By-AYUSH GUPTA

MBA-IB

University Business School

Chandigarh

What is Capital Account ?

What is Capital Account Convertibility ?

Measures

Advantages and Disadvantages.

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Capital Account It reflects change in ownership of nation’s assets

Foreign Investment in India(FDI, FII, ADR, direct purchase of land ,assets etc.)

External Commercial Borrowing , External assistance etc

Capital account= Change in foreign ownership of domestic assets – Change in domestic ownership of foreign assets

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Capital Account Convertibility Floating Exchange Rate

What it means ? – Freedom of Conversion

CAC allows anyone to freely move from local currency into foreign currency and back.

Changes of ownership in foreign/domestic financial assets and liabilities.

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Tarapore Committee Formed in 1997

Chairman- Former Deputy Governor of RBI S.S Tarapore

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TARAPORE COMMITTEE Preconditions

- Gross fiscal deficit to GDP ratio to come down from a 4.5 %n 1997-98 to 3.5% in 1999-00.

- A consolidated sinking fund has to be set up to meet government's debt repayment needs; financed by RBI.

- Inflation rate to be at 3-5 per cent for the 3-year period 1997-2000 .

- Gross NPAs of the public sector banking system needs to be brought down.

-Average effective CRR needs to be brought down from the current 9.3% to 3% .

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18th march 2006

“Given the changes that have taken place during the last two decades there is a merit in moving towards fuller capital account convertibility with a transparent framework…..I will therefore request the Finance Minister and RBI to revisit the subject and come out with a format based on current realities.”

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Second Tarapore Committee on Fuller Capital Account

Convertibility S.S Tarapore again as chairman

Submitted its report on September 2006.

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Roadmap For FCAC Phase I : 2006-07 involves move from current capital

movement of individuals from $25000 to $50000.

Phase II : 2007-09 Further raised to $100000

Phase III : 2009-11 Raised to a maximum of $200000

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In case of corporate the remittance would rise from 200 percent to 400 percent

In case of banks overseas borrowings are made more liberal

In case of mutual funds overall ceilings should be moved from $2 billion to $5 billion.

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Advantages Diversification

Foreigners Investment

Catalyst for financial market, institutional development, competition, technologies and discipline macro economic policies

Reduction in size of black money

Induces competition against Indian finance.

CAC also allows the people and companies not only to convert one currency to another, but also free cross-border movement of those currencies, without the interventions of the law of the country concerned.

Thus, Indians could convert their rupees into dollars and park it in the US if there was capital account convertibility here.

Imagine if a large number of Indians were to do this out of an irrational fear that India might go to war with Pakistan!

However, a word of warning…

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East Asian Crisis THAILAND

During 1985-96 was growing at highest rate of 9%

Real estate sector was booming

High interest rate

Export growth was very high

Thailand Baht was pegged at 25 to US $.

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Reason for Failure US had increased interest rate to curb inflation this made

US investors to take their money from Thailand and invest in US.

Citizens of Thailand also lost confidence in Thailand Baht.

It reached its lowest point of 56 units per $.

This made foreign loan costlier

Biggest corporation “Finance One” collapsed.

Fear among foreign investors.

Leads to political instability and people loosing their jobs.