Snapshot of Tarapore committee report

1. S napshot of Tarapore Committee Report on CAPITAL ACCOUNT CONVERTIBILITY Presented by: Apoorva Soni 11020241071 Pankaj Baid 11020241121 Rashmi Sonare 11020241124 Swapnil Rathi 11020241134 1

2. Introduction Tarapore Committee was constituted by the RBI under the Chairmanship of Dr. S.S.Tarapore to prepare a roadmap towards Full Capital Account Convertibility (FCAC). The Committee submitted its report in May 1997. Result of “no clear definition of CAC “ in India. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 2

3. Capital account Convertibility (CAC) “Freedom of currency conversion in relation to capital transactions in terms of inflows and outflows” Committee’s version of CAC: ‘ CAC refers to the freedom to convert local financial assets into foreign financial assets and vice versa. It is associated with changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by, the rest of the world. CAC can be, and is , coexistent with restrictions other than on external payments .’ 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 3

4. Need for 1997 Committee.. Tarapore committee observed that the capital controls can be useful in insulating the economy of the country from the volatile capital flows during the transitional periods. It recommended the implementation of CAC for a 3 year period i.e. 1997-1998,1998-1999 and 1999-2000 and had set out detailed pre-conditions for moving towards CAC 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 4

5. Signposts for moving towards CAC Gross Fiscal Deficit of the Centre as a percentage of GDP should be 3.5% for 1999-2000 (4.1% in 2005-2006) Inflation rate should remain between an average 3-5% for 3 years (1997-2000) (4.6% in 2005-2006) In Financing s ector, the Gross NPA’s as a percentage of total advances of the public sector public banking system should be 5% by 2000 (5.2% in 2004-2005) Average effective CRR for the banking system should be 3 % for 1999-2000 (5% in 2004-2005) A consolidated sinking fund set up to ensure smooth repayment of borrowings. Monitoring Exchange Rate band of +/-5.0 % around the neutral R eal Effective Exchange Rate ( REER) with no intervene of RBI. Designing external sector policies to increase current receipts to GDP ratio such that DSR comes down to 20% from 25%. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 5

6. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 6

7. Move towards FCAC The report of this committee was made public by RBI on 1 st September 2006. Three phased adoption of CAC scheme: 2006-07 (Phase I) 2007-08 and 2008-09 (Phase II) 2009-10 and 2010-11 (Phase III) 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 7

8. Objectives of FCAC To facilitate the economic growth through higher investment by minimising the cost of both equity and debt capital. To improve the efficiency of the financial sector through greater competition. To provide opportunities for diversification of investments by residents. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 8

9. Recommendations… RBI didn’t implement all the recommendations and took a number of additional measures like: Removal of tax benefits to NRIs. Greater autonomy to RBI. Complete cheek on fiscal deficit. Disallowing investment channel led through a particular country (like Mauritius). Reduction of government stake in banks from 51 per cent to 33 per cent. Allowing industrial houses a stake in existing banks or allowing them to open a new banks. Allowing enhanced presence of foreign banks. 10 per cent voting limit for investment in banks should be scrapped. Non-resident corporates should be allowed to invest in Indian markets. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 9

10. Continued… All individual NRIs should also be allowed to invest in Indian Market. Revenue deficit of both central and states should be eliminated by 2008-09 and building a revenue surplus of 1 percent by Financial Year 2011. Raising the ceiling on External Commercial Borrowing (ECB). Banning Participatory Notes (PNs) and phasing out the existing PNs within one year. Enhancing the ceiling on government debt from $2 billion to 10 percent of issuance and $1-5 billion to 25 per cent of new issuances in a year of corporate debt. Building adequate reserve and limiting the current account deficit to under 3% of GDP. All banks should be brought under Companies Act. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 10

11. The committee has suggested for providing greater financial freedom for all the three key stakeholders: resident individuals, domestic companies and foreign investors. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 11

12. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 12 Proposed Changes by Tarapore Committee Source: RBI appointed Tarapore Committee Report 2006

13. Status of CAC for non residents in India (2005): F or foreign corporates, and foreign institutions, there was a reasonable amount of convertibility, F or non-resident Indians (NRIs) there was approximately an equal amount of convertibility, but accompanied by severe procedural and regulatory impediments; F or non-resident individuals, other than NRIs, there was ‘near-zero’ convertibility. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 13

