It's 1991 again as RBI clamps capital controls, bans property buy abroad

In what can only be seen as a panic move, the Reserve Bank of India (RBI) on Wednesday reversed the long-term secular trend of easing capital controls by severely limiting the amount of money citizens can remit abroad, and businesses can invest in foreign ventures. Gold imports are being further squashed.

In recent months, industrialists ranging from Kumar Mangalam Birla to Cipla’s Yusuf Hamied to Apollo Tyres’ Neeraj Kanwar have been talking about investing abroad rather than in India due to a vitiated business climate here.

[caption id=“attachment_1034163” align=“alignleft” width=“380”]  Reserve Bank of India logo. Reuters[/caption]

On Wednesday evening, the RBI put a spoke in their collective wheel by indicating that Indian companies can invest only amounts equal to their current net worth abroad through the automatic route - as against four times their net worth currently. If this norm had been in place 10 years ago, the Tatas would have thought thrice about buying Corus or Jaguar Land Rover, the Birlas would have found it tough to buy Novelis and Bharti Airtel may not have bought Zain. All these deals would have had to pass through tedious government clearances.

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The RBI press release said that “this reduced limit would also apply to remittances made under the ODI (overseas direct investment) scheme by Indian companies for setting up unincorporated entities outside India in the energy and natural resources sectors. This reduction in limit, however, would not apply to ODI by Navratna PSUs, ONGC Videsh Ltd and Oil India in overseas unincorporated entities and incorporated entities, in the oil sector.”

In short, Indian companies that want to invest abroad-especially the smaller ones-cannot do so without bureaucratic vetting, while the public sector oil companies, already enfeebled by having to dole out subsidies, will be allowed to do what they find difficult.

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In a related move, the RBI also de-liberalised the allowances for Indian residents who want to make remittances abroad. The remittance limit under the “Liberalised Remittance Scheme (LRS Scheme) has been slashed from US$ 200,000 to US$ 75,000 per financial year”. In recent years, many Indians have used the LRS route to invest in property and other assets abroad, but this will now be down to a trickle.

In fact, the RBI has gone one step further and simply banned the purchase of property abroad. The press release said: “While current restrictions on the use of LRS for prohibited transactions, such as margin trading and lottery would continue, use of LRS for acquisition of immovable property outside India directly or indirectly will, henceforth, not be allowed.”

These measures may curb short-term outflows, but they send a chilling message of serious crisis. The limited freedom that Indians-ordinary citizens and businesses-enjoyed on capital account convertibility is now being rolled back bit by bit. They can’t buy gold without paying more for it; they can’t buy property; and they can’t invest abroad easily to expand business opportunities. India Inc will not be happy.

To be sure, the RBI has also said that “the present set of measures is aimed at moderating outflows. However, any genuine requirement beyond these limits will continue to be considered by RBI under the approval route”. But when capital controls are being slapped back, no one will expect the RBI to be liberal with its clearances. The word “genuine” requirement will put discretionary power back in the hands of babus - something the nation has been trying to move away from.

The government has also banned the import of gold in the form of coins and medallions, and importers of gold will have to pay upfront before getting any of the yellow stuff. And at least 20 percent of gold imported will have to be re-exported, Arvind Mayaram, economic affairs secretary, told newspersons. These steps follow the increase in gold import duties to 10 percent yesterday - up five-fold since last year.

It is not clear what impact all these measures will have on foreign sentiment and capital inflows. The big questions are:

#1: Will foreign investors now stop investing because they may worry about whether more capital controls will be introduced to limit outflows? Will money come in if it is not free to move out?

#2: Will NRIs now worry about their ability to move in and out of Indian bank deposits at will?

#3: Will more of the Indian demand for gold, already subject to high import duties, now shift to unofficial and illegal channels? The evidence is that it already has. Now smugglers will be the main beneficiaries.

#4: Will Indian business now clam up further? If they don’t want to invest in India, and can’t invest abroad, will they now just sit on their hands and wait for the crisis to blow over? Or a new government to come in?

#5: Will some exporters now begin underinvoicing exports in order to keep more of their dollars abroad, out of the clutches of the Indian state?

Make no mistake, the message coming out of North Block and Mint Street is a clear downer for India Inc. In terms of the sense of crisis, we are back to pre-1991 days.