Government of India Volume I: Analysis and Recommendations

CHAPTER 8
Capital controls
Capital controls are restrictions on the movement of capital across borders. The design
of controls vary from country to country. Typically, capital controls include a range of
measures from reserve requirements to quantitative limits, licensing requirements and
outright bans. Controls may be imposed economy-wide or may apply only to specific
sectors. In addition, restrictions may apply to all kinds of flows or may differentiate by
type or duration of flows.
India’s current account is fully liberalised. The Commission has no view on either
the timing or the sequencing of capital account liberalisation. These are decisions which
should be made by policy makers in the future. The focus of the Commission has been on
establishing a sound framework of law and public administration through which capital
controls will work.
8.1. Objectives of capital controls
While some nations have used capital controls as part of their policy response to sudden
inflows, the International Monetary Fund (IMF) recommends that capital controls be
implemented only on a temporary basis, when other macroeconomic policy responses
have been exhausted. The Commission notes that empirical studies present mixed evidence
on the effectiveness of capital controls in addressing macroeconomic imbalances
and systemic risk. The Commission also acknowledges that, in the current Indian context,
a distinction must be made between strategic and tactical capital controls. While
the former involves defining a ‘credible framework of rules of the game which can be
used by foreign investors to decide their investment strategy’, the latter would be ‘situation
specific - to be imposed when particular circumstances arise and withdrawn when
they abate.’ Consequently, the Commission recommends that capital controls be available
for policy purposes as a temporary measure during macroeconomic crises.
Even in countries which have achieved full capital account convertibility, the legal
framework provides for the imposition of controls for preventing foreign ownership of
certain national assets for reasons of national security. The Commission recommends
that in the Indian context too, the law should restrict foreign ownership of national assets.
Accordingly, the draft Code provides for the pursuit of this objective with clarity on
instruments and objectives.
The application of capital controls should be consistent with the principle of competitive
neutrality. Controls should only be imposed at the entry level. Once all entry level
FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION 81