Amidst ongoing volatility in the capital markets, Reserve Bank of India governor D Subbarao on Monday cautioned that India’s reserves comprise essentially borrowed resources, and are therefore more vulnerable to sudden stops and reversals as compared with countries with current account surpluses
?Be that as it may, in evaluating the level of reserves and the quantum of self insurance, it is important to distinguish between countries whose reserves are a consequence of current account surpluses and countries with current account deficits whose reserves are a result of capital inflows in excess of their economy?s absorptive capacity. India falls in the latter category,” he said while addressing special governors? meeting in Kyoto on implications of the expansion of central bank balance sheets
However, Subbarao argued that managing capital flows should not be treated as an exclusive problem of emerging market economies (EMEs).
?The burden of adjustment in the context of massive capital flow has to be shared. How this burden has to be measured and shared raises both intellectual and practical policy challenges. The intellectual challenge is that we do not have a good theory that explains the role of capital flows in the determination of exchange rates. What we now need is a theory that encompasses both current and capital accounts and one that gives a better understanding of what capital controls work and in what situations. That is the intellectual challenge. What is the practical challenge? The practical challenge is that once we have such a theory, we need to reach a shared understanding on two specific aspects: first, to what extent are advanced economies responsible for the cross border spill over impact of their domestic policies, and second, what is the framework of rules that should govern currency interventions in the face of volatile capital flows,” he noted.
On capital control measures, Subbarao said that the challenge for policy makers is to design and implement controls where the cost of compliance is lower than the cost of evasion. ?Refreshingly, the IMF has shed its long held orthodoxy against capital controls,” he said said.
According to Subbarao, India has experienced both ?floods? and ?sudden stops? of capital flows and has followed a consistent policy on allowing capital inflows in general and on capital account management in particular. ?Our position is that capital account convertibility is not a stand alone objective but a means for higher and stable growth. We believe our economy should traverse towards capital convertibility along a gradual path – the path itself being recalibrated on a dynamic basis in response to domestic and global developments,? he explained.
Among the components of capital flows, India preferred long term flows to short-term flows and non-debt flows to debt flows. Historically, RBI has used policy levers on the debt side of the flows to manage volatility.