Why are capital controls imposed?
As economies globalise, a direct consequence is liberalisation of financial sector. This means giving foreigners the opportunity to invest in the domestic economy through various routes. These investments can be very sensitive to the global political and economic situation. During times of crisis, these flows become volatile. If the domestic economy does not have the capacity to absorb the flows capital, controls are imposed. Huge capital inflows also cause the exchange rate to appreciate hitting the global competitiveness of the economy.
What are capital controls?
Any economic mechanism that limits the free movement of capital or money across borders is considered as capital control. There are two kinds of controls: direct or administrative controls and indirect or market-based controls. Direct controls consist of measures that would prohibit, or have a discretionary approval procedure for, cross-border capital transactions. Indirect controls discourage particular kind of capital movements by making them more costly.
Examples of capital controls
The Tobin Tax, levied on conversion of one currency into another, thereby dissuading short-term speculative currency flows. Other measures are quantity restrictions that limit the amount of inflows through a particular route such as debt or equity.
What are the controls used by India?
India currently has capital controls in place for the amount of investment into government and corporate debt. There are presently no taxes on foreign investment on the portfolio side.
