Mr. Reddy reports on recent developments and concerns in the emerging
market countries and the current scenario in the Indian economy Key note address by the
Deputy Governor of the Reserve Bank of India, Dr. Y.V. Reddy, at the CII seminar on
'Emerging Scenario in Foreign Currency Management' in Mumbai on 20/2/98.
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
The recent crisis has many unique features which are worth relating as a backdrop
to the current concerns.
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 the 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, and also as to the role of relevant institutions. Thirdly, and most
importantly, there is widespread agreement that the economies concerned will bounce back but
the issue is, how soon and at what cost, even if they are transitional. Also, the bounce back will
necessarily be different for differently affected countries.
Areas of Concern
It is not, therefore, surprising that there are new concerns expressed, or what may
be called emerging concerns. These relate not only to the state of the economy or policies of
each of the emerging markets but also the broader role of government, aspects relating to market
failures in both capital exporting and importing countries, sovereignisation of private debt,
financial sector liberalisation especially regulation of banks, volatility of capital flows, the pace
of capital account liberalisation, regulatory systems in major financial markets, exchange rate
management, international bankruptcy procedure, the role of multilateral agencies, and of course
international lender of last resort, etc.
Emerging Concerns and the Indian Economy
Broadly speaking, there are five major areas of concern today, whenever one
analyses an emerging economy. These relate to macro-economy, external sector management,
regulation of the financial sector, the state of the corporate sector and the broader issue of
transparency in the system. More important, the specific aspects of concern in each are different
now compared to say a year ago. Without entering into a debate on the appropriateness of such
concerns or the differences about what should be a concern or what magnitude should engage
attention, I will address clearly identifiable areas currently being looked at by market
participants and the present status of the Indian economy in respect of each of these.
Macro-Economy
The annual growth rate of Gross Domestic Product has been in the range of 7 to
7.5 per cent during the last three years (i.e., fiscal years 1994-95 to 1996-97). For the current
year, estimates range between 5.0 to 6.0 per cent. Investments as a percentage of GDP has also
been reasonably steady in the period at around 26 per cent on average.
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 will not
be very different.
The fiscal deficit of the Government of India as a percentage of GDP has 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 will 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
199697 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
On the external front, in SDR terms, exports have grown at 13.6 per cent and 16.7
per cent during 1994-95 and 1995-96 while imports have grown at 18.0 and 23.7 per cent. Last
year, (1996-97) there has been a deceleration to 9.6 and 10.6 per cent, respectively. This year,
during April-December, growth of exports was 9.1 per cent and that of imports 13.5 per cent,
both in SDR terms.
The Foreign Direct Investment flows continue to rise and are US$ 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 period; 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 $22.4 billion at the
beginning of the financial year.
More important, some mention about external debt management and magnitudes
would be in order. The RBI controls by a process of approval of each case, the total short-term
debt, including trade-related credit beyond 180 days. Our short-term debt as a per cent of our
reserves is around 27 per cent, while as a per cent of total external debt, it is about seven per
cent. Each external commercial borrowing, including maturity, interest terms etc., has to be
approved by the Government/RBI. In fact, a micro level productive use of such external debt is
ensured during the approval process. In fact, our volume of external debt has been generally on
the decline and during 1993-97 total external debt was reduced by US$ 1 billion, 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
As most of you may be aware, we have adopted international standards of capital
adequacy for banks, and their non-performing assets are closely monitored with a view to
bringing them down. In particular, I would like to emphasise some major features.
First, our banks' total exposure to assets of Asian and East Asian countries was
less than US$ 500 million, and foreign liabilities are well below 10 per cent of total liabilities.
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. Fourth,
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. Fifth, 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. Sixth, the non-banking
financial companies have been brought under tight legislative, regulatory and prudential
framework recently.
Corporate Sector
The debt of corporates as a percentage of equity, on the basis of annual surveys
audited by the RBI indicates that corporate debt of 1730 selected non-financial public limited
companies was 76.5 per cent of the extent of equity in 1993-94 and it has come down to 57.9 per
cent in 1995-96.
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, the corporate sector of India as a whole is not
overexposed to external liabilities.
Transparency
On all areas of public interest involving RBI's operations, press releases on a
daily basis are common. The Reserve Bank releases a weekly statistical supplement which is
virtually a balance sheet of the RBI and captures monetary, fiscal and external sector
developments. In addition, the monthly bulletin of the RBI gives a wide array of information,
including for instance forex operations of the Reserve Bank. One can note all the forex
transactions of the RBI, including outstanding forward liabilities in the monthly bulletin. The
formal statements of the Governor, especially on monetary and credit policy developments
clearly express a view of monetary and credit developments. The Annual Report in Trends in
Banking contains a wealth of authentic information and the latest issue gives bank-wise ratios
relating to performance. Parliamentary oversight and occasional recourse to judiciary by affected
parties ensure that an acceptable degree of transparency is maintained.
Conclusion
In brief, we ensure sustainable current account deficit, restrict reliance on
short-term external debt; limit access to external debt and emphasise productive use of such
debt. We encourage Foreign Direct Investment as the main source of non-debt creating capital
inflows. Also, the exchange rate is market-determined though the RBI closely monitors and
occasionally intervenes to avoid volatility and also ensure orderly conditions in forex markets.
We undertook financial sector reforms, especially banking reform as a prelude to liberalisation
of some capital account transactions in the external sector. We discourage banks' investments in
real estate and stock markets. Non-banking financial companies are currently subject to
regulation. Corporate exposure to debt, especially external debt, is within reasonable limits,
though growing. There is transparency in operations of the Reserve Bank of India - whether it is
forward market or whether it relates to performance of banks. In fact, the RBI takes initiatives in
the orderly development of the money market, government securities market and foreign
exchange markets. We hold constant formal and informal consultations with market participants
on these issues. To conclude, we believe that market participants should note these features of
the current state of our economy in assessing our prospects - both short and medium-term.