14. INTERACTION OF MONETARY POLICY AND EXCHANGE RATE POLICY 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 14

15. There has been upsurge of capital inflows with the relaxation of capital accounts controls I mpossible trinity – independent monetary policy, open capital account, and a managed exchange rate cannot be attained, but Indian authorities have been trying to find out intermediate solutions. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 15

16. Monetary Policy Instruments and Operations Indian real interest rates needs to be better aligned with international interest rates OMOs should be used to for modulating liquidity conditions, correct any serious misalignments between short term and long term rates RBI needs to control the interest rate changes during the capital inflows and outflows to contain the inflationary expectations SLR to be altered to below 25% when felt necessary Liquidity Adjustment facility should be used as an instrument of equilibrating very short term liquidity RBI should operate variable rate repo/reverse repo auctions. 1997 committee recommended that, RBI should have a monitoring exchange rate band of +/- 5% around NEER. If Current Account Deficit moves beyond 3% of GDP, the exchange rate policy should be reviewed. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 16

17. REGULATORY AND SUPERVISORY ISSUES IN BANKING 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 17

18. Banking system needs to be strengthened with appropriate regulatory measures in place since capital inflows and outflows bring risks along with them. Strong & Resilient banking system, efficient clearing and settlement arrangement, appropriate accounting, public disclosure standards, auditing standards. Banks be able to manage multidimensional risk ( their risk as well as the company’s risk) Resident and non-resident banks to undertake transactions in multiple currencies which exposes the economy to risks such as currency, counterparty credit, transfer, legal, arbitrage, derivatives transactions. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 18

19. Prudential Regulation Improvements in financial institutions liquidity management and disclosures practices, corporate governance in PSBs. Issuing restricted banking licenses rather than whole banking licenses to enable banks to exploit core competencies. Introduce higher core capital ratio, pricing risks efficiently, keeping high capital requirements(currently 9%). Differential treatment of complex banks. RBI to allow banks to undertake market making, deal with derivatives, large cross border borrowing & lending. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 19

20. Measures for Strengthening Regulation and Supervision Proposed Measures Liquidity Risk Monitored at Head/Corporate office level Monitor liquidity position at granular level, at territory level. Examine the need for limit on short term borrowings of banks Interest Rate Risk(IRR) Fix appropriate internal limits for IRR Banks adopt Duration gap analysis to measure IRR in their Balance Sheet. Compute volatility of equity and earnings under various IRR scenarios Forex Open Position Review the open position limits for banks in Forex . Asset Concentration To ensure diversification, fix internal limits for exposure to Particular industry, country, region, counterparty category etc. Income Recognition Asset Classification and Provisioning (IRAC) Norms To make provisions for non fund based commitments in NPA accounts. Banks should make a higher level of provisions for the contingent liabilities. Introduce Uniform asset classification. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 20

21. Proposed Measures Capital Adequacy To keep differential CRAR for different banks Increase core capital ratio to 66% RBI should decide on the methodology for setting off the losses against capital funds. Risk Mitigants Use and monitor Interest Rate Futures and options, Credit Derivatives, Commodity Derivatives, Equity Derivatives Level of Computerisation and Branch Interconnectivity Online connectivity to all major branches, MIS content should support the risk management requirements Off-balance sheet Exposures – comfort Letters Ensure strict norms are in place for issuing comfort letters and also to plan to meet demands of the same Accounting Standards Full Compliance with AS-11 Type of Supervision the Capital Adequacy, Asset Quality, Management, Earnings and Liquidity System (CAMELS) approach should be adjusted to accommodate the proposed focus and become Capital Adequacy, Asset Quality, Risk Management, Earnings an d Liquidity System (CARMELS) approach. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 21

22. Proposed Measures Types of Supervision Put in framework to ensure adherence to Anti Money laundering/ KYC requirements. Introduce the concept of Central point of contact(CPOC) in RBI for a dedicated official tracking developments in alloted bank. Financial Soundness Indicators(FSI) To reduce the compilation of FSI from 6 months to 2 months 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 22

23. TIMING AND SEQUENCING OF MEASURES FOR FULLER CAPITAL ACCOUNT CONVERTIBILITY 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 23

