Has India met criterion for full capital convertibility?
Given the excitement over the Gujarat International Finance Tec-City (GIFT) and the possibility that, with capital controls relaxed in it and similar international financial centres, India could win back part of the markets that had been off-shored, senior officials have raised hopes of even bigger moves—the Percy Mistry report had, for instance, projected Indian firms could earn as much as $48 billion by 2015 if Mumbai was developed as an international finance centre. Over the past fortnight, RBI Governor Raghuram Rajan and minister of state for finance Jayant Sinha have spoken of the need for India to move towards capital account convertibility—while neither has put a time frame to the move, the fact that they have spoken of it suggests there is some thinking within the government on the subject. While the benefits of capital account convertibility are obvious—it imposes more discipline on governments and lowers costs of acquiring capital—the talk does sound extremely ambitious given it was less than two years ago when, as the rupee was crashing on account of FIIs withdrawing funds based on the likely taper, India withdrew even the limited capital account liberalisation done in the past. As of today, with few countries other than the US looking good, it is unlikely that introducing capital account convertibility would result in large capital outflows with locals running to sell their houses here to buy property overseas—indeed, the IMF has even projected India will grow faster than China this year.
The point, however, is to look at things from a longer-term perspective, more so given the sad history of convertibility exacerbating problems in countries with convertible currencies. While being over-cautious has its own perils, both the committees set up to examine the issue recommended certain macro fundamentals being in good shape—these include the fiscal and current account deficits being under control, banks being in good shape, tax rates being broadly in sync with those overseas and deep financial markets that can deal with the volatility associated with capital moving in and out in large volumes. While the government appears more serious about meeting the FRBM targets on the fiscal deficit, it is useful to keep in mind the 3% of GDP target was originally set for FY09, a number we now hope to achieve only in FY18—the FY16 target is 3.9%. The current account deficit has been very comfortable for several quarters, but it was as high as 6.5% of GDP not too far back in Q3FY13—the indicative target set for this was around 2-3% of GDP. And certainly, the bad and restructured assets of banks are so large as a proportion of their loan book, the banks are decidedly weak. None of this is to say that India should not aspire to capital convertibility or that progress has not been made on several fronts, but we have to get into the water gradually and without stepping back. To begin with, RBI needs to adopt the Sahoo panel report on lifting all ECB restrictions; after toying with lifting all restrictions on FIIs investing in GSecs and becoming part of a JPMorgan-type bond index, the government developed cold feet. And as for tax rates, India is nowhere near international levels. If the government is serious about capital convertibility, it needs to fix its internal policies first—capital convertibility results from an economy being strong, the converse is not necessarily true.