From Business World of 17 January 2005.
An unequal
triangle
Last week the finance minister shared
front-page headlines with the governor of the Reserve Bank. Y Venugopal Reddy,
in his inimitable bureaucratise, said, “A view needs to be taken on the
quantity and quality of FII inflows. While quotas or ceilings, as practised by
certain countries, may not be desirable at this stage, there is merit in our
keeping such an option open and exercising it selectively as needed, after due
notice to the FIIs.” As he said these words at the Indira Gandhi Institute of
Development Research, telephone lines relayed his weighty words to Nariman
Point, and the sensex started tumbling. As soon as he heard about it in Delhi,
the finance minister announced, “I am quite clear in my mind that there is no
question of taxing FII inflows.” To make sure that Reddy did not repeat
himself, Mr Chidambaram added that in the Governor’s view, taxing FII inflows
was not effective at all. The next day he repeated, this time on the sidelines
of a seminar on water management, that he had no plans to tax foreign
investment inflows.
Mr Reddy was not
talking off the cuff; he had obviously put some work into his speech. He talked
about reviewing the eligibility of FIIs, assessing risks involved in various
portfolio inflows, the “know-your-investor” principle, and closer monitoring of
FDI. He expressed concern about round-tripping (that is, domestic investors
sending money abroad and bringing it back in the guise of foreign investment)
and about portfolio investment reducing foreign greenfield investment. Mr
Chidambaram may have silenced Mr Reddy, but he certainly cannot stop him from
entertaining dark forebodings about volatile money coming from shady FIIs.
Worse, the
finance minister cannot stop him from putting some of his other threats into action.
For instance, the governor could institute a machinery that would require banks
to give far more information on investment inflows, and thus obstruct or slow
them down. He could start interfering in SEBI’s registration of FIIs. Although
less draconian than FERA, the Foreign Exchange Management Act gives the Reserve
Bank many ways of being obnoxious.
This is not the
first time that the finance minister and the governor have differed. A circular
issued by the RBI three years ago required private banks to get its permission
before they could sell 5 per cent or more of their shares to a foreign direct
investor. Soon thereafter, the Dutch ING group raised its 20 per cent share in
the equity of Vysya Bank to 49 per cent; RBI has neither approved nor disapproved
this acquisition, and ING’s shareholder rights remain undefined. This October,
the finance minister proposed that foreign banks should be allowed to buy 10
per cent of an Indian bank’s equity every year – the implication being that
they should be allowed to take control in 5 years. It is difficult to imagine a
more divergent view from the RBI’s position.
This situation
could not have arisen in any previous government. While many governments have
given autonomy to their central banks, the Reserve Bank has been clearly and
unquestionably subordinate to the finance ministry in our administrative
architecture. Rangarajan would not have dreamed of making the statement Reddy
did without the then finance minister Manmohan Singh’s go-ahead.
Dr Manmohan
Singh was fully in charge because Narasimha Rao made him so. The public
differences between Reddy and Chidambaram suggest that Reddy feels, rightly or
wrongly, that he has the Prime Minister’s support. The Prime Minister was once
governor of the Reserve Bank himself; and the Reserve Bank has an uncanny knack
for brainwashing its governors. Whether they were reformers or socialists
before, they all become control freaks once they are ensconced in the
governor’s seat. So it is not an unreasonable assumption that Dr Reddy and Dr
Singh think alike.
If that is so,
we have two problems. The minor one is that every once in a while the governor
and the finance minister will make divergent statements, and the Prime Minister
will have to cap the controversy by means of some meaningless and soothing
words. In the present circumstances, for instance, he cannot but say that he is
foreign investors’ best friend. The major problem is that a rift is emerging in
economic policy. The immediate issue concerns the exchange rate and reserve
accumulation. The finance ministry would rather the Rupee was appreciated; the
Reserve Bank would rather cap foreign portfolio investment. This rift is
unhealthy; the Prime Minister should remove it instead of temporizing.
