A closed capital account is not a real option. We should focus on sequence and timing.
In his article, ‘Against the flows’ (IE, February 24, goo.gl/rOG0oD), Gulzar Natarajan said capital controls were good and necessary. Liberalising our capital account, he claimed, will not benefit India either through higher growth or investment. It will only result in currency crises and higher risks, which we cannot manage.
India must, therefore, not liberalise its capital account — even the IMF has endorsed this line of reasoning according to Natarajan. But this argument ignores India’s de facto capital account openness, the aspirations of a young and ambitious country, which does not want to go back in time, and the enormous body of evidence on the failure of capital controls as a tool of macroeconomic policy.
Economists like to think that there is a debate about capital account openness and that a decision about whether it should be open or closed is yet to be made. But this is not what happens in the real world. In the real world, a maturing country develops a capable financial system and sophisticated firms. It develops a liberal democracy, where the government is unable to interfere in the freedom of citizens. Once a country reaches this state of maturity, the capital account is de facto open.
Whether some economists think it should be open or not, in the eyes of the top 10 per cent of India — which makes decisions for the bulk of the economy — the capital account is open. To close it requires intruding on personal freedoms, inflicting harm on internationalised firms, and damaging the financial system.
When some Indian bureaucrats have argued in favour of a closed capital account at international forums, they have faced amusement from the audience. No country has taken this idea seriously. This so-called “lesson from the global financial crisis” is something no one is interested in learning. There has been no reduction in capital account openness — either among advanced countries or among emerging markets — after the crisis. The free movement of goods, services, ideas, capital and enterprise across national borders is an integral part of modernity.
Capital controls in emerging economies, where they exist, are like tariff or non-tariff barriers that can be switched on and off. They can be price- or quantity-based. Most evidence shows that these controls have little usefulness, both in terms of the time period for which they are actually effective, and in terms of their macroeconomic impact, which is limited and short-lived.
Advocates of capital controls have argued that their failure to deliver results is because they have been temporary. It is contended that permanent controls, which intrude deeply in the functioning of continued…