Analysis of the recent proposed SARFAESI amendments : are these consistent with the Insolvency and Bankruptcy Code?

Analysis of the recent proposed SARFAESI amendments : are these consistent with the Insolvency and Bankruptcy Code? The Leap Blog, May 29, 2016 (with Richa Roy).

Real GDP is growing at 5%, not 7.1%

Mint, March 14, 2016

Are our gross domestic product (GDP) numbers credible? Many commentators have expressed their doubts. But no one has yet identified problems with the Central Statistical Organisation’s (CSO) methodology. This is because they have been looking in the wrong place. The problem is not, as many have suspected, in the nominal numbers. It lies in the system for constructing the deflators. This methodology is flawed, yielding exaggerated estimates of the speed at which the economy is growing. As a result, policy decisions such as the Union budget are taken on the basis of a “broken speedometer”.

No one is talking about the deflators, but they are important. That is because the real numbers are derived by taking nominal data on the economy and deflating them by price indices. So, if inflation is understated, then real growth is going to be overstated. And this is what has been happening.

In the latest data released by the CSO we focus on the gross value added (GVA) numbers. This measure is conceptually similar to the old GDP at factor prices. In nominal terms, GVA increased by 7.9% in the third quarter (October-December) of the fiscal year 2015-16, below its usual level of 10-15%. This increase translated into a 7.1% real growth, because the deflator reportedly increased by only 0.7%.

Could India’s inflation be so low? In effect, the CSO is saying that despite India’s booming economy, producer inflation is lower than that of the recession-wracked economies of the West, or even that of Japan, which has been wrestling with deflation since the 1990s (see adjoining chart.) This is not plausible.

How could the CSO have come to such a conclusion? The answer is that in a number of sectors, it has proxied the deflator by using the wholesale price index (WPI). This approach is problematic. For one thing, the WPI and the GVA deflator can move in different directions. To see this, we need to look at value added from the income side. Firms’ value added is paid out to the factors of production, namely labour, land and capital. The biggest share of this income goes to labour, which means that wages form the bulk of the deflator. We do not have good data on wages, but we know that they have been going up. Yet, the WPI has been going down—by 1.5% in the third quarter.

Next, we turn to value added from the production side. When commodity prices decline, the commodity-heavy WPI will decline, as we have just seen. But the GVA deflator will need to increase. This may sound strange, but the reasoning is straightforward. Plunging commodity prices boost firms’ profits, increasing their value added, which is what the nominal GVA measures. But since ‘real’ GVA is measured at constant prices, this increase in nominal GVA needs to be deflated away. Hence, the deflator needs to rise.

In other words, by relying heavily on the WPI, the CSO has been led astray from the true deflator. As a result, the growth estimates have also strayed from reality. Over the past year, the dynamos of the economy—investment and exports—have remained mired in a slump. Yet, according to the CSO, the economy, excluding agriculture and government, expanded by 9.6% in the third quarter. This growth was powered by two sectors—trade and finance—that reportedly grew by around 10%, and one—manufacturing—that grew by 12.6%. In other words, the CSO is telling us that good times are back. But this is not consistent with what we see all around us.

If the WPI is such a poor proxy for the deflator, what numbers should be used in its place? There is no single answer. For the service sectors, one could look at the consumer price index (CPI) for services such as health and education. For manufacturing, one could take the CPI for clothing/footwear and miscellaneous household goods. All of these indices are running at 5-5.75%.

So, let us be conservative and use 5% as the deflator for finance and manufacturing. In that case, financial real GVA would show a growth rate of 2.6% as opposed to the reported 9.9%.

For the manufacturing sector, only 70% of the estimated GVA is derived by deflating the nominal numbers from the corporate sector, while the remaining 30% is based on the Index of Industrial Production. Accordingly, one needs to take 70% of the nominal GVA, deflate it by 5%, then add back the remainder. In that case, real growth of manufacturing GVA comes to 7.7% as opposed to the reported 12.6%.

With these adjustments for finance and manufacturing, keeping the numbers for the other sectors unchanged, we get a real GDP growth rate for the third quarter of 5%. In other words, the economy is struggling, not racing ahead. Now, that seems consistent with what we are seeing.

Where Is The Strategy To Solve The Investment And Banking Crises?

