Wages of Capital Account Liberalisation

India’s creeping liberalisation of controls on capital flows seems set to accelerate. In late June, for example, the government announced a set of measures that expanded the scope for entry and improved the terms of operation for foreign financial investors in India. To start with, it increased from $15 billion to $20 billion the ceiling on foreign institutional investor (FII) investment in government securities (G-Secs), with a reduction from five to three years in the residual maturity required for investments in excess of $10 billion. The intention, clearly, is to increase the permitted volume of investment and allow for earlier exit, even if the market is not very active. The carrot of easier exit has been held out to FIIs in long-term infrastructure bonds (with a reduction in the lock-in and residual maturity requirement from 15 months to one year) and the Infrastructure Development Fund (with lock-in reduced from three years to one year and residual maturity fixed at 15 months). In addition, the government has now allowed new entities such as sovereign wealth funds, multilateral agencies, insurance companies, pension funds, endowments and foreign central banks to invest in government debt. With more players allowed to enter and exit faster, the volume of investment would be larger, it hopes.

The move to increase the number of agents who could steer foreign capital flows into the economy is not restricted to G-Secs. In a new, incremental scheme for external commercial borrowing (ECB), the government is permitting foreign exchange earners in the manufacturing and infrastructure sectors to borrow abroad. An additional ECB window of $10 billion has been sanctioned for this purpose, over and above the indicative ceiling of $30 billion for total annual ECB. An individual foreign exchange earner can borrow up to a maximum of 50% of its average annual export earnings over the previous three financial years. Moreover, this borrowing can be used either to repay domestic, rupee loans or to finance new rupee capital expenditure. The argument seems to be that this substitution of existing or potential rupee liabilities with foreign exchange liabilities is not risky because the currency mismatch is neutralised by the evidence of the foreign exchange earning capability of the borrower.