Economics Tutorial #1
Capital Account Convertibility

by Vinaya HS on August 4, 2006

in The SP Jain Blog

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Through my brief tutorials I hope to spread knowledge about concepts in economics that we read and hear, but which we never stop to learn and understand. The first tutorial addresses the issue of Capital Account Convertibility. I would love to hear your feedback on this initiative.

Capital Account Convertibility (CAC) is a measure of the freedom with which you can convert local financial assets into foreign financial assets and vice versa at market determined rates. At a time when India’s foreign exchange reserves stand in excess of US$160 billion, there are increasing arguments for the full convertibility of the Rupee. The Rupee, by the way, is fully convertible on the current account.

A convertible currency is accepted in a non-convertible country (e.g. US dollar, pound sterling etc. are convertible in India) while a non-convertible currency is not accepted in a convertible country (e.g. Rupee is of no value in US, Europe, Japan etc.).

Full CAC of the Indian Rupee was first investigated by the Tarapore Committee-I in 1997 at the behest of Mr. P. Chidambaram during his first tenure as the finance minister. This committee had recommended full convertibility within three years ending in 1999 – 2000. However, the Asian financial crisis put the report into the trash bin. Chidambaram has once again ventured into this issue with the Tarapore Committee-II. The committee has submitted its report on July 31, 2006, but its content has not yet been made public knowledge.

India is slowly opening up convertibility on the capital account. You can now invest up to US$25,000 in foreign assets (equity, bonds, property etc.). With full convertibility, you can move as much money as you want into and out of India without any restrictions – of course through legitimate transactions.

What does India gain by full convertibility?

  1. India becomes a major financial hub in Asia
  2. Full CAC is the defining characteristic of a mature modern economy

Why India should not rush into convertibility?

  1. Empirical evidence on the benefits of full convertibility is lacking
  2. India’s fiscal conditions are far from ideal
  3. Financial sector is still insufficiently developed in India
  4. India is far from being fully integrated on the trade front
  5. It can place the ongoing reforms in other areas at grave risk

Finally, what approach the Government will take can only be discussed once the Tarapore Committee-II report is made public knowledge.

Further reading:


The Economic Times
The Hindu Business Line

Thanks for reading this article. I'd love to hear your opinion. Please use the comments section below to share your thoughts. I frequently write new articles that also cover several other aspects of personal finance including credit cards, financial goals, health insurance, income tax, life insurance, mutual funds, retirement planning, and much more. You can Subscribe through Email and receive new articles directly in your Inbox or you can Subscribe through the RSS Feed and receive new articles in your feed reader.

{ 5 comments… read them below or add one }

Goutham August 4, 2006 at 10:57 AM

Vinay, this is all fine as long as it is restricted to your blog. Don’t bring these topics into our talk when you are in Bangalore. You will have to bear with some “Saikumar” brand of dialogues from me then.

NOTARY August 4, 2006 at 2:38 PM

aila!!!yeh kya tha??? muje toh kuch samaj mein nai aaraah!
abe…..14 th aarahehiona tab baitke baat karenge…cya!

Anoop August 4, 2006 at 7:37 PM

Kya L***a baath karu mein Notary ke paas…..Mathe yeno idu yeno blog maadbittiddeya..its like me blogging about photonic crystals instead of Something general..yaargu artha agalla kano..

Chandru August 7, 2006 at 3:33 PM

Thanks for the information. Generally this economics is a tough subject. You have tried to explain the concept simply and have suceeded in it.

Vinaya HS August 8, 2006 at 9:08 AM

Anoop, the whole idea is to make people understand.

Thanks Chandru, for your encouragement.

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