India s Experience with Capital Flow Management Rajiv Ranjan Director Department of Economic and Policy Research Reserve Bank of India Meeting of BRICS Economic Research Group February 27, 2011 New Delhi 1
Outline Trends in Capital Flows to India India s Approach to Capital Account Management Lessons from Capital Account Management in India 2
Trends in Capital Flows to India Table I: Key Components of Balance of Payments Crisis Year 1990-91 1991-92 1992-93 to 2002-03 Period Average 2003-04 to 2007-08 (US$ Million) 2008-09 to 2010-11 1. Equity 103 133 4,549 20,036 33,231 1.1 Net FDI 97 129 2,360 6,544 16,566 1.2 Portfolio Investment 6 4 2,189 13,492 16,664 2. Debt 7,069 4,272 3,885 17,913 19,884 2.1 External Assistance, Net 2,204 3,034 747 931 3,424 2.2 ECBs, Net 2,254 1,462 1,393 8,698 7,456 2.3 NRI Deposits, Net 1,536 290 1,773 1,993 3,483 2.4 Short Term Trade Credits 1,075-514 -28 6,290 5,521 3. Other Capital 16-628 184 7,050-14,118 4. Capital Account Balance (1+2+3) 7,188 3,777 8,617 44,999 38,997 5. Current Account Balance -9,680-1,178-2,340-4,718-36,860 6. Change in Reserves (5+6) (+: Increase/-: Decrease) -2,492 2,599 6,277 40,280 2,137 3
Trends in Capital Flows to India Table II: Relative Share of Debt and Equity in Capital Flows (in per cent) Crisis Year Period Average 1990-91 1991-92 1992-93 to 2002-03 2003-04 to 2007-08 2008-09 to 2010-11 1. Equity 1.5 3.0 54.0 52.8 62.6 1.1 Net FDI 1.4 2.9 28.0 17.2 31.2 1.2 Portfolio Investment 0.1 0.1 26.0 35.6 31.4 2. Debt 98.5 97.0 46.0 47.2 37.4 2.1 External Assistance 30.7 68.9 8.8 2.5 6.4 2.2 External Commercial Borrowings 31.4 33.2 16.5 22.9 14.0 2.3NRI Deposits, net 21.4 6.6 21.0 5.2 6.6 2.4 Short Term Trade Credits 15.0-11.7-0.3 16.6 10.4 Note: Equity Debt composition of Capital Accounts excludes other capital 4
Trends in Capital Flows to India Table III: Key Components of BoP as a percentage of GDP Crisis Year (in per cent) Period Average 1990-91 1991-92 1992-93 to 2002-03 2003-04 to 2007-08 2008-09 to 2010-11 1. Equity 0.0 0.0 1.2 2.3 2.3 1.1 Net FDI 0.0 0.0 0.6 0.8 1.1 1.2 Portfolio Investment 0.0 0.0 0.6 1.5 1.2 2. Debt 2.2 1.6 1.0 2.0 1.4 2.1 External Assistance, Net 0.7 1.1 0.2 0.1 0.2 2.2 External Commercial Borrowings, Net 0.7 0.6 0.4 1.0 0.5 2.3NRI Deposits, Net 0.5 0.1 0.4 0.2 0.3 2.4 Short Term Trade Credits 0.3-0.2 0.0 0.7 0.4 3. Other Capital 0.0-0.2 0.0 0.8-1.0 4. Capital Account Balance (1+2+3) 2.2 1.4 2.2 5.1 2.7 5. Current Account Balance -3.0-0.4-0.6-0.5-2.6 6. Change in Reserves (5+6) (+: Increase/-: Decrease) -0.8 1.0 1.6 4.6 0.1 Memo Item: Real GDP Growth Rate 5.3 1.4 5.8 8.7 7.8 5
Trends 2007-08 - Deluge Example 1: During the phase of high inflows Net capital flows to India increased from US$ 45 billion in 2006-07 to US$ 107 billion during 2007-08 Inflows excess of CAD (US$ 15 billion) Reserve accretion of US$ 92 billion RBI used a number of instruments in combination to manage the surplus; Around US$ 78 billion purchases of forex MSS (US$ 26 billion) CRR ( US$ 12 billion) LAF OMO Combination of GOI surplus balances, Foreign exchange swaps, liberalization of capital outflows, pre-payment of external debt, lowering of interest rates on NRI deposits 6
Trend 2008-09- Crisis Example 2: Experience during the crisis and RBI policy measures During 2008-09 capital flows ebbed to US$ 9 billion. CAD rose to US$ 29 billion Reserves declined Volatility in capital flows translated into sharp volatility in the exchange rate. Drying up of forex liquidity, RBI took several measures to ease liquidity; Rupee-dollar swap facility for Indian banks Special Market Operations (SMO) Upward adjustment of the interest rate ceiling on NRI deposits, relaxation in the ECBs and short-term trade credits. Domestic liquidity enhancing measures- OMO, special repos, buyback of MSS securities (de-sequestering), special refinance facilities, sharp and swift reduction in policy rates 7
Capital Account Management Changing Views Bretton Woods institutions have reversed their earlier approach IMF (2010): circumstances in which capital controls can be a legitimate component of the policy response to surges in capital flows The World Bank : capital controls might need to be imposed as a last resort to help mitigate a financial crisis and stabilize macroeconomic developments. G20: Acceptance 8
Capital Account Management in India Capital account liberalization began in 1991 following balance of payments (BoP) crisis The analytical foundations for reforms were provided by three reports: Report of the High Level Committee on Balance of Payments (Chairman: C. Rangarajan, 1991) and Two reports on Capital Account Convertibility (Chairman: S.S.Tarapore, 1997 and 2006). Reports suggested: i. Encouragement to private capital inflows ii. iii. iv. Shift from debt creating to non-debt creating flows Within debt - A shift from short-term to long-term debt Monitoring of external commercial borrowings v. Gradual liberalisation of outflows. 9
India s Approach to Capital Account Management India has used mild capital controls as a part and parcel of the liberalized process- to grant 'a breathing space' to implement more fundamental reforms The policy approach in India to the issue of capital flows has evolved from the broader objective of maintaining financial and macroeconomic stability. sequencing of the process conditional on underlying domestic macroeconomic fundamentals and sustainability of the BoP. The CAL is a process rather than an event. 10
