Full Capital Account Convertibility: Need for Caution

The debate around capital account convertibility is once again likely to become live in India after the Reserve Bank of India Governor, Raghuram Rajan referred to the need to move towards with a pre-defined time frame. Though it was capital account convertibility, in an academic context while speaking to students at the Gokhale Institute of politics and Economics in Pune. Every time when this issue emerges, arguments are made for fuller capital account convertibility, the governments officials, economists and investors all begin weigh the pros and cons of convertibility, until it is realized that the timing is not yet right and it would be perileous, then the debate closes. Same fate of this debate can be expected this time as well. .

However, the minister of state for finance Jayant Sinha too immediately after, picked that very hastily and even stated that capital account convertibility is one of the measures that India must take over a period of time such as to become a leading global economy. He further asserted that we have to make it possible for our capital markets to be broader, deeper and for that, capital account convertibility also becomes important, Though Mr. Sinha said so without specifying any particular time frame. But FCAC is not the need of our economy at all. Rather, it is more of long awaited opportunity for foreign institutional investors and speculators

In every respect time is still not ripe for moving to full capital account convertibility (FCAC) and would prove to be a misadventure as yet. Attempts are being made for FCAC since 1997. In 1997 on but, after learning a lesson from the Asian crisis of 1997, P. Chidamberam the then finance minister in the third front government had to retreat from his firmly declared intent to do so. The IMF, one time strong votary of the capital account convertibility (CAC) for India, too had to abandon its campaign for the same, then in the late 90s itself. The most vociferous advocate of the IMF’s erstwhile campaign for the CAC worldwide, and former chief economist of the World Bank, John williamson too had thereafter become the most skeptical of the results of FCACC and had cautioned India too that any premature move towards it would increase the risk of things going worse.

What the full capital a/c convertibility would mean?

Capital account convertibility means legal freedom for every citizen or non-citizen as well as corporates in the country to convert there rupee assets into any foreign currency and back for all kinds of capital transactions. India has current account convertibility but not capital account convertibility. Every one of us would have the option to have even our ordinary bank fixed deposits too into any currency, without seeking any approval from anywhere. Thus it would mean:-

·         Freedom to convert local financial assets (including those of Indian citizens and corporate) into foreign ones at market-determined exchange rates.

·         Allows to freely exchange of currency and an unrestricted mobility of capital into and of the country.

·         May be beneficial for a country with very strong external sector fundamentals. Because it enhance faith of investors into that currency and inflow of foreign investment too might increase. But, India altogether lacks such fundamentals, with heavy trade, current account and fiscal deficits. 

·         Therefore, the flip side, is that it might destabilize the economy due to massive surge of capital flows in and out of the country.

It is no secret that if Indians are given freedom to convert and maintain their capital balances in foreign currencies in overseas banks and if Indian banks are allowed to raise up to 100 percent of their capital, by overseas borrowings as earlier recommended for phase - II and III by the Tarapore committee - II, appointed by the RBI. Then, majority of the elite Indians and corporate units might rush to convert their capital balances from rupees into dollars, euros and pounds. Many persons would borrow funds in foreign exchange, speculate in derivative trading in currencies and may even get bankrupt to bring unprecedented pressure upon the exchange rate. This would deflate demand for rupees and generate insatiable demand for leading foreign currencies, ultimately leading to a meltdown of rupee value to any depth.

Such a meltdown would not be a distant possibility after the FCAC, as our economy is even not as mature as were the South East Asian Economies in the pre-1997 crisis period. All those economies viz. the South Korea, Thailand, Malaysia, Indonesia and Philippines were having much stronger macroeconomic fundamentals. The growth rates were booming, inflation rates were low, forex reserves were piling up. Inflow of foreign capital was steadily growing in the pre crisis year and all these 5 economies received a net capital flow of $ 93 billion. Yet, they faced a shivering crisis solely due to the FCAC. Had there been partial restrictions on convertibility the crisis would not have precipitated. India stood unscathed, mainly because the rupee was not a freely exchangeable currency.

Moreover, there is no conclusive empirical evidence to prove that CAC is necessary for smooth and rapid economic growth and development. In a cross-country study, Dani Rodrik of Harward has found little correlation of per capita income growth, investment and inflation with capital account convertibility. In another study, conducted by Prasad, Eswer, Kenneth Rogoft, Shang Jin and M Ayhan of IMF, they failed to find evidence that a complete absence of controls brings faster growth or other economic benefits. Hence, there are no apparent gains of FCAC, but, there is every likelihood that it would lead to a worst crisis.

