View: Capital Account Convertibility, driving the fuller convertible

On a March morning 15 years ago, the day RBI turned 70, Manmohan Singh, addressing a small audience, said, ‘Our position, internally and externally, has become far more comfortable. I will request the finance minister and the Reserve Bank to revisit the subject [of capital account convertibility (CAC)] and come out with a roadmap based on current realities.’ As Prime Minister Singh spoke, governor Y V Reddy and his predecessors listened with stoic faces that central bankers down the years have perfected.

It was the summer of 2006. The stock market was up. A 10% growth seemed just a step away. Buoyed by leverage and a commodity boom, there was exuberance. A plan to convert Mumbai into an international finance centre was doing the rounds. Almost everyone felt India had finally arrived. And CAC — the freedom to freely convert local financial assets (shares, bonds, bank deposits) into foreign financial assets and vice versa — was the next logical step.

A second committee under former RBI deputy governor S S Tarapore drew the roadmap towards a ‘fuller’ CAC. It was taking forward the story of liberalising capital flows — set off in the early 1990s under duress — from avantage point.

As the ‘good times’ lingered, the annual limit under RBI’s liberalised remittance scheme (LRS) — which allows resident individuals to bet on overseas stocks and properties — was raised from $25,000 to $200,000 between December 2006 and September 2007. A year later, the story ended abruptly with the Lehman collapse. CAC and its advocates slipped into a slumber.

Eleven days ago, in a world that has changed since then, discussions on CAC were revived in a speech by RBI Deputy Governor T Rabi Sankar (bit.ly/3baeJDm). It came when faith in globalisation is shaken, multilateralism is under threat and countries are asserting nationalism. Even as States put up trade barriers (restricting current account flows), they are willing to loosen (capital account) rules to attract foreign investment — an irony of the times we live in.

It will be a mistake to overread Rabi Shankar’s speech. While reminding that CAC is not an event but a process (that began long ago and has come a long way), he, nonetheless, alerted banks to brace themselves for greater convertibility. Traders, who by now know that CAC is a story of twists, turns and baby steps, weren’t excited. The pitfalls of a full-fledged convertibility are known and IMF, once the champion for CAC, has long changed its position.

While proponents of CAC claim it would give a partially closed economy access to the global money pool and lower borrowing cost, the unsettling impact of sudden outflows when chips are down has stripped CAC of its sheen. Still, the CAC debate has re-emerged. Why?

Afew ideas have captured the imagination amid large forex reserves and an optimism stoked by sustained foreign investments despite a pandemic. First, making GoI bonds part of global bond indices — the way bluechip stocks are included in global indices like MSCI — by easing constraints on foreign investment in GoI debt papers.

A berth on a global index would make India a recipient of ‘passive inflows’. A slice of money, based on the weight in the index, would flow in every time an offshore portfolio manager allocates funds that are believed to be more stable. It would help GoI finance the deficit and check borrowing costs.

The chat on ‘global indices’ began when forex reserves were $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. A case has also been made (by MNC banks, among others) for raising the LRS limit. How can a promoter and his manager have the same limit? Shouldn’t there be a choice to hold assets in multiple currencies?

The urge to ‘protect’ wealth in offshore trusts, hold foreign 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 abit of outflow amid strong foreign direct investment (FDI) and foreign portfolio investment (FPI) inflows?

But, while the CAC theme may have been timed to serve a limited purpose, it masks a message that goes beyond RBI and markets. Even if there is no flight of capital, large inflows would mean little if the real economy is unable to absorb the money. The familiar plot, benefiting GoI and big businesses, would then play out: RBI will buy incoming dollars to hold the rupee, and then lock in the extra liquidity created from dollar purchases if there is no capex and loan growth.

A‘fuller CAC’ makes sense when local businesses invest, spending resumes, loans pick up, bankruptcy proceedings quicken, ease of business becomes a reality, FDI has fewer hurdles, and tax clarity and policy certainty are achieved. If we are luring foreign money in debts, we must know how to use it. A ‘fuller CAC’ must be more than a triumphant headline.


Leave a Reply

This website uses cookies. By continuing to use this site, you accept our use of cookies.