Capital Account Management: Salient elements An explicitly stated active capital account management framework- Non-debt creating Flows and Long Term Flows Policy space to use multiple instruments Short-term debt permitted only for trade transaction Avoiding the original sin Prudential regulations to prevent excessive dollarisation of balance sheets of financial sector intermediaries - banks Cautious approach to liability dollarisation by domestic entities Significant liberalisation of permissible avenues for outward investments for domestic entities 11
Capital Account Liberalization - current status Considerable Progress made. Non-residents provided considerable extent of convertibility - Can invest through portfolio investment route- Recently QFI including individuals and groups permitted to invest Residents: More restricted - Corporates, financial institutions & individuals Corporates- ADRs/GDRs/ECB Banks can borrow up to 50 % of unimpaired Tier I capital Outward Investment Corporates 400% of net worth Banks can invest abroad upto 25 % of DTL Mutual Funds can invest abroad with agg. Limit of US$ 7 billion Individual can remit upto US$ 100,000 per annum 12
Capital Account Management: Instruments Preference: FDI over FII; Rupee over FC; LT over ST FDI is freely allowed subject to sectoral limit ceilings revised upward; certain sectors prohibited; Outward Also Foreign Portfolio Investment No prior approval- sectoral and individual limits - no reversal of policies Debt flows ECB and NRI deposits modulated- both Price and quantity FII Investment in Sovereign debt US$ 15 billion FII Investment in corporate debt US$ 45 billion ECB Automatic and approval Route; All in Cost ceiling; End use restrictions and minimum maturity. NRI deposits - interest rate ceiling linked to LIBOR/SWAP In sum, gradual and calibrated liberalization - sequencing 13
Lessons from Capital Account Management in India 1. It is necessary to integrate the capital account management (CAM) with other policies. Especially fiscal management, regulation of the financial sector and monetary policy 2. CAM should be treated as an essential component of countercyclical policies. 3. CAM cannot be divorced from the development in foreign exchange markets and developments in current account. 4. To ensure credibility and effectiveness of the CAM, it is necessary to ensure that there is full commitment of the public policy both at the level of the government and the central bank. 14
Lessons from Capital Account Management in India 5. CAM may involve both price and administrative measures. 6. Capacity of the central bank to intervene at the time of the depreciation of the currency is limited, while not so in appreciation. So policy in reduction in volatility has to incorporate necessary caution in strategies adopted. 7. Nature of capital flows and the complexity in the operations of financial intermediaries keep changing requiring sufficient flexibility in the CAM measures. 8. CAM is a tool that is necessary at all times, even when used as a purely temporary measure. 9. The critical part of CAM relates to the financial sector where the stability of financial institutions and the exchange rate are closely inter-twined- Important regulation of financial sector 15
Trends in Capital Flows to India (Contd..) External Sector Vulnerability Indicators (Per cent) Indicators End-March 2008 End-March 2011 End-Sep 2011 1. Ratio of Total Debt to GDP 18.1 17.4-2. Ratio of Short-term to Total Debt (Original 20.4 21.9 Maturity) 21.2 3. Ratio of Short-term to Total Debt (Residual 37.6 42.2 - Maturity) 4. Ratio of Concessional Debt to Total Debt 19.7 15.5 14.7 5. Ratio of Reserves to Total Debt 138.0 99.5 95.4 6. Ratio of Short-term Debt to Reserves 14.8 21.3 22.9 7. Reserves Cover of Imports (in months) 14.4 9.6 8.5 8. Reserves Cover of Imports and Debt Service Payments (in months) 9. Debt Service Ratio (Debt Service Payments to Current Receipts) 13.6 9.1 8 4.8 4.3 4.9 10. External Debt (US$ billion) 224.4 306.4 326.6 -: Not available 16
Infrastructure financing with global savings To facilitate infrastructure financing 100 per cent FDI is allowed under the automatic route in some of the sectors FDI is also allowed through the Government approval route in some other sectors Debate on possibility of using foreign exchange reserves for investment in infrastructure sector Reserves for such purposes does not meet the criterion of reserve management objectives However, a special and limited window has been created RBI invests in Special Purpose Vehicles (SPV) of the IIFCL Investment on repatriation basis by new class of eligible nonresident investors in Rupee and Foreign Currency denominated bonds issued by IDF-NBFCs and Rupee denominated units issued by IDF-MFs 17
Infrastructure financing with global savings Opening of debt market to foreign investors with a three year lock-in period RBI has liberalised and rationalised the ECB policies concerning infrastructure sector The limit for corporates implementing infrastructure projects to avail ECB in a financial year raised to USD 750 million from USD 500 million under the automatic route Indian companies in the infrastructure sector allowed to import capital goods by availing of short-term credit in the nature of bridge finance Indian companies in the infrastructure sector allowed to avail of ECB in Renminbi, under the approval route 18
Thank You 19