It is no secret that India’s external sector was quite vulnerable till recently before the sudden respite in oil prices. The current account deficit last year in 2012-13 it self was above the comfort level of 2.5 per cent of the gross domestic product. It was 4.2 per cent of gross domestic product (GDP) in 2011-12 and rose to 4.7 per cent in 2012-13. Only after severe curbs, including restrictions on import of precious metals and unprecedented fall in oil price, the deficit fell to 1.7 per cent in 2013-14. In 2014-15, it stayed low, with the third quarter showing a deficit of 1.6 per cent, solely due to respite in the oil prices.

The fiscal situation is though partly under control, yet, it continues to be fragile. The fiscal deficit of the central government had been 4.6-6.5 per cent in the past six years, before falling to 4.1 per cent in 2013-14. The government is committed to keeping the fiscal deficit low and the target of 3.9 per cent has been retained for this year. The deficit target is being scaled down to 3.5 and three per cent in 2016-17 and 2017-18, respectively.

   Any imminent move towards further opening up of the capital account is unwarranted, as the RBI had tough time to regulate the debt market movements.

These are the debt markets where most of the capital account restrictions do lie and would go with FCAC. The RBI had tough time to manage this market over the past 12-18 months. The overall limit for foreign inflows into government debt has remained static at $30 billion since 2013. This limit was fully used up last year when foreign investors rushed to buy Indian debt on the expectation that falling inflation and lower interest rates in the economy would be positive for gains in bonds. Since then, the foreign institutional investors have (FII’s) actively lobbied for a revision of that limit, and the RBI has not relented. The inflows into corporate bonds are also restricted at $51 billion and this hasn’t changed recently either. But, all such restrictions would have to go away with FCAC. All these limits on inflows were crucial according to the RBI which has pointed that without these limits the potential for volatility in debt flows was high at a time when the US was starting to normalize monetary policy. Moreover it wasn’t just the quantum of inflows that the RBI has continued to restrict. The central bank had also to micro-manage the nature of flows. Even, very recently, in the February 2015 itself, the RBI had to ban incremental investments from foreign investors into commercial paper, just due to the short-term nature of these investments. The fear was that any time on a sudden outflow of funds from this market due to global reasons could lead to an unwarranted spike in corporate funding costs.

A similar precautionary decision had been taken regarding foreign investments in government treasury bills in April 2014 following the experience of August-September 2013. At that time, heavy selling from FIIs in government debt, particularly short-term debt, had led to a sharp fall in the Indian rupee, leading to several ramifications in the economy. So, a liaising fair policy towards the capital account would be precarious. 

Rather, as the things stand, all future investments from the foreign institutional investors (FIIs) into Indian debt will need to have been regulated well with a minimum residual maturity of three years.

With respect to the external commercial borrowings too, the RBI had to  kept a strict watch on these. There are sectoral limits in place, restrictions on the cost at which such debt can be raised and what it can be used for. The central bank has not opted to announce any significant liberalization in recent years inspite of such a demand. Then, how all these regulation be allowed to with FCAC.

 Indeed, India’s economic fundamentals have to be far more robust, and the global environment more benign with lesser turbulence, before the country can consider further easing of the restrictions on debt flows. Moreover, same is true for capital investments too.

Where is the need for the FCAC, when the economy is already growing at 7.4 percent p.a. without FCAC. Even if the proposed move is intended to facilitate foreign investments, though they are not going to benefit us in any way and are bound to harm in the long run with growing repatriations, yet the economy is receiving the foreign investment too steadily to bridge the current account deficit, though that is also quite unhealthy practice. Moreover, the China is receiving even more FDI than us while it has even not moved for market determined exchange rates then what to talk of capital account convertibility. Even, the RBI's attempt to appoint the Tarapore committee II a decade ago to draw a road map for FCAC was a futile and unwarranted attempt as the pre-conditions laid by the committee a decade ago, are yet quite distant. Indeed, FCAC would allow unrestricted conversion of the rupee assets into any currency (dollar, pound, euro or any other currency) at the going exchange rate. It would empower the citizens to convert their monetary assets into currencies of their choice. The foreign direct investors too would be free to take out their money any time without any restrain or charge.  Indian citizens, companies and banks would also become free to invest, speculate and borrow (even for non-productive speculations) in any currency.

