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 Indiaâ€™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 â€“ 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 â€“ of course through legitimate transactions.
What does India gain by full convertibility?
- India becomes a major financial hub in Asia
- Full CAC is the defining characteristic of a mature modern economy
Why India should not rush into convertibility?
- Empirical evidence on the benefits of full convertibility is lacking
- Indiaâ€™s fiscal conditions are far from ideal
- Financial sector is still insufficiently developed in India
- India is far from being fully integrated on the trade front
- 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.
- Don’t rush into full convertibility
- The Capital Myth – The difference between trade in widgets and dollars
The Economic Times
The Hindu Business Line