What Parikh Can't do for the government" Financial Express: Feb 6 2010

It may sound uncharitable to say that the Kirit Parikh Committee Report on Pricing of Petroleum Products is quite banal and lacks novelty. But we have had the Rangarajan and Chaturvedi Committee Reports in the past that spoke on similar lines. Hence, we already know that petroleum prices should be freed and there should be competition. The problem is on the implementation side, which is always outside the purview of government-appointed committees. Therefore, while this report does not really add to the literature on the subject, or at best, is an update, it can be considered to be another reminder to the government to act fast.
At the moment the government supports fuel prices at levels lower than the market price, leading to losses of around Rs 40,000 crore for the oil companies this fiscal year. The suggestions, to begin with, are to increase the price of petrol by Rs 3 per litre, of diesel by Rs 3-4 per litre, of LPG by Rs 100 and of kerosene by Rs 6 per litre. Further, better distribution of kerosene and LPG is recommended.
The focus here again is on implementation. Two different kinds of analogies may be drawn that provide a view on government action when moving from a controlled to an open system. The first is the telecom sector, where BSNL/MTNL had a monopoly and could charge high prices. Competition and opening of the market helped to lower prices. This was welcome but the two parties involved were a government company and the common man. The common man benefited finally and the government companies were forced to become efficient.
The farm sector is the second area where there is considerable regulation in terms of prices. Here the minimum support prices fixed by the government are often biased upwards to help the farmer. However, higher prices emanating from free market operations are viewed with suspicion. One can recollect that futures trading in wheat, sugar, etc, have been banned at times based on this argument.
This is so because the government gets caught in a quandary whether to favour the farmer or the consumer. Higher farm prices, while helping the farmer, also mean higher inflation for the consumer and that is not exactly palatable. Therefore, inflation caused by higher MSPs is acceptable, while the same for non-MSP products is not. The argument is that when the market arrives at a higher price, it is the middlemanwho gains and not the farmer, while when it is due to the MSP, it is the farmer who is gaining and not the middleman.
The farm analogy is pertinent to oil prices because the two counter-parties concerned are the common man and the oil company—that is the government at present. Keeping this in mind, the freeing of fuel prices raises some questions.
Let us assume that these recommendations are implemented and the prices are market- determined. Prices will move in line with world prices. Higher volatility currently has been eschewed by having prices fixed by the government. A deviation will lead to greater volatility. Another scenario is when global prices fall to, say, $40 a barrel and retail prices are rolled back commensurately, then both the government (excise collections) and oil companies will have a problem on their P&L. This is why prices remain sticky downwards. Are we prepared for this situation?
Higher fuel prices would automatically mean that transport costs will increase and feed into commodity prices. Therefore, even a good harvest could mean higher prices if fuel prices move up. Are we willing to accept these price changes?
Free pricing in the market that has, say, four to six companies will create an oligopolistic situation where prices can be driven higher to enhance profits. This happens in all markets where initial competition can lead to lower prices to keep others out, but that gets reversed subsequently. In this case it is more likely that prices will gravitate upwards. Is this okay with us?
Further, an oligopolistic situation can lead to shortages as companies will take bets on future price movements and it may make sense to supply less today and more in the future when prices increase. Will petrol and diesel then be classified as essential commodities and stock limits placed by the government as they have done for foodgrains?
Assuming that such situations come up, will the sugar model (or muddle) be applicable here where the government suddenly starts imposing quota releases and price bands for oil products?
While some of the doubts raised here may sound far-fetched, we have seen that the government isn’t politically prepared to have open markets and free pricing for essential commodities. Freeing markets is easy, but we need to show character by sticking to the consequences. Otherwise, the present approach where the referee (government) increases or decreases theprice is adequate. But, then this is not analogous to free pricing and competition.

