Description
This is a PPT explaining Capital Account Convertibility.
Capital Account Convertibility
Introduction
?A country’s balance of payments is the set of accounts recording flows of value between a nation and rest of the world during a period of time. ?It comprises of current account, capital account and official international reserves. ?Current account includes transactions related to exports and imports of goods and services, income receipts and payments and gifts. ?The net value of flows of financial assets and similar claims constitute capital account. ?Official international reserves are money assets held by government. ?Capital account is termed fully convertible when there is freedom to convert local financial assets into foreign financial assets and vice versa at market determined exchange rates.
Backdrop of Liberalization Era
?Unprecedented external payment crisis in 1990-91, current account leading to the collapse of capital account, dipping of foreign currency assets forced the country to take liberalization policies, open up the economy and take the following measures: ?Stabilisation measures: Import containment, raising loans against pledging of gold. Exchange rate adjusted downwards in 2 stages cumulatively by 18%. ?Structural reforms: Liberalisation of trade. Reduction and rationalisation of tariffs. Abolition of licensing. Encouraging foreign equity participation ?Current account convertibility was established with acceptance of obligations under Article VIII of IMF in August 1994, thereby reducing Current Account Deficit over the period 1992-93 to 1996-97 ?Growth accelerated, Gross fiscal deficit declined, Tax system was revamped, inflation reduced and Foreign exchange reserves were built up ?Controls continue to operate on ability of resident individuals and corporate to send money abroad and also on inflow and outflow of capital associated with banks and non bank financial entities.
East Asian Financial Crisis 1997
?The financial crisis was caused by drop in the value of currencies, leading to sale of foreign exchange reserves. ?This causes interest rates to rise and thus slow economic growth. ?Further, recent liberalization of capital markets had increased the scope of the crisis. ?The crisis had affected the world economy in both micro and macro way.
Causes of the crisis…
? Opening up of the economies to foreign capital without adequate preparedness Exchange rates in close alignment to the US dollar with narrow band adjustment. Lack of regulations and government control. Questionable borrowing and lending practices of banks. Capital outflows and growing interest rates. Lack of skilled manpower and bureaucracy in appointment of offices. Lack of control by governments of huge capital markets leads to speculation.
?
? ? ? ? ?
Capital Account Convertibility - Advantages
? ? ? ? Helps country reap benefits of integration with global markets Capital from abroad available at cheaper cost, reducing country’s cost of capital Tax levels move closer to international levels, reducing tax evasions Reduction of risks for residents by diversification of investments
Capital Account Convertibility - Disadvantages
Excessive capital outflows: ?Can lead to export of domestic savings which disrupts financing of domestic investment ?Exposes economy to larger macroeconomic instability due to volatility of short term capital movements Excessive capital inflows: ?Results in exchange rate appreciation. Imports preferred over exports, widening trade deficit ?Currency appreciation ? larger borrowing abroad ?Debt led expansion in economic activity ?Risk of reversal of inflows due to lack of credibility or recessionary trends abroad ?Outflow is sudden and home currency depreciates uncontrollably ?Debt repayments become more expensive ?Country plunges into financial crisis
Recommendations of the S.S. Tarapore Committee (1997)
? Meet prerequisites before making capital account convertible ?Fiscal Consolidation ?Reduction in fiscal deficit from 4.5% in 1997-98 to 3.5% in 1999-00 ?Mandated Inflation Rate ?Rate of inflation for period 1997-98 to 1999-00 to average 3-5% ?Strengthening Financial System ?CRR to be reduced to 3% and NPAs to 5% by 1999-00 ?Prudently regulated banking system ?Increasing the system’s capacity to absorb external shocks ?Adequate Forex reserves ?Adequately capitalized banking sector
Tarapore Committee II (2006)…in the years of boom
? In the backdrop of high growth of the Indian economy over preceding 4-5 years, Manmohan Singh asked RBI to revisit the subject of CAC ?Recommends a 5 year transition period divided into 3 phase
?This enables stock taking before proceeding to the next phase
?Separation of Capital Controls from Procedural issues ?Large Capital inflows require adequate domestic monetary expansion ?Need for States to adopt fiscal consolidation and budgetary prudence and thereby assisting the Union government ?Moving from Fiscal Deficit to a PBSR regime (Public Sector borrowing Requirement) ? "A weak and fragmented domestic banking sector cannot co-exist with a system opened to global influences“ ?Net Current A/c Deficit is financed by capital inflows and the excess causes accretion to the foreign exchange reserves ?Non-debt related accretion to forex reserves has increased from 1% in 1990-91 to 50% in 2004-05
How has the progress been?