            It may also be true under certain context that the FCAC is the mark of well-matured economy but has our economy matured for the FCAC is a big (?) question mark. Even China, having a robust trade surplus of $380 billion (almost equal to our total expoets) and cushioned with a voluminous pile of $ 4 trillion forex reserves has no intent to move  for the CAC. It has even not thought of a market determined exchange rate in spite of such a thick pile of forex reserves and towering trade surplus, where we are below the benchmark and both are to our disadvantage. China had not at all cared for the Euro-American pressure and displeasure when we were complying to the Fund-Bank sponsored structural adjustment, and kept its currency fixed at 8.28 Yuan to the US dollar from 1994 to 2005. It helped China to bring down its inflation from 25 to around 2 percent. Thereafter, in the past one decade too it had a calibrated exchange rate management and allowed to appreciate its Yuan to 6.19 Yuan per dollar in such a calibrated manner to use exchange rate management as a fire wall against any imminent dollar driven or the exchange rate driven inflation. In comparison to china, when  our exports are one sixth of that of the china and exchange reserves are just around one tenth of the China's and to the contrary, we have a wide trade deficit too. The  free  given in early 90s float to the Re and convertibility of currency granted earlier in trade, current and partly in capital account too has not gave use any edge. In addition to this, if we have a look upon the large share of vulnerable receipts in our forex reserves, all time high trade and fiscal deficits, growing hold of foreign institutional invertors (FII's ) on our stock markets and the psyche of Indian elites, the FCAC appears to prove to be the biggest misadventure, if brought about. Rather it would be a boon to paint black money stashed abroad as white by round-tripping.

Need for a quicker Turnaround with Better Regulatory convergence

Reckless leveraging to generate imaginary wealth by fake financial innovations, leading to the present crisis has once again raised doubts about the credibility and reliability of the credit raters and the global financial regulatory  system, including the central banks of crisis ridden countries. The subprime in the US would not have permeated to the entire financial sector, but, the securitization of home mortgage loans coupled with the flow of foreign funds into the US Fed and the US government sponsored firms like Fannie Mae and Freddie Mac, finding its way to credit markets has led to reckless leveraging.

This reckless leveraging out of foreign funds has fuelled a debt financed and import driven consumer binge in the U.S., whereby the US consumers could spend $500-800 billion over and above their GDP for last seven years. Now, almost $3 trillion worth of mortgage backed securities in the U.S. and another $2 trillion worth of these securities have gone sublime in Europe. In view of such a huge meltdown out of incredible leveraging, a multilateral regulatory regime has to be put in place to assess the asset base and sustainability of securitization, absorbing global investments.

However, on the macro-economic front in case of India, the trade deficit might breach the $100 billion mark and the current account deficit may touch 3.5 percent of our GDP, worse than 1991-92, when India had to pledge gold with the Bank of England. Fiscal deficit might also touch 5 percent of our GDP, double of budgeted target of 2.5 percent and 40 percent above the limit of 3 percent fixed under the fiscal Responsibility and Budget Management Act.

Now, when almost in all parts of the world, the tremors of recession are being felt out of this crisis, a quicker turnaround has to be ensured. In this regard, India should plan to channelise its surplus savings to demand generating investments, instead of further opening up of the financial sector (including the insurance), the educational sector and other services for foreign direct investments. Indigenous resources, available shall have to be channelised for fresh investments and demand creation, for sustainable inclusive growth in the long run.

Compulsory License for Nexavar: A Laudable and Revolutionary Step

The first ever compulsory license granted for the cancer drug Nexavar to the Indian Pharma company Natco, which has offered to sell the monthly dose of the medicine at Rs. 8,800 vis a vis Rs. 2,80,000 being charged by the Bayer AG of Germany due  to its monopoly is a welcome move of the Indian Patent Office. The bold ruling of P H Kurian, the Patent Controller of India  is the first ever step of the Indian Patent Office, ever since the change of law from, process patent to product patent on the drug molecules, invented after January 1, 1995. Indian Patent office has paved the way for the future course, for the patent administrators in India and world over, especially in the developing countries.

The multinational companies dubbing the decision ‘as disappointing and another blow to innovation’, should feel ashamed for profiteering more than 3300 percent out of human sufferings. The Indian generic company Natco would also invest in the R & D, to develop the process to synthesise that drug at its end, and earn profit even at a price just 3% of what is being charged by the monopoly manufacturer, the Bayer AG of Germany and that too after paying a royalty of 6 % to the Bayer AG, as ruled by the patent controller. There are a number of other drugs, which also fall in the category of monopoly drugs, even as per the definition of the Food and Drugs Administration (FDA) of the US. Most of which are patented and exhorbitantly priced. All these need to be contested for compulsory licensing.

