India On Cusp Of Fuller Capital Account Convertibility: RBI's Rabi Sankar
India is on the cusp of fundamental shift in the direction of fuller capital account convertibility, which may need to be managed through a combination of measures, according to RBI Deputy Governor T Rabi Sankar.
Changes such as the opening of a fully accessible route for debt investments and greater integration with the global markets will make India's capital account more open, Rabi Sankar said in a speech at the Foreign Exchange Dealers Association on Thursday.
"The rate of change in capital convertibility will only increase with each of these and similar measures," said Rabi Sankar, adding that this calls for more effective management of flows. "With that comes the responsibility to ensure that such flows are managed effectively with the right combination of capital flow measures, macro-prudential measures and market intervention."
The Fully Accessible Route allows foreign investors unfettered access to key government securities, including the benchmark 5-, 10- and 30-year bonds. This route was opened up as India tried to gain entry into global bond indices. It will mean that the macro-prudential limit of 6% imposed foreign investment in outstanding government securities will no longer hold.
With the Fully Accessible Route, over time the entire government securities issuance would be eligible for non-resident investment, said Rabi Sankar. "While experience of other countries suggest that non-residents are unlikely to hold a major portion of outstanding stock, substantial debt holdings might make India vulnerable to the risk of sudden reversals," he added.
Since this channel was permitted in the context of inclusion of India’s G-secs in global bond indices, there is a natural safety mechanism as index investors are unlikely to indulge in sudden reversals. It may need to be considered, from a macroprudential perspective, whether FAR should be linked to index inclusion.T Rabi Sankar, Deputy Governor, RBI
Amid all these changes, there is a need to consider a proper mechanism for information flow so that exchange and interest rate management can continue to be effective in an environment of larger offshore transactions, the deputy governor added.
In light of greater opening up, integration between domestic and overseas financial markets may rise. "As G-secs get held by global custodians and traded abroad, more and more non-residents get to hold Rupee assets and take Rupee exposure," Rabi Sankar said.
This would precipitate questions such as whether India is ready to allow such non-residents to hold rupee accounts. "This will be an important early step in internationalisation of the Rupee and, therefore, needs to be carefully considered."
The deputy governor also spoke on other changes that may need to be considered on the capital account.
For instance, the liberalised remittance scheme may need to be reviewed keeping in mind the changing requirements such as higher education for the youth, requirement of startups, etc. "There might even be a case for reviewing whether the limit can remain uniform or can be linked to some economic variable for individuals."
Some changes, such as allowing Indian banks to deal in the non-deliverable forwards market, are already helping in ensuring smoother integration between onshore and offshore markets.
For instance, the NDF-onshore spreads have substantially narrowed after allowing Indian banks into the NDF space, Rabi Sankar said. Other measures, such as the setting up a retail forex platform, are still to take hold, said the Deputy Governor, while urging banks to popularise the initiative.
In all of this, the job of the regulator will be like that of a gas regulator, he said.
"As someone once said, the job of a regulator is like the gas regulator in the kitchen: it cannot ensure the quality of the dish, but it can prevent the kitchen from blowing up," Rabi Sankar said. "The quality of the dish—that is, the efficiency with which investment needs of the country are met—is up to how well Authorized Dealers and other intermediaries adjust to the increasingly fuller capital account convertibility."