The central government has admitted that existing methods to control capital inflows may not work in the present Indian scenario and may require 'innovative policy responses.'
The Mid-Year Review tabled by Finance Minister P Chidambaram in Parliament on Friday said, 'While there are international experiences in this regard with some successful and painful adjustment process, the specific Indian context requires innovative policy responses. Going forward will be a major challenge.'
The view has come at a time there is talk that the government may impose a Tobin tax-like system to reduce exchange rate volatility and stem short-term capital inflows.
Tobin tax, first proposed by Nobel laureate James Tobin in 1972, is a sales tax on cross-border currency trades to discourage speculation by making currency trading expensive.
The Centre said the cost of sterilising a part of capital inflows would increase substantially during the current financial year.
'The fiscal cost of sterilisation, envisaged at Rs 3,700 crore in the Budget estimates of 2007-08, is now being supplemented with Rs 4,500 crore,' the review said.
Accepting that the appreciation of the rupee has hit the export sector, the report says medium- and long-term solution lies in improving productivity and competitiveness. Playing down the impact of rupee appreciation on exports, the report said that over the medium to long term, there is no one-to-one relationship between appreciation of rupee and exports
The rupee appreciated by 9.7 per cent against the dollar between April 3 and October 31. On a year-on-year basis (October 2006 over 2007), the appreciation was 15.1 per cent.
The report said even though increased capital inflows might hit macro-economic aggregates through exchange rate and trade and monetary variables, the growth outlook remained strong.
"The buoyant growth in the first half of the current financial year reaffirms the continuation of the momentum," it said.
The report expressed confidence that though the mid-year deficit limits set by the Fiscal Responsibility and Budget Management Act had been crossed by the second quarter, the government would successfully achieve fiscal and revenue deficit targets by the end of the current financial year.
Highlights of Mid-Term Review 2007-08