Thursday, October 18, 2007

Chronicle of a Capital Control Foretold?

In India today, there seems to be a cloak-and-dagger game at hand between the export lobby (“real” economy) and the financial markets (“monetary” economy) – in so far as capital controls are concerned. The appreciation of the rupee against the USD has threatened to bite seriously into the profits of the Indian exporters. This is particularly true of the small manufacturers, as it is, compete tooth and nail with the Chinese, Malays etc., in the manufacturing sector. Predictably, this interest group wants the government to “do” something to stem the dollar slide. Predictably, a throwback to the eras gone by, one hamhanded response has been to force FIIs to register with the SEBI – this is an old Indian (bureaucratic?) trick. If in doubt, drown them in paperwork. Given the obvious daftness of this effort to control global capital surges and retreats, the next best thing seems to be issue “capital controls”. i.e., devise mechanisms by which FIIs can participate in the Indian equity markets only through very limited, thus rationed (thus corrupt) schemes.

The financial markets are very much against this – and they claim that capital controls is completely the wrong way to go. The rupee appreciation is a reflection of the increased exporting strength of India – and the appreciation is a self-correcting way to correct for emerging imbalances. No doubt, the appreciation affects the Indian exporter – but profit and loss in an industry is hardly the place for governments to intervene. Further, the Indian exporter is hardly the constituency that needs to be salvaged by government programs like NREGA. On the contrary, the government must create programs/schemes to incentivise productivity improving mechanisms. Exchange rate appreciation is perhaps a blessing in form a curse – at least in parts. The government should use this "faith" imposed by global financial markets -- to make radical changes.

All this said, the Indian government is on a back-foot (note, cricketing term!) and after the nuclear debacle and the Communist party’s rhetoric about alternative “development paths” – one shouldn’t be surprised against imposition of moderate to weak capital controls over the next two months. In essence, prepare for a convulsive fortnight in the equity markets, take your profits and hit the mattresses.

An excellent interview with Dr. Ajay Shah here.
(There might be an advertisement early on.)

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