y v reddy : issues in managing capital account liberalisation presentation by dr y v reddy, deputy governor of the reserve bank of india, at commonwealth secretariat - world bank conference on developing countries and global financial architecture, held in london, on 23 june 2000. * * * the objectives of this presentation are : ( i ) to suggest the need of some of the developing countries for managing capital account, implying elements of control, regulation and liberalisation as appropriate ; ( ii ) to emphasise the importance of both international and national context in the management of capital account ; ( iii ) to outline the contours of control and regulatory framework and the possible use of these in prioritising capital flows while suggesting the dynamic elements needed to enable liberalisation ; ( iv ) to elaborate the linkages with other external sector policies, while considering the appropriate control and regulatory framework or liberalisation ; ( v ) to highlight the complementary policies that are necessary while considering liberalisation of capital account. this presentation is from the perspective of policy making in developing countries, and is drawn mainly from the indian experience. need it is currently well recognised that although global capital flows have a potential for improving efficiency and growth prospects, they can also trigger instability, due to a variety of reasons. the objective of current deliberations on the international financial architecture is to enhance efficiency of such flows while avoiding, to the extent possible, instability, and managing instability if and when it occurs. these issues are assessed essentially from the view point of developing countries, which, as a group has tended to be more vulnerable to instability arising out of capital flows. though there are some differences of opinion as to whether liberalisation of capital account would necessarily add to growth prospects of developing countries, there are several developments in regard to international trade in goods and services, international business, technology, cross - border flows of capital, etc. that would necessitate a more active management of capital account, with a view to continuously assessing the costs and benefits of liberalisation vis - a - vis control or regulation. in the current debate on international financial architecture, there is no settled position on several of the actions being considered. in respect of liberalisation of capital account, however, there appears to be a broad consensus, viz. such a liberalisation is desirable, should be gradual, well - sequenced and undertaken in conjunction with several other measures at micro and macro level. in most cases, the desirability of limiting total external debt, especially short - term is generally

several policy areas that have been identified as being critical to the health of global monetary and financial systems in future. many of them fall within the jurisdiction of the countries concerned. there is certainly an implicit recognition that the net benefits from liberalisation of capital account in respect of any developing country would be enhanced if the complementary policies are followed. among the more important of these are : first, strengthening the banking system, diversifying financial intermediation through both banks and non - banks, and developing as well as regulating financial markets in a sound manner. secondly, the regulatory practices and the coordination between regulators as the national level and among the national level regulators at the international level are also attracting attention. thirdly, monitoring the balance sheets of large banks, large corporates and even governments in terms of their growth, quality and vulnerability to shocks is considered important. this monitoring may have to cover stocks and flows, as also foreign currency exposures hedged or otherwise and direct or indirect. fourthly, there is a fiscal burden in case there are systemic problems, especially in the banking sector, irrespective of whether banking is in the public or private sector. the health of the banking sector is critical for many reasons, one of them being stability in the external sector. in india, the complementary policies considered essential have been identified by the committee of capital account convertibility ( 1997 ). the committee observed that while there were benefits of a more open capital account, it could also impose pressures on the financial system. hence the committee indicated certain sign posts or preconditions for a more open capital account and these are : fiscal consolidation, inflation - mandate and strengthening the financial system. of particular significance in regard to complementary policies that are relevant to management of capital account are standards and codes being evolved and monitored by several agencies, including in particular imf, world bank, bis, financial stability forum etc. ( dr. s. n. acharya has made an excellent presentation on this at this conference ). each country will no doubt benchmark their existing practices against the international codes and standards, and consider their appropriateness, extent of application, nature of adaptation needed, relative priorities, etc. several of the actions suggested require tremendous effort in regard to many developing countries and if full compliance is desirable for further liberalisation of capital account, the pace of such liberalisation may not be rapid. in india, several advisory groups have commenced a review of the international standards and codes and an assessment insofar as india