacy of reserves Balance of payments a) To maintain sustainable current account deficit b) Debt Service ratio to come down to 20%

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History Of CAC in India


India, after independence, opted for a model of development characterized by What was then perceived as self-reliance. Hence, till the early eighties, external financing was confined to external assistance through multilateral and bilateral sources, mostly on concessional terms to or through Government. The onset of the nineties, however, saw the impact of the Gulf crisis on India. Combined with the large fiscal deficits of the eighties and political uncertainties, repercussions of this development in the Gulf resulted in drying up of commercial sources of financing and in what could be described as a severe liquidity crisis in the balance of payments. While successfully meeting the Gulf crisis through an adjustment programme, it was decided to simultaneously launch upon a comprehensive programme of structural reform of which the external sector was on component. Policy Framework For Liberalisation The broad approach to reform in the external sector after the Gulf crisis was laid out in the Report of the High Level Committee on Balance of Payments chaired by Dr. C. Rangarajan. The Committee recommended the introduction of a market-determined exchange rate regime while emphasizing the need to contain current account deficit within limits. The Report of the High Level Committee on Balance of Payments, while providing the basic framework for policy changes in external sector, encompassing exchange rate management and, current and capital account liberalisation also indicated the transition path. Accordingly, the Liberalised Exchange Rate Management System involving dual exchange rate system was instituted in March 1992, no doubt, in conjunction with other measures of liberalisation in the areas of trade, industry and foreign investment. The dual exchange rate

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system was essentially a transitional stage leading to the ultimate convergence of the dual rates made effective from March 1, 1993 . This unification of exchange rates brought about the era of market determined exchange rate regime of rupee, based on demand and supply in the forex market. It also marks an important step in the progress towards current account convertibility, which was finally achieved in August 1994 by accepting Article VIII of the Articles of Agreement of the International Monetary Fund. The appointment of a 14 member Expert Group on Foreign Exchange (Sodhani Committee) in November 1994 was a follow up step to the above measures, for the development of the foreign exchange market in India. Many of the subsequent actions were based on this Report. Tarapore Committee on Capital Account Convertibility, 1997, appointed by the Reserve Bank of India, had recommended a number of measures while inviting attention to several preconditions.

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Current Trends of India:

External Debt:
External Sr No Country Debt 1 Brazil 245 2 Russian Federation 174 3 Mexico 167 4 China 154 5 Indonesia 150 6 Argentina 148 7 Korea. Rep. 130 8 Turkey 102 9 Thailand 96 10 India 94
#source: World economic report,2000

Indebtness Classification Severe Moderate Less Less Severe Severe Less Moderate Moderate Less

Going by a number of indicators, India's external debt situation is far better today than it was during the balance of payments (BoP) crisis of 1991. While the absolute size of foreign debt is important, more relevant is the weight this debt imposes on the economy. And, on that count, the burden has become lighter and lighter, even as the stock of outstanding has remained more or less constant. Annual repayments of loans and interest as a percentage of current receipts the debt service ratio which was as high as 35 per cent in 1990-91 has fallen to 13 per cent today. Debt as a percentage of the gross domestic product has nearly halved since the early 1990s. And the short-term debt to GDP ratio, which crossed 10 per cent in 1990-91 and precipitated the BoP crisis of that year, has been held under 3 per cent. India is now been classified by the World Bank as a "less" indebted country. In absolute terms as well, India's position has improved globally. In the mid1990s, India was the third largest debtor in the world; today it is ranked ninth. 21

All this has taken place in spite of the fact that new loans are increasingly being raised on commercial rather than concessional terms, as was the practice for decades. This improvement should be attributed both to a cautious policy on foreign borrowings (which includes annual caps on commercial loans which would not have been possible if the rupee was fully convertible) and to the steady growth in current receipts in the BoP. Fiscal deficit
Year 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-2001 2001-2002 (As% of GDP) 4.7 4.2 4.1 4.8 5.1 5.4 5.7 5.7

