Mr Tarapores Triumph

What is the link between the Tarapore Committee on rupee convertibility, nationalism and populism? The answer is not immediately obvious but the three are intimately connected.

Until the first world war began in 1914, currencies exchanged freely through the medium of gold. But the war meant that British and French money should not go to enemy Germany, and vice versa. So the first capital controls were imposed. Currencies were no longer fully convertible.

Soon after the war, what began as a necessity became a fiscal expedient. During the 1920s, the main European governments wanted to ensure, to the extent possible, that domestic savings stayed trapped within their borders and were not used up by foreigners. Thus capital controls remained in place.

Then came the Great Depression of the 1930s and it led to the Keynesian idea of pump-priming. The state, it was propagated, would become the catalyst for generating industrial demand to take care of unused factory capacity.

In 1939, thanks to the second world war, there was a leap in demand for industrial products and commodities. But this jump was attributed to the efficacy of Keynesian policies.

The idea thus caught on and, for the next four decades, the orthodoxy was that the state would be the engine of economic growth. This meant, in essence, that politicians would determine how vast and increasing sums of money were to be spent. This, in turn, meant ensuring that domestic money stayed within national borders.

To give this practice political legitimacy, popularly elected governments, especially in developing democracies like India, added a twist of nationalism to the argument. It is our money and we will use it as we please, said Indias governments.

But those who owned the money protested at this pre-emption. Whence came predictable populism: these rich fellows dont want us to invest the money for the benefit of the poor, it was said. Our money, we must use it, not foreigners, for the poor, after taking it away from the rich. It was game, set and match for the state. There could be no argument against this powerful combination of nationalism and populism.

And on this idea grew the entire Indian edifice of exchange controls, administered interest rate regimes (if you trap savings, supply goes up and interest rates remain artificially low which helps the public sector) and distorted financial market structures.

However, fed up with government-caused inequities, the rightful owners of the money started smuggling their savings out of India. Something like $25-40 billion dollars went out. But it took the government over a decade to realise that capital controls had been defeated.

It then thought that instead of trapping savings within India, it might be a better idea to attract foreign savings into India. The effect, after all, would be the same increased supply of investible funds. And so, after the usual groaning and grunting, the Tarapore Committee was set up to suggest a face-saving way of getting rid of capital controls.

It has done so. If not in quite an over-my-dead-body way, certainly with a measurable degree of truculence. If the government waits for all its pre-conditions to be satisfied, the rupee will remain unconvertible, possibly until June 2097.

That is perhaps Mr S S Tarapores real triumph. He has shown the way so what if it is the most arduous one possible?