Creating a panic

RBI's fresh controls could be counterproductive

The Reserve Bank of India, apparently with the full support of the Union government in New Delhi, continues to move backwards in time in its efforts to support the falling rupee. Even as India celebrated another year in which dependence on foreigners was supposed to have receded further into the distance, the RBI took a step backward and tightened controls on money leaving the country. In a move that goes sharply against the grain of years of liberalisation of India's external account and ever-weakening capital controls, the central bank reduced the amount that Indian companies and individuals could transfer out of the country. Companies were told that they would now only be granted automatic permission to invest abroad if the investment was 100 per cent or less of their net worth, not 400 per cent as it has been hitherto. Individuals, meanwhile, will no longer be able to take $200,000 a year out of the country, but only $75,000.

These measures - which the RBI's notification insisted were "rationalisations" of foreign-exchange regulation - are likely to be as counter-productive as all the bank's recent efforts to prop up a currency that is inexorably moving downwards. In the first place, while India Inc is indeed bearish on domestic investment and many big names seek to invest elsewhere in the world, the overall trend recently should not have caused any panic on Mint Road. In fact, overseas direct investment by Indian companies in July 2013 was half of what it was in July 2012; overall, it has been lower in the first four months of this financial year than in the corresponding period in the previous financial year. Why, then, this concern? Indeed, if anything, observers will assume that this is just confirmation that the RBI's solution to the "impossible trinity" of supporting the exchange rate, maintaining an open economy and following an independent monetary policy is to close off the economy. In other words, it could be seen as a harbinger of ever sharper capital controls, and might induce the very movement of money out of India that it is supposed to prevent.

The overall impression that the RBI is giving by its hasty moves towards various forms of control in the past few weeks is that India is on a quick path back to a pre-1991 set of policies. The controls on gold imports also announced on Wednesday, together with the government's sharp hike in the Customs duty on gold, only make that impression stronger. This is not just the wrong strategy for a country that has left statism behind, it is also dangerous. The last thing that market participants, foreign and domestic, need to start thinking is that today's policy makers are as helpless, or facing as dire a situation, as those prior to 1991 - and that year's crisis was not prevented by closed-door policies anyway. It would be deeply unfortunate if a weak economy was driven to a crisis purely by the efforts of policy makers seeking to prevent it. The RBI should publicly give up its doomed defence of the rupee. After all, Finance Minister P Chidambaram is right when he told Parliament that the rupee's level is fixed by various uncontrollable factors. But then he, and the Reserve Bank, should then stop trying to control it. No policy maker knows what the correct level of the rupee is; the market should be allowed to decide. That policy, as befits a mature open economy, has a far better chance of staving off crisis than what is on offer at the moment.