A robust external profile has enabled increasing levels of convertibility in both current and capital accounts of India’s transactions with the world. Moreover, the country today boasts strong forex reserves, of $641 bn, and could soon be included in one of the global bond indices. Not surprisingly, there is once again chatter on capital account convertibility. RBI deputy governor T Rabi Sankar recently flagged the prospect of fuller capital account convertibility, entailing more “freedom to convert local financial assets into foreign financial assets and vice versa” as defined by the SS Tarapore Committee’s Report on Fuller Capital Account Convertibility of 2006.
“India is on the cusp of some fundamental shifts in this space with increased market integration in the offing and freer non-resident access to debt on the table. The rate of change in capital convertibility will only increase…,” the deputy governor observed.
Freer non-resident access to debt—sovereign and corporate—is not just on the table but is being actively pursued as well on the policy front. In March 2020, a Fully Accessible Route (FAR) was introduced which places no limits on non-resident investment (NRI) in specified government securities. The DG has noted that, over time, the entire issuance of gilts would become eligible for NRI investment. A more open capital account was also signalled in Budget FY20, when the Centre said it would start raising foreign currency denominated borrowings. However, there hasn’t been much movement on this front as a public debate urged greater caution.
Fuller convertibility no doubt broadens the base for Indian assets through greater integration with international financial markets. It could lower borrowing costs. But it also entails significant risks. If non-residents hold a major portion of the outstanding stock of government securities, the economy could be vulnerable to sudden debt outflows. RBI is, no doubt, well aware of these risks. Nonetheless, the central bank believes that since the FAR channel was permitted in the context of the inclusion of India’s government securities in global bond indices, “there is a natural safety mechanism” as index investors are unlikely to indulge in outflows.
Sovereign debt typically starts with small doses, but could become an addiction if the government is not able to rein its massive borrowing programme. To be fair, this government has tried to be fiscally prudent, and fiscally transparent, under very challenging circumstances. However, fiscal consolidation is needed given the combined fiscal deficit of the Centre and states, estimated at around 11.3% of GDP and public debt at 90.7% are clearly elevated.
Against this backdrop, former RBI Governor YV Reddy observed recently in Business Standard, a roadmap towards opening up capital account is necessary in which sovereign bonds are “backloaded and not frontloaded”.
India survived the Asian currency crisis of 1997 largely because it had capital controls in place. To be sure, we have come a long way since then; today, domestic residents can easily access forex for travel, study and remit $250,000 abroad under the Liberalised Remittances Scheme.
Corporates can borrow to make acquisitions overseas and both portfolio and FDI are allowed in, virtually unrestricted. However, although India is far more globalised today, caution on fuller capital account convertibility is nonetheless warranted. More foreign capital may help the economy, but any big and sudden outflows could disrupt the local markets. Let’s give it some time.