Gross ECB flows this year are expected to exceed the country’s $22 billion ceiling by about a couple of billion dollars. Of course, net inflows are much smaller, as repayment of earlier ECBs takes place continually. As domestic interest rates rose throughout the past year, Indian companies borrowed abroad. No, the government has not reduced the total amount that can be borrowed, but by making it less attractive for foreigners to lend to Indian companies, it is hoping the total sum of borrowings (and thus total inflows) will come down. This would ease the upward pressure on the rupee.

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The attempt to reduce ECB inflows have not come as a surprise. Indeed, it was a surprise that this move did not come with the credit policy—which appeared to focus on allowing greater outflows as a way to ease the rupee pressure. For example, the RBI raised the limit on the amount individuals can remit abroad every year from $50,000 to $100,000. This led to hopes that the policy framework was moving towards capital account liberalisation. Soon, however, it was clear that enhanced capital outflows were not going to be the mechanism to relieve the rupee’s rise. In a circular to banks, the RBI barred remittance of foreign exchange for the purpose of paying margins to overseas exchanges. The money remitted for margins allowed overseas investors to take positions on markets for derivatives abroad. The RBI now allows individuals to buy stocks on foreign exchanges, but not trade in derivatives. Such micro-management of how Indian citizens utilise their $100,000 annual allowance will effectively clamp capital outflows. As it is, since 2004, only $53 million has left the country under this scheme.

The change in the ECB policy suggests that the policy consistency that people had perhaps hoped to see in the form of continued liberalisation of the capital account is not here yet. The sharp volatility of the rupee in April had appeared to indicate that rupee appreciation is going to be used to help tame inflation, while giving priority to the interests of the millions of firms and households suffering from a sharp rise in interest rates. This rise in itself was largely on account of the RBI’s attempts to sterlise its intervention in the foreign exchange market.

However, the move to reduce ECBs shows that attempts to manipulate the rupee continue, even as the clock is turned back on capital controls. Today, it is being done through ECB policy. Tomorrow, it could be back to more forex intervention and higher interest rates. A sustainable solution would require India to abandon one of the three objectives stated earlier.

The sharp increase in the turnover on the foreign exchange market—with gross flows moving in and out of India rising to more than 90% of GDP—no longer makes it easy to do any fine-tuning on the ‘impossible trinity’

What lies ahead? There are two options. One is to genuinely move towards greater capital account convertibility, and to prepare the economy for it. This would mean giving up the objective of rupee manipulation while developing financial markets so that firms gain resilience under changing circumstances. The other is to linger on with the dying days of the old regime—to try to bring back more capital controls and continue to manipulate the currency market. The first would require an understanding of where we are going, how to get there and how to make the transition smooth. It would entail developing a market for currency futures in India, rather than preventing Indians from hedging their currency exposures in the Dubai market for rupee-dollar futures.

The Percy Mistry report on Mumbai as an International Financial Centre has recommended financial system changes that would be required if India’s path towards capital account convertibility is to be a smooth one. The present difficulties and challenges presented by the impossible trinity make it clear that it is becoming enormously difficult for India to continue to keep fine-tuning the three objectives in an attempt to find the right balance.

The sharp increase in the turnover on the foreign exchange market—with gross flows moving in and out of India rising to more than 90% of GDP—no longer makes it easy to do this fine-tuning. It is time that India turns to other countries for “lessons of experience”.

Both the government and the RBI need to offer the country a clear vision. It is about time, too. Sending confused signals only thwarts the plans of those who need to operate on a minimal assumption of policy consistency.

Unfortunately, the RBI continues to claim there are no difficulties with the erstwhile monetary policy framework. This lack of effort on crafting a path for coping with a complex future will not help us face these challenges any better. It is time to get real.

—Ila Patnaik is a senior fellow at the National Institute of Public Finance and Policy. These are her personal views