Capital controls are known to work in countries with closed current accounts. For countries that trade with the world, whose citizens travel abroad, whose companies have operations overseas, and who have windows partially open for capital flows, such controls don?t work. Countries are simply unable to cut off the flow of capital once they have opened themselves up to the world. Still, policymakers keep trying. Especially policymakers who?ve grown used to systems of licencing and controls under regimes that believe that the actions of citizens should and can be monitored and controlled. They keep coming up with new tools of control. Some of these are effective in the short run; when a clamp on a particular item shows a marked reduction, they pat themselves on the back. It?s a different matter that the bulge appears elsewhere. An example of this in India was the restriction on external commercial borrowings (ECBs). Compared the $7 billion net ECB flows in the first quarter of the fiscal, just $3.6 billion was recorded in the second quarter. But total net capital inflows rose from $16.5 billion to $34 billion, too. The bulk of the increase came via items that are not under RBI control. ?Other capital flows? notched up $8.2 billion and ?net banking capital?, $7.1 billion. The logic of capital controls should have been to block these next. However, the control raj mentality is to control what you can.
Some economists, in a meeting with the finance minister on Wednesday, suggested the imposition of a Tobin tax on short-term capital flows. This, it is hoped, will act as a weight to drag inflows down. But will it? As long as India remains a high-growth economy, as long as interest differentials are high, and as long as Indian companies are doing business through locations all over the world, there will always be ways to move money in and out. Sure, a tax on short-term capital movements may help reduce FII flows, but capital inflows will continue to pressure the rupee upwards. It?s best to bin the idea of a Tobin tax. A workable alternative would be to learn to live with an open capital account and a globalised economy. Instead of sliding backwards, India should undertake financial sector reforms that would make local firms and the economy more resilient under the strains and pulls of global forces.
