Name: Anjali MishraRoll no: 14-7290Sub: A Realistic study on Capital Account Convertibility with Reference to India

INDEX

Contents Page no.

Computation 03Declaration 04Acknowledgement05Abstract06Meaning & Introduction07Benefits and drawbacks of CAC: 09Reasons for the introduction of CAC in India: 17Tarapore committee on CAC in India 21Popular News Articles about Capital Account Convertibility 23Conclusion 29Reference 30

Computation

COMPUTATION OF A REALISTIC STUDY ON CAPITAL ACCOUNT CONVERTIBILITY WITH REFRENCE TO INDIAYEAR 2014-15

A PROJECT REPORT

SUBMITTED TO UNIVERCITY OF MUMBAI IN PARTIAL FULLFILLMENT OF THIS REQUIERMENT FOR

M.COM-SEM-2IN THE SUBJECT ECONOMICS

BY

ANJALI S. MISHRA

DECLARETION

I ANJALI SHESHMANI MISHRA Roll no. 14-7290 the student of M.Com (accountancy) part-1 sem-2 (2014), K.V PENDHARKAR COLLAGE, Dombivali, Affiliated to university of Mumbai, hereby declare that the project for the subject ECONOMICS titled A REALISTIC STUDY ON CAPITAL ACCOUNT CONVERTIBILITY WITH REFRENCE TO INDIA. Submitted by me to university of Mumbai, for sem-2 examination is based on actual work carried by me.I further state that this work is original and not submitted anywhere else for any examination.

PLACE: DOMBIVALI Signature of the studentDATE: 06-04-2015 Name: Anjali Sheshmani Mishra Roll no: 14-7290

AcknowledgementI have taken efforts in this project. However, it would not have been possible without the kind support and help of many individuals and organizations. I would like to extend my sincere thanks to all of them.I am highly indebted to my respected teacher for her guidance and constant supervision as well as for providing necessary information regarding the project & also for her support in completing the project.

I would like to express my gratitude towards my parents & member of K.V. Pendharkar Collage for their kind co-operation and encouragement which help me in completion of this project.

I would like to express my special gratitude and thanks to Mumbai University for giving me such attention and time.My thanks and appreciations also go to my friends and relative in developing the project and people who have willingly helped me out with their abilities.

Anjali S. Mishra

ABSTRACT India has vigilantly opened up its capital Account since the early 1990s as policymakers realized that domestic savings and taxes are inadequate to cater countries huge investment needs. Therefore indigenous savings should be supplemented with overseas funds for the future growth of the nation. Hence, India sustained with the policy of moving slowly rather than taking a single leap in accomplishing full convertibility, for the consequences would be disastrous if anything goes off beam. It has been so observed that India has adopted a discriminatory approach depending upon the sensitivity and economic importance of the various forms of capital flows. Over the time, India has been able to draw reasonable sum of foreign investment and there has been a tremendous growth in the transactions allied to foreign exchange market. Indian companies and retail investors too have made investment abroad. India has received foreign money in the form of FDI, ADRs, GDRs, ECB, Bonds, and FII etc. The set of laws related to various components of capital accounts have been revised from time to time based on the economic conditions, global events and needs of the nation. Foreign capital flows have benefitted the country in multiple ways. Forex reserves, Balance of Payment surplus, bullish stock market or growth of MNC s and market all are the upshots of international finance. In recent times, there has been an ongoing turmoil in the developed countries of the world. India too is experiencing the heat of global contagion. This paper explores the impact of measures taken towards the liberalization of capital account in the milieu of Unfavorable events globally and attempts to reach at suitable conclusions and solutions.

MEANINGCurrency convertibility refers to the freedom to convert the domestic currency into other internationally accepted currencies and vice versa. Convertibility in that sense is the obverse of controls or restrictions on currency transactions. While current account convertibility refers to freedom in respect of payments and transfers for current international transactions, capital account convertibility (CAC) would mean freedom of currency conversion in relation to capital transactions in terms of inflows and outflows. Article VIII of the International Monetary Fund (IMF) puts an obligation on a member to avoid imposing restrictions on the making of payments and transfers for current international transactions. Members may cooperate for the purpose of making the exchange control regulations of members more effective. Article VI (3), however, allows members to exercise such controls as are necessary to regulate international capital movements, but not so as to restrict payments for current transactions or which would unduly delay transfers of funds in settlement of commitments.

