Regulatory Mechanisms in India- RBI. Thomas Vengal. Nov 1, 2007
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1 Regulatory Mechanisms 1 Regulatory Mechanisms in India- RBI Thomas Vengal Nov 1, 2007
2 Regulatory Mechanisms 2 Abstract Governments throughout history have experimented with different approaches to economic activity, assuming roles that called for varying degrees of state intervention from laissez-faire to command and control. Some of these approaches have proven more successful than others in fostering economic development, but experience has shown that no one approach is suitable for all countries at all times. Although it is generally agreed that the state and markets play complementary roles and that the state is responsible for laying the foundation for market development for example, defining and protecting property rights there is more controversy about what the state should do and how it should do it in areas such as regulation and industrial policy. (Levy, 1997) Market turbulence or change in the eco-system conditions does not impact the rights of the willful owner/investor. Such situations could create catastrophic imbalance in the market situation and potentially eradicate or extinct a specific class or group of people. Every government and international bodies have evolved to their existence with some specific reasons to protect the rights of the private property so that market economy functions effectively.
3 Regulatory Mechanisms 3 REGULATORY MECHANISMS TO ENSURE RULE OF LAW AND PROTECTION OF PRIVATE PROPERTY According to the economist Suranovic(1996), One question often posed is whether economic globalization represents an opportunity or a threat. The correct answer is that globalization is both an opportunity and a threat. Any change in international trade policy, such as the establishment of regional free trade agreements, will cause changes in the domestic prices of many goods and services. Any price change, regardless of direction, will benefit some groups and hurt others within the country. The decreasing prices of importable goods will harm individuals who earn income in the import-competing industries, like textiles and footwear, but will benefit the consumers of those products. The increasing prices of exportable goods will benefit individuals who earn income in those industries, like aircraft and computer software, but will harm domestic consumers who purchase exportable goods. Whether free trade is an opportunity or threat depends on the source of your income and the type of goods that you purchase. There are different forms of law and regulatory bodies that we could see in day to day life to protect the private property. The following are few of them. Home ministry and Judiciary WTO: World Trade Organization Intellectual property laws (USPTO) Import-Export Laws SEBI: Securities and Exchange Board of India TRAI: Telecom Regulatory Authority of India RBI: Reserve Bank of India
4 Regulatory Mechanisms 4 Case Study: Money Market in India and the regulatory body in India The central banking and monetary policy is regulated by the Reserve Bank of India (RBI). The RBI is equivalent to the Federal Reserve (or Fed ) in the United States. This central banking system operates as an Independent government agency. The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as: "...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage." (RBI, 2007) As detailed by RBI, the main functions of RBI includes the following: (i) Monetary Authority: Formulates implements and monitors the monetary policy. Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors. (ii) Regulator and supervisor of the financial system: Prescribes broad parameters of banking operations within which the country's banking and financial system functions. Objective: maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public. (iii) Manager of Foreign Exchange Manages the Foreign Exchange Management Act, Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India. (iv) Issuer of currency: Issues and exchanges or destroys currency and coins not fit for circulation. Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality.
