duvvuri subbarao : capital account management remarks by dr duvvuri subbarao, governor of the reserve bank of india, at the “ rethinking macro policy ii, ” a conference sponsored by the international monetary fund, washington dc, 17 april 2013. * 1. * * capital account management intellectual shift on capital controls • the change in our world view on capital account management is by far one of the most remarkable intellectual shifts brought on by the crisis. • in her opening remarks yesterday, the managing director said that the crisis shattered the consensus on many macroeconomic issues and shibboleths. nowhere is this more true than in the broad policy area of capital account management. • in my view, the three big issues on which the pre - crisis consensus has dissolved are the following : three issues where consensus is broken ( i ) movement towards a fully open capital account ( ii ) the use of capital controls as short - run stabilization tools ( iii ) the desirability of foreign exchange intervention. i want to comment briefly on each of these. i. movement towards a fully open capital account • on the first issue, open capital account, before the crisis, the consensus was that every country should eventually move towards a fully open capital account. the debate was only about the appropriate strategy – sequencing and timing, in particular – for transitioning to full capital account convertibility. china and india • let me invoke the example of india. moving towards full capital account convertibility has always been our policy goal. the only variable was the road map for getting there which, it was agreed, should be redefined from time to time, consistent with the evolving situation. there was also general agreement that we should start with floating the exchange rate and decontrolling interest rates, and finish with the capital account, on the rationale that this strategy will best preserve macro stability. • there has been a long and vigorous debate in china too on opening up the capital account, with a roughly similar consensus as in india about sequencing. over the last few years though, china has apparently changed its strategy, as is evident from their policy direction. if you accept that measures to internationalize the rmb are a big step towards capital account convertibility, then this initiative by china has been much bolder than its actions on freeing up exchange and interest rates. controls and financial stability • the crisis has, however, changed all this. it shifted the debate, from the strategy and

their ndtl, term repo facility under laf to enable banks to ease the liquidity stress faced by mutual funds, nbfcs and housing finance companies and buyback of mss securities. the cumulative amount of primary liquidity potentially made available through all these measures to the financial system was over rs. 5. 6 trillion ( or over 10 per cent of gdp ). these measures were effective in ensuring speedy restoration of orderly conditions in the financial markets over a short time span. despite these measures, however, the balance sheet of the reserve bank did not expand much, unlike in other advanced economies ( chart 4 ), as these operations were conducted mainly with banks as the counterparties and government securities as collaterals. by synchronising the liquidity management operations with those of exchange rate management and non - disruptive internal debt management operations, the reserve bank ensured that appropriate liquidity was maintained in the system, consistent with the objective of price and financial stability. these measures were supported by fiscal stimulus packages during 2008 – 09 in the form of tax cuts, investment in infrastructure and increased expenditure on government consumption. this raised the fiscal deficit of the central government by about 3. 5 per cent of gdp to 6. 0 per cent in 2008 – 09 ( table 2 ). it is, however, important to note that the entire fiscal stimulus in india was aimed at addressing the deficiency in aggregate demand rather than extending support to the financial sector as in the advanced countries. the expansionary fiscal stance continued during 2009 – 10 to support aggregate demand. subsequently, with further consolidation of growth and inflation emerging as a major concern, india began its exit from accommodative monetary policy pursued during the crisis beginning october 2009. to begin with all special liquidity measures were withdrawn which was followed by hikes in policy rates – laf repo and reverse repo rates have been raised by 200 basis points and 250 basis points, respectively. the crr has also been raised by 100 basis points to 6. 0 per cent now. the process of fiscal consolidation resumed in 2010 – 11 is expected to be further strengthened in 2011 – 12. thus, while the magnitude of the crisis was global in nature, the policy responses in india were adapted to domestic growth outlook, inflation conditions and financial stability considerations. key differences in policy response : india vis - a - vis the advanced countries there were, however, some key differences between the actions taken by the reserve bank of india and the central banks in many advanced