INTRODUCTION:Economic growth and development of a nation is almost always coupled with the progress of its tradable sector. In times of today all economies are finding themselves integrated to each other in some or other way through forces of liberalization and globalization. In context of these sweeping advancements capital account convertibility has been widely persuaded by developed and developing countries around the world. India too is persistently poignant on the path of liberalisation, by opening up its markets and loosening its controls over economic and financial matters. Capital account convertibility (CAC) refers to the freedom of converting local financial assets into foreign financial assets and vice versa at market determined rates of exchange. It refers to the elimination of restraints on international flows on a countries capital account, facilitating full currency convertibility and opening of the financial system. An array of transactions is within the ambit of capital account, the policies regarding these transactions are modified in the shift towards capital account convertibility. A country can achieve scores of benefits in its move towards capital account liberalization but it has associated costs which can be disruptive. The process of capital account liberalization is therefore, managed with farthest prudence given the latent for sudden reversals. Practically, there is a mix and match of experiences with the countries those who have liberalized their capital account. All developed countries have adopted full convertibility, but the 2008 crises of USA and current turmoil of European Union has raised several questions while China has written its success story without full capital account convertibility. It may be noted that full capital account convertibility does not inevitably lead to a financialCapital account convertibilityis a feature of a nation's financial regime that centers on the ability to conduct transactions of local financial assets into foreign financial assets freely and at country determined exchange rates. It is sometimes referred to ascapitalasset liberation or CACIn layman's terms, full capital account convertibility allows local currency to be exchanged for foreign currency without any restriction on the amount.This is so local merchants can easily conduct transnational business without needingforeign currencyexchanges to handle small transactions.CAC is mostly a guideline to changes of ownership in foreign or domestic financial assets and liabilities. Tangentially, it covers and extends the framework of the creation and liquidation of claims on, or by the rest of the world, on local asset andcurrency markets. In a country's balance of payments, the capital account features transactions that lead to changes in the overseas financial assets and liabilities. These include investments abroad and inward capital flows. Capital account convertibility implies the freedom to convert domestic financial assets into overseas financial assets at market determined rates.It can also imply conversion of overseas financial assets into domestic financial assets. Broadly, it would mean freedom for firms and residents to freely buy into overseas assets such as equity, bonds, property and acquire ownership of overseas firms besides, free repatriation of proceeds by foreign investors.Currency Convertibility: Advantage, Benefits and Preconditions for Capital Account Convertibility!Capital Account Convertibility of Rupee:

As explained above, under Capital Account Convertibility any Indian or Indian company is entitled to move freely from the Rupee to another currency to convert Indian financial assets into foreign financial assets and back, at an exchange rate fixed by the foreign exchange market and not by RBI.In a way, capital account convertibility removes all the restrains on international flows on Indias capital account. There is a basic difference between current account convertibility and capital account convertibility. In the case of current account convertibility, it is important to have a transaction importing and exporting of goods, buying and selling of services, inward or outward remittances, etc. involving payment or receipt of one currency against another currency. In the case of capital account convertibility, a currency can be converted into any other currency without any transaction.The Reserve Bank of India appointed in 1997 the Committee on Capital Account Convertibility with Mr. S.S. Tarapore, former Deputy Governor of RBI as its chairman. Tarapore Committee defined capital account convertibility as the freedom to convert local financial assets with foreign financial assets and vice-versa at market determined rates of exchange.In simple language, capital account convertibility allows anyone to freely move from local currency into foreign currency and back. The purpose of capital convertibility is to give foreign investors an easy market to move in and move out and to send a strong message that Indian economy was strong enough and that India had sufficient forex reserves to meet any flight of capital from the country to any extent.The Benefits of Capital Account Convertibility:The Tarapore Committee mentioned the following benefits of capital account convertibility to India:

1. Availability of large funds to supplement domestic resources and thereby promote economic growth.2. Improved access to international financial markets and reduction in cost of capital.3. Incentive for Indians to acquire and hold international securities and assets, and4. Improvement of the financial system in the context of global competition.Accordingly, the Tarapore Committee recommended the adoption of capital account convertibility.Capital Account Convertibility and Menace

It is a discernible fact that a number of empirical studies do not find evidence that greater openness of capital account and higher flows of capital lead to advanced growth (Prasad et al 2000). Some economists believe that the opening up of capital account is the last mile connectivity to the globalised world; to others it Symbolize a shortcut to economic ruination. Indias most recent negative experiences with the capital account liberalization are as follows:

(1) Depreciating Rupee: With the liberalization of capital account large amount of money is flowing in and out of the economy. Subsequently rupee has become highly volatile and slipped to its all time low (1$=57.33). Indias imports are greater than its exports and former has further declined due to financial crisis in Euro zone. Reserve Bank is not able to peg rupee at harmless levels, consequently imports have become too expensive and the risk of widening trade deficit is obvious. Reserve Bank has to buy or sell dollars in substantial amount to maintain the value of rupee at reasonable levels. Weakening rupee has also created problems in setting appropriate interest rates. (2) Volatility in Stock Markets: International financing and investment shifts from country to country in search of higher speculative returns. Stock markets have undergone this phenomenon rapidly. In good times of the economy (good rating, healthy IIP, high GDP, political stability) foreign institutional investors are on buying spree, but in bad times FII quickly lose their confidence in market and there is an abnormal selling. Investors experience huge losses some become bankrupt too.