Swarajya, February 29, 2016

The 2016-17 Budget was presented by the finance minister against the backdrop of an economy that is facing two important macro problems—a crisis of investment and a crisis in the corporate and banking sectors. Other than the GDP numbers, all other statistics point towards an economy that is in trouble. The need of the hour was a July 1991 Dream Budget that would recognize the problems in the economy and outline a strategy to address them. The Budget presented today did not live up to these expectations and may go one step further in discouraging investment. Apart from a few good elements, this is not the Budget that would deliver the much-needed boost to private sector optimism in a modern market economy.

A few announcements in the Budget speech, mostly in the field of financial sector reforms, deserve mention. Setting up a resolution corporation for financial firms is a welcome step. This was recommended by the Financial Sector Legislative Reforms Commission (FSLRC) and is part of the Indian Financial Code. This, along with the Insolvency and Bankruptcy Code, when enacted, will reform the current insolvency resolution system, paving the way for faster restructuring of viable firms and exit of the unviable ones.

The amendment of the RBI Act to establish a Monetary Policy Committee (MPC) is important in context of the Monetary Policy Framework Agreement that was signed earlier last year and to achieve the inflation-targeting objective in a transparent and accountable manner. However, the devil lies in the details of the MPC. It remains to be seen what the composition and organization of the Committee will be. The setting up of the Financial Data Management Centre (FDMC) for data integration in the financial sector was also recommended by the FSLRC and is an important step.

Finally, adhering to the fiscal deficit target of 3.5 percent of GDP and reducing the revenue deficit target from 2.8 percent to 2.5 percent is prudent and may call for some cheer. But the manner in which it is sought to being achieved may be called into question. One needs to look closely at the numbers to assess the quality of this proposed fiscal deficit reduction. The calculations are based on a GDP growth rate of 7.6 percent. While the new GDP data show that India is doing very well, the new GDP data has its own share of problems and so far no step has been taken to correct these. If we assume that the new GDP data is hiding the true health of the economy, which in reality is a lot worse, then the tax buoyancy that the Budget speech refers to may be exaggerated.

Leaving this aside, there is also the question of windfall gains received by the government for the last several quarters on account of the fall in oil and commodity prices. This could have been used to further reduce oil-related subsidies and achieve a primary surplus. The Budget speech made no mention of such a plan. Instead, it announced the imposition of a series of cesses, a rise in tax on dividends, tax on long-term capital gains and a tripling of the Securities Transactions Tax (STT) on Options. At a time when encouraging investment is the need of the hour, measures such as these would send wrong signals to the private sector.

As the dust settles, it will be important to closely look at the revenue and expenditure calculations. Given that implementation of the recommendations of the 7th Pay Commission amount to roughly 0.6 percent of GDP and a deficit reduction of 0.4 percent of GDP is targeted, revenue measures adding up to roughly one percent of GDP are needed. That is indeed a big number and it is doubtful that all the tax measures announced in the Budget speech would add up to this. This calculation does not even take into account the expenditure on account of the Defense OROP programme. The Budget speech did not lay out any roadmap for gradual disinvestment of shares in public sector enterprises either.

The Budget speech was silent on how the government plans to tackle the two pressing problems that the economy is facing—investment crisis and banking crisis. It lacked the vision required to encourage domestic and foreign investment and to revive the economy. Two steps that could have helped in boosting investment optimism are a reduction in the corporate income tax and a proposal to table a bill in the Parliament to remove retrospective taxation. Not only were these missing in the speech, the tax on dividend was increased, a step that would discourage private investment.

The banking sector is buried under a mounting pile of bad debts amounting to Rs. 8 lakh crore. The FM announced a recapitalisation of Rs. 25,000 crore and the possibility of consolidation of public sector unit (PSU) banks. Given the magnitude of the crisis, Rs. 25,000 crore does not even scratch the surface. Even if one were to overlook this, allocation of any amount needs to be placed in context of a broader strategy to resolve the problem. There needs to be a forward guidance on how the bad debts can be resolved such that the banks can start lending again and the corporate sector can start investing again.

The Budget speech was an opportunity to announce a full blown strategy of how to fix the fundamental problems in the banking system that caused the crisis to begin with, what kind of deeper banking reforms will be undertaken so that a similar crisis is not repeated in future and how banking regulation will be modified to ensure that the RBI is better equipped to either prevent or deal with such a crisis the next time around.

But the Budget speech did not give a sense of the strategy the government will pursue to clean up the mess in the banking system. In absence of this, recapitalisation is merely going to postpone the problem. It will lead to moral hazard among the PSU banks as it will act as an implicit insurance against any loss that the banks suffer owing to NPAs.

