If India is to become an economic powerhouse, the central bank’s bumbling cannot be left unchecked
Unlike May 17, 2004, which will always be remembered for market mayhem, January 12 may be forgotten by everybody but the Reserve Bank of India (RBI). That was the day when some quick-thinking and timely action by finance minister P Chidambaram doused a market panic that seemed destined a day after RBI governor Venugopal Reddy’s comments about taxing and regulating the flow of money coming from foreign institutional investors (FIIs).
A crisis was successfully averted and there will now be plenty of opinions on the merits or otherwise of Dr Reddy’s comments. But nothing can explain the dangerous folly in the timing of his comments, especially since central bankers all over the world are acutely aware that their comments are minutely dissected by the market and so choose their words and timing very carefully. In this case, the Sensex was down 600 points over a week and investors were beginning to get nervous about the implications of a sustained pull-out by FIIs who are, by far, the most dominant players in the market today.
In a nutshell, governor Reddy said a view needed to be taken on the quantity and quality of FII flows. And although quotas or ceilings, as practised by certain countries, may not be desirable at this stage, there is merit in keeping such an option open and exercising it selectively, after due notice to the FIIs. He also mentioned the possibility of tightening FII registration norms and raised doubts about the quality of remittances from expatriate Indians. The question really is not what the governor said and there is probably some merit in some of his concerns (although why the RBI should think aloud and not investigate first, is another matter). The question is of timing.
It is indeed true that RBIs ‘Report on Currency & Finance’ had mentioned that a chunk of FII investment was risky and in the nature of hot money. However, its sermonising hadn’t gone down well even then, because the RBI itself was caught napping in 2000, having registered scores of dubious Overseas Corporate Bodies (OCBs) with a Post Box address and a $10 capital. Thanks to RBI’s supervisory failure or negligence, these companies channeled money for brazen manipulation of what were known as K-10 stocks (Ketan Parekh stocks). That hot money inflow led to the scam in 2000, which nearly destroyed the Unit Trust of India (UTI) and led to its split. What’s worse, UTIs reduced clout is the reason why FIIs have emerged as the most dominant players in today’s market. And it is also why investors were filled with blind terror at the prospect of their policy-induced stampede to the exit.
The obvious question is, why wasn’t the RBI alert to hot money in 2000? Why did it fail to notice the mischief of OCBs? It is because India’s forex reserves were a mere $35 billion then, compared to $131 billion today and the RBI wasn’t manipulating currency markets to keep the rupee down.
• Nothing can explain the dangerous folly in the timing of Reddy’s comments
• RBI itself was caught napping in 2000, having registered dubious OCBs
• The bank is openly at loggerheads with the finance ministry and Sebi
In the aftermath of Wednesday’s ‘misunderstanding,’ commentators have plenty of advice to offer. From those who think the governor had the choice of ‘standing by’ his comments but chose not to, to others who feel his only mistake was speaking in plain English, rather than the gobbledygook that passes as the “constructive ambiguity” of central bankers.
The latter policy would, indeed, have the advantage of making it easier for the finance minister to explain future gaffes by the governor as misunderstandings. It would also keep commentators in business, trying to decipher the governor’s utterances. However, a sudden recourse to obfuscation would be rather strange, given that the central bank is openly at loggerheads with the finance ministry and the Securities and Exchange Board of India (Sebi) over several issues.
On foreign equity in private banks and their acquisition, the RBI is opposed to the finance ministry’s proposal (backed by the Prime Minister) to allow 74% foreign direct investment in the banking sector. RBI’s draft guidelines of July 2004 on ownership in private banks have proposed a cap of 10% on ownership by any single entity or group and a 5% cap on cross-holdings. Again, its insistence on restricting foreign ownership is inexplicable, given that it had earlier cleared a much larger stake for foreign investors in UTI Bank, ING Vysya and Centurion Bank. That apart, its own supervisory shortcomings led to the collapse of Nedungadi Bank, Global Trust Bank and many cooperative banks. Restricting foreigners is not only a bogey, it smacks of hypocrisy.
RBI has been waging a turf battle with Sebi over the debt market , too. It has set up its own automated, order-driven, Negotiated Dealing System (NDS), which plans to splinter the debt market by restricting access to chosen institutional investors and eliminating brokers altogether. The NDS was to have been launched in September last year, but has been stalled due to another timely intervention by the finance minister in response to Sebi’s protest. In this case too, the RBI’s attitude borders on arrogance, given that debt markets and stock exchanges are both under Sebi’s regulatory jurisdiction and the NDS will be a quasi-exchange promoted by the central bank.
A central bank’s views may be different from those of the government. But its bumbling cannot be left unchecked if India has to be the economic powerhouse it has the potential to be. For far too long, RBI has been allowed to function in an opaque manner, without being subject to any external audit or accountability, merely because it combines in a single entity the role of monetary authority, banking supervisor and policy maker , as well as player in the foreign exchange and public debt markets. The growing incidence of public discord between the government and the central bank, and their repeated supervisory failures suggest it is time for some fundamental changes that will let much-needed sunlight into the ivory tower in which the central bank operates.