Further Benefits and drawbacks of CAC:To sum up, CAC is concerned about the ownership changes in domestic or foreign financial assets and liabilities. It also represents the formation and liquidation of financial claims on or by the remaining world. It enables relaxation of the Capital Account, which is under tremendous pressure from the commercial sectors of India. Along with the financial capitalists, the reputed commercial firms in India jointly derive and enjoy the benefits of the CAC policy, which speculate the stock markets through investments. In fact, the CAC policy in India is pursued primarily to gain the speculator's and the punter's confidences in the stock markets.However, CAC does not serve the purposes of the real sectors of Indian economy, like eradication of poverty, escalation of the employment rates and other inequalities.In spite of CAC being present in Indian economy, there will be a co-existence of financial crises. Despite several benefits, CAC has proved to be insufficient in solving the Indian financial crises, the complete solution of which lies in having a regulated inflow of capital into the economyHistory of CAC:CAC was first coined as a theory by theReserve Bank of Indiain 1997 by theTarapore Committee, in an effort to find fiscal and economic policies that would enable developing Third Worldcountries transition to globalizedmarket economies.However, it had been practiced, although without formal thought or organization of policy or restriction, since the very early 1990s. Article VIII of the IMFs Articles of Agreement is agreed by most economists to have been the basis for CAC, although it notably failed to anticipate problems with the concept in regard to outflows of currency.However, before the formalization of CAC, there were problems with the theory.Free flowof assets was required to work in both directions. Although CAC freely enabled investment in the country, it also enabled quick liquidation and removal ofcapital assetsfrom the country, both domestic and foreign. It also exposed domestic creditors to overseas credit risks, fluctuations in fiscal policy, and manipulation.As a result, there were severe disruptions that helped to contribute to the East Asian crisis of the mid 1990s. InMalaysia, for example, there were heavy losses in overseas investments of at least one bank, in the magnitude of hundreds of millions of dollars. These were not realized and identified until a reform system strengthened regulatory and accounting controls.This led to the Tara pore Committee meeting which formalized CAC as utilizing a mixture of freeasset allocationand stringent controls.TentsCAC has 5 basic statements designed as points of action. All types ofliquid capitalassets must be able to be exchanged freely, between any two nations in the world, with standardizedexchange rates. The amounts must be a significant amount (in excess of $500,000). Capital inflows should be invested in semi-liquid assets, to prevent churning and excessive outflow. Institutional investorsshould not use CAC to manipulate fiscal policy or exchange rates. Excessive inflows and outflows should be buffered bynational banksto provide collateral.

Application In most traditional theories ofinternational trade, the reasoning for capital account convertibility was so thatforeign investorscould invest without barriers. Prior to its implementation, foreign investment was hindered by uneven exchange rates due to corrupt officials, local businessmen had no convenient way to handle large cash transactions, and national banks were disassociated from fiscal exchange policy and incurred high costs in supplying hard-currency loans for those few local companies that wished to do business abroad.Due to the low exchange rates and lower costs associated with Third World nations, this was expected to spur domestic capital, which would lead to welfare gains, and in turn lead to higher GDP growth. The tradeoff for such growth was seen as a lack of sustainable internal GNP growth and a decrease in domestic capital investments.When CAC is used with the proper restraints, this is exactly what happens. The entire outsourcing movement with jobs and factories going overseas is a direct result of the foreign investmentaspect of CAC. The Tarapore Committee's recommendation of tyingliquid assetsto static assets (i.e., investing in long termgovernment bonds, etc.) was seen by many economists as directly responsible for stabilizing the idea of capital account liberalization.

ControversyDespite changes in wording over the years, and additional safeguards, there is still criticism of CAC by some economists. American economists, in particular, find the restriction on inflows to Third World countries being invested in improvements as negative, since they would rather see such transactions put to direct use in growing capital.