Subbarao’s monetary policy muddle: Financial Express: 30th January 2010

A couple of days before the credit policy was announced, it was interesting to hear some of the chiefs of large banks, including those in the public sector, actually stating that they would not increase interest rates even if RBI hiked them. This is significant not because it is a view of bankers, but because it may also mean that the credit policy per se may be becoming a little less relevant in terms of drawing the desired response from the banks. On the lighter side, this may be the reason why the policy document is just 13 pages. Two issues in the policy document stand out that leave ample scope for debate, as there is a certain degree of ambivalence in them. The first is with respect to GDP growth. RBI has, quite uncharacteristically, upped its projection of growth in GDP for the year from 6% to 7.5%. Such a sudden increase actually means adding something like Rs 50,000 crore of real GDP to the original estimate. Is this achievable? Growth in GDP during the first half of the year has been around 7% and in order to average 7.5% for the full year the economy will have to grow by around 8% during the second half of the year. Agricultural production would play an important role in these two quarters with its weight of around 17-18% in GDP. The kharif crop has been suboptimal with a fall in output of rice, soybean, groundnut, maize, sugarcane, etc. The double-digit decline in output can only partly be addressed by the expected good performance of the rabi crop. This is so because we have already attained peaks in production of wheat, chana and mustard in FY09, which are the major rabi crops. Hence, scoring over these numbers would be a bit difficult. Even at the most optimistic level, there would still be a decline in farm output by at least 5%. Now, even if industry grows by 10% (it has been 7.6% for the first eight months), finance sector by 9% and the social sector (fiscal stimulus sector) by 10% during the second half of the year (which will come over an increase of 17% in FY09), GDP growth would come to at best 6.5%. This is assuming buoyant growth in other areas like construction (8%), transport and trade (9%) and mining (9%).
The second issue pertains to monetary policy per se. The basic objectives of monetary policy are growth and inflation. Is RBI targeting inflation or growth? The answer is not clear based on the actions of RBI. The central bank has highlighted the downside risk of inflation becoming even higher than it is perceived today since even cost-push-inflation on the supply side feeds into inflationary expectations. In fact, if RBI’s projection of 7.5% growth in GDP is to work out, then the economy will be getting overheated, in which case inflation on the demand side would also emanate. Prices of manufactured goods have already started increasing in the last two months, which means that we cannot brush aside inflation as being only a supply-side phenomenon. In such a situation, RBI should have been raising rates, which it has chosen not to do. The reason is ostensibly to not do anything that impedes growth. But, is the policy supportive of growth? The answer is not clear since RBI will absorb Rs 36,000 crore from the system to send signals that it means business. However, with surplus funds of Rs 70,000 crore being invested in the reverse repo auctions on a daily basis by banks, this amount is evidently not significant from the point of view of liquidity as there will still be surpluses with the banking system. But, given that RBI expects the economy to grow rapidly in the second half, especially industry, there should logically be an increase in demand for credit. But, if this happens, then the move to absorb liquidity through the 75 bps increase in CRR will be counter-productive. Absorbing surplus liquidity cannot control inflation just as the SLR increase earlier did not matter when banks had an investment-deposit ratio of 30%. The move is also not supportive of growth as it withdraws money from the system. Besides, the banks too would be bearing a loss of above Rs 1,000 crore as interest income forgone as this was being invested in the reverse repo auctions at 3.25%. The credit policy, while clear on its numbers for growth and inflation, blows hot and cold on how its monetary measures would actually help in achieving them.

