CHAPTER 1. INTRODUCTION

Convertibility

Convertibility means the system where anything can be converted into any other stuff without any

question asked about the purpose.

Balance of Payment

Balance of payment (BoP) is a statistical statement that summarizes, for a specific period, transactions

between residents of a country and the rest of the world. BoP positions indicate various signals to

businesses. BoP comprises current account, capital account and financial account.

Signals that the BoP account of a country gives out, for example, large current account transactions

indicate towards openness of an economy. This was the case with India as reduction in trade

restrictions and duties led to increase in both exports and imports after 1991. Also large capital account

transactions may indicate well-developed capital markets of an economy.

Capital and current account balances for India were quite stable between 1991 and 2001. After 2001,

primarily because of increased exports of IT services and transfers, current account balance went into

surplus. But due to increasing imports and an increasing oil bill, it started deteriorating after 2004 and

went into deficit.

Sound fundamentals and a large untapped market coupled with a deregulated regime allowed foreign

investors to invest in India, thereby increasing capital inflows after 2000. However, the global

meltdown has led to an outflow of capital, which has led to a sudden fall in the capital account balance

after 2007.

Reserves were built up over the years mainly because of capital inflows. But a recent deficit in current

account and capital outflow led to a fall in 2008-09.

Healthy BoP positions or surplus in capital and current account keeps confidence in the economy and

among investors. However, healthy BoP positions may be different for different countries. For

example, surplus in current account is often more important for developed countries than surplus in

capital account as most of them have sufficient capital to fund their investments. On the other hand,

developing countries like India may place more importance on capital account as reserves and funding

for investment is crucial for them at present.

Large balances often attract foreign investors into an economy, thus bringing in precious foreign

exchange. Often credit ratings are based on BoP positions, thereby affecting the flows of credit to

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businesses. Businesses can make predictions about exchange rates by studying BoP positions. A

healthy BoP position can signal domestic currency appreciation, hence encouraging businesses to

engage in future contracts accordingly. Also, the BoP position influences the decisions of policy

makers, which are crucial for any business.

India’s Balance of Payment

India presently has a deficit in its current account of BoP, which has increased substantially after

reforms in 1991. In 1991-92, current account deficit was $1,178 million, which rose to $17,403 million

in 2007-08, and accounted for $36,469 million for the last three quarters of 2008. After the reforms in

1991, India’s position of merchandise trade (exports and imports of goods) kept on deteriorating, but

its position on invisibles (services, current transfers etc) improved during the period. However, one of

the major factors for increasing current account deficit in the last few years has been a rising oil import

bill. Some countries like Japan and Germany have current account surpluses, while the USA and UK

have deficits.

India has done fairly well on the capital account side. In 2007-08 it had a capital account surplus of

$108,031 million. In the same year it increased its foreign exchange reserves by $92,164 million,

which provided stability to the economy. Foreign investments have increased manifold since 1991,

peaking in 2007-08 to $44,806 million.

India’s overall current account and capital account deficit is $20,380 million for April–December

2008, which is expected to rise to a figure between $25 and 30 billion by the year ending March 31,

2009. There has been dip in reserves from $309,723 million in March 2008 to $253,000 million in

March 2009. Reasons for this are portfolio flows from foreign institutional investors and the

appreciation of the US dollar. But this may not pose a significant threat to the Indian economy and

businesses because of large pool of reserves that are still providing enough cushion. However, some

businesses like those related to equities and realty are hit when outflows from these sectors occur. Not

only is there fall in asset prices and erosion of investment value, but economic activity also gets

reduced in these sectors.

However, recent profitability/growth numbers have indicated signs of a revival. Also political change

and expected stability might bring in foreign exchange and may improve India’s capital account

position and reserves. This may lead to the appreciation of the Indian rupee and may affect exporters

and importers accordingly. At the same time, reserves infuse stability into the system, which in turn

has positive effects on businesses and investments.

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Current account convertibility refers to currency convertibility required in the case of transactions

relating to exchange of goods and services, money transfers and all those transactions that are

classified in the current account. On the other hand, capital account convertibility refers to

convertibility required in the transactions of capital flows that are classified under the capital account

of the balance of payments.

Current 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.