Is India ready for full Capital Account Convertibility?Before the voyages of discovery, the earth was believed to be flat, such that people feared that once one reached the end of the world, one would fall off the edge of the Earth. Soon, it was discovered that the Earth was actually a sphere and one could safely go around it. However, more recently, the Earth is said to be becoming flat again, a theory propounded by Thomas Friedman in his bestseller book The World is Flat. The forces of Globalization and Liberalization are cutting across borders, re-integrating the world towards a common goal of development. The liberalization reforms which swept across the country in 1991 changed the face of the Indian economy.The results are paying off and India has witnessed exceptional growth rates of 9.6% and 9.4% in 2006 and 2007, respectively.Thus, in the current stream of events, where globalization has become the hot word and financial liberalization is synonymous with developed economies, the key issue that is to be considered, is whether India is ready to take the plunge towards Full Capital Account Convertibility (FCAC).Capital Account Convertibility (CAC) is the freedom to convert local financial assets into foreign financial assets at market determined exchange rates. Referred to as Capital Asset Liberation in foreign countries, it implies free exchangeability of currency at lower rates and an unrestricted mobility of capital. India presently has current account convertibility, which means that foreign exchange is easily available for import and export for goods and services. India also has partial capital account convertibility; such that an Indian individual or an institution can invest in foreign assets upto $25000. Foreigners can also invest along the same lines. At present, there are limits on investment by foreign financial investors and also caps on FDI ceiling in most sectors, for example, 74% in banking and communication, 49% in insurance, 0% in retail, etc.TheFirst Tarapore Committeewas set up by the RBI in 1997 to study the implications of executing CAC in India. It recommended that the before CAC is implemented, the fiscal deficit needs to be reduced to 3.5% of the GDP, inflation rates need to be controlled between 3-5%, the non-performing assets (NPAs) need to be brought down to 5%, Cash Reserve Ratio (CRR) needs to be reduced to 3%, and a monetary exchange rate band of plus minus 5% should be instituted. However, most of the pre-conditions werent entirely fulfilled. Thus, CAC was abandoned for the moment.However, recently there has been a renewed optimism as some of the targets suggested by theFirst Tarapore Committeehave been achieved. Moreover, consolidation of banks, a strong export front, large forex reserves amounting to $300 billion and high growth rates have also instilled within, some hope. Thus, aSecond Tarapore Committeewas set up in 2006 to look into the PMs proposal to reevaluate the earlier stand. Although the report hasnt been released yet, the committee does plan to increase the threshold level for investments from $25000 to $200000 in 3 phases.CAC can be beneficial for a country as the inflow of foreign investment increases and the transactions are much easier and occur at a faster pace. CAC also initiates risk spreading through diversification of portfolios. Moreover, countries gain access to newer technologies which translate into further development and higher growth rates.Even though CAC seems to have many advantages, in reality, it can actually destabilize the economy through massive capital flight from a country. Not only are there dangerous consequences associated with capital outflow, excessive capital inflow can cause currency appreciation and worsening of the Balance of Trade. Furthermore, there are overseas credit risks and fears of speculation. In addition, it is believed that CAC increases short term FIIs more than long term FDIs, thus leading to volatility in the system.However, if we were to judge the implications of CAC in India, independent of its general pros and cons, CAC may not be such a good idea in the near future. The instability in the international markets due to the sub-prime crisis and fears of a US recession are adversely affecting the entire world, including India. Moreover, rising oil prices which touched $100 a barrel recently are also fueling inflationary pressures in the economies, worldwide.Not only is there instability in the international arena, but Indias domestic economy is also going through ups and downs. The rising prices and the appreciation of the rupee are adversely affecting Indias exports and the Balance of Trade. Moreover, the fiscal deficit has been highly underestimated by ignoring the deficits of individual states and through issuance of oil bonds to the public sector oil companies, making severe losses due to the heavy subsidies on oil. The government is yet to compensate these companies and these deferred payments have been left out from the deficit. Also, corruption, bureaucracy, red tapism and in general, a poor business environment, are discouraging the inflow of investment. Poor infrastructure and socio-economic backwardness act as deterrents to FDI inflow.Hence, India still needs to work on its fundamentals of providing universal quality education and health services and empowerment of marginalized groups, etc. The growth strategy needs to be more inclusive. There is no point trying to add on to the clump at the top of the pyramid if the base is too weak. The pyramid will soon collapse! Thus, before opening up to financial volatility through the implementation of FCAC, India needs to strengthen its fundamentals and develop a strong base.Hence, India should either wait for a while or implement CAC in a phased, gradual and cautious manner.

Experience of countries that have opted for capital account convertibilityThe initial experience has been that of an improvement in their balance of payments position. In Malaysia, Indonesia, Mexico and Argentina, the surge in capital flows meant a widening of their current accounts. Inflation was also subdued for some time and the reserves were also bolstered.But after the current account deficit could be not sustained, some of these countries introduced some controls. Mexico and Argentina reintroduced controls in the 80s, while Chile also placed fetters after it faced a crisis between '82 and '89. However, all of them subsequently opened up.

CAC (Capital Account Convertibility) for Indian Economyrefers to the abolition of all limitations with respect to the movement of capital from India to different countries across the globe. In fact, the authorities officially involved with CAC (Capital Account Convertibility) for Indian Economy encourage all companies, commercial entities and individual countrymen for investments, divestments, and real estate transactions in India as well as abroad. It also allows the people and companies not only to convert one currency to the other, but also free cross-border movement of those currencies, without the interventions of the law of the country concerned.Following are the pre-requisites for Capital Account Convertibility in India:The Tarapore Committee appointed by the Reserve Bank of India (RBI) was meant for recommending methods of converting the Indian Rupee completely. The report submitted by this Committee in the year 1997 proposed a three-year time period (1999-2000) for total conversion of Rupee. However, according to the Committee, this was possible only when the following few conditions are satisfied: The average rate of inflation should vary between 3% to 5% during the debt-servicing time Decreasing the gross fiscal deficit to the GDP ratio by 3.5% in 1999-2000

Evolution of CAC in India economic and financial scenarios:In 1994 August, the Indian economy adopted the present form of Current Account Convertibility, compelled by the International Monetary Fund (IMF) Article No. VII, the article of agreement. The primary objective behind the adoption of CAC in India was to make the movement of capital and the capital market independent and open. This would exert less pressure on the Indian financial market. The proposal for the introduction of CAC was present in the recommendations suggested by the Tarapore Committee appointed by the Reserve Bank of India.

