## Wednesday, January 09, 2008

### Has the strategy of bringing back capital controls worked?

The government has sallied forth with reversals of reforms, with capital controls against private equity in February 2007, external commercial borrowing (ECB) in August 2007, and participatory notes in October 2007. Does this work? Ila Patnaik looks at the recent BOP data and finds that the impact is limited. (I had written on a related issue last month).

In the international experience, when any one component of capital flows is targeted by a government, it is possible for sufficiently stringent action to drive down those numbers. But the real story lies in how other components then swell up.

The camel in the tent, of course, is the current account, which goes beyond the data on capital flows that she examines. Economic agents are able to move capital in and out of the country by misinvoicing on the burgeoning current account.

The bottom line is that the ground realities of the currency market are not altered by these kinds of capital controls; the scale of trading required in order to achieve the desired distortion of the exchange rate continues to be huge and induces unacceptable monetary policy distortions.