Some such examples, out of scores of such monopoly priced drugs, need a mention here. A single 50 ml injection of Roche’s anti-cancer drug Herceptin is sold at  Rs. 1,35,200, Merck’s Erbitux costs Rs. 87,920, Bristol-Myers-Squibb’s Ixempra sells at Rs. 66,460, Pfizer’s Macugen is being sold at Rs. 45,350, and Sanofi-Aventis’ Fasturtec at a price of  Rs. 45,000. Most of these are used against Cancer, Chronic pain management, Diabetes, Cardio-Vascular disorders and other Chronic ailments.

There is a point to feel jubilant for the masses, yet, caution is also needed, and public-health-groups should be vigilant to join as intervener, if the Bayer moves to the Supreme Court. Otherwise, if the Bayer would move to the Supreme Court and get an injunction, the issue would hang in air for an indefinite period. One should not forget that when Novartis, which was charging approximate Rs. 11,00,000 for its anti-cancer drug ‘Glivec’, obtained a stay from the Chennei High Court for more than a year, against the economically affordable Indian version of its basic compound, the Imentinib and 24,000 blood cancer patients had to suffer for months during the period of  stay, obtained on false pre-text of the molecule being of a date later than January 1, 1995. While the molecule was older one and  the court vacated the stay after the hearing was over.

In this case also, a section of commentators are advising the Natco to go for a compromise with Bayer and not to insist to sell Nexavar at such a low price. But, since the Natco would already be paying 6 % royalty on its sales, as ruled by the patent office, to the Bayer for its  invention, even at this low price.  This 6 percent is a fair reward for Bayer’s invention. So, people should raise strong voice to strong then the hands of the patent office and the Indian Pharma company Natco, with the purpose, that other Indian companies  also come forward to apply for compulsory licenses to make the costly monopoly medicines available at affordable prices.

This single decision in the history of new post-WTO patents regime has already sent shivers down the spine of the foreign Pharma MNCS. Therefore the ‘ Roche Holding AG’  a swiss pharma MNC has within days of this decision, bowed down and has announced to sell cheaper versions of its two costly anti-cancer drugs the Herceptin and Mabthra.

The single injection of Herceptin is available at Rs. 1,35,000 and Mabthra at Rs. 76000. But the proposed prices for a cheaper version of the two, would not  be as low as is being offered by the Natco by virtue of its compulsory license . Hence, other Indian pharma companies should come forward to make the costly monopoly priced medicines available at affordable prices, including these two. Moreover, Roche has though announced to sell these two medicines at a lower price, by a different name in India, but that would be  too take i.e by the end 2012 or 2013.

 Moreover, such a move by the other Indian pharma companies would save costly foreign exchange for the country, help to improve country’s balance of trade, enhance R & D in the pharma sector and facilitate growth of the Indian pharmaceuticals sector. This would also pave the way for the Indian generic sector to improve its outreach world-wide, if the Indian players succeed in getting compulsory licenses in other countries as well, as has happened when the sun pharma of India had got a compulsory license from the US for the anti-cancer drug Lipodox, the monopoly drug of Johnson & Johnson.

So, the social organisations, government and all political parties should explicitly support the Natco and Indian patent office in order to pave the way for many more such compulsory license applications. It is also necessary, to ensure that the Bayer AG do not drag the issue to the Supreme Court to kill time and compel the Natco to agree to compromise with the monopoly firm Bayer. Moreover, pressure of public opinion is also necessary so that issue is not dragged to the Dispute Settlement Body of the WTO, some time later.

The US protest over this issue of compulsory license to the Natco for this life saving drug issued by the Indian Patent Office on the ground of public health problem, is altogether unwarranted. The allegation of the visiting US Commerce secretary that it would discourage new investments & dilute the international patents  regime is not sustainable on any count. The Natco has been asked to pay  a royalty of 6% to the Bayer AG is the fair reward for the Bayer AG, the inventor. Profiteering to the extent of 3300% in the name of promoting research cannot be justified, that too in case of medicine for deadly diseases like Kidney & liver  cancer. The Minister of Commerce & Industries of India, the Mr. Anand Sharma has rightly defended the issuance of the compulsory license, by the Indian patent office and  the Government of India should stay firm on this issue and continue to do so in other such cases too. The patent office has strictly complied with agreement on TRIPS of the WTO. Patent should be used only as a means for fair rewards for the R & D, instead being allowed to be used as a tool for monopoly profiteering.

