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KJ Udeshi’s dissent note

Gautam Chikermane’s tweets

While I am in agreement with the recommendations of the Report, I have reservation on the recommendations relating to Capital Controls. The Commission recommends the following formulation:

“The regulations governing capital controls on inward flows should be framed by the Government, in consultation with the RBI. The regulations governing capital controls on outward flows should be framed by the RBI, in consultation with the Government.” (See Chapter 8.3)

Consultation does not imply a consensus and when the RBI is in disagreement with the Government, the Government has the unquestionable powers to issue directions to the RBI. When the rule-making vests with the Government, the RBI may be consulted, but if there is a disagreement, the RBI would willy-nilly have to deal with a fait accompli and be accountable for the actions it would be required to take in the light of the Government’s decisions.

In India, the forex reserves accretion is invariably on account of a capital account surplus and not due to a current account surplus and hence the composition of the inward flows assumes importance. Inward capital flows into India comprise FDI as also debt/portfolio equity flows and the latter are not only volatile but can undergo sharp directional shifts. There is widespread concern among several central banks in Emerging Market Economies about the added pressures on monetary management due to the prevailing extraordinarily strong and volatile cross-border capital flows. If the RBI has no say in initiating policy relating to these volatile flows, the RBI would be constrained to take monetary policy measures, both direct and indirect and administrative actions to deal with the consequences of such flows; such measures may not be what the Government or industry and the business community seek, leading to overall dissatisfaction.

If the RBI is to be accountable for the performance on its Balance Sheet, it has to be enabled to decide on the timing, quantity and quality of inward capital flows so that it can calibrate its forex interventions and sterilisation measures.

To the extent that inward capital flows impact liquidity conditions, it becomes necessary for the RBI to impose a burden on the banking system through imposition of reserve requirements and open market sales of securities. Such measures can impinge on the banking system and may not be in consonance with the medium/long-term policy object.

Both, financial markets and Governments have short time horizons and when initiating policy relating to debt/portfolio equity flows is with the Government, it makes the task of the RBI as Monetary Authority and the Regulator much more difficult. I am, therefore, not in agreement with the Commission’s recommendation to place the policy and rule-making relating to all inward capital flows with the Government.

One of the TOR of the Commission is:

“V. Examine the interplay of exchange controls under FEMA and FDI Policy with other regulatory regimes within the financial sector.”

The formulation of the FDI policy in many jurisdictions is statutorily the prerogative of the Central Governments, since the policy has implications for the macroeconomy, employment, security issues, social and political considerations etc. The Government’s concerns in evolving FDI policies need to be recognised and therefore, my suggestion to the Commission has been that: (a) the Government may be entrusted with the policymaking relating to FDI, in consultation with the RBI, and the framing of the Rules relating thereto and (b) the RBI may be entrusted with the policymaking relating to all other transactions on the capital account, both inward and outward, in consultation with the Government and the framing of the regulations relating thereto.

Since the management of capital flows, excluding FDI is required to be with the RBI and the foreign exchange reserves management function is with the RBI, it is imperative that the policy on exchange rate management should remain with the RBI.

The handling of the foreign exchange crisis of the pre-liberalisation period (1990s) as also the handling of the exchange rate policy and cycles of ebb and flow of forex inflows has shown that such arrangements have worked well.

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