The China crash shows the weakness of capital controls. India should take note

By Bernard Lunn

This story will carbon date me. I recall going to The Bank of England to get a stamp in my passport authorizing me to take £50 out of the country. Then Maggie Thatcher abolished capital controls the day that she took office and (despite the dire warnings of all the cognoscenti) the FX markets gave Sterling a relatively smooth ride.

Sometimes in a crisis there is no option other than putting in capital controls – think of Iceland in 2009 and Greece today.

The problem comes when those capital controls become habit baked into institutional policy. That is the problem that China is facing.

Asian countries learned to love capital controls during the Asian Financial Crisis of 1998. Those without capital controls – such as Korea, Thailand and Indonesia – suffered deeply as hot money fled at the click of a mouse. Those with capital controls – such as China and India – escaped relatively unscathed.

Today the problem is the other way round. The boom and bust cycle in China has a simple explanation. Chinese people can only invest in China. So they ride it up to crazy heights and sell fast and hard when it starts to go down. In a free economy we still have booms and busts – but we have options that smooth the cycles to some degree. If we think one market is overvalued we can move capital to a market that is undervalued. China arresting short sellers does not seem like a good response.

India looks good on the global stage – big market plus good demographics plus tiger growth rates plus reasonably sane valuations plus democracy plus relatively free markets. I can only write relatively free markets because India still has capital controls (on the capital account, it is free on the current account). The Modi Government is committed to free markets and has made some very smart moves. I hope they now seize the day by dropping capital controls. This will free Indian companies to compete globally and open up India as a financial center (turning the dreams of the Gujarat International Fin-Tech city aka GIFT into a reality).

If you want a more detailed review of capital controls in China and India, read this post.

What do you think? Will India make the Rupee fully convertible (on the capital account) during 2015?


  1. Looking at interest rate differentials, is one traditional way to get an insight of what the market is telling us. Foreign bond issuance of Indian companies was very strong in 2014 and continues to be in 2015. In Spring, however, there was a positive move towards deeper and more mature bond markets, when the RBI announced that it would allow Indian companies to sell rupee-denominated bonds overseas. This is one step towards setting the stage for a fully convertible rupee market. Watching how these bonds are priced and trade, will give more information about the market expectations.

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