The debate
around capital account convertibility is once again likely to become live in
India after the Reserve Bank of India Governor, Raghuram Rajan referred to the
need to move towards with a pre-defined time frame. Though it was capital
account convertibility, in an academic context while speaking to students at
the Gokhale Institute of politics and Economics in Pune. Every time when this
issue emerges, arguments are made for fuller capital account convertibility,
the governments officials, economists and investors all begin weigh the pros
and cons of convertibility, until it is realized that the timing is not yet
right and it would be perileous, then the debate closes. Same fate of this
debate can be expected this time as well. .
However, the
minister of state for finance Jayant Sinha too immediately after, picked that very
hastily and even stated that capital account convertibility is one of the
measures that India must take over a period of time such as to become a leading
global economy. He further asserted that we have to make it possible for our
capital markets to be broader, deeper and for that, capital account convertibility
also becomes important, Though Mr. Sinha said so without specifying any
particular time frame. But FCAC is not the need of our economy at all. Rather,
it is more of long awaited opportunity for foreign institutional investors and
speculators
In every
respect time is still not ripe for moving to full capital account
convertibility (FCAC) and would prove to be a misadventure as yet. Attempts are
being made for FCAC since 1997. In 1997 on but, after learning a lesson from
the Asian crisis of 1997, P. Chidamberam the then finance minister in the third
front government had to retreat from his firmly declared intent to do so. The
IMF, one time strong votary of the capital account convertibility (CAC) for
India, too had to abandon its campaign for the same, then in the late 90s
itself. The most vociferous advocate of the IMF’s erstwhile campaign for the
CAC worldwide, and former chief economist of the World Bank, John williamson too
had thereafter become the most skeptical of the results of FCACC and had
cautioned India too that any premature move towards it would increase the risk
of things going worse.
What
the full capital a/c convertibility would mean?
Capital account
convertibility means legal freedom for every citizen or non-citizen as well as corporates
in the country to convert there rupee assets into any foreign currency and back
for all kinds of capital transactions. India has current account convertibility
but not capital account convertibility. Every one of us would have the option
to have even our ordinary bank fixed deposits too into any currency, without
seeking any approval from anywhere. Thus it would mean:-
·
Freedom to convert local financial assets (including those of
Indian citizens and corporate) into foreign ones at market-determined exchange
rates.
·
Allows to freely exchange of currency and an unrestricted mobility
of capital into and of the country.
·
May be beneficial for a country with very strong external sector
fundamentals. Because it enhance faith of investors into that currency and
inflow of foreign investment too might increase. But, India altogether lacks
such fundamentals, with heavy trade, current account and fiscal deficits.
·
Therefore, the flip side, is that it might destabilize the economy
due to massive surge of capital flows in and out of the country.
It is no
secret that if Indians are given freedom to convert and maintain their capital
balances in foreign currencies in overseas banks and if Indian banks are
allowed to raise up to 100 percent of their capital, by overseas borrowings as
earlier recommended for phase - II and III by the Tarapore committee - II,
appointed by the RBI. Then, majority of the elite Indians and corporate units
might rush to convert their capital balances from rupees into dollars, euros and
pounds. Many persons would borrow funds in foreign exchange, speculate in
derivative trading in currencies and may even get bankrupt to bring
unprecedented pressure upon the exchange rate. This would deflate demand for
rupees and generate insatiable demand for leading foreign currencies,
ultimately leading to a meltdown of rupee value to any depth.
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Such a meltdown
would not be a distant possibility after the FCAC, as our economy is even not
as mature as were the South East Asian Economies in the pre-1997 crisis period.
All those economies viz. the South Korea, Thailand, Malaysia, Indonesia and
Philippines were having much stronger macroeconomic fundamentals. The growth
rates were booming, inflation rates were low, forex reserves were piling up.
Inflow of foreign capital was steadily growing in the pre crisis year and all
these 5 economies received a net capital flow of $ 93 billion. Yet, they faced
a shivering crisis solely due to the FCAC. Had there been partial restrictions
on convertibility the crisis would not have precipitated. India stood
unscathed, mainly because the rupee was not a freely exchangeable currency.
Moreover,
there is no conclusive empirical evidence to prove that CAC is necessary for
smooth and rapid economic growth and development. In a cross-country study,
Dani Rodrik of Harward has found little correlation of per capita income
growth, investment and inflation with capital account convertibility. In
another study, conducted by Prasad, Eswer, Kenneth Rogoft, Shang Jin and M
Ayhan of IMF, they failed to find evidence that a complete absence of controls
brings faster growth or other economic benefits. Hence, there are no apparent
gains of FCAC, but, there is every likelihood that it would lead to a worst
crisis.
It is no secret that India’s external
sector was quite vulnerable till recently before the sudden respite in oil
prices. The current account deficit last year in 2012-13 it self was above the
comfort level of 2.5 per cent of the gross domestic product. It was 4.2 per
cent of gross domestic product (GDP) in 2011-12 and rose to 4.7 per cent in
2012-13. Only after severe curbs, including restrictions on import of precious
metals and unprecedented fall in oil price, the deficit fell to 1.7 per cent in
2013-14. In 2014-15, it stayed low, with the third quarter showing a deficit of
1.6 per cent, solely due to respite in the oil prices.
