## Friday, September 01, 2006

### CAC-2 report has been released

I think Jamal Mecklai embarassed RBI :-). The elusive report of the Tarapore-2 committee has been released (you might find my blog entry on the creation of this committee to be of some interest). I haven't read it yet, but a first skim shows some oddities -- their idea of liberalising the capital account involves banning participatory notes, and they don't get the impossible trinity of open economy macroeconomics. Tarapore-II has two dissent notes, by Surjit Bhalla and A. V. Rajwade. RBI has chosen to not implement anything right away (i.e. between July 31 and 1 September), but has setup one more internal group to work on the subject.

Excellent commentary on the report, and on the larger issues of moving towards "fuller capital account convertibility" has come out in the press.

• Economic Times had a front page piece by Shaji Vikraman and M. K. Venu with unnamed Ministry of Finance staff saying that there wasn't going to be a ban on participatory notes. (See this blog entry on participatory notes and moving forward from the Indian FII framework to omnibus accounts).
• See an edit in Indian Express and a main column there by Ila Patnaik.
• An edit in Business Standard, a main piece there by Abheek Barua and another by Subir Gokarn.
• Jayanth Varma has written a blog entry and another one today.
• The other edit in Business Standard helps you place this in the context of the prevailing climate of faulty economic policy making in India.
• Andy Mukherjee gets the impossible trinity in an exuberant piece titled
• Somasekhar Sundaresan has an article on the PN debate.
• And, Sucheta Dalal argues the RBI position on participatory notes.
• There is an ET debate with 3 people on the subject: Omkar Goswami, Susan Thomas and Soumya Kanti Ghosh.
• Ila Patnaik offers a sketch of what the chapter on banking in the report should have been.
• A response on the report from Jamal Mecklai.

Watching RBI and the removal of capital controls, I'm reminded of SEBI and the onset of equity derivatives trading:

 14 December 1995 NSE asked SEBI for permission to trade index futures. 18 November 1996 SEBI setup L. C. Gupta Committee to draft a policy framework for index futures. 11 May 1998 L. C. Gupta Committee submitted report. 24 May 2000 SIMEX chose Nifty for trading futures and options on an Indian index. 25 May 2000 SEBI gave permission to NSE and BSE to do index futures trading. 9 June 2000 Trading of BSE Sensex futures commenced at BSE. 12 June 2000 Trading of Nifty futures commenced at NSE. 25 September 2000 Nifty futures trading commenced at SGX.

1. will it be possible for you to elaborate a bit on the following concept, "impossible trinity of open economics macroeconomics"

2. The impossible trinity of open economy macroeconomics asserts that you can't simultaneously have: a fixed exchange rate, an open capital account, and autonomy of monetary policy. If the capital account is open, and if you try to pursue a fixed exchange rate, then all of interest rate policy will get used up to merely defend the exchange rate.

In the limit - when you have a truly fixed rate and a truly open capital account - there is no doubt that the impossible trinity is a real constraint. What is fascinating is that it's also an interesting idea in the shades of gray that precede the extremes. Even if the capital account is not fully open, attempts at having exchange rate policy impede the flexibility of the country to have an autonomous monetary policy.

Example: In January 1998, RBI raised interest rates (200 bps on 16th) in defending an exchange rate. This was not a good piece of monetary policy from the viewpoint of a country where growth was slowing.

Example: In the post-2002 period, RBI was buying USD in preventing the INR from appreciating. This led to low interest rates in the local economy, at a time when the local economy was booming. The easy monetary policy of this period is arguably the deep source of the high inflation that we're seeing today.

Please note: LaTeX mathematics works. This means that if you want to say $10 you have to say \$10.