Industry is growing, but not speeding, Financial Express 28th January 2010

The economic indicators announced in the last month or so have been very encouraging. The IIP growth number for the first eight months of the year was 7.6% with growth in November being 11.7%. In fact, in the last six months, the month-on-month rate has exceeded 7% and crossed the double-digit mark thrice. Exports have started showing an about-turn, though just for one month. But, given that the world economy is improving, there is reason to believe that all may be well. However, the industrial picture begs certain questions that need to be answered. The first is that the closest indicator of industrial growth, bank credit, has not exhibited a parallel picture. Growth in bank credit is sluggish at 8.8% for the first nine months of the year as against 12.5% last year. Either industry does not demand the funds or banks are not lending easily—either way the result is that growth is low. This quick indicator of industrial activity does not quite gel with the numbers witnessed in the real sector. The second is that growth in bank deposits, which still constitute around 45-50% of domestic household savings, is down at 9.8% as against 11.7% last year. This is a proxy indicator for investment taking place as savings get translated into investment. As this number is low, there is some concern here, even though in terms of equity raised in the market, the picture is more sanguine at Rs 87,146 crore in the first nine months of the year as against Rs 30,517 crore last year. The third concern here on the industrial front is that the corporate performance is not what it should be. Detailed information on corporate performance for the third quarter, and hence the first nine months, would be available only after February. But, if one looks at the first six months’ performance of industry and the corporate performance, there is a disconnect. Industrial growth has been moderately high at 6.3%; but according to RBI’s latest study on financial performance of companies for the first half of FY10, sales for a sample of 1,752 manufacturing companies had declined by -1.6% while net profits were up by 9.6%. Curiously, profits increased mainly due to the sharp cuts in raw material costs by 9.3%. Stocks, too, had registered a sharp decline during this period. Hence, it is difficult to reconcile declining sales and stocks with growing production. A similar picture is witnessed at.the disaggregated industry level, where sales growth in industries such as chemicals, paper, rubber and machinery was lower than the equivalent IIP growth numbers. This is really a conundrum for interpretation because the IIP numbers that show production growth are not getting reflected in the sales performance. Another related factor that provides important support to industrial growth is the electricity sector. This number has been relatively low at 6.1% in the first eight months and at 3.3% as of November. Typically, the power sector output should be rising dynamically with that in manufacturing. The fourth anomaly in the industrial performance can be viewed from the sharp decline in non-oil imports. This is again significant because normally any growth recovery in the economy must get reflected in higher imports. Normally one would expect imports of raw materials and capital goods to increase to support industrial growth. This is not yet visible and the growth rate as late as November has been negative. The consolation here is that the decline in imports has been low at 6% as against double-digit rates during the year. The fifth indicator of state of industry is the movement in prices. Growth of manufactured segment prices is still low at around 5%, which comes down further to around less than half per cent if food products are excluded. Normally when industrial growth picks up, prices also increase for two reasons. The first is the demand factor that pulls up prices. The other is high manufactured goods inflation is a precondition for industrial growth to take place. The absence of such price increases is again not supportive of the growth hypothesis. The last anomaly that cannot be fully reconciled is tax collections. For the first eight months of the year, corporate tax collections increased by 6.6%. However, customs & excise collections were down at 31.2% and 20%, respectively. Quite clearly, the tax payments have not been coming in at the same pace of production. While lower tax rates could be part of the explanation, even in the last two months the drop in excise collections is significant—this was the time when rates were relaxed by the government in 2008. Given these anomalies in related scenarios, it may be prudent to wait and watch before being convinced that industry is really back on its feet.

Pragmatic approach, DNA , January 18, 2010

There is a feeling of economic euphoria in the country today with even economists talking of 8 per cent growth in GDP, double digit industrial growth rate, soaring Sensex, and a revival in exports. The gushing in of foreign investment has added to this optimism. Inflation surely is spoiling the party but then after a point it is beyond our control when there is crop failure.Against this backdrop, there is talk about whether the government is going to pursue an exit policy. What exactly are we talking of?It may be recollected that when there was an economic slump in the last quarter of 2008 following Lehman, the entire world went into a stimulus mode. What governments essentially did was to pump-prime their economies.Central banks lowered interest rates while the Fed and US Treasury provided capital and guarantees to various financial institutions to restore confidence.Governments went soft on their deficits and began cutting tax rates and increasing their spending so that their economies were on their feet. They supported financial institutions through recapitalisation and direct funding measures. In fact, UK, USA, Japan and the Euro zone all have fiscal deficit ratios that are higher than that of India. The basic idea was to eschew the possibility of a full-scale recession as was the case in 1930 when the Depression ostensibly was aggrandised because governments did nothing.
Therefore, the booster shots were all encompassing. The significance of this approach is that it was pursued by all leading economies almost in cohesion; and more importantly they worked. Almost all countries are showing positive growth, and have come out of the low phase and are seriously thinking about rolling back some of these measures.For us in India, it is necessary to debate this issue because we have two critical policies coming up — the RBI credit policy towards the end of January and the Budget towards the end of February. While the first will give us an idea of the official view of the state of affairs, the second will provide a definite direction. So, we can see these two statements actually putting in perspective the confidence that we have in our economy. Now, the high growth witnessed in the country has come mainly from the services sector, where the social and community services segment, which means the government, has played a critical part. The sharp duty cuts reckoned in 2008 have also helped to stabilise industry which is displaying a steady growth rate for the period September-November 2009.A reduction in such expenditure would be justified provided we are sure that the other sectors would be able to provide the necessary bulk to keep the economy on the upswing.For the current financial year, agriculture has been a failure and a negative growth rate is expected, which means that unless we are sure of this growth in future, any withdrawal of the fiscal stimulus would affect overall growth.Or there has to be compensation from some other sector. Assuming high industrial growth this year of say 8-9 per cent, sustaining the same over a high base could be a challenge.As far as tax rates go, while we have accepted a Goods and Services Tax (GST), its implementation is still a distance away and presently we will have to toss whether or not we go back to the pre-2008 duty structure. While industrial growth has been steady, are we prepared to disturb the applecart at this stage? Probably not, because industrial growth has been supported substantially by fiscal action in the last nine months or so and it may be prudent to persevere with the same until we are certain the growth is self sustaining. Industries like capital goods, cement, construction, intermediates and so on have definitely benefited from such action. A roll-backtoday could be counter-productive. How about inflation? Inflation is a grave concern here and should provoke affirmative action from the RBI on January 29. The value of growth is eroded substantially when inflation, especially food inflation is of the order of 15 per cent or so. This has been caused by compression in supplies on the agriculture side and rising demand as evidenced by rapid growth in industry, which has pushed up prices. In fact, if we believe the high growth story, which most do, then there is reason to curb the demand forces and hence tighten the belt. Also it is said that monetary policy has to be forward looking as central banks have to target potential inflation rather than current inflation.There is hence strong economic rationale for monetary action to control inflation while keeping the fiscal window still open for some more time. We should hopefully be within the 6.8 per cent fiscal deficit targeted for this year and there is no hurry to improve on it presently until growth stabilises. Monetary tightening is certainly needed more through rate hikes than reserves pre-emption to control potential inflation. This would be a pragmatic approach.

