India may need some capital controls - economist

MUMBAI Tue Oct 16, 2007 6:18pm IST

People look at a large screen displaying India's benchmark share index on the facade of the Bombay Stock Exchange (BSE) building in Mumbai October 15, 2007. REUTERS/Punit Paranjpe

People look at a large screen displaying India's benchmark share index on the facade of the Bombay Stock Exchange (BSE) building in Mumbai October 15, 2007.

Credit: Reuters/Punit Paranjpe

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MUMBAI (Reuters) - India's record-breaking stock market and surging rupee are damaging the economy and policy makers might need to consider imposing some controls on capital inflows, a central bank adviser said on Tuesday.

Massive capital inflows could mean authorities might have to consider requiring that 10 percent of the funds be deposited with the Reserve Bank of India for one year, S.S. Tarapore, who does not speak for the central bank, told a risk management seminar.

"I am fully aware that the authorities would baulk at such a measure, but unusual times require unusual remedies," said Tarapore, who was a deputy governor of the central bank in the 1990s.

The Reserve Bank has intervened heavily this year to cap the rupee -- latest data shows it bought almost $40 billion in the first eight months of 2007 -- and has made it easier for Indian firms and investors to move local funds overseas.

The government has capped the amount of funds local firms can raise overseas and then repatriate, but policy makers have not proposed controls on foreign money.

Last December, Thailand, looking to stem a rise in the baht, required investors to keep 30 percent of their money in Thailand interest-free for up to a year or face a 10 percent penalty.

The move sparked a 14.8 percent drop in the stock market the next day, prompting an exemption for stocks from the controls.

"An appreciation of the rupee, combined with a rising stock market, is a standing invitation to speculative capital inflows to first flood the economy and then to stampede at the exit door," Tarapore said.

Indian shares hit a record high on Tuesday. It was their 18th record in the 19 sessions since U.S. rates were cut last month, and the market has risen more than 20 percent in that time.

A key driver has been foreign buying of stocks. In the first two weeks of October foreigners bought more than $3.6 billion, taking their net buying this year to $16.7 billion, which if sustained would easily outstrip a record $10.7 billion in 2005.

That in turn has propelled the rupee higher. It has risen about 12.5 percent against the dollar this year, and last week rose to 39.27 per dollar, its strongest level in 9-½ years.

Tarapore said the central bank should raise banks' reserve requirements by 1 percent and if inflows remained strong, it should introduce an incremental cash reserve ratio increase of around 10 percent.

The central bank has already raised banks' reserve requirements by 200 basis points to 7 percent since December.

"The stock market has gone virtually berserk," said Tarapore, who chaired a central bank-appointed panel last year which drew up a plan for more rupee convertibility on the capital account.

"The concern is whether the (benchmark index) would rise further or crash. Either way, it could have implications for capital flows and macroeconomic stability."

Further currency appreciation would widen the current account deficit to unsustainable levels and lead to a sudden exodus of capital, he said.

"A quick reversal is necessary before the risks to the system become unmanageable," Tarapore said.

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