Wednesday, July 18, 2007

Moving towards de facto convertibility

One of the most important phenomena which has been taking place in India in recent years is rapid integration into the world economy. In the case of merchandise trade, trade integration is commonly measured by summing exports and imports, and expressing these as percent of GDP. In similar fashion, I find it useful to focus on the sum of money coming in and going out, on the current account and capital account taken together, as a measure of globalisation. The data shows these gross flows have risen sharply:

Year Trillion rupees Percent to GDP
1999-00 9.16 51.28
2006-07 41.18 110.01

For such a structural parameter, going from 51.28% in 1999-00 to 110.01% in 2006-07 is a substantial change. When 110% of GDP is moving across the boundary, capital controls become increasingly ineffective.

Swaminathan S Anklesaria Aiyar has an article in Economic Times where he talks about big discrepancies in the BOP data. In my opinion, these discrepancies reflect the increasing use of the current account to effect capital flows. If a software company sends out a C program to a customer by email, and gets paid $1 million for it, what RBI inspector can verify what was the current account transaction that took place?

On a related note, Economic Times has an article on the growing internationalisation of the Indian rupee. The MIFC report has written about policy directions that India needs to embark upon, in order to make the INR one of the six key currencies of the world, a currency that would be used for bond issuance and complex financial transactions by issuers and investors all over the world.

On the scale of a trillion dollar GDP, with such large cross-border flows, the present discussions about bringing back capital controls on one small element (ECB) are missing a sense of scale about India's globalisation. Banning ECBs would have probably made a significant difference circa 1997. But not anymore. Instead of looking for ways to bring in more controls, it would make more sense to look forward to the time when India will be a $2 trillion GDP with $4 trillion in cross-border flows, and gear up for that world with the commensurate institutional maturity.

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