Forex reserves don’t work in absence of capital controls, says Acharya

Reserve Bank of India (RBI) Deputy Governor Viral Acharya ( pictured) said on Thursday that foreign exchange reserves do not work in the absence of macroprudential measures or some form of the capital controls, and that the depletion of reserves by short-term external debt can make the situation worse.

“Simply looking at reserves is inadequate and a potentially misleading indicator of vulnerability,” said Acharya at a presentation at the NSE-NYU Stern conference on Indian financial markets.

Macroprudential regulations made reserves effective, Acharya said, giving a presentation. Such measures, he said, included limiting the size of the flow, maturity of investors and investments, while rationing the risky. Both foreign portfolio flows in local debt, as well as foreign debt should be taxed, he added.

The net short-term debt claims to foreign investors should include unhedged foreign exposures and all reversible “hot money” flows to come at the correct picture of liabilities, the deputy governor said.

India has a cap on external debt by having three categories of external debt — foreign portfolio investors, external commercial borrowings and rupee denominated bonds.

Only relatively, high-credit quality borrowers can tap into ECBs, which limit ECBs to high-rated borrowers. On the other hand, this form of taxation does not exist for domestic debt issuances purchased by the FPIs, he said.

In the case of Masala bonds, RBI’s guidelines were more relaxed compared with ECB guidelines as the rupeedenominated bonds did not carry currency risk.

“Masala bonds route gained popularity in the past year as arbitrage over ECB and FPI in domestic corporate bonds,” Acharya said. They were used by related parties to circumvent ECB/FDI. Turning wise from the usage of route, the regulator put in place measures to address macroprudential concerns.