5 Regulatory Mechanisms 5 (v) Developmental role Performs a wide range of promotional functions to support national objectives. (vi) Related Functions Banker to the Government: performs merchant banking function for the central and the state governments; also acts as their banker. Banker to banks: maintains banking accounts of all scheduled banks. The Annual Monetary and Credit Policy Statement for the Year was announced by Dr. Y. Venugopal Reddy, Governor, Reserve Bank of India. This Statement consists of two parts: Part I. Annual Statement on Monetary Policy for the Year ; and Part II. Annual Statement on Developmental and Regulatory Policies for the Year The monetary measures for the FY are, Repo Rate: The repo rate under the LAF is kept unchanged at 7.75 %, Reverse Repo Rate: reverse repo rate under the LAF is kept unchanged at 6.0 %, Bank Rate: Currently at 6 %. Cash Reserve Ratio: 7.5 % (starting November 10, 2007 ) The Indian rupee has appreciated by nearly 10% since late 2006, posing an acute dilemma for Indian policymakers. In some ways, the present strength of the currency, which is now hovering just below the symbolic Rs40:US$1 mark, is an enviable problem. It suggests that the country's attractiveness to foreign investors is increasing and signals optimism about the Indian economy more generally. However, the concerns of exporters, who are part of India's economic resurgence, are rising as their goods become more and more expensive for overseas
6 Regulatory Mechanisms 6 buyers. The currency depreciated steadily for a decade after being floated in 1993, dropping from an average annual rate of Rs31.37:US$1 in the 1993/94 fiscal year (April-March) to Rs48.40:US$1 in 2002/03 (an average annual depreciation of nearly 5%). Between 2003/04 and 2005/06, however, the rupee appreciated against the dollar by 3% on average a year although there was considerable two-way movement of the rupee from month to month. The trend of steady month-on-month appreciation began in September 2006 and has been continuous since then (EIU Viewswire, 2007). The average rupee-us dollar rate in Oct 2007 was the lowest since 1999/2000.: The main reason for the rupee's appreciation during the year has been a flood of foreign-exchange inflows. Foreign Direct Investments (FDI): India's stellar economic growth and a large domestic market that offers promising opportunities along with the rising competitiveness in many sectors have made it an attractive export base for foreign companies. These factors have boosted FDI; in 2006/07 FDI amounted to around US$16bn, almost three times the previous year's figure. More than half of these inflows arrived in the final four months of the fiscal year (December 2006-March 2007). External commercial borrowings (ECBs): Indian companies have borrowed enormous amounts of money overseas to finance investments and acquisitions at home and abroad. This borrowed money has returned to India, boosting capital inflows. India's balance-of-payments (BoP) data (available to December 2006) reveal that inflows through external commercial borrowings (ECBs) amounted to an enormous US$12.1bn during April-December 2006, a year-on-year jump of
7 Regulatory Mechanisms 7 33%. In the first three months of the year, Indian companies notified the RBI of plans to raise nearly US$10bn in overseas debt. (EIU Viewswire, 2007) Foreign Institutional Investors (FII): In 2007, so far FII fund flow in the stock market is $18.8 billion, more than double of $8.85 billion in the same period last year. Another major source of portfolio capital inflows has been overseas equity issues of Indian companies via global depositary receipts (GDRs) and American depositary receipts (ADRs). Inflows from GDRs and ADRs amounted to US$3.8bn in 2006/07, a year-on-year increase of 48%. Another $34.67 billion has come in as remittances under invisibles, which includes fund transfer by NRI s and income from software exports. This year RBI decided not to buy dollars unlike the previous years which caused inflationary trends and now only those who need to import buy dollars and hence the demand for the dollars have dipped considerably while supply has increased. (Ghosh & Prabhakar, 2007) Indian policymakers face a difficult dilemma. On the one hand, the rupee's appreciation has benefited the economy by making imports cheaper. This is no small benefit--containing inflation has been high on the policy agenda during the past year, as the annual inflation rate (as measured by the point-to-point change in wholesale prices) rose to 6.1% in January 2007, compared with 4.2% a year ago. The inflation rate has subsequently moderated. This may offer the RBI some comfort in its battle against inflation, but the bank's new, stricter inflation target (4.5-5% in 2007/08, down from 5-5.5% in 2006/07) suggests that there will be one more increase in interest rates by the end of On the other hand, for both economic and political reasons, policymakers cannot afford to ignore the problems of exporters. Although exports account for a relatively small share of the
