ECONOMICS STUDY MATERIAL

🔆Arguments against Capital Account Liberalisation ☑️ Could lead to the export of domestic savings- which can further erode the capacity of state to finance the national imperatives. ☑️ Could lead to greater tax avoidance- It would weaken the ability of the authorities to tax domestic financial activities, income and wealth. ☑️ Could expose the economy to greater macroeconomic instability- arising from the volatility of short-term capital movements, the risk of large capital outflows and associated negative externalities. ☑️ May lead to ineffective monetary policy- due to speculative short-term movements in the interest rates, leading to other spiraling effects. ☑️ Due to higher capital inflows following capital convertibility, the appreciating real exchange rate would divert resources from tradable to non-tradable sectors (like construction, housing, hotels and tourism etc.) and this would happen in the face of rising external liabilities ("Dutch disease effect"). ☑️ Could lead to financial bubbles- especially through irrational exuberance of investment in real estate and equity market financed by unbridled foreign borrowing. 🔆Way Forward ☑️ Given the trade-off between growth/efficiency and stability associated with capital flows, India’s preference has strongly been in favour of avoidance of instability. Such an approach has imparted stability not only to the financial system but also to the overall growth process. The relative weights to efficiency and stability need to be constantly reviewed in the view of contemporary developments. ☑️ While realizing that the impulses of growth could be supplemented with foreign capital, it is imperative to ensure that liberalisation of the capital account responds to the requirement of the economy in an appropriate, gradual and cautious manner.