India today is a modern market economy where people, especially the youth, are looking for jobs and opportunities and this calls for boosting investment and enhancing growth. This is what the government promised on their campaign trail. They have not delivered on this objective in the last two years and this year’s Budget does not promise a strategy of achieving it either.

The Budget Track Record

Swarajya, February 11, 2016

The Union Budget is a document that describes how much revenue the government expects to earn from what sources, and how much it plans to spend in what categories. Over time, it has become a statement of the work plan of the government for the coming year. It has become a document that spells out the economic vision of the government.

The Narendra Modi-led government has so far presented two Union Budgets. The government was expected to lay out a strategy to solve the pressing problems of the economy and deliver on the promises of growth revival and job creation made on the campaign trail. The Budgets announced by the government in July 2014 and February 2015 had some good elements but, by and large, did not live up to expectations. In recent times, the economic performance has been sluggish. An overall sense of despondency has replaced the initial exuberance that prevailed when the government took over in 2014. Expectations are high for the February 2016 Budget. There are gaps created by the last two Budgets that need to be addressed and a new strategy adopted to turn around the economy.

A downturn began in the Indian economy in 2012. GDP growth fell to a seven-year low of 5.3 per cent. Inflation was stubbornly high at 7 per cent, creating a situation of stagflation. Investment demand was sluggish, and the scope for increasing government expenditure was limited by the fiscal deficit of 5.9 per cent. It was against this background that the new government took charge in May 2014. In the months leading up to the election, the Bharatiya Janata Party made all the right promises. It won the election with a majority in the Lok Sabha—the first majority government in 30 years. With this win, came hope and optimism that the government would unveil a game plan to initiate structural changes in the economy.

July 2014 presented the new government with an opportunity to deliver a Budget that would reshape the economy, the way the P. V. Narasimha Rao-led minority Congress government had done in 1991. That government, elected in June 1991, had even less time to prepare for the interim Budget that Manmohan Singh presented on July 24, 1991. The situation back then was also direr. In comparison, the interim Budget of 2014 announced many small measures but did not spell out an economic vision of the government.

The government announced initiatives such as the development of 100 Smart Cities, a national-level Skill India programme, the Digital India programme, and the Swachh Bharat Abhiyan project. Arun Jaitley’s Budget speech mentioned the keenness of the government to revive growth, restore vibrancy in the economy, boost the manufacturing and infrastructure sectors, promote financial stability and introduce fiscal prudence. These are all good aspirations but what is needed is a long-term strategy to achieve these goals. There needs to be a deeper diagnosis of the problems in the economy, and addressing the underlying institutional bottlenecks by amending laws and constructing State capacity.

The good elements of the Budget were the increase in foreign direct investment (FDI) cap in the defence and insurance sectors to 49 per cent from 25 per cent, aimed at improving the investment climate and the announcement that a monetary policy framework would be put into place. The latter initiative is important because, for decades, India lacked a framework to deliver low and stable inflation.

On the fiscal front, there should have been a detailed roadmap to roll out the Goods and Services Tax (GST). For long in India, poorly designed and executed tax policy and tax administration have resulted in a low tax-to-GDP ratio and have been inimical to growth. With a 35 percent tax rate on corporate income, India has one of the highest tax rates among similar countries. What was needed in the Budget was a strategy to reform the tax policy and the tax administration. Overall, the 2014 interim Budget left much to be desired.

The 2015 Budget was the first full year Budget to be presented by the new government. The fall in global crude oil prices meant that the government was in a position to utilize the resultant windfall to cut back on subsidies. The government should be given credit for accepting the recommendations of the 14th Finance Commission to increase the share of the states in the central taxes to 42 percent. This meant that going forward, the states would be responsible for their own expenditures. This provided the government with an opportunity to bring about fundamental changes in the machinery of central expenditures. All of these could have been used to facilitate fiscal consolidation.

The previous Finance Minister, P. Chidambaram, had committed to a certain fiscal adjustment path. The 2015 Budget, however, announced the extension of the timeline to achieve the fiscal deficit target of 3 percent by one more year to 2017-18. This was unfortunate. The government could have instead announced systematic disinvestment measures to free up resources for capital expenditures and public investments while remaining on the committed trajectory of fiscal consolidation.

While subsidies on petroleum products were cut back in 2014-15, there was a lot more room to reduce expenses by pruning subsidies. The primary focus of the Budget should have been to boost GDP growth and achieve primary surplus so as to bring down the debt-to-GDP ratio. The budgeted primary surplus instead was -0.7 per cent and non-interest expenditures were budgeted to go up only by 4.06 per cent.

