Friday, June 6, 2014

To liberalize capital account or not

Barry Eichengreen and Andrew Rose have this to say about capital controls,
The lesson here is that countries anticipating having to resort to controls for purposes related to macroeconomic or macro-prudential management should hesitate before dismantling their control apparatus. Having done so and moved all the way to capital account convertibility, it can be difficult and costly to go back.
In an op-ed in February I had made the same argument,
Markets overreact when countries respond to signs of currency trouble by reintroducing capital controls. It makes the original decision on liberalisation all the more critical. It is no surprise that China, which had strong capital controls all along, has been the only country to escape all the currency crises of the past decade and a half. All this should be reason enough for India to pause on its pursuit of full capital account liberalization.
In other words, capital account liberalization is a fairly irreversible process. The argument therefore should not be about imposition of capital controls, because its re-erection is a bit like using sand bags to fill the breach left by dismantling parts of a concrete flood barrier. The right question would on whether to liberalize capital account or not. India's policy makers should examine on a case-by-case basis the consequences of any proposed capital account liberalization measure, especially during times of economic distress, given the inevitable cycles of large capital inflows and sudden stops and the lack of credible institutional mechanisms that can mitigate its adverse effects.  

Update 1 (10/6/2014)

The progressive relaxation of rules surrounding ECB borrowings, in response to pressure from corporates to access cheap foreign credit that became available when capital was rushing into emerging markets in 2010-13, has been one of the largest breaches that have opened up in India's capital convertibility framework. For example, while previously ECB under both Automatic and Approval routes were permissible only for financing capital investments, it has now been permitted for "general corporate purposes", which appears to include both "working capital" and "repayment of INR loans". Similarly ECB rules have been relaxed for borrowings by infrastructure firms, raising the concern of currency mismatches. The most far-reaching relaxation though was in June 2012 when the RBI relaxed ECB norms to allow manufacturing and infrastructure firms to borrow externally to repay their rupee loans.  

No comments: