Reserve Bank must prevent capital flight – Jammu Kashmir Latest News | Tourism


Bharat Jhunjhunwala
Data provided by the Reserve Bank of India tells us that the country’s capital account has been negative for the past three years. This means that the amount of capital that has entered is less than the amount of capital that has left the country. Indeed, the negative account was larger during the months of the Corona crisis. However, this does not explain the capital flight from the country as other countries were also affected by the Corona pandemic at these same times. Therefore, capital flight from Corona affected India to another Corona affected country cannot be due to the Corona pandemic. It is necessary for the Reserve Bank to develop policies to prevent this flight of capital because, just as a family becomes poorer when a family member who earns his income leaves, so the flight of capital from the country will make the poorer India.
Despite this harsh reality, a committee established by the Reserve Bank has given four arguments for allowing the free flow of capital from and to India to foreign countries. The first argument put forward by the Committee is that the free movement of capital will increase the availability of capital in the country. It will encourage foreign investors to invest in India. However, this alleged advantage is refuted by the Reserve Bank’s own data which shows that the capital account has been continuously negative for the past 2 years. The free movement of capital leads to capital flight from; not the opposite.
The second argument put forward by the Committee is that the free movement of capital will reduce the cost of capital. This too is not correct as the outflow of capital reduces the availability of capital in India and hence the cost of capital in India is rising instead of falling. The third argument is that it will allow Indian companies to borrow abroad and diversify their borrowing. It’s correct. However, the fact that more capital is leaving the country means that diversification is not helpful in attracting foreign capital. The fourth argument is that the free movement of capital will allow Indian investors to diversify their investment portfolio. Currently, an Indian investor can invest in real estate and equity market in India. After the free movement of capital, Indian investors can invest in real estate in New York and in shares on the New York Stock Exchange. This advantage is correct. However, this is only beneficial for the wealthier part of society as only they have the ability to invest in foreign countries. Outward foreign investment may prove beneficial for them, but not for India. The arguments put forward by the Reserve Bank Committee in favor of the free movement of capital are certainly not beneficial for the country. Contrary to the harmful policies of the Reserve Bank, the International Monetary Fund has advocated that developing countries consider imposing restrictions on the free flow of capital to foreign countries in situations such as the Corona pandemic. They referred to the experience of Korea and Peru which have imposed such restrictions with beneficial results.
The free movement of capital can be much more detrimental in the current situation. The US Federal Reserve Board has adopted an easy money policy in recent years. It made loans available at an interest rate of 0 to 0.25% per annum. It is advantageous for investors to borrow from the United States and invest that money in India at these low interest rates. The Federal Reserve Board has indicated that it will soon reverse easy money and will likely reduce the money supply, which in turn will lead to an increase in the interest rate. If interest rates in the United States rise, it will no longer be advantageous for foreign investors to borrow in the United States and invest in India, as they have to pay high interest rates in the United States. On the contrary, such a rise in interest rates in the United States may cause them to withdraw their money from India and repatriate it to the United States. Therefore, there is a need for the Reserve Bank to urgently reconsider its policy given the impending increase in interest rates in the US economy.
The Reserve Bank’s policy also goes against its own recommendations. The Committee stated that it was necessary to contain the budget deficit while allowing the free movement of capital. We know very well that our country’s budget deficit has been increasing rapidly since the Corona pandemic. On the one hand, the Reserve Bank says that the free movement of capital should not be allowed if the budget deficit is not controlled; but on the other hand, it has increased the limit of money an Indian national can send to foreign countries for investment under the liberalized remittance scheme despite the increasing budget deficit.
An article in the Journal of Indian Association of Social Science Institutions gave four reasons for capital flight from India. First, corruption. The cost of doing business in the country is higher if there is corruption and foreign investors do not want to invest here. Second, the increase in public debt. This means that (1) the government will have to borrow more money; (2) the Reserve Bank should adopt an easy money policy to make government borrowed money available; (3) it will lead to inflation and devaluation of the Indian Rupee; (4) reduce the value of the investment foreign investors may have made in India, resulting in a loss to them. The third is the negative capital account. A negative capital account leads to more outflows, much like herd immunity. One foreign investor follows the other in withdrawing capital from India because a negative capital account leads to devaluation. Fourth, the adoption of free trade. The reason is that if our economy is not competitive, we will lose ground in the world market and this will lead to capital flight. I would like to add a fifth reason which is the social conflict in the country. The social atmosphere has become so negative that foreign investors may not like to come. The time has come for the Reserve Bank and the Indian government to reconsider the policy of free movement of capital, which is leading to capital flight and lower growth rates in the country.
(The author is formerly Professor of Economics at IIM Bengaluru)

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