There was no plan in the 2015 Budget to implement tax reforms. The Direct Taxes Code that seeks to consolidate all direct taxes and is designed to make the tax regime more stable was dropped from the Budget. This was a new low. It is one thing to remain silent on new initiatives. But it is worse when the government announces a work plan to not do reform.

In contrast, the financial sector reforms that were announced may be considered the redeeming features of the 2015 Budget. The announcements included merging the commodity futures with the Securities and Exchange Board of India (SEBI), setting up the statutory Public Debt Management Agency (PDMA), shifting the government bond market regulation from the Reserve Bank of India (RBI) to SEBI, shifting regulation-making power on equity flows related capital controls to the government, setting up the Gujarat International Finance Tec-city (GIFT), and formalizing inflation targeting as a monetary policy strategy through the signing of the Monetary Policy Framework Agreement (MPFA).

Another good element of the Budget was the announcement that a comprehensive Bankruptcy Code would be introduced in 2015-16 in order to facilitate efficient exit of failed firms. The 2015 Budget also mentioned that the Indian Financial Code (IFC)—the most comprehensive and game-changing piece of legislation on financial sector reforms in the history of the Indian economy — was going to be introduced “sooner rather than later”. All of these were steps in the right direction.

Looking back on the implementation, however, several of the announcements made in the 2015 Budget have either been shelved or implemented in a half-hearted manner or continue to be in limbo. The GST is still a far cry from becoming a reality. Discussions to introduce the IFC in Parliament seem to have lost momentum. Establishment of the PDMA and shifting of bond market regulation from the RBI to SEBI have both been rolled back.

One area of reform that has been discussed widely in policy circles in recent times is infrastructure reform. The Budgets of the BJP government did not unleash the wave of public investments in infrastructure needed to revive the economy. The overall outlay allocated to infrastructure projects in the 2015 Budget amounted to less than 0.4 per cent of GDP. The Finance Minister proposed reviving the public-private partnership (PPP) model of infrastructure development. To make this work, deeper institutional reforms are required to sustain private sector participation in infrastructure. This, in turn, needs amendment of laws, establishing well-performing regulators and building adequate State capacity to ensure high quality execution.

On corporate and individual insolvency reforms, the Bankruptcy Law Reforms Committee (BLRC) submitted its report and a draft bill proposing a comprehensive Insolvency and Bankruptcy Code (IBC) in November 2015. The bill was introduced in Parliament in December and was referred to a Joint Parliamentary Committee that is supposed to submit its report around the next Budget session.

Implementing big structural reforms should be a measured process that includes perfecting laws, and creating good institutions. Just as legislative delays exacerbated by political logjam can be damaging for the economy, rushing to pass a bill without perfecting it and without a full implementation plan can also hamper outcomes.

The business cycle downturn that began in 2012 has not ended. Economic performance continues to be bleak. For the 2016 Budget, the government needs a completely new strategy that involves thinking about the full picture, getting clarity on where we want to be by 2019, what is the vision for the economy as a whole, and what steps need to be adopted to achieve this goal.

India’s fiscal situation has worsened over the last few years. At present, the interest rate paid by the government is higher than the nominal growth rate which means that the debt to GDP ratio is now on an upward trajectory. One important component of the next Budget should be steps to achieve fiscal correction in order to restore fiscal stability and debt sustainability.

While increasing fiscal deficit at a time like this would not be prudent, a push for infrastructure reforms is needed. This calls for a strategy to boost public expenditure especially on infrastructure, by using revenues from public disinvestments and subsidy reductions.

There also needs to be a strategy for reforming the tax policy and the tax administration.

Even after taking into account the rollbacks post the 2015 Budget, by January 2016, it appears that a lot of the work in the financial sector has lost momentum. The next Budget should revitalise this process if the financing needs of the infrastructure sector are to be met. There also needs to be a roadmap to introduce the IFC in Parliament.

The economy today is experiencing a balance sheet crisis of the firms and the banks. The government should review the idea of opening up the economy to new private and foreign banks in order to relax the credit crunch that the real sector has been facing.

The need of the hour is big thinking on the scale of the 1991 Budget and bold ambition underlying a slew of policy initiatives. Budget 2016 needs to deliver on strong fiscal, financial and monetary institutions that are needed for India to emerge as a mature, market economy.