Waiting for the central bank: Mint 7th january 2010

Food inflation is complicating RBI’s stance. Perhaps it’s time to restructure the use of monetary policyCan this apply to India’s inflation conundrum today? On the one hand, the government has argued that inflation is cost-push driven, resulting from supply shortages—hence, by increasing interest rates or stifling liquidity we cannot generate more rice and pulses to bring down prices. Monetary policy should, therefore, continue to be supportive. On the other hand, Reserve Bank of India’s (RBI) spokespersons have at times spoken of policy options to control inflation. So which one is it?It is true that monetary policy cannot bring in supplies, but it is also debatable whether increasing rates today will affect investment. This is because if opportunities are there, businesses will invest, notwithstanding higher interest rates —just as steel producers do not stop investment merely because the price of electricity or ore increases. But, for the sake of argument, let us assume that higher rates can spoil the party while the economy is looking to grow now by 7.75% this year. What should be the approach of monetary policy then? Illustration: Jayachandran / Mint First, on the one hand, shortages in supplies will automatically exacerbate the demand-supply imbalance at the macro level and lead to excess demand forces, even if demand per se remains unchanged (the same number of people vying for fewer goods). On the other hand, if we believe in the 7.75% growth story, there will be latent inflation, since demand-pull pressures will build up. There is, then, a need to pull the trigger. Either way, there is a case for monetary action to check inflation. Perhaps RBI knows that already: Its response to inflation in mid-2008 was to increase rates and reserves, even when inflation was predominantly on the supply side.Second, theoretically, monetary policy should be forward-looking. Policy actions take timeto work for both growth and inflation. Therefore, if we are expecting inflation to rise in the future—even if it is not engendered by excess demand —monetary action is required to pre-empt it. That makes a strong case for RBI intervention. Reducing liquidity through a hike in the cash reserve ratio (CRR)—the reserves banks set aside—is a way out. But such quantitative measures are less preferable in a market economy with thousands of separate actors who may react differently, and should be the last resort. We can draw an analogy from foreign trade: Tariffs cause fewer distortions than a quota and are, hence, superior. Therefore, an interest rate hike, which can specifically target banks’ ability to lend based on market forces (higher rates lower the demand for credit) is preferable. Changing the cost of credit is better than lowering the quantum of funds through CRR.The debate over the use of monetary measures raises the question of whether or not monetary policy itself is being abused. Economics’ Rational Expectations School advocates a simple approach, where the authority announces the targets and sticks to it during the year. Given the availability of perfect information to all market participants, the University of Chicago’s Robert Lucas and New York University’s Thomas Sarjent argued that government policy would not really be effective. As a corollary, the only way in which policy would work would be in case the government systematically fooled the public by changing policy measures by going in for “fine-tuning” later. Therefore, if we started off with, say, a CRR of 5%, everyone would adjust to it. But, now, by altering CRR or the repo rate unexpectedly, we would contrive to make our policy work by “fooling” the public. RBI may just have done this in the recent past: In the first half of 2008-09, it countered inflation by aggressive action, which stifled the growth process. Subsequently, in the second half, it did an about-turn to revive the economy. From the point of view of expectations, it would have been better off not doing anything.This is relevant because RBI’s policies have an impact on the market—and one is not sure if RBI works independently or is influenced by the Prime Minister, the finance ministry, the Planning Commission or the Prime Minister’s economic advisory council. Every statement made by any of these authorities swings the market because there are expectations that RBI will follow suit. Further, RBI’s governor and the deputy governors have their own say, often prompting speculation or expectations, which then tend to be self-fulfilling. News of a rate hike can move the bond or call money market substantially as there is, on average, Rs50,000 crore of trading guided by these expectations.The question is whether or not this array of authorities should be providing signals and whether we are to take them seriously? Ideally, if we believe in the Rational Expectations School, RBI should not be having so many policy statements. But the concept of fine-tuning has led it to four policy announcements a year. Moreover, some governors have made it a habit to make announcements between policy statements, thus making the exercise potentially destabilizing.One solution to reduce uncertainty is to set “intervention thresholds” during the year. RBI can set triggers such as point-to-point inflation crossing 6% or non-food inflation crossing 4% as potential intervention points. Theoretically, we need two instruments for two objectives: A Keynesian approach to fiscal policy will address growth, while the monetarist position will tackle inflation. By letting this known, we also pay obeisance to the Rational Expectations School, thus making the policy combine, to borrow a metaphor from the ice cream parlour, three-in-one economics.

