High Time, a Tobin Tax :

The time to institute a tax to regulate the flow of foreign portfolio investment has come.

In the context of the large inﬂows of foreign portfolio investment (FPI) fuelling asset prices and leading to an adverse appreciation of the rupee, the Reserve Bank of India’s (rbi) Governor D Subbarao’s remarks last month in Washington on the advisability of imposing a Tobin tax on such investment ﬂows assume importance. Strangely, the RBI governor seemed to rule out levying such a tax on FPI in the stock market, conﬁning it, if at all, to such investment in the debt market alone (FPI constitutes foreign institutional investment as well as funds from Global De po sitory Receipts. In recent years FII ﬂows have dominated in FPI). Now, given that the bulk of FPI comes into the stock market, not the debt market, the effect of such a tax, conﬁned to foreign purchases in debt instruments, would be of little consequence. For the bulk of the effects of FPI on the real economy is via the stock market.

It does not take much developed country money to drive up prices on the Indian stock market; likewise, it also does not take much to generate an exit and a collapse of those very asset prices. Take, for instance, the, almost consistently, positive and, in some months, huge net FPI inﬂow since April 2009 and the corresponding rise of the index of share prices on the National Stock Exchange – the NIFTY – and earlier, the, almost consistently, negative and, in some months, huge net FPI outﬂows from May 2008 to February 2009 and the corresponding decline in the NIFTY. Along with these, one is witness to the appreciation of the Indian rupee in the recent episode and its depreciation when net FPI ﬂows turned negative earlier. Roughly, if one were to relate all of these to the real economy, a revival of FPI ﬂows leading to a stock market bubble spurs elite consumption because of the wealth effect, which, together with policies promoting private investment, including highly favourable public-private partnerships, revives economic growth. Exactly the opposite effect and sequence come from an exit of FPI.