?From DAYS of IMPORTS to
?Liquidity : Short term debt; ability to cushion short term fluctuations in value of currency, commodities, etc. ?Solvency : Ability to service external debt over a period of time ?Monetary : Vulnerability of economic activity from sudden reversal of capital flows ?Macro situation : As a percentage of GDP ?Still Need to include Supplier's credit, Private equity flows, etc. to make the data more relevant for policy decision making
? Successfully moved from changing rates by 100 and 200 bps to small changes by 25 bps >> avoids adverse knee jerk market reactions ? As we undergo more of financial integration, close linkages develop between the following:
?Money Market ?GSec Market ?Corporate Bond Market ?Securitised debt market ?Forex Market ?Derivatives
Continued progress…
?From DAYS of IMPORTS to
?Liquidity : Short term debt; ability to cushion short term fluctuations in value of currency, commodities, etc. ?Solvency : Ability to service external debt over a period of time ?Monetary : Vulnerability of economic activity from sudden reversal of capital flows ?Macro situation : As a percentage of GDP ?Still Need to include Supplier's credit, Private equity flows, etc. to make the data more relevant for policy decision making
? Successfully moved from changing rates by 100 and 200 bps to small changes by 25 bps >> avoids adverse knee jerk market reactions ? As we undergo more of financial integration, close linkages develop between the following:
?Money Market ?GSec Market ?Corporate Bond Market ?Securitised debt market ?Forex Market ?Derivatives
Quote Unquote
“Capital account convertibility is a process, not an event. I personally believe we should go forward but with slow pace” - D Subbarao “The lessons of the global crisis are in favour of less enthusiasm for capital account convertibility…” - Y V Reddy “There is a need to proceed with CAC but not at a fast pace” - C Rangarajan
RBI Report - Committee on the Global Financial System (2009)
?It boils down to weighing the possible increase in vulnerability arising from volatility in cross-border flows against the potential benefits ?In principle – benefits to both capital importing and capital exporting countries ?But history and current global crises suggests otherwise; it leads to creation of exposure to new global risks ?Rigidity in Capital account management can lead to difficulties in macroeconomic and monitory management
The progress of “capacity” creation…
Financial Soundness Indicators CRAR
2000 11.1
2008 13.0
Gross NPAs to Gross Advances Net NPAs to Net Advances Return on Total Assets Return on Equity Efficiency (Cost Income) Ratio
13.1 7.1 0.7 12.7 61.2
2.4 1.1 1.0 12.5 48.9
Source: CFSA Report, 2008
The way forward…
Considerations: Associated risks to be analyzed No haste in liberalizing the capital account Prudential buffers to be kept to cope with more market based forms of capital allocation ? Failure in these considerations will compromise financial or monitory stability ?Adequate risk management framework for end users of 'complex' derivative products needs to be ensured when increasing the width and depth of the derivatives market
? Successful implementation will yield benefits in terms of exposure to vast monitory resources
The way forward…
?India as a major center for bullion trade
?Committee adovcates liberlaisation of gold imports and introduction of more products (both real and financial) in gold denominations ?Need to facilitate transition of gold from a commodity to a financial asset (4 SBI Branches have been allowed to accept gold deposits, on a pilot basis)
?Dollarization of Indian economy / Internationalization of INR
?Need to develop capacity and system so as to prevent from cons/ risks arising out of dollarization of the Indian economy ?Internationalization of a currency can accentuate the susceptibility to any external shocks, arising out of global integration
?Need to develop market continuum to increase convertibility of currency, thereby making the market more mature and developed ?Need to focus on activity-centric regulation rather than institution-centric regulation ?Need for a robust, independent risk management framework and an appropriate internal control mechanism in banks ?Use of stress tests, both at banks' level and at macro level
The way forward…
?Fiscal Consolidation:
?Reduction if deficits ?Avoidance of meeting interest and principal repayments through fresh borrowings ?PSBR to replace concept of fiscal deficit
?Monetary Policy:
?More objective decision making targeting the soon-to-be composed rural and urban CPIs ?Making decision making more transparent by releasing MoMs (Minutes of Meetings) in the public domain, albeit with a suitable lag ?Government should promote new banks with industrial backing
A sample case w.r.t. IRACP norms
?Rapidly evolving provisioning norms
?Reduction in number of days ? Increase in provision amount ? Exposure norm (If one account becomes a NPA, then all accounts in that become NPAs) ? Provision Coverage Ratio
?Need to tighten the IRACP norms to enhance the shock-bearing capacity in times of crisis
? Increase provisioning for fund based facilities/ exposures ? Extend the present norm of "provisioning for all exposures to that borrower by that bank" to "provisioning for all exposures to that borrowers by all banks" ? Extend the provisioning norm to non-fund based exposures/ contingent liabilities
Capital account liberalization can only provide meaningful benefit when countries move in tandem with a strong macroeconomic policy framework, sound financial system & markets, supported by prudential regulatory and supervisory policies.
