What is most likely to cause tariff reductions within the Indian economy?
Directions: Read the passage and answer the question that follows:
Banks, trading companies, leasing companies and multinational corporations have currency convertibility risk even if they don’t currently attempt to quantify the risk on their balance sheets. Buyers and sellers of currency convertibility protection must not only have a feel for pricing credit derivatives, they must be economists with a penchant for econometrics. These are negotiated transactions. Price, terms, conditions, and size are all negotiated directly between counterparties. As there are so few real counterparties for this type of protection, the broker market is usually ineffective. It is much more effective to contact well–known counterparties in the credit derivatives market and negotiate the transactions and market levels directly. This is a supply and demand driven market, and prices vary from counterparty to counterparty. Sovereign whim can drive this market. Buyers of convertibility protection have a knock–in spot trade. The knock–in is independent of currency levels; sovereign dynamics trigger the event. Credit spreads don’t matter; models don’t matter; intuition doesn’t count. There is no exact mathematical model. The market defines the price.
Recent reactions to the snap poll conducted in Bombay to gauge the atmosphere and expectations about convertibility are symptomatic. Bankers, since their assets are more liquid, and their technology frontline, are optimistic and eager. Industry, alas, is bearish. This doubtless owes in large measure to the manner in which it has been accustomed to function.
The biggest canard meanwhile is that exporters, or those involved in import substitution, alone can extricate us. As matters stand, apart from unjustly enriching a handful, the 'thrust' on exports, based on a rigging of reality and relative prices, has achieved nothing. A telling substantiation of this has been provided in a recent study by Mr. Bimal Roy in the Economic and Political Weekly. He shows how net Indian exports have been stationary over the past 20 years. The study, it may be noted, spans a period over which a variety of fiscal sops were extended to exporters.
Clearly, exports have failed, and there is still a debt to service and repay. Continued tinkering with the convertibility question, therefore, can help only those who would like to varnish the ancient regime. Consider the system now in place. Targeted at exporters and other hopefuls who fetch foreign exchange (FX), it simultaneously imposes a tax on them. This dualism involves that 40 percent of FX earning have to be surrendered to government – but at a rate, which actually undervalues foreign exchange. This is a bit, which then goes towards sustaining official monopsony, and discretionary distribution through channelizing agencies.
The remainder goes towards financing defense purchases, promotion trips, festivals and what not. With a repressed domestic market nestling behind Olympian tariff walls manufacturers who would like to export are, in turn, few. Despite discomfort with Fund–Bank suggestions that Indians, for the present, should concentrate on primary – and lesser value added – exports, that is precisely what manufacturers have been doing while supplying limited quantities of obsolescent manufactures to the domestic tariff area (DTA). Opportunism, and correct opportunity costs make strange bedfellows after all. Without doing away with conditions, which foster the former. India will, in fact, face a future much bleaker than that foretold by even the digitizes.
Note what the present focus on exporters implies. Since, till now, this has been to the exclusion of emphasis on foreign direct investment (FDI)/import substitution through FDI, this implies that, somehow, official – and doubtless entrepreneurial – India prefers to allocate a relatively inferior weight to FX earned/saved through FDI. What, quite evidently disconcerts, more than the presence of aliens, is the cold fear of competition.
Meanwhile, for the intrepid who have already ventured in, the world, which exists, is cozy. Tariff walls and quota restrictions (QRs) allow rentals for all, while the relative overvaluation of exchange rates further spurs the favoured to source more from "home” than from "host'! This is precisely the ambience, which can never kick–start flaccid manufacturers to double as exporters.
The obvious thing to do, therefore, is to introduce competition. And to do so within the DTA, before Fund conditionalities drive the country towards an untimely acceptance of far reaching tariff reductions. This competition will be of no use, however, if all that is yielded is a pantomime confrontation between the obsolescent and the antediluvian, along with the usual rag–tag of 'foreign' add–ons. To avoid this eventuality, nothing less than complete current, and capital account convertibility, along with total industrial liberalization, will do.
Take current account convertibility first. This is the commonest form around, and even economies like Indonesia, Thailand, Taiwan, Malaysia, Singapore, and Hong Kong, quite apart from OECD ones, abide by it.
The closest analogy here is with ISO 9000 certification – currently much in the news. For convertibility too proclaims the existence of certain credible standards which investors, prior to proceeding, like to take for granted. The most crucial one out of these standards has, of course, to do with the ease of profit repatriation.
This is something, which should provide no greater hurt to a nation's integrity that, for instance my banker adversely affects me by charging for his services. Better still, unlike bankers' charges – or interest – this does not entail a recurring charge, regardless of performance. Further, convertibility will happily end official seigniorage where export revenues are concerned. A particularly useful feature of convertibility, meanwhile, is that it prevents the hemorrhaging of retained earnings within the country; such earnings, whenever denied a vent, are usually diverted to speculative uses – or worse.
Secondly, great care must be taken to avoid the temptation to 'fix' the parity. Not only will that preclude needless diversion of energy for the RBI, the efficiency gains of convertibility will also thereby be preserved from sacrifice at the altar of a fetish. Because, if convertibility provides confidence to the prospective investor, floating rates (and import liberalization) serve to keep him on his toes.
The greatest impact of the capital account convertibility would be felt in the banking sector. Total deregulation of the interest rates would instill greater competition in the circle. The weaker banks would further be cornered as `narrow banks`. NPAs reduction would be at focus of attention of banks which would help regaining of its financial health. Margin of banks would be under pressure, infusing adequate asset liability management system in the banks. However, banks will have much more liberal limits for borrowing and deploying funds outside India. Indian banking system should surge ahead in this occasion and accept the challenge by eradicating its weak points and consolidating its financial health.