The government introduced a system of Partial Rupee Convertibility (PCR) (Current Account

Convertibility) on February 29, 1992 as part of the Fiscal Budget for 1992-93. PCR is designed to

provide a powerful boost to export as well as to achieve as efficient import substitution. It is designed

to reduce the scope for bureaucratic controls, which contribute to delays and inefficiency. Government

liberalized the flow of foreign exchange to include items like amount of foreign currency that can be

procured for purpose like travel abroad, studying abroad, engaging the service of foreign consultants

etc. What it means that people are allowed to have access to foreign currency for buying a whole range

of consumables products and services. These relaxations coincided with the liberalization on the

industry and commerce front which is why we have Honda City cars, Mars chocolate and Bacardi in

India.

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.

In simple language what this means is that CAC allows anyone to freely move from local currency into

foreign currency and back.

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CHAPTER 2. COMPONENTS OF CURRENT ACCOUNT

Covered in the current account are all transactions (other than those in financial items) that involve

economic values and occur between resident non-resident entities. Also covered are offsets to current

economic values provided or acquired without a quid pro quo. Specifically, the major classifications

are goods and services, income, and current transfers.

Goods

General merchandise covers most movable goods that residents export to, or import from, non

residents and that, with a few specified exceptions, undergo changes in ownership (actual or imputed).

Structure and Classification

Goods for processing covers exports (or, in the compiling economy, imports) of goods crossing the

frontier for processing abroad and subsequent re-import (or, in the compiling economy, export) of the

goods, which are valued on a gross basis before and after processing. The treatment of this item in the

goods account is an exception to the change of ownership principle.

Repairs on goods covers repair activity on goods provided to or received from non residents on ships,

aircraft, etc. repairs are valued at the prices (fees paid or received) of the repairs and not at the gross

values of the goods before and after repairs are made.

Goods procured in ports by carriers’ covers all goods (such as fuels, provisions, stores, and supplies)

that resident/nonresident carriers (air, shipping, etc.) procure abroad or in the compiling economy. The

classification does not cover auxiliary services (towing, maintenance, etc.), which are covered under

transportation.

Nonmonetary gold covers exports and imports of all gold not held as reserve assets (monetary gold) by

the authorities. Nonmonetary gold is treated the same as any other commodity and, when feasible, is

subdivided into gold held as a store of value and other (industrial) gold.

Services

Transportation covers most of the services that are performed by residents for nonresidents (and vice

versa) and that were included in shipment and other transportation in the fourth edition of the Manual.

However, freight insurance is now included with insurance services rather than with transportation.

Transportation includes freight and passenger transportation by all modes of transportation and other

distributive and auxiliary services, including rentals of transportation equipment with crew.

Travel covers goods and services—including those related to health and education—acquired from an

economy by nonresident travelers (including excursionists) for business and personal purposes during

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their visits (of less than one year) in that economy. Travel excludes international passenger services,

which are included in transportation. Students and medical patients are treated as travelers, regardless

of the length of stay. Certain others—military and embassy personnel and nonresident workers—are

not regarded as travelers. However, expenditures by nonresident workers are included in travel, while

those of military and embassy personnel are included in government services.

Communications services cover communications transactions between residents and nonresidents.

Such services comprise postal, courier, and telecommunications services (transmission of sound,

images, and other information by various modes and associated maintenance provided by/for residents

for/by non residents).

Construction services covers construction and installation project work that is, on a temporary basis,

performed abroad/in the compiling economy or in extra territorial enclaves by resident/nonresident

enterprises and associated personnel. Such work does not include that undertaken by a foreign affiliate

of a resident enterprise or by an unincorporated site office that, if it meets certain criteria, is equivalent

to a foreign affiliate.

Insurance services cover the provision of insurance to non residents by resident insurance enterprises

and vice versa. This item comprises services provided for freight insurance (on goods exported and

imported), services provided for other types of direct insurance (including life and non-life), and

services provided for reinsurance.

Financial services (other than those related to insurance enterprises and pension funds) cover financial

intermediation services and auxiliary services conducted between residents and nonresidents. Included

are commissions and fees for letters of credit, lines of credit, financial leasing services, foreign

exchange transactions, consumer and business credit services, brokerage services, underwriting

services, arrangements for various forms of hedging instruments, etc. Auxiliary services include

financial market operational and regulatory services, security custody services, etc.

Computer and information services covers resident/nonresident transactions related to hardware

consultancy, software implementation, information services (data processing, data base, news agency),

and maintenance and repair of computers and related equipment.