Thank You
doc_859967502.ppt
This is a PPT explaining Capital Account Convertibility.
Capital Account Convertibility
Introduction
?A country’s balance of payments is the set of accounts recording flows of value between a nation and rest of the world during a period of time. ?It comprises of current account, capital account and official international reserves. ?Current account includes transactions related to exports and imports of goods and services, income receipts and payments and gifts. ?The net value of flows of financial assets and similar claims constitute capital account. ?Official international reserves are money assets held by government. ?Capital account is termed fully convertible when there is freedom to convert local financial assets into foreign financial assets and vice versa at market determined exchange rates.
Backdrop of Liberalization Era
?Unprecedented external payment crisis in 1990-91, current account leading to the collapse of capital account, dipping of foreign currency assets forced the country to take liberalization policies, open up the economy and take the following measures: ?Stabilisation measures: Import containment, raising loans against pledging of gold. Exchange rate adjusted downwards in 2 stages cumulatively by 18%. ?Structural reforms: Liberalisation of trade. Reduction and rationalisation of tariffs. Abolition of licensing. Encouraging foreign equity participation ?Current account convertibility was established with acceptance of obligations under Article VIII of IMF in August 1994, thereby reducing Current Account Deficit over the period 1992-93 to 1996-97 ?Growth accelerated, Gross fiscal deficit declined, Tax system was revamped, inflation reduced and Foreign exchange reserves were built up ?Controls continue to operate on ability of resident individuals and corporate to send money abroad and also on inflow and outflow of capital associated with banks and non bank financial entities.
East Asian Financial Crisis 1997
?The financial crisis was caused by drop in the value of currencies, leading to sale of foreign exchange reserves. ?This causes interest rates to rise and thus slow economic growth. ?Further, recent liberalization of capital markets had increased the scope of the crisis. ?The crisis had affected the world economy in both micro and macro way.
Causes of the crisis…
? Opening up of the economies to foreign capital without adequate preparedness Exchange rates in close alignment to the US dollar with narrow band adjustment. Lack of regulations and government control. Questionable borrowing and lending practices of banks. Capital outflows and growing interest rates. Lack of skilled manpower and bureaucracy in appointment of offices. Lack of control by governments of huge capital markets leads to speculation.
?
? ? ? ? ?
Capital Account Convertibility - Advantages
? ? ? ? Helps country reap benefits of integration with global markets Capital from abroad available at cheaper cost, reducing country’s cost of capital Tax levels move closer to international levels, reducing tax evasions Reduction of risks for residents by diversification of investments
Capital Account Convertibility - Disadvantages
Excessive capital outflows: ?Can lead to export of domestic savings which disrupts financing of domestic investment ?Exposes economy to larger macroeconomic instability due to volatility of short term capital movements Excessive capital inflows: ?Results in exchange rate appreciation. Imports preferred over exports, widening trade deficit ?Currency appreciation ? larger borrowing abroad ?Debt led expansion in economic activity ?Risk of reversal of inflows due to lack of credibility or recessionary trends abroad ?Outflow is sudden and home currency depreciates uncontrollably ?Debt repayments become more expensive ?Country plunges into financial crisis
Recommendations of the S.S. Tarapore Committee (1997)
? Meet prerequisites before making capital account convertible ?Fiscal Consolidation ?Reduction in fiscal deficit from 4.5% in 1997-98 to 3.5% in 1999-00 ?Mandated Inflation Rate ?Rate of inflation for period 1997-98 to 1999-00 to average 3-5% ?Strengthening Financial System ?CRR to be reduced to 3% and NPAs to 5% by 1999-00 ?Prudently regulated banking system ?Increasing the system’s capacity to absorb external shocks ?Adequate Forex reserves ?Adequately capitalized banking sector
Tarapore Committee II (2006)…in the years of boom
? In the backdrop of high growth of the Indian economy over preceding 4-5 years, Manmohan Singh asked RBI to revisit the subject of CAC ?Recommends a 5 year transition period divided into 3 phase
?This enables stock taking before proceeding to the next phase
?Separation of Capital Controls from Procedural issues ?Large Capital inflows require adequate domestic monetary expansion ?Need for States to adopt fiscal consolidation and budgetary prudence and thereby assisting the Union government ?Moving from Fiscal Deficit to a PBSR regime (Public Sector borrowing Requirement) ? "A weak and fragmented domestic banking sector cannot co-exist with a system opened to global influences“ ?Net Current A/c Deficit is financed by capital inflows and the excess causes accretion to the foreign exchange reserves ?Non-debt related accretion to forex reserves has increased from 1% in 1990-91 to 50% in 2004-05
How has the progress been?