While it is relatively easy to enumerate a list of agenda items for the Budget, the announcements in the Budget speech are only a part of the overall strategy. This has to be followed up with a full implementation plan to turn the Budget speech into concrete actionable points that can be delivered over the next financial year. Short of that, merely a good Budget speech will be akin to engaging in “isomorphic mimicry” where the reform process gains legitimacy through announcement of policy initiatives without actually obtaining the desired outcomes.

A better bankruptcy regulator

Business Standard, January 10, 2016 (with Pratik Datta)

The Insolvency and Bankruptcy Code (IBC) introduced in the winter session of Parliament recommends setting up a regulator, the Insolvency and Bankruptcy Board of India (IBBI). A regulator is a 'mini-state' with legislative, executive and quasi-judicial powers. Fusing all three aspects of the state into one agency is problematic, and requires particular care for achieving good outcomes. The current draft of the IBC requires many improvements on this score.

The IBBI will regulate insolvency professionals (IPs), IP agencies, information utilities (IUs) and resolution procedures. The entry of players needs to be monitored, and their behaviour needs to comply with standards specified through regulations. Violations of these standards must attract sanctions. In order to achieve malleability, many details of the insolvency process have been delegated to regulations to be specified by the IBBI.

While there is merit in proposing a new regulator, there is considerable scepticism about the performance of existing regulators in India, be it for regulation of professions (e.g. Institute of Chartered Accountants of India, Institute of Company Secretaries of India, Medical Council of India, Bar Council of India, etc) or regulation of industries (e.g. Reserve Bank of India, Securities and Exchange Board of India). If existing regulators have problems, why should we expect better from the IBBI?

Where have we gone wrong? The governance of existing regulators, including the composition of the board and its relationship with the management, is faulty. The procedures for writing subordinate legislation are neither well-defined nor transparent. The mechanisms for exercise of executive powers for conducting inspections and investigations are idiosyncratic and give arbitrary power to officials. Basic principles of rule of law are violated in the quasi-judicial function. Finally, feedback loops of accountability are feeble and fail to set off a continuous process of self-improvement.

Most existing regulators do not exercise a clear separation between their executive, legislative and quasi-judicial powers. The regulatory staff often controls the legislative functions supposed to be performed by the board of the regulator. The power to write law must vest with Parliament, or must be delegated to unelected officials under the control of the board, with requirements about due process.

Executive and quasi-judicial powers often get muddied. The wide-ranging executive powers given to regulators are not balanced with proper systems governing the application of administrative law. The concept of an administrative law wing like in the US Securities and Exchange Commission (SEC) is wholly absent in the Indian regulatory context. Quasi-judicial powers must be exercised by regulatory staff, who are at arms-length from the executive wing. The prosecution in a criminal case can never be the judge of its own cause.

There is no accountability of performance of existing regulators. The annual report should be a tool through which the public is able to judge the performance of the regulator. Lack of clarity in the laws also results in the regulator getting away with releasing minimal information on its performance. Recently, the Supreme Court came down heavily on the RBI for non-disclosure of information, emphasising that under the rule of law, punishments cannot be given in secret.

So how do we ensure that the IBBI performs better than existing Indian regulators? Sound regulatory governance requires considerable detail encoded into the primary law, which specifies all five aspects: board and governance, legislative function, executive function, quasi-judicial function and accountability. Conventional laws in India are skimpy on specifying these details, which is what has led to pervasive underperformance.

For a market to function properly, regulators must treat market participants as equal stakeholders. While framing regulations, the IBBI must consult relevant market participants. It must do detailed cost-benefit analysis to assess if a particular regulation solves a case of market failure. It must issue regulations in a transparent manner after deliberations at the board level. Surprises should not come about, where a regulation which is released today takes effect from tomorrow, without any warning.

The quasi-judicial function in the IBBI is special. Persons who write orders must not be involved either in writing law or in enforcing it. Hearings must take place, where the accused have an opportunity to present their point of view, and reasoned orders must come out in writing on the regulator's website. Efficacious methods for appeal must be available to those found guilty.

The establishment of sound processes for the legislative, executive and quasi-judicial functions will create an environment of rule of law. This generates accountability in and of itself. In addition, the IBBI must be required by law to publish an annual performance report documenting its performance according to well-defined parameters.

The current draft of the IBC does not specify these basic requirements in adequate detail. It does not provide sufficient clarity on the regulation making process of the IBBI, nor does it provision for a well-defined accountability mechanism for the regulator. The independence of the quasi-judicial function from the legislative and executive powers of the regulator is also not clearly spelled out. Now that the draft bill has been introduced, these are some of the issues that should be high on our minds when we think of bankruptcy reform and the associated enabling infrastructure.

