The results of the last national election in India, with Congress returning under a stronger mandate, raised private sector and foreign investor hopes that long-delayed 2nd phase reforms would be tackled.  Alas, the slow, messy grind of India's democratic machinery has dashed hopes that reform would gusher, but that may benefit India.

In particular, many foreign investors and domestic private India interests favor wide scale loosening of India's capital account regulations.  Currently the restrictions on portfolio investments in equity instruments are not overly restrictive (at times SEBI, the Indian regulator, has clamped down on what it considers "hot money" flows), but the ability of private companies to borrow abroad is relatively restricted, as are the linkages between the Indian and global banking sectors - Indian banks have very limited exposure to global banking assets.

Given the poor condition of the global banking sector, and the significant risks of additional financial crisis and contagion around the world, Indian authorities would serve domestic interests best if capital account and banking sector reforms maintain a policy of limiting domestic exposure to global banking - meaning that it would not be unreasonable to limit the domestic economy's exposure to international debt flows (both direct borrowing and indirect exposure).  In practice, such a policy should (i) limit short-term "hot-money" inflows into a nascent India bond market and Indian bank's exposure to short-term international funding, (ii) continue restrictions on the India banking sector's exposure to foreign debt securities (i.e. no exposure to dodgy foreign assets) and (iii) keep a wary eye on the Indian private sector's exposure to foreign-currency denominated debt.

In the go-go days before the global financial crisis restrictions on international money flows were considered taboo.  That is no longer the case.  Some talk of introducing a Tobin-tax or something similar to reduce the velocity of international money flows, through an agreement at the G20.  There appears to be little appetite among policymakers for such tax and international bankers oppose it.  In any case, a Tobin tax or similar might only throw some sand in the gears...it is insufficient on its own to protect against contagion.

Continued capital account restrictions are anathema to some Indian private interests and to many international investors in India,  and could reduce the uptick in Indian GDP growth by a small margin in  the short-term.  So be it.  Domestic savings are increasing and given that investment opportunities in India are attractive, India may pay a small price to structure capital inflows to be long-term.  Better to have a slower uptick in GDP growth than to be caught up in the whirlwind of a spreading global financial crisis phase II.  Remember that many investment managers, such as hedge funds, have so-called "gates" - they can restrict redemptions in times of illiquidity and market crisis.  It would seem to be a double standard to eliminate a similar strategy for a sovereign, especially if the sovereign's policy restrictions are implemented up front as opposed to ex-post, like so many funds did as the global financial crisis impacted.

Those who take a long-term view on Indian investment opportunities will cheer rather than jeer when the Indian government announces capital account and banking reforms that "do not go far enough".  Listen to Colbert and Beware the charging bears.

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