Not A Capital Idea At All

Context: RBI Deputy Governor while speaking at the Fifth Foreign Exchange Dealers’ Association of India Annual Day, resurrected a debate surrounding capital account convertibility (CAC).

Challenges full capital account convertibility

• Increases vulnerability of emerging market economies to global macroeconomic shocks: Emerging economies do not have international reserve currencies like US dollar and.
  • Weak macroeconomic fundamentals: India’s susceptibility global macroeconomic shocks such as sudden reversal of forex inflows or rising oil prices.
• Merits of CAC are exaggerated and risks are underestimated: As seen from global financial crises and experience of Latin American and East Asian crises.
  • During East Asian crisis, India remains apart from countries like Indonesia and Thailand and protected from economic devastation as it was far more conservative in moving towards CAC.
• Policy priority is not full CAC: Caution from IMF that full capital account liberalization is not an appropriate goal for all countries.
  • Under certain circumstances, capital controls may have a place in a country’s macroeconomic policy toolkit.
• Vulnerabilities in debt management: Volatile debt flow risks of ‘unambiguous’ move towards an ‘unfettered access for non-residents into government securities’ must be carefully thought.
  • Debt flows may end up fuelling the asset bubble: Through funding purchases in secondary market instead of funding much-needed infrastructure.
  • Impact on foreign Policy: Foreign policies may become hostage to global debt flows.

Conclusion: There seem to be threshold levels of institutional development only above which the benefits exceed the costs of capital account liberalisation. We are not there yet. Not by a long shot.