'Temporary capital control is an appropriate tool'

Q&A: John Lipski, Deputy MD, International Monetary Fund

Praising India for managing the economy well during the global financial crisis, John Lipski, first deputy managing director of the International Monetary Fund, stresses the need for rolling out a medium-term plan to contain the fiscal deficit and liberalising the debt market further. Excerpts from his interaction with the media on the sidelines of an international research conference organised by the Reserve Bank of India

Emerging markets, including India, have seen huge capital inflows from international investors, posing a challenge to central banks to manage liquidity. Is the Fund in favour of countries placing controls to curb the adverse impact of capital flows?
The flow of funds to emerging markets up to 2008 was justifiable on the basis of improvement in their fiscal conditions, structural reforms and low inflation. It was a positive development. In 2008, there was a sudden drop in these inflows due to the global financial crisis.

The original basic judgement about opportunities (for investing in emerging markets) has remained intact.

The present surge in capital flows is in a sense a kind of catch-up for investment not made in the last two years. It is reasonable that the authorities want positive effects (of capital flows) and not destabilising ones.

IMF does not have a specific view on imposing restrictions. It is possible that capital controls may be an appropriate tool in certain circumstances as a temporary measure.

In emerging economies, authorities would like to gradually control foreign flows into markets, as they are in a transition phase. I would expect acceleration in capital inflows into India to level out soon.

There has been a sharp rise in fiscal deficit in India as the government rolled out fiscal stimulus measures for managing the economic slowdown. Is it time for the government to chart out a fiscal consolidation path?
In the near term, I do not see it as a problem. The failure to control fiscal deficit will create problems and will be an impediment to growth.

The Fund, in its recent assessment of the Indian economy, has advised the country to phase out subsidies on petroleum products. Can you explain the rationale?
Subsidies are designed to protect the needy. But experience suggests that people who deserve the least benefit the most. The pricing arrangement should be such that it encourages efficient use of fuel while protecting the needy. IMF has favoured an end to regressive subsidies and introduction of market-based pricing for petroleum products. Over time, subsidies on products consumed predominantly by the poor should be replaced with targeted support.

Should India liberalise the norms for investments by foreign institutional investors (FIIs) in the debt market?
India should allow more foreign investments in its debt market to boost trading and lower borrowing costs. Increasing foreign participation will provide additional liquidity and more robust pricing of local bond market issues.

India caps foreign investments in government debt at $5 billion, and in corporate bonds, at $15 billion. India should have one foreign investment ceiling for both government and company debt.

The European Union (EU) has decided to back Greece in fighting financial woes. Will IMF come up with a specific package for the troubled European nation?
We welcome the support for Greece from its EU partners, which, together with policy actions undertaken by the Greek authorities, are important new steps in response to the challenges faced by the country. The Fund is prepared to offer expertise and support.

IMF remains a cooperative institution. We stand ready to help the Greek authorities in the way that they will deem appropriate.