Reserve Bank of India (RBI) governor D. Subbarao has done well to clearly state that the Indian economy is not being swamped by capital inflows that will inflate asset bubbles and, hence, the central bank has no plan to curb these inflows. He was speaking to reporters in Kolkata on Thursday. He said this a day after RBI capped the interest rates at which Indian companies could take on commercial loans abroad, a move that did raise some murmurs whether it was a sign of coming capital controls.
This newspaper had argued in favour of capital controls in 2007 and 2008, when the dollars that were flooding the economy were feeding a credit bubble, fanning asset price inflation and had pushed growth beyond what was sustainable. The situation now is dramatically different: India is in the initial stages of economic recovery and has an output gap if measured in terms of excess capacity. The more serious inflationary pressures today come from supply-side constraints in agriculture and infrastructure.
Subbarao was finance secretary in New Delhi when it was an open secret that the finance ministry and the central bank in Mumbai had clashed on how to manage strong capital inflows in the boom years. So it was interesting to hear him offer a revisionist view of those months, when he said at a recent event organized by news channel CNBC TV18 that both sides had then agreed “there must be controls on capital because…(capital inflows were)…putting a cost on the economy”. The debate was what to do and when, according to Subbarao.
Illustration: Jayachandran / Mint
Capital controls have been in the air ever since Brazil put up walls in recently to prevent further appreciation of its currency, which had already moved up 23% against the dollar, leading to a loss of export competitiveness. India is nowhere near that situation right now, and the capital coming in can be absorbed through the current account deficit and increased foreign exchange reserves.
That said, it is quite clear capital will keep flooding into Asia because of the superior growth and financial returns here. The problem of plenty will get worse in 2010 and the decision about whether or not to tax or turn away this capital will become a more difficult one. The old dilemmas will resurface: Should policy target the exchange rate, maintain an independent monetary policy or control capital inflows? It is well accepted that only two of these three goals can be pursued together.
Subbarao may have to revisit his views sooner rather than later, as the trade-offs become more complex.
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