Firm insolvency process: Lessons from a cross-country comparison

Firm insolvency process: Lessons from a cross-country comparison The Leap Blog, December 22, 2015 (with Anjali Sharma).

To internationalize the rupee or not?

Mint, December 2, 2015 (with Bhargavi Zaveri)

The recent decision by the International Monetary Fund to include the Chinese renminbi in the Special Drawing Rights basket and announcements by the Reserve Bank of India (RBI) allowing Indian companies to issue offshore rupee-denominated ‘masala’ bonds have triggered discussions on whether India is ready to ‘internationalize’ the rupee.

In popular discussions, rupee internationalization is often seen as a goal in itself. The notion that there needs to be a specific agenda for internationalizing the rupee is wrong.

To explain this proposition, it is necessary to understand what is an international currency. Rupee will be an international currency if non-residents are willing and able to trade in it and invest in rupee-denominated assets. For example, a Russian importer must be able (and willing) to invoice and pay for her imports from South Africa in rupees. Similarly, a UK resident must be able (and willing) to invest her savings in rupee-denominated bonds or shares. In these cases, non-residents take risks in the rupee as a currency.

The willingness and ability to transact and invest in a currency depend on three prerequisites. First, the issuing country must have sufficient scale, both in terms of nominal gross domestic product and volume of international transactions. For instance, while China is a $10.36 trillion economy, India is roughly at $2 trillion. For India to attain sufficient scale, the economy needs to grow at a sustainable average rate of 7-8% for the next five years or so. India’s current share of global trade is also relatively small and the bulk of it is invoiced in US dollars. Improvements in scale are linked to macroeconomic fundamentals, which cannot be changed through an internationalization-driven agenda.

Second, the value of the currency must be stable over time. A currency is considered stable when the general level of prices does not vary too much. Stability has multiple aspects: macroeconomic, financial and political. On macroeconomic stability, earlier this year, India undertook an important reform in the form of the Monetary Policy Framework Agreement that formally lays down inflation targeting as the objective of monetary policy in India. The proposed Monetary Policy Committee (MPC) Bill, if introduced and passed, will complete this reform by institutionalizing an accountable and transparent decision-making framework for monetary policy.

Not much progress, however, has been made on financial stability. The banking system continues to be overburdened with burgeoning non-performing assets. None of the attempts undertaken so far by either the RBI or the government to resolve banks’ asset quality problems seems to be yielding expected results. Improving financial stability will need urgent reform of the banking system and strengthening banking regulation.

In terms of political stability, the fact that India is a democracy, like issuers of most international currencies in the 19th and 20th centuries, goes in its favour. Democracy and associated checks and balances on the executive, instil confidence in foreign investors about the policy credibility of the government, thereby imparting stability to the national currency.

Stability is often confused with a managed currency that does not exhibit volatility. This is wrong. A currency is deemed stable when its value reflects underlying market forces. If market forces cause a currency to fluctuate, then artificially managing its price does not make it stable. One way to look at this problem is to think of administered prices. There was a time in India when prices of commodities such as steel and diesel were controlled and exhibited no volatility. Today, these prices freely fluctuate in response to supply and demand conditions. That is how a currency market should work as well.

Third, the currency must be liquid. A currency is liquid if significant quantities of assets can be bought and sold in the currency, without noticeably affecting its price. This requires depth in financial markets, a large stock of domestic currency-denominated bonds and adequate options to hedge currency risk exposures. India lacks a deep, liquid and well-functioning corporate bond market. Hedging opportunities for foreign investors are limited. On the exchange side, RBI and Securities and Exchange Board of India (Sebi) control the kind of currency derivative products that can be offered by exchanges, mandate underlying exposure requirements to buy those products and set position limits. Off exchange, there are entry barriers on who can offer and trade in currency derivative products, and on what conditions. Extensive regulatory reform is required to create a deep market that will offer foreign investors suitable hedging options.

Liquidity has been historically found to be less in countries that have capital controls. A large base of foreign investors adds to the liquidity in the domestic market. India has one of the least open capital accounts among emerging economies. Relaxing capital controls to attract foreign investor participation is crucial for enhancing rupee liquidity.

To conclude, any conversation on rupee internationalization dehors structural reforms is futile. Scale, stability and liquidity can be achieved through strong economic fundamentals and a process-driven regulatory environment. These, by themselves, are important policy goals to achieve for India. It is possible that once these are achieved, the rupee will come to be accepted as an international currency.