Royalties and license fees covers receipts (exports) and payments (imports) of residents and non-

residents for (i) the authorized use of intangible non produced, nonfinancial assets and proprietary

rights—such as trademarks, copyrights, patents, processes, techniques, designs, manufacturing rights,

franchises, etc. and (ii) the use, through licensing agreements, of produced originals or prototypes—

such as manuscripts, films, etc.

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Other business services provided by residents to nonresidents and vice versa cover merchanting and

other trade-related services; operational leasing services; and miscellaneous business, professional, and

technical services.

Personal, cultural, and recreational services covers (i) audiovisual and related services and (ii) other

cultural services provided by residents to non-residents and vice versa. Included under (i) are services

associated with the production of motion pictures on films or video tape, radio and television

programs, and musical recordings. (Examples of these services are rentals and fees received by actors,

producers, etc. for productions and for distribution rights sold to the media.) Included under (ii) are

other personal, cultural, and recreational services—such as those associated with libraries, museums—

and other cultural and sporting activities.

Government services i.e. covers all services (such as expenditures of embassies and consulates)

associated with government sectors or international and regional organizations and not classified under

other items.

Income

Compensation of employees covers wages, salaries, and other benefits, in cash or in kind, and includes

those of border, seasonal, and other non-resident workers (e.g., local staff of embassies).

Investment income covers receipts and payments of income associated, respectively, with residents’

holdings of external financial assets and with residents’ liabilities to nonresidents. Investment income

consists of direct investment income, portfolio investment income, and other investment income. The

direct investment component is divided into income on equity (dividends, branch profits, and

reinvested earnings) and income on debt (interest); portfolio investment income is divided into income

on equity (dividends) and income on debt (interest); other investment income covers interest earned on

other capital (loans, etc.) and, in principle, imputed income to households from net equity in life

insurance reserves and in pension funds.

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Current transfers

Current transfers are distinguished from capital transfers, which are included in the capital and

financial account in concordance with the SNA treatment of transfers. Transfers are the offsets to

changes, which take place between residents and nonresidents, in ownership of real resources or

financial items and, whether the changes are voluntary or compulsory, do not involve a quid pro quo in

economic value.

Current transfers consist of all transfers that do not involve

a. transfers of ownership of fixed assets;

b. transfers of funds linked to, or conditional upon, acquisition or disposal of fixed assets;

c. forgiveness, without any counterparts being received in return, of liabilities by creditors.

All of these are capital transfers.

Current transfers include those of general government (e.g., current international cooperation between

different governments, payments of current taxes on income and wealth, etc.), and other transfers (e.g.,

workers’ remittances, premiums—less service charges, and claims on non-life insurance).

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CHAPTER 3. COMPONENTS OF CAPITAL ACCOUNT

1. Foreign Investment(FDI, FII)

2. Banking Capital (NRI Deposits)

3. Short term credit

4. External Commercial Borrowings(ECB)

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CHAPTER 4. CURRRENT ACCOUNT CONVERTIBILITY

Current account convertibility opens up the domestic economy to foreign capital. Foreign capital

augments investible resources of the home country and facilitates faster growth.

Cost of capital for domestic firms is lowered and access to global capital markets is enhanced. Just as

there are gains from international trade in goods and services, there are gains from trade in financial

assets. It allows residents to hold globally diversified portfolios improving their risk return trade off. It

lowers the funding cost for resident borrowers.

Economists talk of capital output ratio. In order for the GDP to grow at 8-9 percent, 25 percent more

investment is required. Twenty to 25 percent of the country’s gross income should be invested in

various infrastructural assets. India’s investment rate has not been more than 20-25 percent of GDP at

best of times. The remaining five to six percent must come from foreign investments otherwise we will

not be able to achieve a high growth rate. Our savings rate should be 32-34 percent but in actuality it is

only 26 percent. The gap has to be filled by foreign investment.

Take the case of Japan, Scandinavia and Europe—there the opportunities for investment are limited.

They are looking for more attractive investments abroad which will give say, eight percent return as

against the three percent they get in their own country. So money is lying idle in those countries.

Developing countries are short of funds; therefore, the opening up of capital account does augment the

investible resources of the home country. Our companies can access the capital and their cost of capital

will come down. If we are to rely only on domestic capital, the cost would be high. Some investments

will simply not be undertaken.

