Key note address by Dr. Y V Reddy, Deputy Governor, Reserve Bank of India, at the CII seminar on `Emerging Scenario in Foreign Currency Management' on February 20, 1998 in Mumbai.

Emerging Concerns and State of Indian Economy

On this occasion, I propose to address the limited issue of identifying the emerging concerns on the state of economies of emerging markets with particular reference to recent developments and place before you a factual account of the current scenario in the Indian economy.

The Recent Crisis

First, it was unexpected, by almost all concerned i.e., Governments, multilateral institutions, rating agencies and market participants.

Second, it is unusual since its origin is not of low economic growth or low savings or high government deficit or financial repression but in a way failure of the market mechanisms or private sector.

Third, it is pervasive since it is a crisis of currencies, corporates stocks and banking.

Fourth, it is the most contagious so far, with an impact, initially on neighbours, then other developing countries and soon developed world also.

Fifth, it is still, by and large inexplicable though the immediate cause appeared to be sudden confidence erosion and global scale herding by market participants.

Sixth, the response of the official policy makers and the international financial community seems to have been often delayed and pretty much behind events - following or reacting to events rather than shaping them.

Seventh, it is not only pervasive and widespread but also deep - say the extent of depreciation of some currencies.

Eighth, while there are some similarities between the directly affected countries, there are significant dissimilarities.

Ninth, similarly while there are some internal causes (i.e. domestic situation or excessive short-term borrowing and lending to non productive sectors) there are also some external causes (i.e., global factors such as developments in Japan and China, including in particular excessive lending from major financial centres.)

There are three important aspects of the crisis which we need to note.

Firstly, it appears to be a case of unrealistically high expectations and disappointment on the part of participants.

Secondly, there is still some lack of consensus on the appropriate response, as also the role of relevant institutions.

Thirdly, and most important to all this, there is a widespread agreement that the concerned economies will bounce back but the issue is, how soon and at what cost, even if they are transitional. Also, bounce back will necessarily be different for different affected countries.

Areas of Concern

Emerging Concerns and Indian Economy

Macro-Economy

The current account deficit as a per cent of GDP has been consistently in the range of 1 to 1.8 per cent, and has averaged 1.3 per cent, and the current year's position would not be very different.

Fiscal deficit of Government of India as a percentage of GDP had come down gradually from 6.1 per cent in 1994-95 to 5.5 per cent in 1995-96 and 5.0 per cent in 1996-97. Though there are some fiscal strains, it is hoped that there would be no directional change.

The annual rate of growth in Broad Money (M3) was 22.3 per cent in 1994-95, but dropped subsequently, pulling down the annual average growth rate between 1994-95 and 1996-97 to 17.3 per cent and in the current year it should be around 15.5 per cent. There is a similar pattern in regard to inflation, which averaged 7.4 per cent between 1994-95 and 1996-97 and the wholesale Price Index this year is estimated to be around 6 per cent, less than last year's 6.9 per cent.

Finally, non-food credit growth has averaged 21 per cent per annum in the last three years and this year it is expected to be around 20 per cent including investments in PSU and corporate bonds, debentures and CP.

As you may be aware, the latest CSO estimate places GDP growth of 1996-97 at 7.5 per cent and net capital inflow from abroad for the last two years has been placed at 1.86 and 1.15 per cent of GDP at market prices.

External Sector

The Foreign Direct Investment flows continue to rise and are USD 2.5 billion during April-December 1997-98 as against $ 2.7 billion during the whole of 1996-97. More important, the policy framework and the procedures ensure that most of the value of FDI flows to infrastructure and productive sectors.

FII investments during the current year so far are less compared to $ 1.9 billion for the entire 1996-97; but, it is expected that it would be at least $1 billion during this year. The flows on account of external aid last year, commercial borrowings and non-resident deposits are positive on a net basis, and broadly as per expectations at the beginning of the year.

The invisibles have also been on track and as a result, the foreign currency reserves as on February 6, 1998 are higher at $ 24.4 billion compared to $ 22.4 billion at the beginning of the financial year.

More important, some mention about external debt management and magnitudes would be in order. The RBI controls by a process of approval of each case, the total short term debt, including trade related credit beyond 180 days. Our short-term debt as a per cent of our reserves is around 27 per cent, while as a per cent of total external debt, it is about seven per cent. Each external commercial borrowing, including maturity, interest terms etc., has to be approved by the Government/RBI. In fact, a micro level productive use of such external debt is ensured during the approval process. In fact, our volume of external debt has been generally on the decline and during 1993-97 total external debt was reduced by one billion US Dollar, while there was accretion to reserves of the order of US $ 16.6 billion. Indeed, strict control over external debt is the cornerstone of our external sector liberalisation.

Sometimes, the issue of forward liabilities of the central bank is raised. We have been very cautious by generally limiting such aggregate outstanding liabilities and rarely does it exceed 10 per cent of reserves. Of course, there is no rigid rule. We observe great prudence in these matters while exercising flexibility. We publish all such operations from time to time. Finally, the exchange rate is flexible but volatility has been and is being checked by the Reserve Bank of India.

Financial Sector

Second, lending to property is frowned upon and is generally restricted to housing finance.

Third, lending to stocks is also severely restricted and there is a ceiling of 5 per cent of incremental deposits for this purpose. Actually, very little of this facility has been used.

Fourthly, by virtue of close monitoring and approvals required and in the absence of derivatives etc., off balance sheet items of banks are minimal and closely monitored.

Fifthly, the banks are permitted to borrow or invest abroad only up to 15 per cent of their net unimpaired capital.

The authorised dealers (apart from a few money changers) on foreign exchange are almost always banks, whose exposures, open positions etc. are closely monitored.

Sixthly, the non banking financial companies have been brought under tight legislative, regulatory and prudential framework recently.

Corporate Sector

Also, as a percentage of total debt, external debt was about 10 per cent in respect of large corporates and less than 2 per cent in respect of all corporates covered by the study in respect of 756 selected companies.

At the present juncture, therefore, corporate sector of India as a whole is not overexposed to external liabilities.

Transparency

Conclusion