Last month,the RBI Governor D Subbarao told a meeting of central bankers and economists in Argentina that India must move towards capital account convertibility (CAC) along a roadmap. He also said that global and domestic developments will play a crucial role in determining this roadmap. This cautious approach towards CAC is understandable in light of the ongoing global financial crisis.
The debate on full CAC in India has generated many government reports including the two Tarapore committee reports. The current position is that India does not have full CAC and can impose capital account restrictions. The Foreign Exchange Management Act (FEMA) empowers RBI to regulate (and even prohibit) capital account transactions. For example,in October 2007,when capital inflows touched an all-time high of $110 billion,RBI used the power conferred by FEMA to limit ECBs by Indian companies in order to stem the appreciation of the rupee. Economists heatedly debated the merits of this. This restriction has since been eased and the informal absorptive capacity of net capital inflows in India has been increased from $110 billion to $150 billion.
The current position on capital controls and full CAC in India is consistent with the IMF Articles. Notwithstanding IMFs ideological stand on capital account liberalisation,the IMF Articles do not interfere with the legal right of member countries to impose restrictions on capital account. IMF Articles obligate its member countries to liberalise only current account transactions and not transactions on their capital account. But this position is not consistent with Indias obligations under the numerous bilateral investment treaties (BITs) that we have signed with nearly 70 different countries. This is the point that most economic debates have missed. The issue here is not whether capital controls per se are good or bad to meet a particular macroeconomic objective; the issue is whether India is legally competent to adopt such capital controls or not in light of its international obligations contained in BITs.
Under BITs,one country accepts restrictions on its regulatory ability as part of its international legal obligations aimed at protecting investors and investments of another country. In case a country fails to protect investments as per the BIT,the BIT empowers investors to enforce their rights against the host state through a binding international arbitration mechanism. A crucial component of this regime is to grant the foreign investor the right to transfer funds (both inflows and outflows) related to investment. This is called the capital transfer provision (CTP) and plays an important role in a foreign investors decision to invest in a particular country. Lack of freedom to transfer funds may result in investments not being made in the first place. But the foreign investors right to transfer funds may not be absolute,and the host country can restrict such transfers under certain circumstances,provided such restrictions are recognised by the BIT.
In Indias case,more than 50 BITs out of the 70-odd that India has signed give an absolute right to foreign investors to bring in and take out capital. Only a handful of Indian BITs recognise exceptions to the transfer of capital or subject capital transfers to domestic laws,thus giving India the policy space to impose controls in national interest.
The absolute right in a majority of Indian BITs includes the right to transfer any funds related to investment in a convertible currency without unreasonable delay and at the prevailing market rate of exchange. Thus,these BITs do not recognise situations in which India may need to impose capital controls for monetary objectives like regulating the inflow of capital to prevent the appreciation of the rupee or to prevent capital flight in case of a balance of payments (BoP) crisis. And these BITs are with countries that are big investors in India like Mauritius,the UK,France,Switzerland,Sweden and Germany.
Hence,what the RBI Governor presented as something to be achieved gradually has actually already been achieved by India in relation to a large number of countries. India cannot adopt capital controls without violating international law vis-à-vis those foreign investors who are protected by one of the BITs that grants investors the absolute right to transfer capital. Arguably,in such cases,India can rely on some other exceptions in the treaty or on customary international law. But the possibility of succeeding is remote,given the stringent character of these exceptions.
This issue becomes even more critical in light of the fact that foreign investment is very broadly defined in all Indian BITs. Foreign investment is not limited to FDI but also includes portfolio investments. Thus,even when restrictions are imposed on portfolio investments,such restrictions are very much within the purview of the BIT.
Why has no dispute arisen so far between a foreign investor and India on the issue of capital controls? Possibly because the capital controls adopted so far have not been intrusive enough to adversely affect the economic interests of a foreign investor because India has not witnessed a BoP crisis in recent times. But does this mean that India will never face a BoP crisis? Forget a BoP crisis; a dispute can even arise if India tightens inflows or outflows that,in turn,adversely affect the economic interests of a foreign investor. Are we waiting for foreign investors to bring cases against us in international arbitration,like US companies have done against Argentina for alleged violation of the CTP in US-Argentina IIA,before we take cognisance of such a major flaw in our BITs?
The author is a PhD candidate at Kings College,London and assistant professor at National University of Juridical Sciences,Kolkata