The debate on capital controls has certainly not ended with the passing of the financial crisis. In their latest discussions around the subject, the government and RBI have come to the conclusion that the Indian economy can tolerably absorb up to $150 billion of net capital inflows without the need to resort to capital controls. This is a significant revision from the $110 billion that the government had informally set until now. According to the government and RBI, India?s fast growing economy, which is being driven more by domestic growth than growth in exports, can absorb increasing amounts of foreign capital. In fact, the government feels that there will be a real need for more foreign capital to finance a growing current account deficit that is estimated to be close to 3% in 2010-11. On the whole, this seems a reasonable line of argument. In any case the Prime Minister?s economic advisory council only expects $73 billion of inflows in this fiscal and $91 billion of inflows in 2011-12, both of which should be entirely manageable.
But beyond the near future, there is a serious need to rethink the entire discourse on capital controls in India. Even though India desisted from the idea of imposing a Tobin Tax on foreign capital flows, something at least some countries did during the course of the financial crisis. But we are still rather old-fashioned while thinking about capital flows. Apart from continuing to impose controls, India also places a subtle hierarchy on different types of capital flows?FDI is considered superior, followed some distance behind by portfolio capital, which is then trailed by an even greater distance by debt. The latest research in macroeconomics is increasingly suggesting that such hierarchies (particularly between FDI and portfolio flows) may not have a firm analytical basis and in any case serve little purpose. Of course, the financial crisis has proved that it can be potentially risky to take on too much foreign-denominated debt when incomes are in the local currency?any fluctuation in the currency can then lead to serious debt crises. But the real problem is the denomination of the debt, not the size of debt. In India, incredibly enough, there are greater restrictions on foreign purchase of rupee-denominated bonds than there are on dollar-denominated external commercial borrowings. So it?s not just our thinking, but also our practice which is out of date. The government and RBI need to revise their thinking as the country eventually moves towards a full convertibility regime.