Full Capital Account Convertibility

Wednesday, March 22, 2006

The Polit Bureau of the Communist Party of India (Marxist) has issued the following statement:

On Full Capital Account Convertibility

The Polit Bureau of the CPI (M) expresses its strong opposition to the move to introduce full capital account convertibility, announced by the Prime Minister at Mumbai on 18th March 2006. The CPI (M) considers this to be a significant departure from the Common Minimum Programme, which far from advocating capital account convertibility, is committed to reducing the “vulnerability of the financial system to the flow of speculative capital”. The Party does not agree with the view that the “comfortable” position of the Indian economy, both “internally and externally”, warrants a “revisiting” of capital account convertibility, which was shelved after the contagion of severe currency crises hit the South-East Asian countries in 1997-98, from which India could insulate itself only because of the extant capital controls. Following the experience of successive financial crises in countries like Mexico, Russia, Brazil, Turkey and Argentina besides the South East Asian countries over the past decade it is now widely held within policy circles across the developing countries that full capital account convertibility, which allows any entity to transfer their funds at will in and out of a country, causes more harm than good.

Out of the foreign exchange reserves of $ 143 billion currently being held by the Reserve Bank of India, $ 44 billion, i.e. over 30% is on account of the FIIs. External Commercial Borrowings by domestic companies have also risen steadily to nearly $ 15 billion in 2005-06. According to the RBI, the ratio of volatile capital flows (defined to include cumulative portfolio inflows and short-term debt) to reserves, which was 36% on March 2004, had increased steadily to 40.5 % on September 2005. In contrast, the share of net FDI in total private capital inflows was around 10%. Far from generating any sense of comfort, such rising proportions of volatile capital inflows increase the possibility of financial turbulence. In fact the combination of an unsustainable stock and real estate bubble fuelled by ‘hot money’ inflows, currency appreciation and a widening current account deficit, being witnessed in India currently, looks eerily similar to the situation prevailing in the South East Asian countries in the period preceding the currency crises of 1997-98. Introducing capital account convertibility at this stage would further encourage such speculative inflows and reckless commercial borrowing.

The UPA Government’s proclivity to gratify the speculators was evident in the decision to abolish the long-term capital gains tax in its very first (interim) Budget. The lure of tax-free speculative gains have attracted billions of dollars of portfolio investments into the Indian capital markets over the past two years, which in turn has led to an unprecedented stock market boom. FII equity holdings currently comprise over 13% of market capitalization in the Indian stock market in contrast to less than 3% in China. This is enhancing risk within our financial system and has the potential of causing enormous pain to the common people who would have to bear the brunt of adjustments once the ephemeral boom comes to an end. Besides increasing the number of billionaires in India, that too not through entrepreneurial profit but through untaxed capital gains, this massive inflow of portfolio investments does not have any positive impact on the productive sectors of the economy. The Government’s stubborn refusal to reintroduce the long-term capital gains tax in the Budget 2006 and instead allowing Indian Mutual Funds to invest abroad has testified to its pro-speculator bias. It is in keeping with this bias that the UPA Government has announced its intention to move towards full capital account convertibility.
It is disconcerting to note that such an important announcement was made by the Prime Minister at the Asian Corporate Conference at a time when the Parliament is in session and the Finance Bill being debated. The Finance Minister’s clarification in the Rajya Sabha yesterday that no decision has been taken so far in this regard does not hold water since following the Prime Minister’s directive, the RBI has already announced the formation of a Committee headed by S S Tarapore to chalk out a roadmap for full capital account convertibility. The CPI (M) reiterates its unequivocal opposition to full capital account convertibility and demands that the decision to form the Committee be rescinded.