Reasons for the introduction of CAC in India:The logic for the introduction of complete capital account convertibility in India, according to the recommendations of the Tarapore Committee, is to ensure total financial mobility in the country. It also helps in the efficient appropriation or distribution of international capital in India. Such allocation of foreign funds in the country helps in equalizing the capital return rates not only across different borders, but also escalates the production levels. Moreover, it brings about a fair allocation of the income level in India as well.The forecasts made by the Tarapore Committee regarding Indian CAC are as follows: A prescribed average inflation rate of 3% to 5% will exist for a three-year time period, from1997-98 and 1999-2000. The non-performing assets will experience a decline to 12%, 9% and 5% by the years 1997-98, 1998-99 and 1999-2000 respectively, with respect to the total or aggregate advances. By the years 1997-98, there will be a complete deregulation of the structure of interest rate. The gross fiscal deficit will fall from 4.5% in 1997-98 to 4.0% in 1998-99 and further to 3.5 % in 1999-2000, with respect to the GDP.CAPITAL ACCOUNT CONVERTIBILITY:JOURNEY SO FAR The national freedom of India was lost to the foreign traders who were licensed to trade by the rulers of that era, so general opinion about the foreign trading interests or foreign capital has been very guarded and suspicious since independence. It was also felt that the domestic economy is endowed with a reasonable base of human skills, institutional, social and physical infrastructure and diversified industrial base that the country could productively commence on the path of self reliance with relatively low level of economic reliance on rest of the world. Therefore, for the first four decades after sovereignty in 1947, all economic policies were entered on regulation and capital controls. Although there were intervallic reforms in areas of foreign procurement, technology, travel, education, exchange rate depreciation and easing of restrictions on inflows. As these measures were narrow in scope so they had little impact on inflows and outflows of foreign exchange. Real liberalization was initiated in 1991 aftermath balance of payment crises. On the basis of recommendations made by Rangrajan Committee the reforms in the external sector were initiated. Recommendations included dismantling of trade restrictions, transition to market determined exchange rates and gradual opening of capital account. In 1997 a committee under stewardship of S.S.Tarapore submitted its report on Capital Account Convertibility which provided the initial roadmap for the liberalization of capital account transactions. Taking the lessons from international experience, committee recommended a set of preconditions to be achieved prior to liberalization of capital account. It was the time when banking sector reforms were also instigated on the proposition of Narasimhan committee. Finally in year 2000 Foreign Exchange Regulation Act (FERA) was scrapped and a new act Foreign Exchange Management Act (FEMA) came into existence. Till now, all the rules pertaining to foreign exchange are governed by FEMA. All the current account transactions are permitted under FEMA and no prior permission of RBI is required for any such transactions, while there remain restrictions on capital account. Under FEMA some capital account transactions are completely permitted, some are totally prohibited while some are allowed within a fixed ceiling. Sectaral rules have also been shaped and enforced with FEMA rules. On the success of the measures adopted, the issue of capital account liberalization was re-examined by Tarapore committee II. Setup in year 2006 it was an extension of the previous committee. It also did not recommended unlimited openings of capital account but preferred a phased liberalization of controls on outflows and inflows with a comprehensive review of the actions taken.PROGRESS AT CUSTOMER LEVELIndian customers have gained in plenteous ways, and are getting superior quality, competitive prices and added features in the goods available in the market. They have a bundle of offerings in every sector from fast moving consumer goods (FMCGs) to automobiles, furniture to food, health clubs to telecommunication, clothes to electronics and so on. This has amplified the price wars and there has been an eminent improvement in customer services and customer information through 24 7 help lines and World Wide Web technology.

