What is capital account convertibility?
There is no formal definition of capital account convertibility (CAC).
The Tarapore committee set up by the Reserve Bank of India (RBI) in 1997
to go into the issue of CAC defined it as the freedom to convert local
financial assets into foreign financial assets and vice versa at market
determined rates of exchange.
Can CAC coexist with restrictions?
Contrary to general belief, CAC can coexist with restrictions other than on external payments. It does not preclude the imposition of any monetary/fiscal measures relating to forex transactions that may be warranted from a prudential point of view.
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 anytime they change their mind
they will be able to re-convert local currency back into foreign currency
and take out their money.
Following the East Asian crisis, even the most ardent votaries of CAC in the World Bank and the IMF realised that the dangers of going in for CAC without adequate preparation could be catastrophic. Since then the received wisdom has been to move slowly but cautiously towards CAC with priority being accorded to fiscal consolidation and financial sector reform above all else.
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 certain pre-conditions — primarily fiscal consolidation, strengthening of the financial system and a low rate of inflation. With the exception of the last, the other two pre-conditions have not yet been achieved.
What is the position in India today?
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. It is only residents — both individuals as well as corporates — who continue to be subject to capital controls. However, as part of the liberalisation process the government has over the years been relaxing these controls. Thus, a few years ago, residents were allowed to invest through the mutual fund route and corporates to invest in companies abroad but within fairly conservative limits.
Buoyed by the very comfortable build-up of forex reserves, the strong GDP growth figures for the last two quarters and the fact that progressive relaxations on current account transactions have not lead to any flight of capital, on Friday the government announced further relaxations on the kind and quantum of investments that can be made by residents abroad. These relaxations are to be reviewed after six months and if the experience is not adverse, we may see further liberalisation and in the not-too-distant future full CAC.