Deepak Lal provides a fresh perspective on international capital flows (“Reviewing capital controls”, April 16). However, he relies on flexible exchange rate to take care of a “sudden stop” of foreign portfolio investments in India. This may have worked in the past but it may or may not always be adequate to take care of the problem. However, we need not go to the other extreme and rely on capital controls to avoid the problem, as some others have suggested.
The Reserve Bank of India (RBI) can buy a credit line from the International Monetary Fund (or any other international financial institution since IMF can be controversial). Some countries like Poland, Columbia and Mexico have already bought the Flexible Credit Line (FCL). India can do the same. A credit line gets the RBI funding (in foreign currencies) as and when and if it is needed so that RBI can allow capital account convertibility meaningfully and without undue worries.
A credit line can be cheaper than foreign exchange reserves. So there can be scope for even reducing costly foreign exchange reserves if these are large. Many years ago Montek Singh Ahluwalia had suggested a reduction of foreign exchange reserves. However, he did not provide a solution to the problem of a possible “sudden stop”. With a credit line now, his suggestion is more meaningful.
We need an optimal mix of foreign exchange reserves and credible credit lines, with an occasional role for capital controls in an extreme situation. At present, we rely primarily on reserves. This is sub-optimal.
India has now become part of the proposed credit line arrangement between the BRICS countries. This is a welcome development but it is inadequate. A credit line needs to be used more extensively to ensure financial stability at reasonable cost.
Gurbachan Singh, Visiting Faculty,
Indian Statistical Institute, New Delhi
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