Going slow on convertibility

The RBI made public the Tarapore committee report on Capital Account Convertibility (CAC) late August. Even "fuller" convertibility than we have now isn't going to happen soon, if the authorities accept the recommendations of the committee. It will happen in three phases starting: Phase I-2006-07. Phase II: 2007-09 and Phase II- 2009-11. Considering the downside risks to CAC, that is just as well.

I have commented on the report in my column in the Economic Times.

There are some points I didn't have a chance to make in my column:

• PNs: The Finance ministry is reluctant to phase out PNs because of the likely impact on the stock market. This is being myopic. It is far more important to ensure the integrity of the financial system and to show that you are practicing “zero tolerance” in respect of KYC norms. Over the long run, this will do a lot to inspire confidence in the Indian financial system and encourage inflows. The benefits will outweigh whatever we gain from the surge in PNs at the moment. The RBI has taken a tough line towards banks found to flouting KYC norms in the IPO scam. It would be inappropriate to practise laxity in this respect towards foreign investors at the same time.
  
  I said in my piece that the answer to the PN issue may to allow direct investment by non-residents right away. But this presumes that we are confident about banks’ grip on KYC. If we are uncertain about this, it is better to defer direct investment by non-residents.
  
• Banking system: Tarapore II wants industrial houses to be allowed to set up banks- with immediate effect, something that surprises even ultra-liberaliser and dissenting member Surjit Bhalla. This would be a major departure for RBI. I can’t see how this can be done without violating the ceiling of 10% on ownership in private banks and the requirement of diversified ownership.
• Data: The committee has asked for liberalisation of outward remittances by Indians going up to $200,000 in the last phase. What has been the experience with the current limit of $25,000? Do we have data? Perhaps we should have a norm for such outflows in relation to reserves/imports. And, of course, we should have the capacity to monitor and cut-off outflows- a real-time monitoring system that can be acted up on in times of crises.