There is no formal definition of
capital account convertibility (CAC). However, the Tarapore committee set up by
RBI to go into the question of CAC in 1997 defined it as the freedom to convert
local financial assets into foreign financial assets and vice versa at market
determined rates of exchange. Simply put, CAC allows anyone to freely move from
local currency into foreign currency and back.
Current
account convertibility allows free inflows and outflows for all purposes other
than for capital purposes such as making investment and loans. It allows
residents to make and receive trade-related payments—receives dollars (or any
other foreign currency) for export of goods and services and pay dollars for
import of goods and services make sundry remittances, access foreign currency
for travel, studies abroad, medical treatment, etc. In India, current
account convertibility was established with the acceptance of obligations under
Article VIII of IMF’s Articles of Agreement in 1994.
Contrary
to general belief, CAC can coexist with restrictions other than on external
payments. For instance it does not preclude the imposition of policy
restrictions on foreign holding in any sector. The US,, for example, restricts how
much foreigners can own in the airlines industry even though the dollar is
fully convertible on capital account.
CAC
is widely regarded as one of the hallmarks of a developed economy. It is also
seen as a major comfort factor for overseas investors since they know that at
anytime they will be able to re-convert local currency back into foreign
currency and take out their money.
To
attract foreign investment, many developing countries went in for CAC in the
1980s, not realising that free mobility of capital leaves countries open to
both sudden and huge inflows and outflows, both of which can be potentially destabilizing.
More important, unless you have the institutions, particularly financial
institutions capable of dealing with such huge flows, countries may not be able
to cope as was demonstrated by the East Asian crisis of the late 90s.
In India, the
Tarapore committee had laid down a three-year road-map, ending 1999-2000, for
CAC. It also cautioned that this time-frame could be speeded up, or delayed,
depending on the success achieved in establishing the pre-conditions—primarily
fiscal consolidation, strengthening of the financial system and low rate of
inflation. With the exception of the last, the other two pre-conditions have not
been achieved.
Convertibility
of capital for non-residents has been a basic tenet of India’s foreign
investment policy all along, subject, of course, to fairly cumbersome
administrative procedures and the government’s policy on foreign direct
investment. It is only residents—both individuals and corporates—who have been
and continue to be subject to capital controls.
However,
as part of the liberalisation process, the government has been relaxing these
controls. Thus, residents have been allowed to invest through the MF route and
corporates have also been given much greater freedom to invest abroad. Limits
on external commercial borrowings have also been steadily relaxed.
Buoyed
by India’s healthy forex reserves, comfortable external debt position, improved
showing on the fiscal front, strong GDP growth and the fact that progressive
relaxations on the forex front have not led to a flight of capital, the
government has now appointed another committee to draw up a roadmap to move to
full CAC.
Ref- http://www.financialexpress.com/news/whats-capital-account-convertibility/129382/