Capital Account Convertibility from indian perspective
Capital account convertibility (CAC) is the process of freely converting any local financial assets into foreign financial assets and vice versa. This means there is free flow of capital inside and outside of the country at market determined exchange rate.
Capital account convertibility has various benefits like it can provide cheap capital to the home country’s businesses because of the lower interest rates charged by the other countries compared to home country as well as it will give confidence to the investors that they can move capital freely anytime at market determined exchange rate.
Capital account convertibility is the hallmark of the developed countries. IMF and World Bank made lot of efforts to force all countries (which used to trade heavily with US) to implement full capital account convertibility in 90s however they had to reconsider their decision after east asian crisis where CAC was the main culprit because of the weak financial structure of the east asian countries. India was not hit during that crisis because of the restrictions by regulatory body.
Tarapore committee formed by Indian government gave its suggestions for implementation of capital account convertibility. The committee suggested to implement CAC slowly in various phases and put forward three preconditions before implementing the same. The three conditions were – fiscal stability, low inflation and financial sector reforms. These conditions were required so that India can handle the situation where sudden large outflow of capital takes place as well as Indian financial institutions can utilise huge capital inflow prudently.
Even today, all three preconditions suggested by tarapore committe have not been fulfilled and without fulfilling these preconditions, India will be in dangerous situation by fully implementing capital account convertibility. India has been able to control inflation within acceptable limits during last few years except last year when it reached to very high rate. I hope India will soon achieve fiscal stability and reform of financial sector so that capital account convertibility can be implemented successfully. Let’s wait and watch.