Capital Account Convertibility

Capital Account Convertibility is nothing but the freedom to convert the local financial assets into foreign financial assets and vice-versa at market determined rates of exchange. It is associated with the changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by the rest of the world. Also referred to “Capital Asset Liberation” in foreign countries, it implies free ex-changeability of currency at lower rates and an unrestricted mobility of capital.

CAC in India

For the largest democracy in the world the Indian Economy, we see that India since implementing the powerful trio policy of LPG, under the leadership of Prime Minister PV Narasimha Rao and Finance Minister Mr. Manmohan Singh, has moved towards the current account convertibility which is the easy availability of foreign exchange for import and export for goods and services.

If we talk about CAC, India currently has partial capital account convertibility according to which an Indian individual or an institution for that matter can invest in foreign assets up to $25000. The same investment is applicable for the foreign individuals. Currently there are limits on investment by foreign financial investors and also FDI ceiling exists in most sectors, for example 49% in Aviation, 74% in broadcast sector, 51% in multi-brand retail and up to 100% in single brand retail, etc.

CAC Regulations

In order to implement the capital account convertibility in the economy, RBI in 1997 has set up a committee named Tarapore Committee which after studying the implications of CAC in the Indian economy recommended reducing the fiscal deficit to the minimal level of 3.5% of GDP. Committee also recommended controlling inflation at the level of 3-5% whereas the NPAs were suggested to be brought down to 5%. Apart from these recommendations the committee made certain guidelines available pertaining to the CRR levels and monetary exchange band. CRR to be reduced to 3% with monetary exchange rate band of plus minus 5% to be implemented was suggested by the committee for moving India to CAC regime. However the impact of global crisis on Indian economy increased and most of the pre-conditions are not met till date thus rejecting the CAC implementation.

A second Tarapore committee too was setup in 2006 to review the status of CAC in India as some of the macroeconomic numbers reflected an optimistic growth for the country.  Consolidation of banks, strong export front, huge forex reserves, high growth rates etc. were some of the key features which derived the setting up of new Tarapore committee to review the decision.

Advantages of CAC

It is needless to say that Capital Account Convertibility can be beneficial for a country:

i) It leads to the increased inflow of foreign investment.

ii) It initiates risk spreading through diversification of portfolios.

iii) There is availability of newer technologies which could result in further growth and development of the economy.

Disadvantages of CAC

On the contrary, CAC has many disadvantages as well:

i) It can actually destabilize the economy through massive capital flight from a country.

ii) Capital outflow, excessive capital inflow can lead to currency appreciation and worsening of the Balance of Trade, which are some of the major consequences which can be faced upon implementation of CAC.

iii) Overseas Credit Risk

iv) Fear of speculation increases since CAC leads to increment in short term FIIs more than long term FDIs thus resulting in volatility.

CAC Implication in India

Accordingly the stated implications of CAC in Indian economy, CAC is not such a good idea in the near future owing to the fact that India is currently a growing economy and is a young economy with an independence of only 60+years.

The recent global economic crisis also known as the great subprime crisis of 2008 resulted in huge slowdown across the global economy. It also showed its ill effects on the Indian economy as a result of which the Indian GDP growth rate showed a sluggish response and is expected to continue the same in days to come. Moreover, the rising oil prices too were a matter of great concern for the economy. Rupee too depreciated by huge margin and ended at the levels of 53 touching all time low 57 thus fueling inflationary pressure in the economy. The current deficit is recorded at over 5.75% which is a matter of concern for the economy to show some positive growth.

India’s exports and the Balance of Trade have faced a major hit due to the soaring prices and rupee depreciation. Severe losses were also incurred by the oil companies due to the heavy subsidies on oil which is yet to be compensated by the government. Issues within the economic boundary of India like corruption, bureaucracy, red tapism, poor business environment etc. are discouraging the inflow of investment. Improper infrastructure and socio-economic backwardness are just adding fuel to the fire if nothing better.

Thus it won’t be wrong in saying that currently India needs to improve over its fundamentals which involves proper education, healthcare, sanitation, women empowerment etc. Efforts in these areas shall become the growth strategy of the economy. It is needless to say that their lies immense power with the bottom of pyramid which is left ignored in the country, in order to ensure proper growth, care needs to be taken, policies needs to designed in order to uplift and safeguard the interest of bottom of pyramid and thus we can see a shining India which will actually be the right time for the implementation of capital account convertibility.

For the Indian economy to open up to financial volatility through the implementation of Capital account convertibility, it is very important that the nation strengthen its fundamentals and ensure a strong base is developed.