#Source: RBI Bulletin-2002 If India has achieved its CAC targets on adequacy of reserves and inflation there are couple of gray areas. Fore most among them is the Tarapore panel recommended a GFD/GDP ratio of 3.5% this should be accompanied by states fiscal deficit. This is one area where things have gone haywire. The revised estimated of GFD/GDP in 2000-01 was 5.1% and Budget estimate for 2001-02 was 4.7%. Against this the actual for 2000-01 were 5.7% and revised estimate for 2001-02 also 5.7%. The budget estimate for 2003 has been 5.3%. The slowdown in economic growth has been exacerbated by the intractability of high fiscal deficits, says Economic survey. The deleterious effects of such a high impact on the economy has been made worse by similar levels of deficits been made worse by the similar level of deficits recorded by the state government.

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Interest rate Deregulation of interest rates is one of the recommendations of the Committee. RBI has introduced deregulations of interest rates both in advances and deposits in phased manner. Except for savings deposits the interest rates for all other deposits are deregulated. A similar exercise has been adopted for lending also. Maximum lending rate during 1001-92 was at 19% when inflation was 13.7%and now it is 11.50 %. PLR has been converted to benchmark rate for banks rather than treating it as minimum rate. Phased deregulation of interest rates suggested in the road map has been achieved.

Inflation TC suggested that the mandated inflation rate should be an average of 3-5%. Movement of inflation rate is an imp indicator of macroeconomic stability. The point-to-point annual inflation rate in 2001-02 was 5%. It started decling after 2001 and recorded a low of 1.3% in Jan 2002.

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Financial Reforms: The second generation of reforms in the financial sector has been initiated with important measures being taken up to strengthen the health of the banking sector by 1) Monitoring capital adequacy norms 2) Setting up guidelines for risk mgmt in banks 3) Facilitating recapitalisation of banks. This being positive sides of the activities of the regulator, banking sector on whole is still struggling to get over NPA problem. The committee has suggested gross NPAs to be at 5% by year 2000 when its position in 1997 was 13.7%. The expectation is that with implementation of various reforms contemplated in finance sector the NPAs can be brought down to 5%in 3 ys.

NPA of SCBs
100% 80% 60% 40% 20% 0% 1998-99 1999-01 2000-01 2357 4655 51710 2614 4761 53033 3071 6039 Foreign 54773 Private Public

#Souce: RBI bulletin 2001

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But in reality the picture is different. The gross NPAs of SCBs do not indicate very positive trends. In absolute terms the gross NPAs have increased. The only satisfying features is fall in % terms. Now gross NPAs are likely to grow up as the duration of treating a NPA might come down to 90 days in absolute terms. Apart from accumulation of NPAs several sources of vulnerability exists in the market such as stock market scams. The structure of financial system is changing and supervisory and regulatory regimes are experiencing the difficulties of accommodating changes. Certain weak links in banking and non-banking financial sector are clearly visible such as: 1) Poor legal system that cannot enforce on erring parties 2) Labor laws that do not permit quick settlement of industrial disputes. 3) Ineffective bankruptcy laws. 4) Poor corporate governance among business units.

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Balance of Payment Selected Indicators of balance of payments (expressed as% of GDP)


Exports Imports Trade Balance Invisible Balance Current account balance External Debt Debt Service Payments 1990-91 5.8 8.8 -3 -0.1 -3.1 28.7 2.8 1997-98 8.7 12.5 -3.8 2.7 -1.2 24.5 3.2 1998-99 8.3 11.5 -3.2 2.2 -1 23.6 2.6 1999-00 8.4 12.4 -4 3 -1.1 22.2 2.5 2000-01 9.8 13 -3.1 2.6 -0.5 22.3 2.9

