Saturday, Nov 21, 2009 (Financial Express 23rd Nov 2009)
Finance minister Pranab Mukherjee has laid to rest speculations about India imposing capital controls in the face of rising capital inflows. In a recent statement, he clearly said that while the government would monitor the inflows, India is not planning to impose restrictions on capital inflows in the near future.
The first question that should be asked before a meaningful discussion on imposing restrictions, is about the magnitude of capital flows to India today. The latest balance of payments data is available for the quarter April-June 2009. Net capital inflows in the quarter were $6.7 billion. This figure is a fraction of the inflows in late 2007 and early 2008 when they reached highs of more than $30 billion per quarter. When we compare foreign inflows today to the two quarters following the financial meltdown, when they were negative, they appear large. But when seen in historical perspective, inflows are, in fact, quite moderate.
Further, if we look at the components of capital flows in April-June 2009, the largest component was foreign direct investment, at $9.4 billion. This was followed by FII investment at $8.2 billion. The usually worrisome factor, loans, have not bounced back. As a consequence, we saw negative numbers for some categories with net loans outflow of $3.3 billion and net banking capital outflow of another $3.3 billion.
In the past, an inflow of capital has been a cause of concern for RBI. One of the main reasons for this was that RBI was trying to prevent rupee appreciation. When the rupee was touching Rs 40 per dollar, there was pressure from exporters to prevent further appreciation. Today RBI’s concerns are quite different. The central bank is faced with the difficult task of trying to boost growth and keep inflationary expectations under control. Were it to raise interest rates, growth could suffer. Were it to lower them, inflationary expectations could flare.
Under such circumstances, rupee appreciation offers an easier path to control inflation. The rupee today, at above 46, still has a long way to go before it becomes a serious lobbying point. Exporter lobbies are not going to be heard particularly seriously at least until it reaches Rs 40 per dollar. Had capital continued flowing out, as it did in the previous couple of quarters, or as it does for loans and banking capital, and had foreign investment not returned, there would have been further rupee depreciation that would have raised inflation rates. RBI might then have been selling dollars in the foreign exchange market to prevent rupee depreciation and rising prices. This would have resulted in further problems such as a contraction of liquidity.
The return of foreign investment is the best solution to the policy dilemma facing RBI and the government. Not only does it encourage a stronger rupee, it brings in funds for investment. In a credit constrained economy where domestic banks are reluctant to lend, where foreign loans have dried up, where the non-banking financial sector has seen one of its worst crises, foreign investment is welcome, and as the finance minister said, much-needed by India.
What could be the other concerns because of which there might have been reasons to restrict capital inflows? One concern that is sometimes cited as a good reason to restrict controls is to reduce buoyancy in the stock market. On this count it is difficult to imagine that the government would, at present, be keen to prick the bubble, even if, like RBI, it believes that there is a bubble.
The stock market is one of the few places where the financial sector is signalling optimism (bank credit has still not picked up). If at this stage the government were to step in with measures such as a tax on foreign portfolio investment, as Brazil has done, it is likely to have an adverse impact on the stock market. In addition to the impact this will have on business sentiment, on a more pragmatic note, this would be bad timing, as the government is planning to raise resources by selling shares of public sector companies to lower its fiscal deficit.
Even if all the above reasons for not imposing restrictions are overruled, such as in the event of the exporter lobby becoming overwhelmingly strong, and the government does decide to impose restrictions on capital inflows, it has been seen in the past that capital controls have not been very effective. They appear to be effective in the short run and in terms of the specific category of capital inflows on which they are imposed, but they are not effective in controlling the total amount of money coming in.
We have seen that in the case of the ban on participatory notes (PNs), which, of course, stopped money coming into India under the head of PNs, but did not bring down net capital inflows or even total foreign investment into India. There are multiple ways of bringing in money and other than creating distortions in the market; there is little that further capital controls can achieve today. Imposing controls that will make a serious dent on net capital inflows or will bring the number below the last quarter’s figure of $6.7 billion, is neither feasible nor desirable.
—The author is professor, NIPFP
I had sent my views on the above article to the Editor,as under :
This refers to Ila Patnaik’s article titled :” Tobin Tax is only for text books” in FE of 23rd November 2009.
As rightly advocated by her,this tax,whose name comes from James Tobin, a Nobel laureate economist at Yale University,needs to be kept on hold at the moment,so that FDI continues to flow into the country.
FDI is the need of the hour and imposing such a tax will give wrong signals to the investors.Of course,a token tax on speculative transactions could be thought of with a view to discourage volatile short-term trading which can have a destabilizing effect on our currency.
The inflows can be used by us for funding worthy projects for alleviating human sufferings,by providing the large poor populace with cheaper housing,cheaper modes of conveyance,cheaper food and other basic items,and of course for creating a better unpolluted environment for a healthy living.
Other areas where poilitical willingness and consensus is necessary are : efforts to reduce the ever widening gap between the haves and havenots,generating more job opportunities for the vast rural unemployed populace, “safety nets” for the very old,infirm, elderly and senior uncared for citizens,sustainable development in various areas,fighting growing spectre of global warming and climatic changes and last but not the least, poverty and hunger.
Many local issues and problems like disaster management in times of floods and draughts, health programmes for the rural masses,water and sanitary systems etc also need to be solved and can be solved if the inflows are wisely and judiciously used.