8 Regulatory Mechanisms 8 economy, India's rapid export growth in recent years has been an important catalyst of economic growth. Given the limited extent to which the RBI can intervene in the foreign-exchange market in the face of large and sustained capital inflows, policymakers can only stem rupee appreciation substantially by easing limits on domestic firms' overseas investments or restricting inflows--for instance, through further controls on ECBs. The RBI has already taken tentative steps in this direction, making it more difficult for Indian firms to borrow in foreign currency and eliminating the exemption from ECB limits previously enjoyed by real-estate firms. (EIU Viewswire, 2007) Who gains? The gain is mainly for the importers and the foreign travelers. This is good news for the Indian economy even after the crude oil price has gone up in the global markets and it has not affected the Indian markets, which other wise would have created inflation in the Indian domestic market. Who loses? The industries that are purely dependent on the exports are in a miserable position. The industries such as textiles, handicrafts, sea-food, agricultural exports, leather, IT and BPO. IT and business-process outsourcing (BPO) exports have expanded at an especially robust pace, with exports of software services reaching US$21.8bn in April-December 2006 (a year-on-year increase of 31%). However, the rupee's appreciation is alarming exporters, as it makes their products more expensive in overseas markets and erodes their international competitiveness. The RBI's deputy governor, Rakesh Mohan, recently referred to the effects of the rupee's appreciation as a case of "Dutch disease". There is already evidence in India of an export downturn in a number of sub-sectors. In the apparel sector one of India's major export industries--the strong currency has eaten into the value of exports to the US, which declined by
9 Regulatory Mechanisms 9 3.5% year on year in January-April (EIU viewswire, 2007). The exporters operate with a margin of 5-7%. With the Rupee appreciating over the dollar by more than 14% in the past 12 months, exporters are in deep crisis. Of the Tirupur town s four lakh workers, 7000 to 8000 have been rendered jobless in the past three months (Chandramouli, 2007) During the period January- April 2007, apparel exports to the US by China, India's most important competitor, rose by 57%. Moreover, for India the decline marks the reversal of a positive trend apparel exports to the US rose at an average rate of 21% a year after import quotas were phased out at the beginning of (EIU viewswire, 2007) Most Recent developments in the monetary control RBI has recently reviewed the current liquidity situation taking into consideration of the foreign funds inflows after the recent US Federal Reserve rate reduction; it has been decided to increase Cash Reserve Ratio (CRR) of all banks by 50 basis points to 7.50 per cent of their demand and time liabilities by 10-Nov This would be Rs 16,000 crores of funds to be sucked out by CRR hike. RBI expects that this could control the inflation by around 5% by fiscal end. This is a typical case of monetary tightening which is used to drain out excess money in the market. (Reddy, 2007) However the CRR hike is a kind of tariff enforced by the regulatory body on the banks since they do not earn interests.
10 Regulatory Mechanisms 10 Conclusion As we have seen many of the scenarios, Regulatory bodies are required in every market place as it would keep a good watch and control on the market situation. We should choose policies which cause more benefits, in total, than losses. In economic terms the policies are based on aggregate economic efficiency. This will occur if a country pursues free trade in most cases. Often times, supporting free trade or market influenced trade is misrepresented or incompletely described. Economics does not simply justify the popular notion that economic competition and free trade is best for everyone. According to Ricardo s Theory of Absolute advantages, even though the aggregate effect may be positive in a complete free market economy, but in my opinion benefits will not necessarily be positive for every individual or section of the people involved even in the long-run as we have seen in few of the examples earlier. However for a country like India, which has one-fifth of the world population; it might be suicidal for certain large population who might be below the poverty line who gets impacted drastically due to opening up of free trade decisions on one fine day by the regulatory bodies. These control, tariffs and the protectionism needs to be done in a slow manner that it does not damage the industry and society completely but give it a chance to grow along with the global markets within a period of time.
11 Regulatory Mechanisms 11 References Levy, B (1997): How can states foster markets?. Retrieved Oct 31, 2007 from EIU Viewswire (2007): India s strong Rupee. The Economist on the web. Retrieved Oct 21, 2007, from 64&story_id= Samuelson & Nordhaus (2007): Economics Eighteenth Edition. Tata McGraw-hill edition RBI (2007): RBI Website Retrieved Oct 31, 2007 from OSC (2004, July 17): The Hindu Online.Retrieved Oct 21, 2007from Ghosh, A & Sinha, P ( 2007, October 28): Hit by Rupee. The Times of India, Bangalore Edition. pp. 15 Chandramouli, R( 2007, October 28): Bloom to gloom:knitwear hub in cold. The Times of India, pp. 15 Aghion, P., R. Burgess, S. Redding, and F. Zilibotti (2003): The Unequal Effects of Liberalization: Theory and Evidence from India, LSE mimeo. London, UK: LSE. Retrived Oct 21, 2007 from Reddy dashes rate cut hopes with 0.5% CRR hike (2007, October 31). The Economic Times, Bangalore Edition p. 1,2 Suranovic, Steve( 1996): A new perspective on the choice between free trade and protectionism. Retrieved Oct 21, 2007 from
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