CHALLENGES OF CAPITAL ACCOUNT CONVERTIBILITY AND THEIR MANAGEMENT:In the process of capital account liberalization, Indian economy has been able to attract reasonable foreign investment without any major shocks. The benefits that have been derived with an open capital account have induced the growth and development of Indias financial markets and external sector. Due to some or other reasons from inside and outside macroeconomic instability has lingered in the economy and things are not going well. Inflation rate is high from the year 2009onwards. The average yearly inflation was 10.9% in 2009 and 11.7% in 2010. In 2011 the rate of inflation stood at 9.6%. Between the periods it rose to double digits too. RBI has revised monetary policy during the different time periods. Cash Reserve Ratio (CRR) was revised 13 times in the time frame of 2 years which is a benchmark in itself. Despite continuous efforts RBI is not able to tame inflation and it is still modest at the level of 8% according to latest estimates. The depreciation in the value of rupee to the level of 1 USD=57.33 INR has also raised serious questions and concern on the conduct and policies of Reserve Bank and Government of India. Global rating agencies Standard & Poor (s & P) and Fitch have revised Indias rating from Stable to Negative. S&P has released a report strongly criticizing the Governments inability to move ahead with economic reforms and referred to cracks in ruling coalition that they were holding progress. Fitch has censured and added the general elections due in early 2014 could see politically driven pressure to loosen fiscal policy, which could further weaken Indias public finance related to peers. The ratings and statement of S&P and Fitch raise the risk of Indian bonds slipping into junk category, hurting the countrys image as an investment destination. The cost of overseas borrowing for Indian companies could also go up. The story is not yet over. Equity market is plummeting week after week because FII are on selling fling. Sensex is currently trading lower than 17,000 and Nifty near 5,000. Investor sentiments are down. Individual portfolios are making losses. Volatility and panic are the latest buzz words for the .Dalal Street.. Food inflation is constantly maintaining its double digit levels causing a decline in domestic savings with banks. IIP has fallen to the level of 3.5% from 8.1% of the previous year. GDP growth in 2012- 13 is estimated at the aching level of 6.5% while fiscal deficit is at 5.9%. Reserve Banks Governor D.Subbarao said .fiscal deficit in 1991 was 7% and it is ruling at 5.9% in 2012. Is it an alarming signal? Because, India was going through its meagre times in 1991 and latest GDP estimates too are worrisome.There are additional doubts about Governments ability to trim subsidy level to cut fiscal deficit, which could further increase the prices of essential commodities. A new retro tax GAAR (General Anti Avoidance Rule) is also proposed to be enacted in budget for fiscal 2013. GAAR aims to target tax evaders, partly by stopping Indian companies and investors from routing investments through Mauritius or other tax havens for the sole purpose of avoiding taxes. It has sparked an outcry among foreign investors. Thus the recent global turmoil, volatile capital flows and economic instability have considerably heightened the uncertainty surrounding the outlook for India, complicating the conduct of monetary policy and external management. The intensified pressures have necessitated stepped up operations in terms of capital account management and more active liquidity management with all instruments at command of Reserve Bank. Therefore in this scenario, it is suggested that India should adopt a go slow approach in moves to liberalize capital account. Instead, it is important for the country to be ready to deal with potentially large and volatile outflows along with spillovers. In this context, there is a need of manoeuvre for Reserve Bank to deal with present serious matters by deployment of monetary policy instruments, buying and selling operations of forex, complemented by prudential restrictions and measures for capital account management.

Tarapore committee on Capital Account Convertibility in India:Jumping into capital account convertibility game without considering the downside of the step can harm the economy. The Committee on Capital Account Convertibility (CAC) or Tarapore Committee was constituted by the Reserve Bank of India for suggesting a roadmap on full convertibility of Rupee on Capital Account. The committee submitted its report in May 1997. The committee observed that there is no clear definition of CAC. The CAC as per the standards, refers to the freedom to convert the local financial assets into foreign financial assets or vice versa at the market determined rates of exchange. The Tarapore committee observed that the Capital controls can be useful in insulating the economy of the country from the volatile capital flows during the transitional periods and also in providing time to the authorities, so that they can pursue discretionary domestic policies to strengthen the initial conditions. The CAC Committee recommended the implementation of Capital Account Convertibility for a 3 year period viz. 1997-98, 1998-99 and 1999-2000. But this committee had laid down some pre conditions as follows: Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5 per cent in 1997-98 to 3.5% in 1999-2000. A consolidated sinking fund has to be set up to meet governments debt repayment needs; to be financed by increased in RBIs profit transfer to the govt. and disinvestment proceeds. Inflation rate should remain between an average 3-5 per cent for the 3-year period 1997-2000. Gross NPAs of the public sector banking system needs to be brought down from the present 13.7% to 5% by 2000. At the same time, average effective CRR needs to be brought down from the current 9.3% to 3% RBI should have a Monitoring Exchange Rate Band of plus minus 5% around a neutral Real Effective Exchange Rate RBI should be transparent about the changes in REER External sector policies should be designed to increase current receipts to GDP ratio and bring down the debt servicing ratio from 25% to 20% Four indicators should be used for evaluating adequacy of foreign exchange reserves to safeguard against any contingency. Plus, a minimum net foreign asset to currency ratio of 40 per cent should be prescribed by law in the RBI Act. The above committees report was not translated into any actions. India is still a country with partial convertibility. However, some important measures in that direction were taken and they are summarized as below: The Indian Corporate were allowed full convertibility in an automatic route up to the $ 500 million overseas ventures. This means that the limited companies were allowed to invest in foreign countries. Indian corporate were allowed to prepay their external commercial borrowings via automatic route if the loan is above $ 500 million. Individuals were allowed to invest in foreign assets , shares up to $ 2, 00, 000 per year. Unlimited amount of Gold was allowed to be imported. The last measure, i.e. allowing unlimited amount of Gold is equal to allowing the full convertibility in capital account via current account route The Second Tarapore Committee on Capital Account Convertibility Reserve Bank of India appointed the second Tarapore committee to set out the framework for fuller Capital Account Convertibility. The committee was established by RBI in consultation with the Government to revisit the subject of fuller capital account convertibility in the context of the progress in economic reforms, the stability of the external and financial sectors, accelerated growth and global integration. The report of this committee was made public by RBI on 1st September 2006. In this report, the committee suggested 3 phases of adopting the full convertibility of rupee in capital acount. First Phase in 2006-7 Second phase in 2007-09 Third Phase by 2011. Following were some important recommendations of this committee: The ceiling for External Commercial Borrowings (ECB) should be raised for automatic approval. NRI should be allowed to invest in capital markets NRI deposits should be given tax benefits. Improvement of the Banking regulation. FII (Foreign Institutional Investors) should be prohibited from investing fresh money raised to participatory notes. Existing PN holders should be given an exit route to phase out completely the PN notes.

