NAME: DEVANSH THAPAR

CLASS: SYBBI

ROLL: 54

CURRENT AND CAPITAL ACCOUNT CONVERTABILITY

The freedom to convert one currency into another internationally accepted currency is known as currency convertibility. There are 2 types of convertibility. One is current account convertibility and the other is capital account convertibility Current account convertibility refers to freedom in respect of Payments and transfers for current international transactions. In other words, if Indians are allowed to buy only foreign goods and services but restrictions remain on the purchase of assets abroad, it is only current account convertibility. As of now, convertibility of the rupee into foreign currencies is almost wholly free for current account i.e. in case of transactions such as trade, travel and tourism, education abroad etc. Capital Account convertibility is defined as the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. In simple language what this means is that CAC allows anyone to freely move from local currency into foreign currency and back. Currency convertibility implies the absence of restrictions on foreign exchange transactions or exchange controls. It is compatible with other forms of transactions international transactions in goods services or capital. India has made the rupee convertible on current account on August 9, 1994. The Indian rupee became partially convertible. Under the current account convertibility, there is a freedom to buy or sell foreign exchange for the following purposes: 1) The international transactions consisting of payments due in connection with foreign trade. Other current businesses include services and nominal short term banking facilities 2) Payment due as interest on loans and as not income from other investments

3) Payment on moderate amount of amortization of loans for depreciation of direct investments 4) Moderate remittances for family living expenses Currency convertibility provides increased capital flows. It also provides a signal to the international community that the country intends to manage its affairs without exchange restrictions which would eventually help to enhance international confidence in the countrys policies, freezing exchange restrictions could uplift the quality management of balance of payments of the country. Flexible and realistic approach in exchange rate
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NAME: DEVANSH THAPAR

CLASS: SYBBI

ROLL: 54

determination combined with favourable macro economic policies could help to provide a viable of balance of payments.

The RBI constituted a committee on capital account convertibility under the chairmanship of Dr. S.S Tarapore. The committee recommended in June 1991, the full convertibility of the rupee in a phased manner after meeting certain pre conditions. These conditions are as follows: 1) 2) 3) 4) Low fiscal deficit Low inflation Efficient financial system Healthy foreign exchange positions

The committee also recommended freedom to banks and financial institutions to operate in the domestic and international gold markets The following are the difficulties and problems in making the Indian rupee fully convertible: 1) 2) 3) 4) 5) 6) 7) Lack of competitive strength of industry Lack of adequate technological base Lack of adequate integration between the different segments of economy Low speed of implementation of reforms Lack of political stability Inadequate banking and financial sector reforms Lack of effective exchange rate mechanism at work

In India, Banks and Financial institutions are not financially strong to grapple with the intricacies of full convertibility. It would also worsen our micro economic imbalances due to free movement of foreign capital. The high rate of interest would serve as an open invitation to the inflow of capital, which will result in an appreciation at the rupee and consequent fall in exports

How is CAC different from current account convertibility? Current account convertibility allows free inflows and outflows for all purposes other than for capital purposes such as investments and loans. In other words, it allows residents to make and receive trade-related payments receive 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 and gifts etc. In India, current account convertibility was established with the acceptance of the obligations under Article VIII of the IMFs Articles of Agreement in August 1994.
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NAME: DEVANSH THAPAR

CLASS: SYBBI

ROLL: 54

What is the position in India today? Convertibility of capital for non-residents has been a basic tenet of Indias 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 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. Why is CAC such an emotive issue? 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. In a bid to attract foreign investment, many developing countries went in for CAC in the 80s not realising that free mobility of capital leaves countries open to both sudden and huge inflows as well as outflows, both of which can be potentially destabilising. More important, that unless you have the institutions, particularly financial institutions, capable of dealing with such huge flows countries may just not be able to cope as was demonstrated by the East Asian crisis of the late nineties.