respective authorities which included capital controls on the one hand and taking measures to attract relatively longer term flows on the other. capital inflows & outflows : hierarchy of choices 10. let me now make some comments on capital controls. our framework of capital account management, has been more inclined towards capital inflows than capital outflows. in a, capital scarce growing economy with large investment needs, it has been our longstanding policy to encourage capital inflows to augment domestic savings with a bias towards flows that are stable, long term and those that are least prone to sudden stoppages and reversals. here i would like to highlight our approach to some of the critical elements of capital flows. foreign direct investments 11. foreign direct investment ( fdi ), characterized by lasting interest and some degree of management control by the investor, is positioned high in the hierarchy of capital inflows not only because of it is resource augmenting but also because it usually brings in better technology and more efficient management and business practices. the framework for fdi, which gets legal sanctity under the regulations notified by the reserve bank under fema, is set by the government of india in consultation with the reserve bank of india, and the only restriction on fdi pertains to sectoral investment limits – the degree of control that can be ceded to a non - resident - motivated by strategic or socio - economic considerations. the rest of the regulatory framework is a matter of procedural detail, and we have been continuously trying to rationalize and streamline the regime to make it as investor friendly as possible. to illustrate the point, one can cite some of our recent measures, such as, doing away with the regulatory prescription of pricing methodology, introduction of optionality in inward fdi, etc. foreign portfolio investors 12. there is a tendency to see inflows on account of foreign portfolio investment as “ hot money ” which can cause sudden stoppages or reversals. over two decades of experience as well as recent studies show that this fear is perhaps exaggerated. portfolio investment flows do exhibit some volatility and surge either way, but at an aggregate level there is a fair degree of stability. since its introduction in 1992, the regulatory regime for portfolio investment has evolved over time. you are all aware of the recent simplifications and liberalizations brought about in the scheme in sync with regulations notified by the securities and exchange board of india ( sebi ) wherein the fiis and

instruments. improved it architecture / mis – the basic requirement for implementation of basel ii is improved information systems for managing and using data for business decisions. banks should, therefore, be encouraged to strengthen their it architecture and also improve their information and reporting systems. this would also equip banks to cope appropriately with the pillar 3 disclosure requirements. consolidation – in the normal course of operations banks would be constantly looking for opportunities of inorganic growth. banks which operate with capital above the minimum levels have an edge over the other banks to the extent that they would be able to seize an opportunity for merger / acquisition as and when it is available without any loss of time. however, it would be necessary for such banks to improve their internal controls and risk management systems before embarking on a path of inorganic growth. basel ii implementation would enable banks to meet the above pre - requisites and place them in a situation where they can take advantage of opportunities as and when they arise. data issues – implementation of basel ii, both under standardised approach and irb approaches, would involve utilisation of data for computing capital requirements. while the dependence on data under the standardised approach would be largely similar to basel i, the data requirements are considerable under the advanced approaches. banks would require adequate and acceptable historical data to compute capital requirement under these approaches. at the minimum banks need to have historical data for computing the probability of default, loss given default and operational risk losses. while building up this data base banks also need to ensure purity and integrity of such data. capacity building – above all, capacity building, both in banks and the regulatory bodies is a serious challenge, especially with regard to adoption of the advanced approaches. banks would need to focus on equipping their staff suitably to handle the advanced risk management systems and supervisors need to equip themselves with equal skills to have effective supervision. given the demand for skills in the sector, the level of attrition is likely to be high. hence, banks need to focus on motivating the skilled staff and retaining them. we have initiated supervisory capacity - building measures in india to identify the gaps and to assess as well as quantify the extent of additional capital, which may be required to be maintained by such banks. the magnitude of this task, which is scheduled to be completed by december 2006, appears daunting since we have as many as 90 scheduled commercial banks in india. external ratings – in a situation where countries do not have domestic rating agencies or