Popular News Articles about Capital Account Convertibility

Pre-mature capital account convertibility can harm economy: RBI

NEW DELHI: Reserve Bank of India(RBI) GovernorD. Subbaraohas said that India will "gradually" move towardscapital account convertibilityonly after preconditions like fiscal consolidation are met."There is no evidence (the world over) that capital account convertibility, regardless of macroeconomic circumstances, has been a positive force," he said at a panel discussion on India's economic reforms and development here last evening.On the contrary, evidence suggests that premature capital account liberalization can create macroeconomic imbalances with huge costs to growth and welfare, he said."All the historical evidence shows that pre-mature capital account liberalization can turn you into a 'high beta' economy," he said explaining that high beta economy is vulnerable to volatile external cycles, sharp fluctuations in exchange rates and asset price build-up and bubbles.Capital Account Convertibility (CAC) -- or a floating exchange rate -- means the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. This means that capital account convertibility allows anyone to freely move from local currency into foreign currency and back."We are committed to opening up the capital account gradually along a road map, with the road map itself getting recalibrated on a dynamic basis," the Governor said. "We need to balance the needs of the macro economy with the compulsions of macroeconomic and financial stability."Preconditions for CAC are "fiscal consolidation, financial sector should be more resilient, increase our export competitiveness and imposts should be more price elastic, and more liberal FDI policy with less bureaucratic interface and became a more friendly investment destination", he said.

India should not rush into capital a/c convertibility

HYDERABAD: Four wise men three ex-governors and one serving governor of the Reserve Bank of India came together on Friday to brain-storm on the challenges for the central bank as economies are hoping to come out of the woods after the global financial turmoil. They agreed on many prescriptions and disagreed on some though the disagreements were more in terms of nuances.At RBI's platinum jubilee celebrations, M Narasimham, C Rangarajan and YV Reddy, all former governors and the serving governor D Subbarao saw excess liquidity, over-leveraging and poor regulation as the root cause of the global financial crisis. While Mr Reddy talked about the present and the past legacy of excess liquidity, others felt that past-legacy posed less of a problem.The panellists broadly concurred that India should not rush into capital account convertibility, meaning freedom to convert local financial assets into foreign financial assets and vice-versa, at market determined rates of exchange.Mr Reddy was more conservative as he questioned the merits of capital account convertibility. Others were of the view that the macro economic situation, costs and benefits need to be weighed before transition. "Capital account convertibility is more of a process. We need to go forward, but slowly," said Mr Subbarao.The panellists echoed a similar view on the creation of international financial centres, saying the timing was not right yet.The RBI governor listed out four challenges: solving the tension between fiscal and monetary policies, defining the mandate of central banks and reforming the regulatory architecture, getting the right balance between regulation and liberalisation and conducting monetary policy in a globalised world.But Mr Rangarajan saw price stability as the primary objective of the central bank. "Hard inflation targeting specifying a rate may not be acceptable in an economy like ours where supply side constraints are apparent. However, soft inflation targeting that refers to maintaining a degree of price stability should be the dominant objective of monetary policy," he said.Mr Subbarao was of the view that a minimalist focus on inflation targeting would not deliver macro economic or financial stability. Over-regulation could thwart financial innovation and suppress growth stimulus. A judgement therefore should be made between the costs and benefits of regulation, he said.Mr. Narasimham made out a case for a coordination panel between regulators with RBI at the helm to guide regulation and prevent regulatory arbitrage. The panellists also voiced concerns on the timing and mode of exit policy by the central bank as and when the crisis is over to mop up excess liquidity. RBI hasnt abandoned plans for full convertibility

MUMBAI: Even as it is in favor of imposing capital controls in the short-term, the Reserve Bank of India governor D Subbarao has clarified that India's central bank has not abandoned long-term plans for fuller capital account convertibility.Responding to a query on whether RBI was backing down from the capital account convertibility road map. Mr Subbarao said "I believe we are not. We are still traversing the road map but we will re-work the road map. It will be dependent on developments within the country and around the world.'' The governor was speaking at a research conference organised by the central bank to mark its 75th anniversary in Mumbai attended by central bankers across the world.

It may be recalled that in early 2006, the central bank had appointed a committee to looking to the possibility of a fuller capital account convertibility which had recommended a three phased process over the years, but there is limited progress so far.On the issue of use of dollar as reserve currency, Mr. Subbarao underscored the importance of the green back in the global financial landscape. "If some other currency has to displace the dollar, then it has to happen in an organic manner," Mr Subbarao said.On inflation targeting as a sole monetary policy objective, Mr Subbarao said, that Indian central bank is a multiple services and has an objective of price stability, growth and financial stability, with weightage of each varying in its every quarterly reviews depending on the economic conditions. He also said that in India one of the limitations was that we did not have one single inflation measure that captured the price conditions in the entire economy.Among the other things, Mr. Subbarao reiterated for the second day in the seminar deliberations that the high government borrowings and the resultant fiscal policy was undermining the autonomy of the central bank in the country.He also responded to the issue of inflation targeting as the sole of objective of monetary policy, saying that India cannot adopt it as the sole monetary policy objectives. One of the reasons for this being that India does not have a single inflation indicator that captures the price situation for the entire country. House should debate capital account convertibility: CPM

NEW DELHI: The CPM wants a debate in Parliament on the Tarapore Committee recommendations on fuller capital account convertibility before the RBI goes ahead with their implementation.Describing further liberalization of capital accounts as a "risky and adventurist" path to take, the party on Friday said its benefits would only be restricted to a handful of corporate, banks and high net worth individuals.

