India can resort to capital control as and when needed: RBI

Capital controls were a legitimate response to a surge in volatile capital inflows and India’s central bank will resort to the same if and when the need arises, said D Subbarao, Governor of the Reserve Bank of India (RBI) on Tuesday, adding that global perception of capital controls as an economic tool had improved.

Subbarao said that there was a broad consensus among most central banks about making capital controls a legitimate component of the policy response to surges in capital flows. While delivering a speech in Colombo on the occasion of the 60th anniversary celebrations of Central Bank of Sri Lanka, the Governor said the multi-speed recovery around the world and the consequent differential exit from accommodative monetary policy have triggered speculative capital flows into emerging market economies (EMEs).

'The most high profile problem thrown up by capital flows, in excess of a country's absorptive capacity, is currency appreciation which erodes export competitiveness,' he said adding that ideally capital inflows to EMEs should be stable on a medium term basis to benefit the host country and also be roughly equal to the economy's absorptive capacity.

He noted that while multilateral institutions like the International Monetary Fund (IMF) used to see capital controls as a form of protectionism, the views of most economists even in the developed world has changed since the financial crisis of 2008. 'The crisis has changed the terms of that debate. It is now broadly accepted that there could be circumstances in which capital controls can be a legitimate component of the policy response to surges in capital flows,' Subbarao said.

India has so far not imposed any capital inflows, but some other countries including Brazil had resorted to such restrictions. Capital controls are generally in form of some Tobin Tax, named after James Tobin, who was first to propose that cross boarder capital movement should attract a small tax to discourage volatile flows. Since India runs a significant current account deficit (CAD) of around 2.5-3% of its gross domestic product (GDP), it has been following a wait and watch policy on inflows so far. 

While there was a surge in capital inflows by middle of the current financial year, off late, foreign funds have been on the sell mode due to concerns including a high inflation and potential slowdown. Recovery in advanced regions has also lead to slowdown in inflows into emerging economies in recent months. Subbarao stressed that there was a need for economists from both developing and rich world to develop consensus on how temporary surge in inflows or outflows should be handled so as to bring more stability in global financial system.