Foreign money is rushing into the Indian stock exchanges. Whenever that happens, the Reserve Bank of India panics, and imposes more restrictions on capital inflows. Equity inflows are supposed to be good for the economy. Ever since Manmohan Singh permitted them in 1992, they have been sacrosanct. The RBI may express frustration, but in practice it would not dare touch them. Hence the controls that have been imposed have been entirely on debt inflows. They do not synchronize with the preferences of the Indian corporate sector. The Securities and Exchange Board of India has made it virtually impossible to issue shares in the Indian capital market unless the issuer makes a deal with what Sebi deems to recognize as Qualified Institutional Investors. They are an oligopoly, and drive a hard bargain with issuers. Institutional investors abroad are less greedy, and offer a much larger market. So Indian companies have preferred to raise capital abroad; in effect, heavy-handed regulation has led to the emigration of the capital issue industry.

Capital issues abroad must, however, go through a number of regulatory and institutional hoops; they are only for big companies. So Sebi and the RBI between them have cut off access to the capital market for small and new companies. These must look for equity capital to relatives and friends; and if the latter are unable or unwilling to invest, the companies must choose not to grow. Thus India’s regulatory institutions have become an obstacle to the growth of new enterprise and competition. The obverse is that the Indian capital market is narrow and responds strongly to changes in inflows from abroad. This volatility in turn attracts speculative flows. Thus, Sebi and the RBI are ultimately responsible for the currently surging foreign inflows into the equity market — and will eventually be for an outflow.

The RBI would not, of course, see things that way, for it has a religious belief in its regulations. But it cannot run away from the consequences. It has worked out ways of dealing with those consequences that do not offend its religion. First it thought of raising banks’ liquidity requirements, so that the increase in their cash balances following inflow of foreign exchange would not lead to a general rise in credit and in expenditure. More recently, it has thought of complicated ways of restricting Indian companies’ access to foreign capital. In all this fervent worship, it has lost sight of better alternatives. Most industrial countries have largely given up controls on capital issues, and yet managed to keep down volatility of exchange rates. They have done so by deregulating and promoting markets in foreign exchange, both spot and forward; the greater the volume of transactions, the less is the exchange rate affected by sharp temporary flows across the monetary frontier. The RBI should take some time off from its rituals, and take another look at its controls on “speculative” flows of capital.