Good for banks, but the system? January 6, 2010 Financial Express

The McKinsey-EY Report on consolidation of public sector banks is timely because this is the time when RBI should have been opening up the sector to foreign participation. With more foreign banks entering the country and capital account convertibility around the corner (though everything has been delayed by the financial crisis), there is evidently a need to seriously debate the issue of consolidation among banks. Is consolidation an answer to future competition? The answer is a shoulder shrug, even though consolidation would help banks become more competitive. Consolidation helps organisations attain scale. A bigger balance sheet makes it easier for a bank to raise capital against the background of Basel II requirements. Further, such alliances bring about synergies for an organisation, especially across geographies and businesses. A bank focused on wholesale banking and another on retail can merge to create a monolith that provides complete banking solutions. A bank with a strong branch network and another with technology can merge to emerge stronger. Similarly, a bank based in the North can work with one with base in the South. All this helps in diversifying risk, which makes consolidation a viable proposition. So far, in India, mergers involving public sector banks have been restricted to rescuing failed banks. In the case of private banks there were different reasons such as survival (universal banking), weakness of a partner or plain loss of interest by the promoter. When it comes to public sector banks, the issue is more ticklish. To begin with, the ownership is with the government for all the entities. The management is professional with its appointment following the same procedures. The culture and quality of staff of these banks would also tend to be the same, since the recruitment process is standardised. In terms of profitability and other financial indicators there would be significant differences, which can make consolidation a worthwhile proposition. However, one needs to examine the rationale for creating these many public sector banks. All these banks tend to be stronger in various regions while there are some, like SBI, that have an all-India presence. Under these circumstances, the objective was to reach out to a larger cross-section of society and make banking more inclusive. The same could have been done by just having SBI stretch out, but multiple organisations made sense from an administrative point of view. While consolidation would be a sound idea today in a world where size matters, we would have to unwind these structures. The two areas of concern would be the branches and workforce. With the growth in banking, there has been a tendency for banks to open branches in common centres, which makes them redundant when one goes in for consolidation. The other is workforce. While some have been nimble-footed like Corporation Bank, others could have legacy issues that have to be ironed out. Are we in a position to close down these branches and downsize? The answers to these questions must be juxtaposed with other fundamental questions behind the consolidation debate. Have our banks exhausted the route to organic growth? They are well-capitalised today and have scope to go into non-fund based activities like the private banks. Therefore, there may not prima facie be major advantages in such like-minded banks merging. The second is, are we prepared for concentration in this sector? New private banks have already merged and there are probably three major ones that will continue to dominate the scene in future. Consolidation on the rationale of size would germinate the process of concentration. Third, how real is this threat of competition? Foreign banks operate under unequal regulatory conditions in terms of, say, priority sector lending, but have limitations when opening branches. The performance of public sector banks is almost on par with that of foreign banks. Therefore, prima facie there may be little justification to think that they have a major competitor to tackle. Globally, our banks are still too small, with only SBI making a mark with a domestic share of around 30%. Hence by having a merger that accounts for 7-8% of the system, little can be achieved even in terms of making a global mark. Therefore, before deciding on a roadmap for bank consolidation, we need to be sure of our objectives. As long as they are state-owned, capital should not be a problem unless we are ideologically inclined towards privatisation. Size building is good for leveraging synergies and diversifying risks, but the costs of technology, physical infrastructure and workforce redundancy have to be balanced. There is hence a necessity to have a serious discussion on the issue.

