View: Convertibility of the capital account, conduct of the more complete convertible

One morning in March 15 years ago, the day RBI turned 70, Manmohan Singh, speaking to a small audience, said, “Our position, internally and externally, has become much more comfortable. I will ask the Minister of Finance and the Reserve Bank to come back to the subject [of capital account convertibility (CAC)] and come out with a roadmap based on current realities. ‘ As Prime Minister Singh spoke, Governor YV Reddy and his predecessors listened stoically to the faces central bankers have perfected over the years.

It was summer 2006. The stock market was up. 10% growth seemed to be on the way. Driven by leverage and a commodity boom, the exuberance was there. A project to convert Mumbai into an international financial center was circulating. Almost everyone felt that India had finally arrived. And CAC – the freedom to freely convert local financial assets (stocks, bonds, bank deposits) into foreign financial assets and vice versa – was the next logical step.

A second committee headed by former RBI deputy governor SS Tarapore mapped out the roadmap to a “more comprehensive” CAC. He advanced the story of the liberalization of capital flows – initiated under duress in the early 1990s – from the point of view of benefit.

As the “good times” lingered, the annual limit under the RBI’s Liberalized Payout Program (LRS) – which allows residents to bet on stocks and properties overseas – was increased by $ 25,000 to $ 200,000 between December 2006 and September 2007. A year later the story came to an abrupt end with the Lehman collapse. The CAC and its lawyers have fallen asleep.

Eleven days ago, in a world that has since changed, CAC talks were reignited in a speech by RBI Deputy Governor T Rabi Sankar (bit.ly/3baeJDm). It came when faith in globalization is shaken, multilateralism is threatened, and countries claim nationalism. Even as states erect trade barriers (restricting current account flows), they are willing to relax (capital account) rules to attract foreign investment – an irony of the times we live in.

It would be a mistake to read Rabi Shankar’s speech too much. While recalling that CAC is not an event but a process (which started a long time ago and has come a long way), he nevertheless alerted the banks to prepare for greater convertibility. The traders, who now know that the ACC is a story of twists and turns and small steps, were not thrilled. The pitfalls of full convertibility are known and the IMF, once champion of the ACC, has long since changed its position.

While proponents of CAC claim it would give a partially closed economy access to the global money supply and lower borrowing costs, the destabilizing impact of sudden exits when tokens are down has robbed the CAC of its shine. Yet the debate over ACC has resurfaced. Why?

A few ideas have captured the imagination amid large foreign exchange reserves and optimism fueled by sustained foreign investment despite a pandemic. First, integrate GoI bonds with global bond indices – the way blue-chip stocks are included in global indices like the MSCI – by relaxing the constraints on foreign investment in GoI debt securities.

A place on a world index would make India a beneficiary of “passive inflows”. A slice of money, based on the weight in the index, would be paid out each time an offshore portfolio manager allocates funds that are considered more stable. This would help the GoI finance the deficit and control borrowing costs.

The discussion of “global indices” began when foreign exchange reserves stood at $ 300 billion.

At $ 640 billion, the urgency is less and large inflows can be a headache for RBI. But it’s an idea that has now been sold. There have also been arguments (by multinational banks, among others) to increase the limit of the LRS. How can a promoter and his manager have the same limit? Shouldn’t there be the choice to hold assets in multiple currencies?

The urge to “protect” wealth in offshore trusts, hold offshore bank accounts and buy jumbo life insurance remains. So why not let the rich do it legitimately, instead of dealing with embarrassments like the Pandora Papers every few years? Why not allow some exit amid heavy inflows of foreign direct investment (FDI) and foreign portfolio investment (FPI)?

But, while the ACC theme may have been programmed to serve a limited purpose, it masks a message that goes beyond the RBI and the markets. Even if there is no capital flight, large inflows would mean little if the real economy is unable to absorb the money. The familiar plot, benefiting the GoI and large corporations, would then unfold: The RBI would buy incoming dollars to hold the rupee, and then block the additional liquidity created by dollar purchases if there is no growth in the dollars. investment spending and loans.

A ‘fuller CAC’ makes sense when local businesses invest, spending picks up, loans increase, bankruptcy proceedings speed up, ease of doing business becomes a reality, FDI has fewer barriers and tax clarity and political security are affected. If we are luring foreign money into debt, we have to know how to use it. A “more complete CAC” must be more than a triumphant title.