Source: Indian economy survey, 2001

It is shocking to note that Indias share in international trade is 0.7%. Another disturbing factor is that out of $1tn, annual flow of FDI across the globe, annual outflow into the India are $3-4bn. Current Account deficit in 2000-01 has narrowed down to 0.5% from 1.1% deficit last year. Apart from subdued non-oil import demand, dynamism in export performance and substantial increase in software services export are the reasons for these significant improvements. When we refer to current account deficit and few recommendations of CAC committee many of the parameters are at satisfactory level in the external sector

Reserves: Tarapore Committee ON CAC put the foremost step in direction of an effective foreign exchange policy forward 1) Imports cover of not less than 6 months. 2) Reserves should not be less than 3 months of imports+50%of annual debt services payment and one month of imports and exports taking into account the possibility of lags. 3) 60% in the ratio of short-term debt and portfolio stocks to reserve. 4) Net foreign exchange assets to currency ratio should not be less than 40%.

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Reserves adequacy should take into account the composition of reserves. Reserves in nature of hot money cannot provide stability to FEM. In case of India, short-term outflows like FII investments, NRI deposits of less than one-year maturity and short-term debt payments are vulnerable liabilities. This amount should be set aside from reserves build up.

Exchange Reserves In $mn


Year 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 SDRs 2 1 8 4 2 10 GOLD 4,054 3,391 2,960 2,974 2,725 3,047 FCA 22,367 25,975 29,522 35,058 39,554 51,049 Total 26,423 29,367 32,490 38,036 42,281 54,106

Source: RBI bulletin

Judicious composition of reserves Composition of reserves should be such that it has least burden in economy. Added importance should be given to FDI equity flow rather than FIIs and debts. Long-term debt having interest rated should be phased out or re-priced to bring down interest burden.

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Policy for Utilization of Excess Reserves: Piling up of foreign currency has opportunity costs. Direct financial cost of holding reserves is the interest paid by the public and private sectors on external liabilities. Therefore it is necessary that such reserves earn more than the interest payments. At the same time RBI cannot let the dollars be in the market, as it will appreciate the domestic currency. After making reserves for volatile payments and exchange rate management, RBI should allow domestic banks, financial institutions and Corporate to use these reserves abroad.

Conclusion for reserve: Reserve adequacy should be judged in multi dimensional framework. It should be viewed along with interest rate policy, exchange rate policy foreign investment policy and overall macroeconomic policy. In Indian case the current level of foreign exchange is adequate to carry forward the liberalized capital account in form of more freedom to banks and financial institutions and corporate entities to invest funds in international financial markets. The need of the hour is to bring down the cost of keeping foreign exchange reserves and at that same time protect domestic financial market from International contagion.

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Conclusion
1. Capital account liberalization is not a choice. Globalization of the world economy is reality that makes opening up of the capital account an unavoidable process. It is prudent for developing countries to work out an orderly liberalization of the capital account instead of reforming under duress after a crisis has hit the country. 2. The main impediments in the way of capital account convertibility are the weak initial conditions related to the health and development of the financial sector and problems related to asset liability management of the banking system. Of crucial importance are measures addressing bank soundness, interest risk management, hard budget constraints for public enterprises, Without underlying changes in the structure of the financial system, macroeconomic and financial instability is a predictable consequence of moves towards capital account liberalization. 3. As far as India is concerned it is incredulously getting clear that there is considerable amount of work to be done at the national level to ensure that the preconditions for the freedom of capital movements are at its place. Capital account certainly calls for bold visions and cautious implementation. It is time that we move away from hoopla of CAC towards the strengthening of financial systems that encompasses improvement in supervision and prudential standards, framing sound monitory and fiscal policies that in consonance with the chosen exchange rate regime .The results thus would be more capital inflows and less volatility in markets irrespective of CAC. 4. We should remember that capital account convertibility is journey and not a destination

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Bibliography
Analyst, Dec 2002 Treasury Management, Nov 2002 www.bankingindiaupdate.com www.financeclububs.org www.odi.org.uk

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