Snapshot of Tarapore committee report

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Snapshot of Tarapore Committee Report on CAPITAL ACCOUNT CONVERTIBILITY

Presented by:

Apoorva Soni 11020241071

Pankaj Baid 11020241121

Rashmi Sonare 11020241124

Swapnil Rathi 11020241134

04/10/2023 Source: RBI appointed Tarapore Committee Report 2006

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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.


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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.’


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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


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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 sector, 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 Real 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%.


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Move towards FCAC

The report of this committee was made public by RBI on 1st 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)


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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.


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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.


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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.


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The committee has suggested for providing greater financial freedom for all the three key stakeholders:

◦ resident individuals,◦ domestic companies and ◦ foreign investors.


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Investment

Relaxation

External commercial borrowing

Resident individual’s

overseas investment

MFs overseas investment

FII investment

FIIs’ debt investment

JVs / Wholly-owned subsidiary

abroad investment

Phase-I 2006-07

Status quo on ECB limit of $18

billion

$25,000 limit should be hiked to $50,000 per calendar year

$2 billion investment limit

to be raised to $3 billion

200 per cent of net worth limit

should be raised to 250 percent

Fresh participatory

notes should be banned

G-Sec investment limit of $2 billion to be modified as

6 per cent of gross borrowing

Phase-II2007-09

Gradual increase, but

automatic limit to be raised from $500

million to $750 million

Raised to $1,00,000

Further raised to $4 billion

Ban to continue

8 per cent of total gross borrowing

Further raised to 300 per cent of

net worth

Phase-III 2009-11

Gradual increase, but limit to be

raised to $1 billion per financial year

Raised to $2,00,000

Further raised to $5 billion

Ban to continue

10 per cent of gross borrowing

Further raised to 400 per cent

Proposed Changes by Tarapore Committee

Source: RBI appointed Tarapore Committee Report 2006


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INTERACTION OF MONETARY POLICY

AND EXCHANGE RATE POLICY


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There has been upsurge of capital inflows with the relaxation of capital accounts controls

Impossible 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.


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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.


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REGULATORY AND SUPERVISORY ISSUES IN BANKING


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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.


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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.


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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 AssetClassification 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.


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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 BranchInterconnectivity

Online connectivity to all major branches, MIS content should support the risk management requirements

Off-balance sheet Exposures – comfortLetters

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 and Liquidity System (CARMELS) approach.


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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


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TIMING AND SEQUENCING OF MEASURES FOR FULLERCAPITAL ACCOUNT CONVERTIBILITY


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` 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 1/3rd 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 $


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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.


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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.

Three 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

Quality of regulatory and supervisory arrangements.


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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.


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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


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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.


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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.


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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 GDPCRR:4.5%Inflation Rate:6.87%Forex Reserves:290 Bn $


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Sourceshttp://

www.rbi.org.in/scripts/NotificationUser.aspx?Mode=0&Id=7136

http://www.rbi.org.in/scripts/BS_FiiUSer.aspx

http://www.rbi.org.in/commonman/English/scripts/pressreleases.aspx?id=111

http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=7537&Mode=0

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CB4QFjAA&url=http%3A%2F%2Frbidocs.rbi.org.in%2Frdocs%2FPublicationReport%2FPdfs%2F86253.pdf&ei=Ez9nUJ3LI4TprAfSvYHYCQ&usg=AFQjCNF_J9JBuL9soSYPryZOFzCGlgXaag

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