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Time has come to dismantle capital controls: RBI official

Rising openness to global trade may create ways for circumvention of capital account restrictions.

By: ENS Economic Bureau | Mumbai | Published: May 19, 2015 1:58 am
RBI, Reserve Bank of India There is no denying the fact that sound capital controls have hitherto worked well in the Indian case and helped in protecting the economy from the vagaries of international capital flows.

Although capital controls have worked well in the Indian case, the time has probably come to revisit the issue of greater capital account liberalisation, a senior Reserve Bank of India official has said.

“As the Indian economy grows further and becomes global in dimension, a greater opening of capital account is inescapable,” RBI Executive Director G Padmanabhan said while addressing a conference in Mangalore. “India needs to continue moving towards full capital account convertibility. There is simply no escape from it.” Capital account convertibility essentially means the ability to freely conduct transactions of local financial assets into foreign financial assets and vice versa at market determined exchange rates. India has already achieved current account convertibility on the trade front.

There is no denying the fact that sound capital controls have hitherto worked well in the Indian case and helped in protecting the economy from the vagaries of international capital flows and in insulating the economy from the contagion effect of various currency crises but the time has probably come to revisit the issue of greater capital account liberalisation, he said.

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So what should India do or how should it proceed further on this path? “A truly globalised economy, which the Indian economy is likely to become in the not too distant a future, cannot afford to remain isolated for a very long period of time. Sooner than later, it will need to get closely integrated with the rest of the world,” he said. While there are risks associated with full capital account convertibility, resisting liberalisation over an extended period may prove futile and counterproductive. “As the economy gets more globalised, it will become harder to maintain closed capital accounts,” Padmanabhan said.

According to him, increasing openness to international trade may create opportunities for circumvention of capital account restrictions through under-and over invoicing of trade transactions and the increasing sophistication of investors and global financial markets makes it much easier to do so. Transfer pricing is one of the methods which corporates may employ to get around capital account restrictions. In any case, keeping any restriction for too long is self defeating as people end up finding new methods of bypassing that restriction.

It is a moot question as to how fast the movement should be. “That will depend on how fast we can meet the most important preconditions like fiscal consolidation, inflation control, low level of NPAs, low and sustainable current account deficit, strengthening of financial markets, prudential supervision of financial institutions, etc. India has already made visible progress on these fronts,” he said.

“There are of course risks, but we need to accept these risks and move forward boldly while controlling the risks as far as practicable,” Padmanabhan said. If the experience of developed countries is any pointer, sound policies, robust regulatory framework promoting a strong and efficient financial sector, and effective systems and procedures for controlling capital flows greatly enhance the chances of ensuring that such flows foster sustainable growth and do not lead to disruption and crisis. India has all these in place and we need to keep on strengthening them, he said.

“A freely convertible country must have sound, credible, and time consistent macroeconomic policy,” he said. What does that translate to, operationally? Fiscal prudence and low inflation. “Where do we stand in respect of these parameters? I wouldn’t think we are very comfortable here. Both fiscal management and inflation have their own logic and dynamics in a large, diverse, developing country like India,” Padmanabhan said.

How optimal will it be to throttle social expenditure and blow up interest rates just to attain capital account convertibility? The second threat emanating from capital account convertibility is contagion of disturbance in the global financial markets. “The brunt of this has to be borne by the domestic financial system. Though tightly regulated, the financial sector, particularly the banking industry is surely not in the pink of heath,” he said.

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  1. ramalingamvenkatraju
    May 19, 2015 at 7:07 am
    crimes against common people of India, with out job by government, judicures, but now makeing black money, bribes, scams, legal, for world war 3 .
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    Reply
    1. k
      k.sampathkumar
      May 19, 2015 at 7:05 am
      what will happen in the case of full convertibility to the food prices which are killing the indian mes?
      (0)(0)
      Reply