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Not an unmixed blessing

The recent developments in the financial markets of Thailand have major implications for India. On Monday, with a view to stemming further appreciation of the baht which was straining the country's export competitiveness, the Thai authorities imposed currency controls. In effect, banks in Thailand were asked to withhold, for a year, 30 per cent of funds received from abroad for investment in stocks and bonds. If the "lock-in" was not complied with, overseas investors would get back only 10 per cent of the money sent. As the dominant foreign institutional investors voted with their feet, the domestic stock indices fell sharply dragging down the stock markets of not just Thailand but of many other countries too, including India. Forced to backtrack, the Thai authorities retained currency controls only for investments in bonds and securities. The stock markets everywhere rallied but there are many issues that need to be addressed. High up on the list is a re-examination of the macroeconomic priorities especially those concerning the external economy. In Thailand, as in India, foreign institutional investors have propped up the stock markets. Their capital flows have substantially boosted the official forex reserves and, in India's case, bridged the deficit in the balance of payments.

But such dependence claims its own price. For instance, in India, the accumulating inflows necessitated a two-pronged central bank strategy: first, buy up the accumulating dollars — which then get added to the reserves — and then "sterilise" the domestic liquidity that got boosted because of the RBI action in the first place. The Thai experience of overseas investors forcing the authorities to do a U-turn might be an extreme case. But Indian stock markets too have had to face the consequences of not having a broader investor participation. Recently, in the wake of the RBI's decision to hike the CRR (to combat inflation), large scale selling by foreign institutional investors caused a 1000 point drop in the Sensex over three days. Fortunately, India's conservative stance in exchange rate management and capital account convertibility has served the country well. The rupee is on a managed float and has been trading within a relatively small band. The progress towards full convertibility of the rupee has been measured. Unlike Thailand, which went through the painful experience of having to overcome a currency crisis in 1997 and therefore make structural changes in its economy, India has been able to sustain macroeconomic stability, thanks to its judicious external sector management.

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