U.S. Treasury Secretary Henry Paulson said on Monday that India "for the most part" was on the right path to reduce risks from increased foreign investment, but warned that limiting capital flows would hurt the country's competitiveness.
In prepared remarks at an infrastructure conference in Mumbai, Paulson said restrictions on capital flows were "blunt instruments" that could have unintended consequences.
"I urge my Indian colleagues to continue, and accelerate, their efforts to liberalize the economy and develop the financial system -- to assure that the vibrancy and growth that the Indian economy now enjoys continues well into the future," Paulson said.
The comments were his first on capital flows since India last week announced new restrictions on anonymous investment flows into Indian shares, which have put upward pressure on the rupee in recent months.
"Limits on debt and equity financing, and asset allocation restrictions on financial institutions, are impediments to putting resources to their most productive use," Paulson said.
The U.S. Treasury Secretary said he understood that Indian officials were concerned that as Mumbai gains strength as a major financial center, increased capital flows into India could increase inflationary pressures, destabilize domestic financial markets or add to exchange rate volatility.
"For the most part, India is on the right path to reduce these risks. India has allowed greater flexibility in the exchange rate in recent months, and the appreciation in the rupee has helped to reduce inflationary pressures," Paulson said.
In the long term, he said India could take a number of steps to become more competitive, such as reducing requirements that financial institutions hold large amounts of government debt, reducing requirements for banks to provide credit to certain priority sectors, and removing various restrictions and caps on foreign investment.
Paulson said Wall Street stood ready to help India build Mumbai into a major capital market center, particularly in the development of a domestic bond market that would provide long-term financing for much-needed infrastructure development in India.
A corporate bond market also would provide opportunities for such long-term investment by insurance companies and pension funds, he added.
Paulson said the United States supported India's ambitious plans to attract public-private partnerships to help finance its infrastructure needs, but said this would require transparent and independent regulatory frameworks, where government entities do not act as both regulator and services providers.
"Investors, especially those who must make long-term commitments as in most infrastructure projects, want certainty in their operating environments," Paulson said.