The AIIB, India and Changing Economic Landscape

The global financial architecture is subject to experience a sea change in the aftermath of the decision of major Western powers to join the Asian Infrastructure Investment Bank (AIIB), being floated under Chinese initiative. The twin major economic powers viz. the Japan and the United States have already got isolated and their apprehensive displeasure too may come true after this new realignment of the global economic diplomacy wherein this present century may turn into a Chinese Century. The Chinese initiated twin development banks, viz. the BRICS bank and the AIIB may bring a major shift in the global power-balance by paving way for gradual replacement of the 'Washington Consensus' by a 'Beijing Consensus' as a pre-requisite in global economic affairs. India has though, agreed to be among the founder members of both the China-proposed ventures, but China would enjoy a relatively more affirmative influence in both the ventures by virtue of her greater capital contribution and GDP. So, it is quite imperative that the AIIB with 57 or more participating countries and dominated by China, can enable it (China) to have greater influence, to wean many countries away from India, if it would have greater influence over the Board for Approval of Infrastructure Loans. Though, India would have one of the vice Presidents in the governing Board of the AIIB, yet India and other major powers should ensure that the board of the AIIB for loan approvals does not come under more affirmative Chinese influence in loan sanctions. India should now even think to endeavor enhancing greater economic integration of South Asia at least to retain the traditional proximity of the countries of South Asia and Indian Ocean region with it. The Asian Development Bank founded in 1966 with the participation of 31 countries and regions from Asia, North America and Europe is headed by Japanese president alone wherein, Japan accounted for 15.67 percent, of its capital followed by the U.S. 15.56 percent, China 6.47 percent, India 6.35 percent, Australia 5.8 percent, Canada 5.25 percent, Indonesia 5.17 percent and South Korea 5.05 percent. Though it headquartered in Manila. Though the ADB is believed to maintain fairness and impartiality as applications being made to it for loans are screened by a Board of Governors, made up of representatives from all member nations wherein no single country exerts undue influence. But, with respect to the AIIB, the US and Japan apprehend that, it would be under strong Chinese influence and may not have such an impartial board for screening loan applications. Moreover, once the AIIB would start its operations, No country would then be able to stop Beijing from making unilateral decisions. So, its Articles of Association need to be cautiously balanced for neutrality. Any presumption of making the AIIB as an impartial international financial institution through inside efforts after joining it may sound genuine and feasible now, but would any member country endeavor to clash head-on with China, once the details are worked out.  

Especially when, China is believed to have proposed this new infrastructure bank with the  intent to compete with and overtake Euro-American controlled funding agencies, and securing decisive benefits for Chinese infrastructure developers. Moreover when, inspite of the U.S. opposition, 57 nations have already declared their intent to join it, including 14 members of the G-20. Shall any other country would have any superior influence than the US? It was inspite of U.S. objections, the U.K. Chancellor of the Exchequer, George Osborne, announced to join the AIIB, and the Germany, France and Italy immediately announced to join it. Israel’s decision to join the bank was all the more astonishing. Even Taiwan too tried to become a charter member, but China rejected her application, because the mainland considers Taiwan as a province of China. Indeed UK is believed to be having the ambition that London can evolve as a major clearing market for the Chinese yuan (CNY) if that currency ever becomes freely convertible, along with an apprehension as well that, if it stayed out of the AIIB then, other financial centers might overtake London in this regard.

Now, when the American economy has already gone down from occupying half the share of the world economy 70 years ago to occupying less than a fifth of it today. The writing on the wall is clear that the trend of decline would continue. Notably, the aggregate economic activity of the BRICS countries alone now equals that of the United States, and the Chinese GDP alone is more than 60 percent of the US in general terms and more than 120 percent of US manufacturing. China tops the world in global foreign exchange reserves too. So, with the growing influence of the "Beijing consensus" in global affairs, out of its growing economic clout, China would now expand its role in shaping the global financial architecture. Although China's actions won't immediately overturn the existing international economic and financial order, but, they are creating a grumpy imbalance among the major economic powers.

The 69^th anniversary year of creation of Bretton Woods Institutes (IMF and World Bank) after the, cessation of Second World War 70 years ago. The two new rival banks viz BRICS Bank and AIIB would redefine governance of the world economy as well as the global financial architecture, have a different ideological pretext. The fundamental ideals of the Bretton Woods system have been a free market economy and democracy. In contrast, the AIIB is being floated by an authoritarian market economy of China that does not permit democracy political opposition, freedom of expression and open space which ultimately might establish the hegemony of Peiking consensus. Besides, this new infrastructure bank of China may also help it to redeem its ambition for a globalized renminbi currency, most likely to upend the 70-year-old global economic order pivoted around Euro-American economies and currencies. So, India should be vigilant to ensure parity with Chinese might at all decision making for of the AIIB.