Wednesday, December 05, 2007

Combating competitive tissue papering

The RBI appears to have done a good job in limiting the amount of tissue paper denominated securities that it holds. The worry is that the other currency denominated securities that it holds may soon turn to tissue paper if the US can convince all the central banks to drop rates. What should RBI (or rather India ) do to hedge against this scenario ?

  1. RBI can follow the follow the policy of competitive tissue papering ( Thanks Nitin). This would result in high inflation. A politically unacceptable solution for a government that always seems to be on the verge of an election.
  2. Slow down the growth of forex reserves. It could choke the inflows or increase the outflows. Choking inflows through blunt weapons like Tobin Tax or curtailing investments comes with its own set of problems. Encouraging outflows seems to be a better option.
What can RBI do to encourage outflows without hurting the Indian industry too much.

  1. RBI/GOI could encourage outflows on the capital account by removing the current investment caps for individuals & firms. There will not be any immediate impact for these moves ( I doubt if a large number of people are even investing to the current limit of 100,000 dollars ) but it will create some uncertainty in the minds of FIIs who are making a one way bet on the rupee.
  2. Remove wealth tax on gold. Indian gold demand would go up & we would end up exchanging tissue papers for gold, which is not a bad bargain
  3. Increase the strategic reserves of oil. India is doing that, may be it is time to accelerate the whole process.
  4. Lower customs duties. Domestic industry seems to be doing well. It is probably a good time to usher in more competition

Added on Dec 6th 14:20 PM IST
Disclosure : I have some investments in gold through ETF & some oil company stocks

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