Export and import of goods and services is good for the welfare of all countries engaged in it. For

example, software services from India, we do it much better than developed countries. But we have to

import a lot of goods either because other countries produce it better. Then why not apply the same

logic to capital. The major fear is not only about foreigners investing here but what if domestic

investors start investing abroad. But why should they do it. As a wise investor, who will be tempted to

invest abroad and earn three percent when the same investment can yield eight percent in the domestic

market? Why should you park your investments abroad if the rate of return is low? Rate of return on

investment has come to two percent in Japan.

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In India it is 4.6 percent. Unless we fear a massive crisis—either a political or economic collapse, the

fear about capital account convertibility is not justified. Our political system is working well,

government is functioning well, and no major political crises are also foreseen? We also do not expect

an economic crisis as in Thailand. Foreign capital in India constitutes a very small part of the total

capital. Particularly short term capital that has a maturity of six month. That constitutes a much small

portion. Even if all of that leaves tomorrow, Indian economy is not going to collapse. Our total foreign

debt as a percentage of GDP is very small. Short term debt component in that is still smaller. So this

fear about taking foreign capital away from India if capital account convertibility comes is totally

unjustified. Today India and China offer the best investment opportunity globally in manufacturing,

services and infrastructure. Because of wrong policies in power, roads, ports, investments are not

flowing in. Current account convertibility also means, competition among financial intermediaries,

improves efficiency, cuts transaction costs, deepen financial markets.

Specialisation in financial services guided by core competence may be increased, increasing allocative

efficiency. Capital account convertibility imposes certain disciplines on federal, state governments and

policy makers. Domestic tax regimes and other fiscal parameters must converge to international

standards to prevent capital flight from home. Competition is the best way to increase efficiency in

public sector banks and other private banks. Our banking sector requires a dose of competition. Banks,

investment companies, mutual funds and insurance sector will only benefit from competition.

Capital accounts convertibility will also lead to specialization in products offered by banks. It also puts

a cap on uncontrolled budget deficits, uncontrolled government expenditure thereby putting certain

discipline in the Finance Ministry.

Large deficits show up on current account as debits and running up large current account deficits will

lose the confidence of foreign investors in meeting our liabilities. When there is current account

deficit, it means imports are more than exports. In normal situations it should not exceed 1.5-2 % of

GDP. Anything beyond that is not sustainable and quite dangerous also. In Thailand, the current

account deficit for three years was nine percent of GDP. If we have to keep current account under

control then budget deficits should also be under control. They must raise more resources by way of

taxation not by way of borrowing. Borrowing creates problems for the future as interest burden will

increase. Large deficits will also lead to depreciation of currency. Imposes discipline on domestic

macroeconomic policy making. Monetary policy must work within the constraints of uncovered

interest rate regime must be in tandem with what is happening and cannot be arbitrary.

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Right now the country’s capacity to attract foreign capital is substantial. Once the capital account is

convertible then the monetary policy, interest rate policy, fiscal policy must converge to international

standards a there cannot be any undue restriction on flow of money.

Financial markets will become volatile with interest rates, exchange rates fluctuating every minute.

Banks, companies, individuals will have to learn to live with it. Financial derivatives have been

evolved to manage these volatilities. Financial products to hedge the risks have to be in place.

When foreign capital flows freely in the country in times of a political or economic crisis it can be

taken back as freely by investors. In crisis times, every investor is not rational. They follow a herd

mentality. The remedy for this is prudent economic management, prudent political management, but

keeping political capital out is not the answer.

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CHAPTER 5. CAPITAL ACCOUNT CONVERTIBILITY

Capital Account Convertibility (CAC) means freedom to convert domestic financial assets into

overseas financial assets at market-determined rates. Simply put, the regime of full convertibility

allows any Indian resident to go to a foreign exchange dealer or bank and freely convert rupees into

dollars, pounds or Euros to acquire assets abroad. The overseas assets can be anything; equity, bonds,

property or ownership of overseas firms.

It refers 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.

Capital Account convertibility in its entirety would mean that any individual, be it Indian or Foreigner

will be allowed to bring in any amount of foreign currency into the country. Full convertibility also

known as Floating rupee means the removal of all controls on the cross-border movement of capital,

out of India to anywhere else or vice versa. Capital account convertibility or CAC refers to the

freedom to convert local financial assets into foreign financial assets or vice versa at market-

determined rates of interest. If CAC is introduced along with current account convertibility it would

mean full convertibility.

