Capital a/c liberalisation possible in medium term: RBI...

Indicating a slowing down in the country’s economic growth, the Reserve Bank of India (RBI), in its annual report for 2007-08, has said that going forward, the overall balance of risks to the short-term global growth outlook remains tilted towards the downside, with growth in advanced economies expected to fall well below their potential.

However, it is important to recognise that the development of financial markets is a gradual process. While continuing to work on development of the financial markets, capital flows have to be managed through other tools in the short term. The gradual process of

fuller capital account liberalisation could be pursued over the medium-term, keeping in view, the issues raised by recent financial market turbulence in advanced economies, the RBI said in its report.

The report further adds that the issue, therefore, is not either financial market development or management of capital account, but how much of each approach should be adopted in a given situation and over time, while recognising and taking into account the scope and prospects for reforms in fiscal and real sectors.

According to the annual report, notwithstanding the improved position, there are several underlying fiscal pressures that are not entirely evident in the headline fiscal indicators. Although the implementation of fiscal rules has had a positive effect of focusing attention on fiscal issues, there has been an increased recourse to other fiscal liabilities.

The issuance of bonds has been resorted to frequently for financing not only fuel, food and fertiliser subsidies, but also deferred liabilities with regard to bank loan waivers and contribution to capital of public sector banks. Although the issuance of such bonds does not directly increase the conventionally measured fiscal deficit, the proceeds from such bonds are used to effectively fund current subsidy expenditures.

Their macroeconomic and financial market impacts and crowding out of resource availability to the private sector are similar to an expansion of the fiscal deficit, the report notes. The significant quasi-fiscal transactions to finance recurrent revenue expenditures through de facto borrowings also create apprehensions about the quality of the fiscal consolidation process that is underway and poses challenges for fiscal, external and monetary management cautions the report.

“While the need to eliminate revenue deficit and target a nominal limit on fiscal deficit is important, the mode of financing of the fiscal deficit and the appropriate use of resources so raised are equally important, particularly in the context of pressing requirements for adequate investment in social and financial infrastructure. Furthermore, there is a need to work towards durable fiscal correction and consolidation through fiscal empowerment, i.e., by expanding the scope and size of revenue flows,'' said the report.

It would also be the endeavour of the RBI to further deepen and widen the various segments of the financial market by improving market infrastructure, increasing the number of participants and introducing new instruments especially, those for hedging market risks. Going ahead, some segments of the financial market such as term money market, derivatives market, and corporate bond market and creation of secondary markets in certificates of deposit and commercial paper may require greater attention of the RBI .

Efforts would also be made to facilitate further integration of the markets so as to strengthen the monetary transmission mechanism and ensure efficient dispersal of risk amongst various market participants, especially in the context of the envisaged move towards fuller capital account convertibility. Furthermore, with increasing liberalisation and integration with global financial markets, the focus would be on ensuring that domestic financial market participants are in a position to absorb unanticipated and large shocks should they arise, so that financial stability is maintained, said the report.