Indian Forex Policy
Global financial crisis :
The U.S. financial crisis has had its reverberations on both developed and developing world. It is not possible to insulate Indian economy completely from what is happening in the financial systems of the world. Effectively speaking, however, the Indian banks and financial institutions have not experienced the kinds of losses and write-downs that even venerable banks and financial institutions in the Western world have faced.
By and large, India has been spared the panic that followed the collapse of banking institutions, such as Fortis in Europe, and Merrill Lynch, Lehman Brothers and Washington Mutual in the U.S.
The relative freedom from the contagion spreading from the global tsunami on the Indian financial system owes much to the wise and judicious policies of our central bank and the Government of India.
Discussions on this subject have proceeded on two lines. One is to point out that the Indian banks have taken less risk than their peers abroad. The less risk you take, the more will be safer you are. This, however, begs the question, “Why did the Indian banks take less risk?”
The answer lies in the wise regulations and meticulous supervision by the RBI. At a time when total deregulation was the order of the day in the 90s, Dr. Man Mohan Singh as the Finance Minister authorized a path-breaking study of the Indian financial system by an experienced central banker, M. Narasimham. He had the wisdom to foresee that the financial system had to be placed on a well-regulated basis. Mr. Narasimham’s classic reports gave the policy framework for the Government of India and the RBI to formulate the structure of India’s banks and financial institutions. Mr. Narasimham’s model was based on adequate capitalization, good provisioning norms and well-structured supervision. Government of India and RBI accepted these recommendations and proceeded to implement them.
What was, indeed, important was that the model did not allow investment banking on the pattern of the American paradigm. In a sense, RBI enforced its own version of the U.S.’ Glass-Steagal Act of 1933, which insulates banks from capital market exposures. The RBI enforced strict capital adequacy requirements and if any financial institution or bank exceeded the specified limits of exposure to stock markets, it would have to provide more capital. This effectively insulated the banks and financial institutions from volatility of the bourses. Enforcement of the above instructions has paid good dividends. Erosion of capital of the banks and financial institutions has been reduced. These exposure limits, however, deserve to be reviewed from time to time.
The RBI must be congratulated for imposing Basel-II norms impartially and in a flexible manner. They have kept it in line with the Indian financial system. Observation of these limits, however difficult it may be in practice, will definitely help the Indian financial system to escape the kind of trouble, which is afflicting the financial system in other countries.
There is another observation, which has to be kept in mind in judging the relative freedom of Indian banking system from the catastrophic mess in the U.S. This is based on the important fact that the Indian banking system is basically owned by the public sector. The State owns many of the banks and financial institutions in the country. There is greater confidence of depositors in a state-owned bank than in a privately-owned bank. This is evident from the fact that in the latest version of the rescue package in the U.S., the government has come forward to infuse capital into distressed banks and financial institutions. Maybe, we can congratulate ourselves that India had already done what Washington is now doing in the midst of the crisis and therefore escaped much of the confidence problems.
Credit is also due to the Government of India and the RBI for having avoided the temptation of total capital convertibility. Had we embarked on total capital convertibility, we would have been exposed to much greater contagion from the current mess than we have been so far. The lesson is that in economic reforms, we have to proceed with caution. Striking the rig
Concluding Observations
India has by-and-large been spared of global financial contagion due to the sub prime turmoil for a variety of reasons. India’s growth process has been largely domestic demand driven and its reliance on foreign savings has remained around 1.5 per cent in recent period. It also has a very comfortable level of forex reserves. The credit derivatives market is in an embryonic stage; the originate-to-distribute model in India is not comparable to the ones prevailing in advanced markets; there are restrictions on investments by residents in such products issued abroad; and regulatory guidelines on securitization do not permit immediate profit recognition. Financial stability in India has been achieved through perseverance of prudential policies which prevent institutions from excessive risk taking, and financial markets from becoming extremely volatile and turbulent.
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Article Source: ArticlesBase.com – global financial crisis and its impact