The fiscal situation is though partly under control, yet, it continues to be fragile. The fiscal deficit of the central government had been 4.6-6.5 per cent in the past six years, before falling to 4.1 per cent in 2013-14. The government is committed to keeping the fiscal deficit low and the target of 3.9 per cent has been retained for this year. The deficit target is being scaled down to 3.5 and three per cent in 2016-17 and 2017-18, respectively.
Any imminent move towards further
opening up of the capital account is unwarranted, as the RBI had tough time to
regulate the debt market movements.
These are the debt markets where most
of the capital account restrictions do lie and would go with FCAC. The RBI had
tough time to manage this market over the past 12-18 months. The overall limit
for foreign inflows into government debt has remained static at $30 billion
since 2013. This limit was fully used up last year when foreign investors
rushed to buy Indian debt on the expectation that falling inflation and lower
interest rates in the economy would be positive for gains in bonds. Since then,
the foreign institutional investors have (FII’s) actively lobbied for a
revision of that limit, and the RBI has not relented. The inflows into
corporate bonds are also restricted at $51 billion and this hasn’t changed
recently either. But, all such restrictions would have to go away with FCAC.
All these limits on inflows were crucial according to the RBI which has pointed
that without these limits the potential for volatility in debt flows was high
at a time when the US was starting to normalize monetary policy. Moreover it
wasn’t just the quantum of inflows that the RBI has continued to restrict. The
central bank had also to micro-manage the nature of flows. Even, very recently,
in the February 2015 itself, the RBI had to ban incremental investments from
foreign investors into commercial paper, just due to the short-term nature of
these investments. The fear was that any time on a sudden outflow of funds from
this market due to global reasons could lead to an unwarranted spike in
corporate funding costs.
A similar precautionary decision had
been taken regarding foreign investments in government treasury bills in April
2014 following the experience of August-September 2013. At that time, heavy
selling from FIIs in government debt, particularly short-term debt, had led to
a sharp fall in the Indian rupee, leading to several ramifications in the
economy. So, a liaising fair policy towards the capital account would be
precarious.
Rather, as the things stand, all future
investments from the foreign institutional investors (FIIs) into Indian debt
will need to have been regulated well with a minimum residual maturity of three
years.
With respect to the external commercial
borrowings too, the RBI had to kept a
strict watch on these. There are sectoral limits in place, restrictions on the
cost at which such debt can be raised and what it can be used for. The central
bank has not opted to announce any significant liberalization in recent years
inspite of such a demand. Then, how all these regulation be allowed to with
FCAC.
Indeed, India’s economic fundamentals have to
be far more robust, and the global environment more benign with lesser
turbulence, before the country can consider further easing of the restrictions
on debt flows. Moreover, same is true for capital investments too.
Where is the
need for the FCAC, when the economy is already growing at 7.4 percent p.a.
without FCAC. Even if the proposed move is intended to facilitate foreign
investments, though they are not going to benefit us in any way and are bound
to harm in the long run with growing repatriations, yet the economy is
receiving the foreign investment too steadily to bridge the current account
deficit, though that is also quite unhealthy practice. Moreover, the China is
receiving even more FDI than us while it has even not moved for market
determined exchange rates then what to talk of capital account convertibility. Even,
the RBI's attempt to appoint the Tarapore committee II a decade ago to draw a
road map for FCAC was a futile and unwarranted attempt as the pre-conditions
laid by the committee a decade ago, are yet quite distant. Indeed, FCAC would
allow unrestricted conversion of the rupee assets into any currency (dollar,
pound, euro or any other currency) at the going exchange rate. It would empower
the citizens to convert their monetary assets into currencies of their choice.
The foreign direct investors too would be free to take out their money any time
without any restrain or charge. Indian
citizens, companies and banks would also become free to invest, speculate and
borrow (even for non-productive speculations) in any currency.
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It may also be true under certain
context that the FCAC is the mark of well-matured economy but has our economy
matured for the FCAC is a big (?) question mark. Even China, having a robust
trade surplus of $380 billion (almost equal to our total expoets) and cushioned
with a voluminous pile of $ 4 trillion forex reserves has no intent to move for the CAC. It has even not thought of a
market determined exchange rate in spite of such a thick pile of forex reserves
and towering trade surplus, where we are below the benchmark and both are to
our disadvantage. China had not at all cared for the Euro-American pressure and
displeasure when we were complying to the Fund-Bank sponsored structural
adjustment, and kept its currency fixed at 8.28 Yuan to the US dollar from 1994
to 2005. It helped China to bring down its inflation from 25 to around 2
percent. Thereafter, in the past one decade too it had a calibrated exchange
rate management and allowed to appreciate its Yuan to 6.19 Yuan per dollar in
such a calibrated manner to use exchange rate management as a fire wall against
any imminent dollar driven or the exchange rate driven inflation. In comparison
to china, when our exports are one sixth
of that of the china and exchange reserves are just around one tenth of the
China's and to the contrary, we have a wide trade deficit too. The free given in early 90s float to the Re and
convertibility of currency granted earlier in trade, current and partly in
capital account too has not gave use any edge. In addition to this, if we have
a look upon the large share of vulnerable receipts in our forex reserves, all
time high trade and fiscal deficits, growing hold of foreign institutional
invertors (FII's ) on our stock markets and the psyche of Indian elites, the
FCAC appears to prove to be the biggest misadventure, if brought about. Rather
it would be a boon to paint black money stashed abroad as white by
round-tripping.
