Within hours of suggesting that a tax on foreign institutional investments could be considered to check volatility in the stock market, RBI Governor Y V Reddy on Wednesday changed his stand and said it might not be a desirable option.
Reddy modified his statement at a hurriedly convened press conference late in the evening after Finance Minister P Chidambaram reacted strongly to his views and said there was no proposal to cap portfolio flows or tax them.
He also said Reddy had been misunderstood. "I have spoken to the governor and am quite clear in my mind that there is no question of taxing FII (foreign institutional investor) inflows. Even the governor is of the same view," the finance minister said.
Earlier in the day, while releasing the India Development Report 2004-2005 of the Indira Gandhi Institute of Development Research, Reddy had said "a view needs to be taken" on capping FII flows into the markets.
He made a strong pitch for taking a close look at the quantity and quality of FII flows. He also said "price-based measures such as taxes (on FII flows) could be examined," though their effectiveness was arguable.
Reddy said, first, a view needed to be taken on the quantity and quality of FII flows. While quotas or ceilings, as practised by certain countries, may not be desirable at this stage, there is merit in keeping such an option open and exercising it selectively as needed, after due notice to the FIIs.
Second, there is scope for enhancing the quality of flows through a review of policies relating to the eligibility for registration as FIIs, and an assessment of the risks involved in flows through hedge funds, participatory notes, sub-accounts, etc.
After the finance minister's statement on a television channel, Reddy, however, clarified that he did not press for a cap on FII flows. "Price-based measures such as taxes could be examined, though their effectiveness is arguable and hence may not be desirable," Reddy said, adding he was "not in favour" of a ceiling on foreign fund inflows, but options would be kept open.
He also said there was merit in examining the quality of such flows. The words were also later added to Reddy's speech on the RBI's website.
Reddy's comments seem to have unnerved the markets, though some pointed out that the central bank governor had never let an opportunity go to air his discomfort over "hot money".
"The comments are certainly ill-timed, though there is nothing new in what he has said," the CEO of a domestic brokerage firm said.
His views were echoed by the CEO of a domestic mutual fund: "The timing of his comment may not go down well in current market conditions, though he has valid concerns on the quality of inflows chasing Indian securities."
Another source at an FII brokerage said: "The markets have already seen a sharp correction in the past few days, but it needs to be seen how much impact the governor's comments will have.
"The world over, the authorities have toyed with the idea of a tax on portfolio flows and generally on cross-border foreign exchange transactions (the Tobin tax). But pragmatism has always got the better of foolhardiness."
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