Published on The Economist, Oct 29th 2009.
IN INDIA, drought sometimes turns to deluge. This summer the country suffered its worst monsoon since 1972, which left half its rural districts parched, followed swiftly by floods that inundated two states. In recent years India’s economic policymakers have confronted a similar phenomenon. A once-sheltered economy is now increasingly open to foreign capital, which rained down on the country in 2007, only to evaporate last year. The rains are now returning: foreigners have invested $13.8 billion in India’s stockmarkets since April, having withdrawn $8.6 billion over the same period last year …
… Keep it simple:
For starters, they are needlessly complex, because India’s policymakers like to retain as much room for manoeuvre as possible. They police capital flows by banning some trades, imposing quotas on others, lifting a price control here or tightening a registration requirement there. This makes life needlessly difficult for foreign investors. The rules are hard to interpret and changes are impossible to predict. One private-equity fund and its investors reckon this confusion and ambiguity cost them $8m in lawyers’ fees.
This accomplishes the policymakers’ aim of deterring foreign capital, but not quite in the way they intended. By raising the cost of doing business, the regulatory thicket acts as an implicit tax on investing in India. Its policymakers could achieve the same effect through simple rules and explicit taxes. The $8m that is now spent on lawyers could be given to the Indian government instead.
Brazilian taxes are not the only way to put a price on inflows. Another, in a similar spirit, is to auction the right to borrow abroad. That would allow the RBI to set an overall cap on foreign fundraising, while letting borrowers themselves decide how much extra they are willing to pay for the privilege. Ministries which still impose an FDI ceiling on the industries they oversee should also abandon them. Few are justified. Why, for example, does India permit 100% FDI in the manufacture of hazardous chemicals and industrial explosives, but 74% in telecoms, 26% in insurance and none at all in supermarkets?
India must learn to live with foreign capital eventually, as its regulators freely admit. Some capital controls may help. But its current rules seem less like stepping stones to a more open future than relics of its shuttered past. (full text).