The strong external profile has enabled increased levels of convertibility in both current and capital accounts for India’s transactions with the world. Moreover, today the country boasts strong foreign exchange reserves, amounting to $641 billion, and it can soon be included in one of the global bond indexes. Not surprisingly, there is again talk of capital account convertibility. RBI Deputy Governor T Rabih Sankar recently pointed out the full convertibility of capital accounts, which entails more “freedom to convert domestic financial assets into foreign financial assets and vice versa” as defined in the report of the SS Tarapore Committee on the convertibility of capital accounts 2006 full money.
“India is on the cusp of some fundamental shifts in this area with greater market integration in the near future and free access for non-residents to debt on the table. The Deputy Governor noted that the rate of change in capital convertibility would only increase….”
Free access to debt for non-residents – sovereigns and corporations – is not only on the table, but also actively pursued on the policy front. In March 2020, a fully accessible route (FAR) was introduced which does not place restrictions on non-resident investment (NRI) in selected government securities. The Director General indicated that over time, the entire issuance of gold bonds would become eligible for NRI investment. A more open capital account was also mentioned in the fiscal year 2020 budget, when the center said it would start increasing foreign-currency-denominated borrowing. However, there hasn’t been much movement on this front as the public debate has urged more caution.
There is no doubt that full convertibility expands the Indian asset base through greater integration with international financial markets. It can lower borrowing costs. But it also carries significant risks. If non-residents own a significant portion of the existing stock of government securities, the economy may be vulnerable to sudden outflows of debt. There is no doubt that the Reserve Bank of India (RBI) is well aware of these risks. However, the central bank believes that since the FAR channel is allowed in the context of the inclusion of Indian government securities in global bond indices, there is a “natural safety mechanism” where index investors are unlikely to indulge in outflows.
Sovereign debt usually starts with small doses, but it can become an addiction if the government is not able to rein in its massive borrowing program. To be fair, this government has tried to be fiscally prudent and fiscally transparent under very difficult circumstances. However, fiscal consolidation is needed given the combined fiscal deficit of the center and the states, estimated at 11.3% of GDP, and public debt at 90.7% are clearly high.
Against this background, former Reserve Bank of India Governor YV Reddy recently noted in Business Standard that a roadmap for opening a capital account is necessary as sovereign bonds are “loaded rather than preloaded”.
India survived the 1997 Asian currency crisis in large part because it had capital controls. We’ve certainly come a long way since then; Today, local residents can easily access Forex for travel, study, and transfer of $250,000 abroad under the Liberated Remittance Program.
Companies can borrow to make acquisitions abroad and both portfolio and foreign direct investment are allowed to enter, almost without restrictions. However, although India is becoming more globalized today, caution about the fully convertibility of capital accounts is warranted. More foreign capital may help the economy, but any large and sudden outflows can disrupt local markets. Let’s give it some time.