Caps unlock

Finance Minister P. Chidambaram is reported to be considering removing FDI caps in various sectors. The imperative for the removal of caps in sectors where they are below 100 is to attract capital flows to India in a situation where the current account is expected to be 5 per cent of the GDP. While FDI in multi-brand retail, pensions and insurance have become political issues, in other sectors such as credit information, asset reconstruction or private security agencies, where the issue is not political, it may be possible to remove restrictions more easily.

Even though it makes good economic sense to ease unnecessary capital controls at times when the country needs inflows, opponents often whip up fears of what might happen when controls are reduced. Instead, we need to determine what the objectives of controls are, the kind of controls that the country would like to keep, and which ones are detrimental and should be removed.

Capital controls, or controls on the cross-border flow of money for sale and purchase of assets, are imposed for three broad reasons. In largely open economies, concerns about terrorism or money laundering require that information be provided before money can be transferred across borders. When a country becomes a member of the Financial Action Task Force (FATF), it is required to pass laws that require it to prevent money flows from being used for such activities. These require financial firms to fulfil various know-your-customer (KYC) obligations. When India became a member of the FATF, it introduced these laws. The regulations in India that flow from these laws are, it has often been felt, far more stringent than in other FATF member countries, involving proof of residence and paper documents beyond proof of identity. While the excesses would need to be sorted, controls arising from FATF obligations will have to remain.

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