India should manage capital account, says YV Reddy

Tobin tax and a financial sector levy could be considered, says former RBI governor.

India should manage its capital account irrespective of high or low inflows, Y V Reddy, former governor of the Reserve Bank of India (RBI), said in Mumbai on Monday.

“India should also consider using taxes to ensure the country gets good quality and less volatile overseas funds. Tobin tax and a financial sector tax could be considered,” he added.

“The policy package that I have been advocating is that the capital account should be managed — in case of more inflows, one should try to moderate, and when inflows are less, you should try to encourage,” Reddy said. “It should be a continuous policy of capital account management, and all instruments required should be put in place and in use.”

Goldman Sachs last week said India was increasingly financing its deficit by short-term capital, that is, increasing its short-term debt and raising its external vulnerability. Almost 80 per cent capital flows were non-foreign direct investment (FDI), and given excess spare capacity globally, FDI might remain weak, it said. Current account deficit, which could widen to four per cent this year till March 2011, was the biggest risk to India’s growth, it said.

RBI has not ruled out any instrument, including Tobin tax, but has not committed to using any of these. RBI Governor D Subbarao said in the November 2 monetary policy that Tobin tax was on the menu but its efficacy had not been established.

Referring to the global crisis, Reddy said the worst was behind us in terms of avoiding the collapse. It was the cost of these actions that one was paying, he added.

In case of some countries, the economic stimulus is adequate. But in others, it is disproportionate. A global co-ordination was easier when the crisis loomed large, but it was tougher now since policy challenges were different, said Reddy.

“Global co-ordination becomes a lot more complex. There could be some more unknowns that are coming up,” Reddy said. “There are significant uncertainties. It requires determined national action and greater global coordination.”

On Ireland and its efforts for a bailout, Reddy said in Europe, there was discomfort but also a determination to get the act together. He said this was not a serious source of global imbalance as only a few European countries didn’t follow fiscal discipline.