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Tarapore panel suggests full deregulation of interest rates

The Committee on Capital Account Convertibility has recommended full deregulation of interest rates and total transparency in 1997-98 to ensure that there are no formal or informal interest rate controls.

Speaking at the 50th annual general meeting of the Indian Banks' Association, committee Chairman S S Tarapore said that the panel has also recommended that the cash reserve ratio should be reduced to three per cent by AD 2000, and to ensure that there is no loss of monetary control. Open market operations and interest rates would need to be activated as instruments of policy.

Tarapore, a former Reserve Bank of India deputy governor, said the committee clearly recognised that strengthening the financial system is the single most important precondition towards capital account convertibility (CAC) and that drastic measures need to be taken to reduce the level of non-performing assets to 5 per cent by year 2000.

A reduction in the cash reserve ratio and non-performing assets would increase spreads (the difference between lending and borrowing interest rates) by 1.8 percentage points. He said taking into account that financial liberalisation would impose a squeeze on spreads, the return on assets would be comparable to the internationally acceptable level of 1.0 per cent.

Talking about weak banks, Tarapore said the committee recommended that they be converted into ''narrow banks'' whose sources of funds are restricted only to investments in government securities. Such banks should be allowed to increase their advances, but there would exist a need for a severe restraint on their liability growth, he added.

Mentioning the country's financial weaknesses, he said, "Since the last five years, we have launched a comprehensive financial sector reforms. The reforms have enabled us to forge ahead in many areas but it has also exposed, under glaring floodlights, the weakness in the financial system." He stressed the need for taking stock of the achievements and failures and focussing attention on the key issues in the coming years.

"At this juncture, there is a need to prepare for a sharp acceleration in the pace of reforms and the better our preparation, the better will be our ability to minimise the casualties in the reform process," Tarapore claimed.

The former RBI deputy governor pointed out that financial crises in the developing countries have been significantly higher and more intense in recent years than in the preceding period. Policy-makers in emerging economies have recognised that vulnerability is not restricted to fiscal deficits but that potential quasifiscal deficits lodged in the financial system are equally important, he stated.

Tarapore pointed out that the exchange rate variations cause currency and maturity mismatches resulting in losses for corporates and these losses ultimately affect banks. "When domestic interest rates are high, a temptation for banks and corporates to incur debt in foreign currency is strong and such strategies come unstuck when there is an exchange rate adjustment," he said.

Speaking on the autonomy of public sector banks, he said there is a need to address certain existing norms on capital adequacy, non-performing assets, liquidity, and risk management skills. "Good banks should be granted a 'navaratna' status and provided total flexibility in their operations. In this case the board should be so constituted that there is an arms-length relationship with the RBI and the government.

He suggested some measures to reform the banking sectors: corporates which totally phase-out their recourse to the cash credit system should be provided free access to the money market and control over the entry into the market should be discontinued; banks which meet certain stipulated norms on capital adequacy and non-performing assets should be allowed to invest in money market assets abroad; and foreign institutional investors could be allowed to cover forward in the exchange market up to their rupee exposure in equities.

Tarapore also suggested that the RBI should withdraw from the primary market for the 91-days treasury bills, but should be active in the secondary market by offering two ways quotes. The FIIs should be given free access to the primary and secondary market for treasury bills for all maturities. The strong and exclusive fiscal concessions should be provided for dedicated gilt funds to encourage effective retailing of government securities.

Finally, the present general refinance facility with bank-wise quotas should be substituted by a system of repos and reserve repos in government securities which would provide liquidity adjustment facility throughout primary dealers across the yield curve, he declared.

Earlier, Indian Banks' Association Chairman Rashid Jilani stated that banks are most eager to fund projects and even are ready to do so with lower margins.