Don't ignore External Commercial Borrowings Business Standard: 26th December 2009

While RBI is right to worry about the share of outstanding ECBs in our reserves, firms need these to finance investment — some prudent limits need to be set.
The Reserve Bank of India (RBI) is seriously concerned about the increased dependence on external commercial borrowings (ECBs) by Indian corporate houses. The worry is palpable when companies flock to the global markets shopping for loans when interest rates are down. Hence RBI has been stipulating the maximum amount that can be borrowed, the all-in cost ceiling (as done recently), end use etc.There are essentially two issues relating to ECBs. The first is that this component will increase the external debt of the country and has to be matched by growth in the forex reserves to maintain solvency in the long run as all such debts have to be repaid. The other is that there is a currency risk involved as depreciation in the rupee will, for example, lead to a higher burden for the borrower when it comes to repayment. Hence, ECBs per se are less preferred to, say, foreign direct investment (FDI), which has the status of permanent parking in the country.The question is whether or not RBI’s concerns are justified at a time when the economy is growing and gradually getting integrated globally and there is progressively a greater requirement of funds to finance our growth story. To address these issues, the various sources of funding for long-term investment are analysed. The main sources of long-term finance today are banks, financial institutions like Sidbi, LIC, GIC etc; capital market in the domestic sphere; and FDI, ECBs and foreign assistance in the external field. As can be observed in the table, financial institutions were the dominant source along with capital markets at the beginning of the century. But, the importance of these institutions declined with the concept of universal banking catching on. Banks today have taken over this role but do face limitations in providing term funds on account of asset-liability considerations as they normally pick up deposits for up to three years and have to provide loans for tenures of over 10 years. Capital markets have provided support to around 25-30 per cent of the requirements, but this component would depend a lot on the state of the equity markets and the appetite for bonds.Now, in the last three years, there has been a tendency for dependence on foreign sources of funds to increase through both the debt and equity routes, and they now account for a little over 20 per cent of the total requirement. In particular, ECBs have become quite dominant in this period.The ECB market has distinct advantages over domestic borrowing. At present, the one-year Libor is just above 1 per cent. Assuming that based on country risk rating, a triple-A rated company can manage to procure a loan at, say, around 5-7 per cent. After considering the currency risk, it would still work out to be cheaper than a domestic loan where the PLR is 11.5 per cent. Therefore, it makes sense to borrow from these markets. Further, the rupee appears to be getting stronger over time, which means that fewer rupees are needed to repay the loans. Unless the rupee falls by around 5 per cent or so, the cost of ECBs would near the domestic PLR. The ideological issue that comes in RBI’s way is that too much dependence on foreign debt could place the country in a vulnerable spot. The external account debt-equity ratio has averaged 1.08 in the last five years and, ideally, it should be less than 1. Further, with inflation rates varying between India and the developed world, real interest rate becomes critical in interest rate formulation. The nominal rates thus would tend to be higher than those in the euro markets and hence, would be more attractive for all potential borrowers to access these markets (to the extent that they have the financial strength) after taking into account the exchange rate risk. Indian banks can lower the rates to only a limited extent by reducing their spreads as the cost of deposits is high partly due to inflation. Therefore, there is a pressing necessity to exercise control over this inflow of funds.ECBs as a proportion of total external debt have been increasing from around 20 per cent in 2005 to 27 per cent in 2009, making it a very important component of debt. RBI’s concern would be the value of outstanding ECBs to our forex reserves. This ratio was over 50 per cent in 2000 but has come down, more on account of increasing reserves, and is now at around 25 per cent.While RBI has a strong case in its favour as it has to maintain the solvency of the external economy, the question is for how long can this be the policy? There is paucity of funds to finance long-term investment; and the external route affords an option to players. When we do go in for capital account convertibility, such distinctions will become less dense and the force of competition will crate demand in different markets. Borrowers should have a choice of the source of finance. RBI should internally set parameters for intervention such as debt-equity ratio, debt to reserves and absolute level of reserves, which can be used for policy changes. This would be a more pragmatic way of addressing an issue which can be both an opportunity and threat simultaneously.