J S BROCA
Here is something extra about Tobin Tax :
TOBIN TAX PRINCIPLES
Act to introduce a world-wide solidarity tax: “The Tobin Tax”
The Tobin Tax is a tax on currency speculation, once per transaction. The idea and name comes from James Tobin, a Nobel laureate economist at Yale University. The currency market is now over one trillion dollars daily, and the proposed tiny percentage tax (suggestions range from .1% to .5%) would be on speculative transactions only. The purpose is to discourage volatile short-term trading and its destabilizing effect on country currencies, restoring national macroeconomic controls over currency fluctuations. Billions in revenue would be generated, as much as $300 billion to $1 trillion yearly. Part of the revenue would go to an international fund, another part to national budgets.
The Tobin Tax is a proposed transaction tax on currency speculation. The concept comes from James Tobin, a Nobel laureate economist at Yale University. Here is how it would work: Currency speculators trade at the rate of over one trillion dollars each day. Speculative transactions would be taxed at a tiny percent of volume (.1%-.5%), once per transaction. Non-speculative transactions would be exempt, about 10-15% of the daily volume. The tax would discourage overnight or short-term currency trades, the most volatile, while leaving longer-term investments barely effected. Dangerous currency volatility would thus be reduced, and national macroeconomic autonomy restored. Billions in revenue, potentially as much as $300 – $600 billion per year, could be generated, according to economic studies. Parts of the revenue would go to international trust funds, other parts to national budgets. Both parts could be used to fund worthy projects.
LIST OF PRINCIPLES
Multilateral Cooperation to Tax Currency Speculators
The financial crisis in Asia and elsewhere is adding to human suffering which must be alleviated. When currency is devalued, the purchasing power of citizens plummets, food and other basic items become too expensive, the environment is less protected, and jobs are lost. Further, this crisis exacerbates existing problems, such as the widening gap between rich and poor, the strain on the global environment, and high rates of unemployment.
One of the causes of the financial crisis is the large volume of currency speculation that now occurs on a global basis. The foreign currency exchange has grown recently to over a trillion dollars daily, much larger than all the stock exchanges of the world. This market is so large and volatile that government central banks can no longer adequately protect the currency of their own nations.
The existing institutions that regulate national and international monetary systems have inadequate and sometimes even destructive policies to deal with the crisis. For example, the austerity programs of the International Monetary Fund increase the level of suffering for those with the least “safety nets,” while doing little to prevent destructive volatility. Reform of these institutions is an essential part of any effective solution to the crisis.
Reforms are needed in many aspects, but should include mechanisms to reduce the volume of destabilizing capital flows, through a transaction tax on currency speculation. Commonly but not necessarily called the “Tobin Tax,” after the Nobel economist who originated the concept, this tax would deter short-term or overnight trades, and thus shrink the volume of daily currency trading from its present trillion dollar daily level. Such a shrinkage would restore each nation¹s ability to control its own currency, as well as generate revenue.
To effectively reduce volume, the tax percentage must be large enough to make overnight speculation unprofitable. Proposals range from .1% to .5% per transaction. Longer-term investments occur less often, so would not be adversely affected by this small tax, and the overall remaining volume would be enough to create sizable revenue.
Adoption by the major currency nations of the Tobin Tax mechanism would accomplish the volume-shrinking goal, so the adoption need not be universal to be effective.
Collection and enforcement of the Tobin Tax are considered to be economically and institutionally feasible, and concerns regarding tax avoidance could be dealt with through adoption of regulatory mechanisms.
Since the revenue could be quite large, over one hundred billion by some estimates, baseline criteria for allocation to meet basic needs should be established. Basic human needs and basic environmental needs must be met first, through existing international agreements such as those addressing environmentally sustainable development, climate change, and hunger.
The international portion of the revenue should be set aside in a series of earmarked trust funds for basic needs that are cooperatively administered in an open and democratic fashion. Administering agencies should cooperate with local civil society to provide actual services for basic needs, such as disaster aid and food distribution, small-scale agriculture and reforestation, health clinics and disease prevention, local water systems and pollution control mechanisms.
Such administration should occur within the framework of producing local jobs, while ensuring adequate environmental safeguards, and protection of the rights of workers and other citizens.
Political will is the key to successful adoption, and grassroots support is essential to educate decisionmakers regarding this opportunity.
Frequently Asked Questions About the Tobin Tax
Is it economically feasible? There is a healthy debate going on among economists, but within that debate, most economists find it a credible proposal which must be studied and dealt with in great detail.
Is it politically feasible? That will depend on citizens, grassroots organizations, political parties, parliamentarians and congresspeople, and heads of state around the world. The Canadian Parliament has recently become the first to pass a Motion about the Tobin Tax.
What would happen to the revenue? This is where local citizens and grassroots organizations come into the picture. It is essential that guidelines be established and priorities be set, so that this will not be yet another “pork barrel”. We should be demanding international criteria such as earmarking funds for poverty and the environment. And we should be asking our elected representatives to look seriously at this opportunity to reverse global environmental devastation and the disaster of poverty.
The following abridged version of my letter has been published in FE of 27th Nov 2009.:
Letters to the editor
The Financial Express
Friday, Nov 27, 2009
Apropos of the article ‘Tobin tax is only for textbooks’ (FE, Nov 23), FDI is the need of the hour and imposing such a tax will give wrong signals to the investors. Though, a token tax on speculative transactions could be thought of with a view to discouraging volatile short-term trading.
JS Broca, New Delhi