The Reserve Bank of India has cautioned corporates against unlimited access to short-term external commercial borrowings to fund working capital and other domestic requirements.

The central bank has reasoned that many of the financial crises in the 1990s were created by excessive short-term debt.

"In respect of short-term ECBs, there is already a strong international consensus that emerging markets should keep such borrowings relatively small in relation to their total external debt or reserves," RBI governor Bimal Jalan said at the 14th National Assembly of the Forex Association of India.

When times were good, short-term debt was easily accessible but the position changes dramatically in times of external pressure.

All creditors, who could redeem the debt, did so within a very short period, causing extreme domestic financial vulnerability, the governor said, cautioning against such a possibility hitting the Indian markets.

"We would do well to continue with our policy of keeping access to short-term debt limited as a conscious policy at all times -- good and bad," Jalan said.

He asked companies and other importers with foreign exchange liabilities to hedge their exposures against currency fluctuations.

Many companies have left payables and foreign currency loans raised in recent months unhedged as the rupee has continued to appreciate against the dollar.

The rupee has appreciated 4.5 per cent to 45.9025/9125 per dollar already in 2003, after posting a 0.55 percent rise in 2002, its first annual gain against the dollar in a decade.

"Exchange rate fluctuations among major currencies are now an everyday fact of life and it is important for all entities with foreign exchange exposures to resort to hedging with appropriate risk management of asset and liabilities," Jalan said.

While pointing out that the rupee was practically convertible for most business and personal transactions, the governor also cautioned against providing unrestricted freedom to domestic residents to convert their domestic bank deposits and idle assets in response to market or exchange rate expectations.

No emerging market exchange rate system can cope with a contingency that could arise if domestic residents (say, in response to a depreciating domestic currency) decide within a very short period to convert a significant part of their domestic deposits into foreign exchange-denominated deposits.

"If a large number of residents decide to convert a part or whole of their stock of assets from domestic to foreign currency (in anticipation of a depreciating domestic currency) within a short period of time, this expectation would become self-fulfilling. A severe external crisis is then unavoidable," the governor said.

Such a contingency could be a reality in India at a time when its domestic stock of bank deposits in rupees is nearly three and a half times the country's total reserves.

"This may be an unlikely possibility today, but it must be factored in while deciding on a long term policy of free convertibility of 'stock' of domestic assets," the governor said.

Referring to the concerns on "cost" of additional reserves and the impact of "arbitrage", he emphasised that the bulk of the addition to the reserves in recent times is on account of non-debt creating inflows, including non-resident Indian deposits.

Under the present conditions, it seems that the "cost" of additional reserves is really a non-issue from a broader macro-economic point of view.

Jalan also said that the "arbitrage", per se, is unlikely to have been a primary factor in influencing remittances or investment decisions by NRIs or foreign entities in the recent period.

"There is very little incentive to send capital to India merely to take advantage of the interest differential. Rather, within a certain low range, capital flows are likely to be more influenced by the outlook for growth and inflation than pure arbitrage even among industrial countries with full capital account convertibility," he argued.

The governor agreed with the point raised by experts that it is paradoxical for a developing country to have a current and capital account surplus and thereby add to its reserves, rather than use foreign savings to enhance the rate of investment in the economy.

It is for this reason that in the recent period, the RBI has been following a soft interest rate policy in an environment of low inflation.

He, however, emphasised that there is very little that the RBI can directly do to use the additional reserves for investment and stated that the equivalent rupee resources have already been released by the RBI to the recipients of foreign exchange and the decision on whether to invest, consume or deposit these additional rupee resources lies with the recipients.