Complete convertibility would mean no restrictions and no questions. In general, restrictions on

foreign currency movements are placed by developing countries which have faced foreign exchange

problems in the past is to avoid sudden erosion of their foreign exchange reserves which are essential

to maintain stability of trade balance and stability in their economy. With India’s forex reserves

increasing steadily, it has slowly and steadily removed restrictions on movement of capital on many

counts.

The last few steps as and when they happen will allow an Indian individual to invest in Microsoft or

Intel shares that are traded on NASDAQ or buy a beach resort on Bahamas or sell home or small

industry and invest the proceeds abroad without any restrictions.

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Accounting of total inflow and outflow of Funds is as follows: -

Increase in foreign ownership of domestic assets – Increase of domestic ownership of foreign

assets = FDI + Portfolio Investment + Other investments.

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.

Need for Capital Account Convertibility

1. Capital account convertibility is considered to be one of the major features of a developed economy.

It helps attract foreign investment. It offers foreign investors a lot of comfort as they can re-convert

local currency into foreign currency anytime they want to and take their money away.

2. Capital account convertibility makes it easier for domestic companies to tap foreign markets. At the

moment, India has current account convertibility. This means one can import and export goods or

receive or make payments for services rendered. However, investments and borrowings are

restricted.

3. 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.

4. For countries that face constraints on savings and capital can utilise such flows to finance their

investment, which in turn stokes economic growth.

5. Local residents would be in a position to diversify their portfolio of assets, which helps them

insulate themselves, better from the consequences of any shocks in the domestic economy.

6. For global investors, capital account convertibility helps them to seek higher returns by sharing

risks.

7. It also offers countries better access to global markets, besides resulting in the emergence of deeper

and more liquid markets.

8. Capital account convertibility is also stated to bring with it greater discipline on the part of

governments in terms of reducing excess borrowings and rendering fiscal discipline.

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Capital Convertibility and its effects on India

As most of us know, resident Indians cannot move their money abroad freely. That is, one has to

operate within the limits specified by the Reserve Bank of India and obtain permission from RBI for

anything concerning foreign currency.

For example, the annual limit for the amount you are allowed to carry on a private visit abroad is

$10,000: of which only $5,000 can be in cash. For business travel, the yearly limit is $25,000.

Similarly, you can gift or donate up to $5,000 in a year.

The RBI raises the limit if you are going abroad for employment, or are emigrating to another country,

or are going for studies abroad: the limit in both these cases is $100,000.

You are also allowed to invest into foreign stock markets up to the extent of $25,000 in a year.

For the average Indian, these 'limits' seem generous and might not affect him at all. But for heavy

spenders and those with visions of buying a house abroad or a Van Gogh painting, it will mean a lot.

But with the markets opening up further with the advent of capital account convertibility, one would be

able to look forward to more and better goods and services.

Evolution of CAC in India economic and financial scenarios

In early 1990s India was facing foreign reserve crisis, the foreign reserves were only sufficient to pay

off two weeks import; therefore India was forced to liberalize the economy. 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 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.

Benefits of CAC

1) It leads to more inflow of capital into domestic financial system. Thus firms have access to more

capital, and this reduces their cost of capital. A reduced COC induces firms to invest more, expand

more and thus output, employment and income expand in medium- to long-run.

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2) Full CAC leads to freedom to trade in financial assets. Investors can choose from a wider range of

financial products across multiple countries.

3) Entry of foreign financial institutions results in eventual efficiency in domestic financial system,

since such entry increases the number of players in the market, and fosters competition. In some cases,

the market could see a transition from the near-monopoly to near-perfectly competitive market. In

order to survive stiffer competition, (domestic) firms are forced to become more efficient. This also

ensures compliance with international standards of reporting, disclosure and best practices.

4) As a consequence of full CAC, tax levels converge to international levels.

5) As more capital flows in, domestic interest rates are reduced, thus cost of government’s domestic

borrowing is reduced, and so fiscal deficit shrinks.

Disadvantages of CAC

1) An open capital account causes an export of domestic savings abroad, to more attractive

destinations. In capital-starved countries, such outbound savings flight can be ill afforded.

2) Increased capital inflows also lead to appreciation of real exchange rate. It shifts resources from

tradable to non-tradable sectors.

3) Premature liberalization and CAC lead to an initial stimulation of capital outflows, which by

appreciating the real exchange rate, destabilizes the economy.

