- The political economy of removing capital controls -- exactly as the Ministry of Industry hated the removal of industrial licensing, the RBI unsurprisingly advocates great caution on removing capital controls. Which incumbent agency operating a system of controls has ever been an impartial thinker when it came to liberalisation?
- Convertibility has to inevitably go with a floating exchange rate, because monetary policy autonomy is more precious than a pegged exchange rate. That will make a dent in another function that the RBI performs, that of manipulating the currency market and being the biggest portfolio manager in India. Ila likens this to a shift from a giant State-run portfolio to a million portfolios run by households.
- Larry Summers recently pointed out that the opportunity cost on India's excessive reserves are bigger than State expenditure on health. This problem will also go away when we switch from public sector reserves management to a million portfolios run by households, for each one will diversify across shares, real estate, corporate bonds, etc., while the RBI reserves portfolio only invests in short-dated government bonds of AAA countries.
All in all, a fascinating set of insights into convertibility. I will add one more element to it. Who stands to lose from the removal of controls? The existing permit-holders. Who are they? The big FIIs who sell PNs. If there's a mass of $50 billion of PNs out there, and if this is a revenue stream of 2% per year, then the revenue stream from renting out permits is a cool billion dollars a year.
In addition, FIIs and FDI investors surely like it when India expends over 1% of GDP on giving them free risk management on currency risk. This adds up to two reasons why existing license-holders are going to be unenthusiastic about convertibility, and why so many FII reports praise RBI's handling of capital controls and the currency regime :-)
The picture I'm getting of the political economy of convertibility is that RBI, FIIs and FDI investors stand to lose from removing capital controls, and everyone else benefits. Let's see who is stronger in the political landscape.