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| March 27, 2006 | Monday | Safar 26, 1427 |
Roadmap for free float of the Indian rupee
INDIAN Prime Minister Manmohan Singh, unlike some of his predecessors, is not in the habit of making casual remarks and then recanting it when the dirt hits the ceiling. So when he referred to the full convertibility of the Indian rupee – pointing out that it was time to revisit the issue, since the foreign exchange position was now comfortable - at a book-launch function at the country’s financial and commercial capital last week, the markets took serious note of it and reacted positively.
The Sensex, the benchmark index on the Bombay Stock Exchange, flared and broke yet another record, crossing the 11,000-mark. Days after Singh’s remarks about the need to take a fresh look at the question of capital account convertibility of the rupee – in effect, a free float of the currency – the Reserve Bank of India (RBI), the country’s central bank, announced the setting up of a committee to chalk out a roadmap.
The committee, to be headed by former deputy governor of the RBI, S.S. Tarapore – who had in 1997 headed a similar committee, and had recommended full convertibility of the rupee in a three-year span – will examine the implications of the move on exchange rate management and on the economy. It is expected to submit its report by the end of July.
The first edition of the Tarapore committee had recommended certain pre-conditions – including reduction in fiscal deficit (to less than three per cent), lower inflation (to below five per cent), a reduction in the bad debts of banks, and deregulated interest rates – but the government of the day had to hastily abandon the recommendations a year later, following the Asian financial crisis.
Experts blamed the hasty manner in which many of the South East Asian economies adopted full convertibility, the lax banking regulations in those nations, and the inability of many of the governments to rein in inflation, for the Asian crisis. But no government in India – or for that matter in other emerging economies – had the courage to ‘revisit the issue’ all these years.
Singh, a former governor of the RBI, is one politician who has all the right credentials to take up the contentious issue. The economist-turned-politician initiated the economic reforms programme in India in 1991, when he became the finance minister. India was facing a huge foreign exchange crisis – having a few months earlier pledged part of its gold reserves to prevent a default on a foreign loan – forcing Singh to go in for drastic reforms.
The rupee was initially devalued, and then came the tortuous process of having a partly-free and a partly-controlled currency. Over the years, the rupee has become fully convertible on the current account, and for overseas Indians, it is almost fully convertible on the capital account as well.
The freeing of the rupee has crippled the ‘hawala’ trade – the illegal remittance of foreign currencies – and destroyed the once thriving black market for hard currencies. It has also triggered off massive in-flows of foreign capital – both direct and portfolio – as investors are confident of being able to repatriate their investments, plus the profits.
Singh justified the need to revert to the question of full convertibility, as the Indian economy is in a healthy position. The country’s foreign exchange reserves are at around $145 billion, inflation is below five per cent, the non-performing assets of state-owned banks is down to around five per cent (from almost 15 per cent in the 1990s), and the economy is growing at a brisk eight-plus per cent.
But for India to seriously tackle its enormous problems – poverty, lack of urban and rural infrastructure, and joblessness – the economy has to grow by between 10 and 12 per cent annually for the next 20 years.
Singh, at the Mumbai function last week, noted that investments amounting to about $1.5 trillion would be needed over the next five years to ensure just eight per cent growth.
MUCH of the investments needed to ensure 10- 12 per cent GDP (gross domestic product) growth in India can only come from international financial giants, especially pension funds and insurance companies. Most state governments are broke, and Indian domestic firms are not capable of generating such huge sums.
But the government’s plans to liberalize the financial services sector, by increasing the limit for foreign investors, from the existing 26 per cent to 49 per cent, in insurance firms, has been stalled in Parliament.
Similarly, the bill for setting up a pension funds regulator and opening up the sector to private and international funds - dozens of large western pension funds are eagerly waiting to enter the country – has been stonewalled.
The left supporters of the United Progressive Alliance (UPA) government, who control most of the public sector insurance unions, are still not willing to accept the tremendous benefits reaped by the insurance sector following its opening up. Further reforms will surely increase coverage, both in urban and rural areas.
India is a hugely uninsured market, with 80 per cent of the one billion-population still not having any kind of insurance coverage, and a whopping 95 per cent of population not having health coverage. State-owned giant, Life Insurance Corporation (LIC), once a monopoly in the sector, has seen its market share whittle down to below 80 per cent within five years of the sector being opened up.
All the top international American and European insurance companies today have a presence in India, and they have been growing their market share spectacularly. The insurance industry is growing at a brisk rate of 15 per cent annually.
The pension fund sector is another under-performing segment, as it is still dominated by state-controlled agencies. Not even 10 per cent of India’s 300 million-strong workforce is covered by a pension scheme.
There are a raft of other restrictions on foreign financial institutions – they cannot own more than five per cent in a domestic bank, or hold over $1.5 billion in corporate debt – which hamper the flow of much-needed funds into the country.
FOREIGN banks are equally bullish about India and continue to plough money into the country, despite the plethora of restrictions. The latest to announce multi-million-dollar investments is UK-based Barclays Plc, which has invested about $150 million in India to strengthen its investment banking operations.
Robert Morrice, chairman and chief executive, Asia-Pacific, for Barclays, said here last week that the bank plans to invest another $70 million into its India operations over the next two years.
International banks are eagerly eyeing opportunities out of India, as corporates go about acquiring firms abroad, or issuing paper.
Indian companies propelled the country to the top position in Asia last year, by issuing convertible bonds worth about $3.5 billion. Barclays itself handled issues worth over $1.25 billion. A growing number of Indian companies are investing abroad, and international banks like Barclays see tremendous scope to cater to their banking requirements.
International banks are also keen on setting up retail branches in the country. Barclays is waiting for the RBI’s approval for opening new branches in India. A few months ago, German giant, Deutsche Bank, announced a major retail foray, establishing nearly 10 branches in the major metros.
The Netherlands-based ING group – which has a presence in banking, mutual funds and insurance – is also looking at growing its presence in the Indian financial services sector. ING group chief executive Michel Tilmant, said earlier in the month that the group had ambitious plans for India, and also hoped to earn excellent returns from its investments here.
But HSBC Holdings Plc, the UK-based banking giant, has done just that: it has had fabulous returns on its investments in UTI Bank. Last week, HSBC sold 20 million shares (representing a 7.19 per cent stake) of UTI Bank – to comply with a law enacted last year, restricting foreign banks’ holdings in domestic banks to five per cent – for $142 million.
HSBC had a 14 per cent stake in UTI Bank, acquired through a global depository receipt. It had paid Rs90 for a share in 2003, but sold it last week at a rate of Rs318.61 each, making a hefty profit on the deal. It now has a 4.99 per cent stake in UTI Bank.
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