The CPM politburo has cited the experience of South-east Asia and other developing countries to express its apprehensions about "volatility" in the financial system, making it vulnerable to capital flight and currency meltdown."In case of such a catastrophe the entire population would be affected through spiraling inflation and other adverse consequences," a politburo statement said. Besides a debate in Parliament, the party demanded that recommendations of the Tarapore Committee are put under "rigorous scrutiny" by the Standing Committee on Finance.It also said such a move would mean overstepping the Common Minimum Program (CMP), which does not mention moving towards fuller capital account convertibility. The CPM said it was a matter of "serious concern" that the RBI had initiated the implementation of the recommendations of the Committee despite "strong reservations from several quarters".These suggestions include raising the remittance limit for resident Indians from $25,000 to $50,000 per financial year, easing norms for external commercial borrowings by banks and other entities, raising the limit of FII investments in government securities from $2bn to $3bn by March '07 and raising the ceiling on overseas investment by mutual funds from $2bn to $3bn.The Left parties had opposed full capital account convertibility saying it was a road leading to "currency crisis and inflation".Prime Minister Manmohan Singh had in March asked the finance minister and the Reserve Bank of India to prepare a roadmap for moving towards capital account convertibility saying that India's own position, both externally and internally, had become far more comfortable.However, the Left refuted Mr. Singh's argument and questioned whether the fundamentals of the Indian economy were strong enough for full rupee convertibility.

CAC is Boon or BaneCurrency Convertibility means ease with which a particular currency or domestic currency can be converted into any other international currency and vice versa. Based on their convertibility currencies can be categorized into three groups namely:Non Convertible currencies are those which cannot be converted into other internationally accepted currencies and vice versa i.e. countries of such currencies do not participate in FOREX Markets.Partially Convertible currencies are those which can be traded in the market with some restrictions from central bank of the country i.e. they cant be freely traded.Fully Convertible currencies are those which can be freely traded without any restrictions from the central bank of the country.Currency convertibility can be talked about in terms of two specific things which are Current Account Convertibility which refers to freedom in conversion in respect of payments and transfers of current international transactions and Capital Account Convertibility which refers to convertibility in respect of capital transactions in terms of inflows and outflows. In India Full Current account convertibility is already present which means that small transactions for any specific purpose such as travelling abroad or study purpose but currently India has restriction over Capital Account Convertibility which means that before doing any financial transaction or sale/purchase of assets which come under capital account one will have seek the permission of Reserve Bank of India.CAC 201529 Jan 2015India is not ready for full capital account convertibility, Reserve Bank of India Deputy Governor H. R. Khan said here.The pros and cons of full capital account openness is a contentious issue, and, in any case, we are not ready for it at this point of time, said Mr. Khan, while delivering the key note address on Derivatives dynamics: looking back and looking ahead at the Finance Conclave 2015, organized by SP Jain Institute of Management & Research, here.

CONCLUSIONAs we say that every coin has its two sides, Fuller Capital Account Convertibility is no exception it also has some pros and cons. Having a closer look at the advantages and disadvantages of FCAC it can be inferred that it can be a boon to our country if managed properly. India should not move into it in hurry instead they should take their own time and first consolidate their fiscal deficit and regulations. They should learn from the mistakes that other Emerging Market Economies did in 90s and what happened to them during the Asian Crisis. In my view India can go ahead with Fuller Account Convertibility but they should still keep some restriction or control over it i.e. they should allow Capital Account Convertibility with reasonable limits on some transactions. After saying this I would also like to add that India and China survived the East Asian Crisis only because they didnt had fuller capital account convertibility and if we open up our economy by allowing FCAC we will increase the susceptibility to economic crisis. Thus any decision taken by RBI and the government will be another wishful thinking that all would go right if some pre-conditions are fulfilled and FCAC will trigger the growth of the economy but there still are some problems with FCAC which will come roaring if there is any global crisis and all the measures taken by government will not be sufficient to avoid such crisis in India. The topic Is Capital Account Convertibility A Boon or a Bane is a debatable one and has been debated in India for decades. There are people who say that India should go for FCAC and other who are against it. So, Whatever happens in the next few years as Tarapore Committee has already set a road map for FCAC lets hope that everything goes as per the plans of UPA government and our economy gets that much needed boost through FCAC.

Referencehttp://articles.economictimes.indiatimes.com/http://theviewspaper.net/http://www.economywatch.com/http://rbidocs.rbi.org.in/

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