You must forgive the government, if in some weak moments of its ongoing battle with the global meltdown it has been tempted with the unspeakable? suspension of repatriation for the FIIs. For a host of reasons, this option currently looks quite appealing.
The government?s reaction to the heavy FII outflows so far, has largely been akin to opening new entry doors while there is a stampede at the exit. During September, FIIs withdrew close to Rs 6,600 crore from Indian equities. In the first 11 trading days of October, the withdrawal figure is close to Rs 10,000 crore. To put things in the perspective of RBI measures, this is roughly equivalent to a CRR cut of a quarter percentage point. In debt markets, September witnessed a net FII inflow of slightly over Rs 3,000 crore. Grasping at anything that may work, the government doubled the debt ceiling for FIIs and the latter responded in October (till last Friday) with a withdrawal of over Rs 1,300 crore.
The sustained selling by FIIs in the Indian equity markets causes three problems?it brings the market and the rupee down and worsens the liquidity crunch. The stone that would kill, or at least maim, all three beasts would be a suspension of FII outflows. In other words, FIIs would not be allowed to take their funds out of the country for, say 6 months, with the government reserving the right to withdraw the ban sooner if market conditions allow. If they sell stocks during this window, they would be compelled to invest the proceeds in the Indian money market.
This ?no-brainer? would seem a brainless solution to many for a variety of reasons. One, it is a sort of betrayal of FIIs who had come in with the knowledge they could exit anytime. Changing the rules of the game around half-time is unethical, and worse, can alienate foreign investors for a long time, if not forever. Also this would doubtless be a retrograde step in the process of liberalisation but the immediate choice is between facilitating counter-traffic in a stampede versus shutting the exit.
By no means is this without precedent. Almost exactly a decade ago, mired in a severe financial crisis along with several other ?Asian tigers?, Malaysia did just that. The Malaysian leader, Mahathir Muhammad, thumbed his nose at the IMF and US Treasury, at a time when their credibility was dented but still far higher than today?s levels, and went 180 degrees to the Washington Consensus. Did it work? It depends on who you ask. A few influential economists including this year?s Nobel Laureate-elect, Paul Krugman, clearly in minority, claim it helped bring Malaysia out of the crisis, while others point out to the near-simultaneous recovery of Korea and Thailand that followed the IMF prescription to argue that it did not work. There is probably a consensus over two things. If it did not work, it certainly did not hurt the recovery. And in business, the step helped Mahathir cronies much more than it helped others. Markets rebounded and the impact on foreign capital flows was negative, but temporary and far from debilitating.
This time around and for India, the penalty for deviating from the ?golden straitjacket? of globalisation, as Tom Friedman puts it, is likely to be milder. First, it is open season for heterodoxy the world over. Second, no one can blame India Inc for weak fundamentals. As the IMF stability report points out, institutions are pulling funds from most emerging markets, to make up for the mess in advanced Western markets. In a way Indian stocks are paying for Western mess-up. Finally, international investors hardly have a choice. If the Indian growth story continues, even in a muted way, they will be in a rush to forgive and forget.
What would the domestic political fallout of this be? Interestingly, with the elections round the corner, capital controls can provide a great spin of aggressive nationalism to the UPA. Investment banks and hedge funds are, even in the best of times, not objects of mass adoration. These days they are just a notch above terrorists and serial killers. Having exported commodity price inflation to financial meltdown to India, Western economies are hardly chart-busters with the Indian public at the moment either. ?Being tough? on these ?foreign speculators? is, therefore, likely to resonate with the Indian voter and may take the wind off the Left?s charge of India becoming a US lackey, post-Nuke deal, as well as the BJP?s ?tough guy? image.
It may well be that having capital controls now is like locking the stable door after the horse has left. Whether there is a carriage behind that horse that can still be saved, only time can tell.
?The author teaches Finance at the Indian School of Business, Hyderabad