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A sort of de facto openness on India's financial markets has risen through a dynamic process of change in the economy and in the country's economic policy over the years, “with a co-evolution between the system of capital controls, macroeconomic policy and the internationalisation of firms, including the emergence of Indian multinationals”.
This is one of the principal conclusions of a study by two senior fellows of the National Institute of Public Finance and Policy (NIPFP), Ajay Shah and Ila Patnaik, who have contributed a working paper on this subject to the International Monetary Fund (IMF). While disclaiming the authors' views as that of the Fund, the IMF said the working paper describes research in progress by the authors and is published by it to elicit comments and to further debate.
Micro-economic distortions
In the study, “India's financial globalisation”, the authors contend that India has evolved a complex system of capital controls. Pointing out that if a single capital controls manual were to be released by the government, it would run into thousands of pages of detailed rules, the study said such complex and detailed systems of rules have many problems.
First, India's positions on foreign borrowing are out of touch with contemporary economic thinking in terms of blocking the onshore rupee-denominated bond market in favour of offshore foreign-currency borrowing. Thus, many other micro-economic distortions are visible, where a sophisticated private sector maximises the rule set, giving unintended consequences in the form of micro-economic distortions, it said.
Second is the transaction costs associated with capital controls. Bureaucrats, lawyers and accountants lead to an increased time and cost of undertaking transactions when compared with that seen in a simpler system, it said, adding that “reforms that remove these deadweight costs would give benefits”. As these fixed costs are justified for large transactions but not for small ones, it said the Indian system of capital controls is biased in favour of giving large firms greater access to the global financial system.
Third, there is more de facto openness than meets the eye, it said, adding that while India seems largely closed at first, the ingenuity of financial engineering, coupled with legal engineering, implies that for a sufficiently large expenditure of time and fees, many transactions are feasible.
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