4) Another possible side-effect is generation of financial bubbles. A sudden burst could replicate the

Asian crisis once again.

5) But the oft-cited argument against CAC is concerning movements of short-term capital. It is

considered to be extremely volatile, highly sensitive to domestic and/or international economic,

political and financial events, and once such an event starts, the extent increases as in a chain-reaction

– such investors invest their capital only lured by the prospect of short-term ‘windfall gains’

precipitated by interest-rate differentials (in most cases). And once some investors withdraw their

capital, the herd mentality is displayed – other ‘arms length’ investors also follow suit and withdraw

their money. This is known as ‘capital flight’. Once capital flight takes place, international investors

lose confidence on the host country’s economy. Creditworthiness diminishes, too.

And the most dangerous consequence of capital flight is that the government has to deploy its Forex

Reserves to the investors who withdraw the capital, and this brings the domestic economy to a highly

vulnerable state. This may well start a financial disruption and/or currency crisis.

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It may be noted that full capital account convertibility doesn’t necessarily lead to a financial crisis, but

it makes the country in question more susceptible to such crises. The symptoms of such financial

vulnerability are: Inadequate capital base, large bad loans (NPA), inappropriate risk management

techniques and (politically) connected lending.

Countries where such symptoms exist should exercise utmost caution while deciding whether or not to

adopt Full CAC, since these are most vulnerable to any shock, and take more time to recover from any

external threat.

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CHAPTER 6. TARAPORE COMMITTEE

Tarapore Committee-I

The first Tarapore committee report on capital account convertibility (CAC), which came out in May

1997, wanted CAC to be phased in over three years (1997-2000). The five-member committee has

recommended a three-year time frame for complete convertibility by 1999-2000. The highlights of the

report including the preconditions to be achieved for the full float of money are 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 government's debt repayment needs; to be

financed by increased in RBI's 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%.

Tarapore Committee -II

In the Year 2006 under Manmohan Singh Government the Tarapore Committee reappointed to give

suggestion on adoption of Fuller Capital Account Convertibility (FCAC). The Committee has given

the following recommendation and the whole process was divided into 3 phases:

Phase - I (2006-07)

Phase - II (2007-09)

Phase - III (2009-11)

Tarapore-II makes wide-ranging recommendations on the strengthening of the banking sector. At

times, it appears to over-step its brief. It is one thing to argue that government’s holdings in public

sector banks should be brought down to 33% as this would help banks augment their capital

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CHAPTER 7. FULLER CAPITAL ACCOUNT CONVERTIBILITY

Capital Account convertibility in its entirety would mean that any individual, be it Indian or Foreigner

will be allowed to bring in any amount of foreign currency into the country.

Full convertibility also known as Floating rupee means the removal of all controls on the cross-border

movement of capital, out of India to anywhere else or vice versa.

Capital account convertibility or CAC refers to the freedom to convert local financial assets into

foreign financial assets or vice versa at market-determined rates of interest. If CAC is introduced along

with current account convertibility it would mean full convertibility.

Complete convertibility would mean no restrictions and no questions. In general, restrictions on

foreign currency movements are placed by developing countries which have faced foreign exchange

problems in the past is to avoid sudden erosion of their foreign exchange reserves which are essential

to maintain stability of trade balance and stability in their economy. With India’s Forex reserves

increasing steadily, it has slowly and steadily removed restrictions on movement of capital on many

counts.

Capital account convertibility means that an investor is allowed to move freely from the local currency

to a foreign currency. India has limited capital account convertibility to prevent shocks to the capital

account and maintain a stable exchange rate, by stipulating sectoral norms that ensure a lock-in period

for investments.

FDI Norms

The press notes simplify the method for calculating FDI and broadly state that as long as Indian

promoters hold a majority stake (more than 51 per cent) in any operating-cum-investing company, it

can bring investment up to 49.9 per cent through FDI. This company would be treated as an Indian

company and it can invest through a joint venture in any other company that may be engaged in

industries in which FDI has a sectoral limit.

Several companies like retailer Pantaloon and media house UTV have restructured their organizations

to raise FDI in their businesses through step-down joint ventures — FDI is prohibited in multi-brand

retail and is restricted to 26 per cent for media

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In one sweep, therefore, any sectoral cap of 49 per cent and below has become meaningless in so far as

downstream investment by a company with foreign investment below 50 per cent and qualifying as an

Indian owned and controlled company,” the DEA argued in a letter, sources said.

