and the implication is that countries that are unable to use fiscal policy in this way, perhaps for political reasons, should go slow on capital account liberalization. " summing up, professor eichengreen refers to the two challenges, going forward, that the authorities in asia face in regard to current problem associated with capital flows. the first relates to the upward pressure on currencies as private capital continues flowing into the region. he comments, " the main tool for countering appreciation of the currency will be fiscal policy, … if currencies are too strong for comfort, then asian governments need to raise taxes and cut public spending. this is politically challenging, but it is a necessary corollary of the decision to free capital flows. " the second relates to limiting the risks of instability. on this, he comments, " if asian stock and bond markets fall sharply, the negative shock could spread quickly from leveraged investors to the property sector, from there to the banks that have lent to them, and ultimately to the real economy. " to sum up, the first and second schools of thought which were dominant till recently have now been supplemented, or perhaps supplanted, by the third and fourth schools. further, in the second school, there is recognition of difference now between equity and debt flows in the context of downside risks. the third school focuses on the importance of proper sequencing of liberalisation of capital account with other policies. the fourth school elaborates on issues relating to management of capital account and takes a more nuanced approach to it. in brief, the third and fourth schools that are of more recent origin, and are gaining respectability, are closely aligned with the approach that india has been following. iv. the current indian context the ministry of finance placed a review of the trends in receipts and expenditures at the end of second quarter of the financial year 2007 - 08 on december 7, 2007. in the document, there is exhaustive analysis of several contemporary issues relating to macro - economic environment. the status and issues relating to management of capital account do find a prominent place in the discussion and refers to the challenges for monetary management and the complexities in managing capital flows in the following passages : " the predominant issue that continues to confront the monetary authority during the current year has been the steady increase of forex flows and the policy response thereto. " [ para 3. 1. 12 ( page 37 ) ] " the management of capital flows is a complex process

such as the liberalisation of overseas investment by our corporates in the real sector is helpful, it has to be combined with other measures to manage the flows depending on their intensity. vi. a pragmatic approach it should be evident from the description of policy perspectives in managing external sector that it is essentially pragmatic, iterative and evolving. i propose to briefly narrate some of the reasons for what may appear to be a more pragmatic but less clearly defined policy of management of the external sector. firstly, international financial markets do not treat emerging market economies ( emes ) like india as full - fledged market economies but only as economies in the process of marketisation. hence, financial markets respond differently to the same macroeconomic or political development depending on whether it is an eme or an advanced economy. hence, emes have to follow a more pragmatic and contextual policy. secondly, the self - correcting mechanisms in markets, particularly the financial markets, are expected to operate smoothly in the absence of capital controls. but, such mechanisms happen to operate more efficiently in advanced economies and far less efficiently in the emes. while there is an advantage in developing the financial sector with appropriate selfcorrecting mechanisms, it is not possible to achieve this in the short term, and is particularly difficult to achieve during highly uncertain global economic conditions. hence, the extent of or lack of self - correcting mechanisms in an economy should be treated as given, in the short term, and a suitable policy of intervention has to be pursued accordingly. thirdly, the real sector flexibilities may be far less in emes. for example, opening a business or closing a business in india requires a considerable amount of time. hence, the real sector responses to exchange rate movements are not likely to be as flexible as in the advanced economies. one has, therefore, to make a judgment on the extent of existence of such flexibility in the real sector. no doubt, the policy makers have to encourage the real sector to change and become more and more flexible to cope with the exchange rate dynamics. at the same time, the pressure for change cannot be to such an extent that the volatile exchange rate movements seriously disrupt the business environment. fourthly, there is a problem in differentiating between the flexibility and the volatility in exchange rates, in view of the evolving situation in emes. the distinction has to be based on the preparedness of the markets and the market participants.