Noise around India’s shift to full capital account convertibility..

As ME was away, capital account convertibility issue again cropped up in discussions on Indian economy.  It is amazing how we make such noise around something whose benefits and risks have been overstated for such a long time.

Before we discuss the issue further, what exactly is a capital account and what is an open capital account? The expression comes from Balance of Payments of a country which represents the account of a country with other countries/institutions. So, we have a current account which records exports and imports of a country. Then there is a capital account which is a mirror image of current account. So, if there is a deficit in current account, one needs surplus in capital account to balance the payments (& vice-versa). Capital account shows all the inflows/outflows from other countries. Includes popular items like FDI, FII, External borrowings etc. etc.

So, if you open the current account it means that one can import and export freely from all countries with some basic regulations in process. In case of opening capital account it means you allow import and export of capital as well. So, one can buy Indian shares freely as Indians can buy shares of other countries freely. Likewise Indian companies can borrow freely from banks based abroad and foreign companies can borrow from Indian banks.

India was a closed economy till 1991 with lots of restrictions on exim business. Since 1991, India moved to current account convertibility rather quickly and most thought opening of capital account is a matter of time. Moreover, it was highly fashionable as most Latin American and South East Asian nations had gone in that direction. But this was not to be.

Committees after committees were floated proposing a detailed path towards open capital account. But each time these reports met dead end. Reason? Well, each time the report was tabled, a crisis followed. So whether it was the report in 1997 or several others in 2006-08 we had a terrible crisis soon thereafter. So much so, this terrific blog post calls all CAC reports in India as a leading indicator of global financial crisis!!

In each crisis, the lessons learnt were that open capital account is an issue. The countries that had opened up their capital account (like SE Asia) suffered more than those what had a relatively closed account (like India). This automatically shut doors for these committee reports. Those who opposed this said one only can comment on the quality of road by driving/walking on the road. Simply attributing the cause of crisis to CAC was foolish as there were multiple factors responsible for the crisis. Moreover, countries which adopted CAC grew faster before the crisis. So, it all evens out really.

In India, policy has been more curious and interesting. The Finance Ministry is always keener to push CAC whereas the central bank has been more conservative. The reason was also quite simple. Finance Ministry traditionally has always had advisers etc from/trained in the west (most having worked at IMF/WB). The so called neo-liberal ideas have always been fashionable with Finance Ministry.

In case of central bank, somehow things have  been more conservative. This is interesting as it is finance minstry which appoints most of the senior staff. So whether it is a trick by the finance ministry to just talk and not walk or it is a case of someone changing his views on joining the central bank. In the first case, the idea is finance ministry itself is unsure of CAC. So it talks of CAC to please the IMF type audience but appoints someone at central bank who is conservative. Then the whole things of differences between the two is orchestrated wonderfully. In second case, the person might join the central bank as a neo-liberal but the thinking etc at the bank makes the person conservative.

So, things remained restrictive at capital account level. We still restrict investment in bond markets and there are caps which are revised from time to time. Then there are restrictions on ECB borrowings as well.

This was the case till there was a regime change at central bank level. Most neo-liberal ideas were adopted and CAC adoption was a matter of time. Infact it is perplexing that this discussion on CAC started so late and has not been implemented till now. As this blog pointed nearly an year ago, CAC was the last thing to be adopted in the neo-liberal agenda. As crisis outcomes were still not clear, CAC was not even mentioned in policy discussions. But now there is unison that in order to be a global economy (whatever that means), CAC is a must. The govt is least interested in making a domestic economy first, but talks of global economy.

Thankfully, this has led to some discussions as we have accepted most neo-liberal ideas without much debate. It has been a one way show. Somehow CAC evokes the kind of emotions which very few topics do (atleast in India). Experts have debated the idea citing both benefits and limitations. TO someone who has followed the debate it only brings yawns as all these have been known for a while.

The real issue is  – Is CAC really such a big deal? How will it matter to most Indians anyways? We have made a mole out of a mountain. The thing with CAC is it will hit us both ways. When global econ is on an upswing things will rub here and when it  is on a downswing it will bite here. People who write on this just argue from one angle and do not put the issue in a holistic manner. We have to assess the institutional capabilities to manage both aspects of global tide which has to be built overtime.

In a country like India where even basics are not in place, the obsession with CAC type ideas will continue. The idea is to keep coming with such things to please financial markets and western institutions. The government should just go ahead with implementing CAC as it will put an end to this whether debate.  It can then  focus on basic things that really matter..

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