Reserve Bank Governor D Subbarao today said quantitative controls on forex inflows can have some short term benefits but they can be distorting and inefficient.
"Our experience has been that while quantity controls are more effective in the short-term, they can also be distorting, inefficient and inequitable," he said at an IMF Conference on Rethinking Macro Policy here.
Referring to the issue of capital control as stabilisation tool, he said the economic crisis has dismantled the consensus that the control was always bad.
"That consensus no longer holds. Received wisdom today is that capital controls are not only appropriate, but even desirable in certain circumstances," he pointed.
In India, he said, "we deploy both price based and quantity based controls".
Citing an example he said, deposits from Non-Resident Indians, which are an important source of capital flows into India, are controlled through the interest rates banks can offer, a price variable.
On the issue of movement towards full capital account convertibility, Subbarao said the debate is no longer about the strategy and timing but "the very imperative for capital account convertibility".
"In other words, the consensus that every country should eventually move towards a fully free capital account is now broken," he said, adding that "there is merit, it is argued, in retaining capital controls".
Referring to the issue of foreign exchange intervention, the Governor said it could lead to diminishing of forex reserves and currency depreciation.
Subbarao added: "The lower your reserves dip, the more vulnerable you become. And the vulnerability can become quite serious if your reserves go below the level markets perceive as necessary to regain market access.
"It should also be clear that a failed defence of the exchange rate is worse than no defence. So, when you are intervening in the forex market, it is important to make sure that your intervention is successful."
Subbarao raised the issue concerning the optimal level of reserves that a country should be holding.
There are two views on the issue, he said. One view is that "it acts as war chest, as a source of liquidity, and as an instrument for inspiring market confidence".
"The argument against holding reserves has centred on the opportunity cost of holding them, and also that the comfort they provide may encourage excessive risk taking and therefore become detrimental to macro stability," he said.