24. ` The Approval limit for ECB should be raised gradually over the span of 5 yrs and ECBs over maturity of 10 yrs and 7 yrs should be kept outside the ECB ceiling. Firms investing overseas: Increase the limit from 200 to 400% ( of net worth) gradually The EEFC limit should be raised from 50% to 100% The FDI norms should be liberalized. Disinvestments procedures to be simplified to provide symmetry between investments and disinvestments. Authorized Dealers limit of borrowing from overseas banks should be raised from 25% to 100% of the paid of capital + free reserves with a sub-limit of 1/3 rd for short term . Aggregate ceiling on investment overseas by mutual funds should be raised from 2 billion to 5 billion $ FII should be allowed to invest in upto 10% of the Govt Securities issued and 25% of the Corporate Bonds issued Residents individuals limit to freely remit $ abroad should be increased from 25000$ to 2,00,000 $ 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 24

25. RFC account holders to be allowed to move foreign currency balances to overseas banks Repatriation of proceeds from the sale of inheritance of assets upto a limit of 1 million should be allowed from the balances held out in NRO accounts. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 25

26. Development of Financial Markets Any country intending to introduce FCAC needs to ensure that different market segments are not only well developed but also that they are well integrated so that the entire financial system is able to absorb the shocks with minimal damage . T hree main dimensions of a well developed financial system Vibrancy and strength of the physical infrastructure of markets as reflected by the IT systems, communication networks Skill and competency levels of people who man the offices of financial intermediaries like commercial and investment banks Q uality of regulatory and supervisory arrangements. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 26

27. Recommendations on developing Money Market Policy initiatives should be taken to facilitate development of different financial markets to encourage capital inflows . Prudential regulations on inflows of foreign capital, segment-wise would be desirable . Suitable regulatory changes need to be progressively introduced to enable more players to have access to the repo market . There is a need to set up a dedicated cell within the RBI for tighter monitoring of all derivatives. This would be specially important as demand for derivatives could increase manifold to meet larger hedging requirements Efforts may be made to activate the market in interest rate futures to all participants including foreign investors. Permitted derivatives should include interest rate options, initially OTC and subsequently exchange traded. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 27

28. Recommendations on developing Govt. Securities Market Promoting a two-way market movement would require permitting participants to freely undertake short-selling. To stimulate retail investments in gilts, either directly or through gilt mutual funds, the gilt funds should be exempted from the dividend distribution tax and income up to a limit from direct investment in gilts could be exempted from tax . Expanding investor base would be strengthened by allowing, inter alia , entry to non-resident investors, especially longer term investors like foreign central banks, endowment funds, retirement funds , etc. To impart liquidity to government stocks, the class of holders of G- secs needs to be widened and repo facility allowed to all market players without any restrictions on the minimum duration of the repo 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 28

29. Recommendations on developing Corporate Bond and Securitized Debt Market GOI, RBI and SEBI should be able to evolve a concerted approach to deal with the complex issues identified by the High Level Committee on Corporate Bond Market . Stamp duty at the time of bond issues as also on securitized debt should be abolished by all the state governments. Corporate bonds may be permitted as eligible securities for repo transactions subject to strengthening of regulatory policies . The limitations on FIIs to invest in securities issued by Asset Reconstruction Companies should be on par with their investments in listed debt securities. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 29

30. Recommendations on developing Forex Markets Authorities need to be concerned about bank margins on Forex transactions of smaller customers. The best way to reduce margins would be first to separate Forex business from lending transactions Introducing an electronic trading platform on which Forex transactions could take place, the customer having the choice of trading with the bank quoting the best price. Allow more flexibility for banks to borrow and lend overseas both on short-term and long-term and increase the limits that are prescribed now to promote more interest parity with international markets. Banking should be allowed to hedge currency swaps by buying and selling without any monetary limits. 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 30

31. CURRENT STATUS AS PER THE BENCHMARKS SET UP BY THE COMMITTEE (2012):   GDP Growth Rate :6.9% Debt Service Ratio:   5.6% External Debt:20%of GDP CRR:4.5% Inflation Rate:6.87% Forex Reserves : 290 Bn $ 11/5/2012 Source: RBI appointed Tarapore Committee Report 2006 31