India Should Tax ‘Volatile’ Stock Inflows, Ex-Governor Says

May 7 (Bloomberg) -- India should tax foreign capital inflows into the equity market that stay invested for less than two years to protect its financial system and sustain economic growth, said former central bank governor Bimal Jalan.

“If you have unstable, unpredictable, volatile capital flows which are affecting financial stability as well as the real economy’s stability, then you have to find a way of handling them so that they are not free for all,” Jalan, who headed the Reserve Bank of India between 1997 and 2003, said in a telephone interview. “I’m in favor of tax on profits earned from capital flows which are going to the stock market.”

Emerging markets in Asia are grappling with a surge in capital inflows as governments and central banks around the world pumped in cash to counter the global recession. Taiwan central bank Governor Perng Fai-nan said this week emerging markets should consider limits, Indonesia has studied the issue and Brazil imposed a levy last year.

Reserve Bank of India Governor Duvvuri Subbarao said on April 26 India “may well employ” some form of capital controls. Record foreign buying of stocks and bonds lifted India’s rupee in each of the first four months of 2010, the longest winning streak in three years.

Asian nations should increasingly consider ways to manage inflows that are fueling inflation and creating asset bubbles, Noeleen Heyzer, executive secretary of the United Nations Economic and Social Commission for Asia and the Pacific, wrote in the report yesterday.

‘Legitimate’ Tool

The International Monetary Fund, which previously criticized capital controls, in February released a study saying limits on capital are a “legitimate” tool in some cases for governments.

Equity and property prices in some markets have surged as the region’s growth outpaces the rest of the world. The central bank estimates the $1.2 trillion economy may expand 8 percent “with an upward bias” in the year ending March 31. Last year, it grew 7.2 percent.

The World Bank predicts as much as $800 billion in global capital flows this year, compared with about $450 billion to developing economies in the second half of 2009 at an annualized pace.

Foreign investors have bought a net 290.2 billion rupees ($6.4 billion) of stocks this year compared with a record 834.2 billion rupees in 2009, according to the nation’s market regulator. The rupee has appreciated 2.7 percent against the dollar this year. Last year, it gained 4.8 percent.

‘Red Light’

At present, India permits the rupee to be freely convertible on the trade and current account and places curbs for the capital account. An advisory panel formed by the central bank in 2006 suggested fuller convertibility in five years.

A cap on the amount of funds Indian companies are allowed to raise abroad as well a ceiling on foreign investments in debt instruments are among the controls imposed by India. The limit on foreign investment in government debt is $5 billion while on corporate debt it is $10 billion.

Kaushik Basu, chief economic adviser in India’s finance ministry, said there is no surge in capital inflows this year and that the country had witnessed bigger influx of funds earlier. “I don’t think it’s really a situation where you need to bring in capital controls,” said Basu.

Jalan said policy makers should improve regulation of capital into the country when the situation is normal instead of waiting until the emergence of a crisis.

“There should be no reluctance to take measures which will provide you financial stability,” said Jalan. “You have free roads but you obey the red lights.”