People's Democracy

CAPITAL ACCOUNT CONVERTIBILITY

Economists Shocked Over Govt’s Decision

A number of prominent economists of the country have expressed, through a statement issued from New Delhi on March 22, 2006, their sense of shock over and opposition to the government decision to make the rupee fully convertible on correct account. The text of their statement follows.

WE, the undersigned members of the economics profession in India, are shocked by the government’s eagerness to introduce full capital account convertibility. This move would imply that the inflow and outflow of capital by residents and non-residents would no longer be subject to any regulation.

This would expose the Indian economy to extreme volatility since, in the event of a capital outflow, it would no longer be only non-resident investors who would be able to repatriate their funds, but also Indian residents who would be free to take out any amount of domestic wealth.

Such outflows by local residents are precisely what had contributed to the massive build-up of Latin American debt in the 1970s and 1980s. In Brazil, for example, the total amount of the outstanding external debt in the beginning of the 1980s was almost equal to the estimated capital flight by the resident rich. The costs of servicing this debt and pursuing the conditionalities required to renegotiate the debt were borne by the working poor. Similar outcomes of capital account liberalisation have been observed in a host of other developing countries, such as Turkey, Indonesia and Mexico.

It should be noted that the Indian economy could insulate itself from the contagion of the South-East Asian financial crisis in the late 1990s only because the capital controls in place at the time prevented destabilising movements of capital. 

We do not want the re-enactment in our country of a scenario in which the poor, who are among the poorest in the world, have to pay the price for the unrestricted freedom of the rich to shift their wealth out of the country  whenever it suits them.

The gains to the economy from this move are nil. The argument that this is necessary for attracting direct foreign investment does not stand scrutiny. The biggest developing country recipients of FDI inflows (such as China today and Taiwan and South Korea in the 1980s) have had major restrictions on capital flows. We know from our own experience that portfolio investment inflows have no stimulating effect on productive capital formation.  On the contrary, they lead either to undesirable appreciation of the exchange rate (leading to recession and unemployment) or to a mere pile-up of foreign exchange reserves which actually involves the economy as a whole borrowing dear and lending cheap. 

According to the government’s own pronouncements, the economy is currently doing very well. In such a context, exposing the country to unpredictable movements in capital flows creates a potential for fragility and crisis which is completely avoidable. This is of particular concern because the stock market is already experiencing a speculative boom.

We urge the UPA government to desist from such an unnecessary and dangerous measure.

Signatories to the statement include K S Krishna Swamy, Ashok Mitra, Amiya Bagchi, Nirmal Chandra, Utsa Patnaik, D N Rao, Ritu Dewan, Jayati Ghosh, V K Ramachandran, C P Chandrasekhar, Praveen Kumar Jha, Madhura Swaminathan, Prabhat Patnaik, Mahmood Alam Ansari, Vikas Rawal, Parthapratim Pal, Prasenjit Bose, Atulan Guha, Smita Gupta and others.