A capital idea

In the past it has been seen that private transfers to India have responded to interest differentials with the rest of the world. When interest rates in India are higher, people prefer to bring their money into India. Since the interest rate on NRI deposits is linked to global interest rates, when global rates fall, it becomes more profitable to withdraw from NRI deposits and bring money into India as remittances. Among invisible receipts, one the items that saw a sharp increase was remittances. Private transfers grew from USD 7.6 billion in the first quarter, to USD 9.3 billion in the second quarter, and to USD 10.9 billion in the third quarter of 2007-08. About half the private transfers this year have been on account of local withdrawals of NRI deposits. The RBI notes that the higher growth inflows through local withdrawal by the overseas Indians may be attributed to higher returns domestically vis-a-vis holding such deposits in NRI accounts.

The result is thus visible on the debate about India and capital controls. The control raj was ineffective. Capital is supple; it is relatively easy to repackage it from one form to another. If the policy says that debt is good and equity is bad, then capital will come through as debt. If policy says that equity is good and debt is bad, then capital will come through as equity. The private sector focuses on reality, on issues such as interest rate differentials, and then figures out how to achieve the objective while not violating the stated rules.

Small tinkering with capital controls damages India’s image, it introduces microeconomic distortions, and achieves nothing in terms of macroeconomics. Large tinkering with capital controls are not feasible given India’s current level of global trade and investment and leads to central bank governors and finance ministers losing their job. For this reason, the focus in Indian policy making should now be on getting the monetary policy framework right, to cope with fluctuations in capital flows. There is no point in yearning for the good old days before India had started off on reintegrating into the world economy.

The writer is senior fellow, National Institute of Public Finance and Policy

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