One key element of the monetary policy debate of 2006 and 2007 was the extent to which capital controls would `solve the problem' and help regain monetary policy autonomy. On one hand were people who cut their teeth on India of the 1970s and 1980s, who were used to instinctively assuming that India was a closed economy where the government had full power over capital flows. They claimed that there was no impossible trinity; all India had to do was bring in capital controls against ECB and FII and the problems would be solved. On the other side were people who understood the de facto convertibility that has come about.
China has loomed large in the Indian monetary policy debate. How do the Chinese do it? was a question which was asked over and over. Is China proof that you can have stringent capital controls while having the full benefits of trade openness? Or did China lose monetary policy autonomy, adopting very low interest rates which were inappropriately inflationary?
As this story in The Economist shows, it is increasingly clear that capital controls in China were not effective. Massive capital flows have been coming into China in response to a one-way bet on the exchange rate, despite an elaborate system of capital controls. In other words, China `did it' by distorting monetary policy (i.e. having very low interest rates) and not by having capital controls that worked.
I remember one seminar at the Centre for Policy Research in New Delhi: a talk on whether India should do convertibility. In my discussant comments, I said this is a debate about how many angels can fit on a pinhead, for India already has more de facto convertibility than you think. It no longer makes much sense to debate whether India should do convertibility, thinking that it is a zero-one binary decision. One of his responses was: If this is correct, then there is no meaningful debate about China's decision on convertibility also. That is correct; there isn't.
Replace the word `China' in the Economist article by the word `India'. Its amazing, how much of this story works for India also.
You might like to also read my recent article on why India should not emulate Chinese monetary policy.