Speaking at the Peterson Institute for International Economics in Washington D.C., around the time of the spring meetings of the IMF and the World Bank, Reserve Bank of India Governor, D. Subbarao, turned his attention to the global chorus in favour of some controls on cross border flows of capital. It is well known that in recent times Brazil has followed past experience in countries like Chile and Malaysia, and experimented with a Tobin-type tax to moderate a surge in capital inflows. Moreover, the experience of capital flight during the recent crisis and the fact that easy liquidity conditions in developed country money markets has resulted in a revival of capital flows to and a synchronised boom in asset markets in “emerging economies”, has encouraged even the IMF to declare this February that there are “circumstances in which capital controls can be a legitimate component of the policy response to surges in capital flows”.
Ever since the 1980s the mindset of both the government and the RBI has been such that when the IMF says something they must take note. So the governor has responded to the IMF study by admitting that the management of volatile capital flows is testing “the effectiveness of central bank policies of semi-open EMEs”. The question naturally follows that if management of such flows is an issue, are capital controls in general and a Tobin-type tax in particular acceptable policy options?
Given the Governor’s inclinations, he only reluctantly admits that they can indeed be. But he is not willing to give up on his preference for an open capital account. India, he argues, has consistently held the position that “capital account convertibility is not a standalone objective but a means for higher and stable growth”, and therefore the “economy should traverse towards capital convertibility along a gradual path - the path itself being recalibrated on a dynamic basis in response to domestic and global developments.” So, despite the experience during the crisis, “we will continue to move towards liberalizing our capital account, but we will revisit the road map to reflect the lessons of the crisis.”
If clarity is a virtue, then “we” seem to be lacking here. But may be the lack of clarity serves to brush under the carpet the signals that the crisis has sent out on the dangers of unregulated capital flows and financial markets. This is in keeping with the position that the RBI and the Finance Ministry have adopted in the past on the issue of convertibility. Just before the East Asian financial crisis of 1997 broke, India was all set to make the rupee fully convertible on the capital account. A road map for full convertibility had been drawn up by the committee chaired by S.S. Tarapore. This would have allowed residents in India to convert their wealth into foreign exchange and transfer it abroad. The 1997 crisis sent out a clear signal that this is bad policy and can pave the way for instability and even a currency crisis. That signal prevented the government from opting immediately for such a misguided policy.
As is normally the case with officialdom this setback was converted into a virtue. Indian policy makers have claimed to be proud of the fact that cautious policies with regard to capital flows and financial integration had helped the country avoid financial crises and reduce the impact of the 2008 crisis on the country. But the evidence is clear that there is a strong segment of government opinion which is still in favour of full convertibility. This is only partly because of the beliefs (i) that India is “different” and can handle convertibility much better than other developing countries; and (ii) that convertibility is a requirement for India to move from developing to developed country status. More importantly, it is the result of pressure from wealth holders within the country who want the option of transferring wealth abroad both to earn returns and hedge against any possible weakening of the rupee. That this could be at the expense of instability that undermines the living standards of the less well-to-do does not obviously bother them.
Pressure from that lobby has only intensified during the years of liberalisation. Either because of his inclinations or in response to that pressure, the governor has chosen to question the case in favour of capital controls and raise doubts on the wisdom of imposing Tobin-type taxes. While admitting that “there are examples of countries, notably Chile, Colombia, Brazil and Malaysia, which have experimented with a Tobin tax or its variant” and that “some lessons can be drawn” from that experience, he suggests that “it does not constitute a sufficient body of knowledge for drawing definitive conclusions.” So he resorts to an equivalent of the time-honoured official practice of setting up a committee to study the issue whenever some decision has to be blocked. In his view: “Now that there is agreement that controls can be ‘desirable and effective’ in managing capital flows in select circumstances, the IMF and other international bodies must pursue research on studying what type of controls are appropriate and under what circumstances so that emerging economies have useful guidelines to inform policy formulation.” Research takes time and can always be declared inconclusive. Clearly, this time too, the RBI and the government, under pressure from the wealthy, are choosing to ignore the lessons that crises elsewhere have delivered to the country.