?From DAYS of IMPORTS to
?Liquidity : Short term debt; ability to cushion short term fluctuations in value of currency, commodities, etc. ?Solvency : Ability to service external debt over a period of time ?Monetary : Vulnerability of economic activity from sudden reversal of capital flows ?Macro situation : As a percentage of GDP ?Still Need to include Supplier's credit, Private equity flows, etc. to make the data more relevant for policy decision making
? Successfully moved from changing rates by 100 and 200 bps to small changes by 25 bps >> avoids adverse knee jerk market reactions ? As we undergo more of financial integration, close linkages develop between the following:
?Money Market ?GSec Market ?Corporate Bond Market ?Securitised debt market ?Forex Market ?Derivatives
Continued progress…
?From DAYS of IMPORTS to
?Liquidity : Short term debt; ability to cushion short term fluctuations in value of currency, commodities, etc. ?Solvency : Ability to service external debt over a period of time ?Monetary : Vulnerability of economic activity from sudden reversal of capital flows ?Macro situation : As a percentage of GDP ?Still Need to include Supplier's credit, Private equity flows, etc. to make the data more relevant for policy decision making
? Successfully moved from changing rates by 100 and 200 bps to small changes by 25 bps >> avoids adverse knee jerk market reactions ? As we undergo more of financial integration, close linkages develop between the following:
?Money Market ?GSec Market ?Corporate Bond Market ?Securitised debt market ?Forex Market ?Derivatives
Quote Unquote
“Capital account convertibility is a process, not an event. I personally believe we should go forward but with slow pace” - D Subbarao “The lessons of the global crisis are in favour of less enthusiasm for capital account convertibility…” - Y V Reddy “There is a need to proceed with CAC but not at a fast pace” - C Rangarajan
RBI Report - Committee on the Global Financial System (2009)
?It boils down to weighing the possible increase in vulnerability arising from volatility in cross-border flows against the potential benefits ?In principle – benefits to both capital importing and capital exporting countries ?But history and current global crises suggests otherwise; it leads to creation of exposure to new global risks ?Rigidity in Capital account management can lead to difficulties in macroeconomic and monitory management
The progress of “capacity” creation…
Financial Soundness Indicators CRAR
2000 11.1
2008 13.0
Gross NPAs to Gross Advances Net NPAs to Net Advances Return on Total Assets Return on Equity Efficiency (Cost Income) Ratio
13.1 7.1 0.7 12.7 61.2
2.4 1.1 1.0 12.5 48.9
Source: CFSA Report, 2008
The way forward…
Considerations: Associated risks to be analyzed No haste in liberalizing the capital account Prudential buffers to be kept to cope with more market based forms of capital allocation ? Failure in these considerations will compromise financial or monitory stability ?Adequate risk management framework for end users of 'complex' derivative products needs to be ensured when increasing the width and depth of the derivatives market
? Successful implementation will yield benefits in terms of exposure to vast monitory resources
The way forward…
?India as a major center for bullion trade
?Committee adovcates liberlaisation of gold imports and introduction of more products (both real and financial) in gold denominations ?Need to facilitate transition of gold from a commodity to a financial asset (4 SBI Branches have been allowed to accept gold deposits, on a pilot basis)
?Dollarization of Indian economy / Internationalization of INR
?Need to develop capacity and system so as to prevent from cons/ risks arising out of dollarization of the Indian economy ?Internationalization of a currency can accentuate the susceptibility to any external shocks, arising out of global integration
?Need to develop market continuum to increase convertibility of currency, thereby making the market more mature and developed ?Need to focus on activity-centric regulation rather than institution-centric regulation ?Need for a robust, independent risk management framework and an appropriate internal control mechanism in banks ?Use of stress tests, both at banks' level and at macro level
The way forward…
?Fiscal Consolidation:
?Reduction if deficits ?Avoidance of meeting interest and principal repayments through fresh borrowings ?PSBR to replace concept of fiscal deficit
?Monetary Policy:
?More objective decision making targeting the soon-to-be composed rural and urban CPIs ?Making decision making more transparent by releasing MoMs (Minutes of Meetings) in the public domain, albeit with a suitable lag ?Government should promote new banks with industrial backing
A sample case w.r.t. IRACP norms
?Rapidly evolving provisioning norms
?Reduction in number of days ? Increase in provision amount ? Exposure norm (If one account becomes a NPA, then all accounts in that become NPAs) ? Provision Coverage Ratio
?Need to tighten the IRACP norms to enhance the shock-bearing capacity in times of crisis
? Increase provisioning for fund based facilities/ exposures ? Extend the present norm of "provisioning for all exposures to that borrower by that bank" to "provisioning for all exposures to that borrowers by all banks" ? Extend the provisioning norm to non-fund based exposures/ contingent liabilities
Capital account liberalization can only provide meaningful benefit when countries move in tandem with a strong macroeconomic policy framework, sound financial system & markets, supported by prudential regulatory and supervisory policies.
Thank You
doc_859967502.ppt