“Such a company can apply for cable TV operations (49 per cent cap), FM broadcasting license (20

per cent cap), licensed defence items manufacture (26 per cent cap), printing news papers (26 per cent

cap) up linking TV news channels (26 per cent cap) etc. Whether this stance has been approved as such

or is an unintended liberalisation is not clear,” the DEA letter said.

Objectives

Economic Growth : The Introduction of FCAC will help in the economic development of the

country through capital investment in the country. This leads to employment generation in the

country, infrastructure development, global competition etc.

Improvement in Financial Sector : There would be improvement in the financial sector as huge

capital flow into the system, which will help the companies to perform better. It will boost liquidity

into the system.

Diversification of Investment : It will also help in the diversification of Investment by ordinary

people, wherein they can invest abroad without any restriction and diversify their portfolio.

Risks Involved In FCAC

Market Risk

Credit Risk

Liquidity Risk

Derivative Transaction Risk

Operational Risk

Market risks such as interest rate and foreign exchange risks become more complex as financial

institutions and corporates gain access to new securities and markets, and foreign participation changes

the dynamics of domestic markets. For instance, banks will have to quote rates and take unhedged

open positions in new and possibly more volatile currencies. Similarly, changes in foreign interest

rates will affect banks’ interest sensitive assets and liabilities. Foreign participation can also be a

channel through which volatility can spill-over from foreign to domestic markets.

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Credit risk will include new dimensions with cross-border transactions. For instance, transfer

risk will arise when the currency of obligation becomes unavailable to borrowers. Settlement risk

(or Herstatt risk) is typical in foreign exchange operations because several hours can elapse

between payments in different currencies due to time zone differences. Cross-border transactions

also introduce domestic market participants to country risk, the risk associated with the economic,

social, and political environment of the borrower’s country, including sovereign risk.

With FCAC, liquidity risk will include the risk from positions in foreign currency denominated

assets and liabilities. Potentially large and uneven flows of funds, in different currencies, will

expose the banks to greater fluctuations in their liquidity position and complicate their asset-

liability management as banks can find it difficult to fund an increase in assets or accommodate

decreases in liabilities at a reasonable price and in a timely fashion.

Risk in derivatives transactions becomes more important with capital account convertibility as

such instruments are the main tool for hedging risks. Risks in derivatives transactions include

both market and credit risks. For instance, OTC derivatives transactions include counterparty

credit risk. In particular, counterparties that have liability positions in OTC derivatives may not be

able to meet their obligations, and collateral may not be sufficient to cover that risk. Collecting

and analyzing information on all these risks will become more challenging with FCAC because

the number of foreign counterparts will increase and their nature change.

Operational risk may increase with FCAC.4 For instance; legal risk stemming from the

difference between domestic and foreign legal rights and obligations and their enforcements

becomes important with fuller capital account convertibility. For instance, differences in

bankruptcy codes can complicate the assessment of recovery values. Similarly, differences in the

legal treatment of secured transactions for repos can lead to unanticipated loss.

Regulatory issues include the risk of regulatory arbitrage as differences in regulatory and

supervisory regimes among countries may create incentives for capital to flow from countries

with higher standards to those with lower ones. FCAC can also bring a proliferation of new

instruments and market participants, complicating the task of financial supervisors and regulators.

The entry of large and complex institutions operating in different countries will increase the need

for cooperation and coordination between domestic regulatory and supervisory agencies and also

with their foreign counterparts.

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Challenges in Adopting FCAC

Risk Management

Interest Rate & Liquidity Risk Management

Derivative Risk Management

o To better manage liquidity risk, the report recommends that banks monitor their liquidity position

at the head/corporate office level on a global basis, including both at the domestic and foreign

branches. In addition the liquidity positions should be monitored for each currency.

o Regarding market risk, the report recommends that banks adopt a duration gap analysis and

consider setting appropriate internal limits on their interest rate risk exposures. The Tarapore

report also suggests that the RBI link the open position limits to banks’ capacity to manage foreign

exchange risk as well as their unimpaired Tier I capital.

o Banks will require more derivatives instruments to mitigate the possible risks from fuller capital

account convertibility. These should include interest rate futures and options, credit derivatives,

commodity derivatives, and equity derivatives, which are not effectively available to banks at the

moment. The RBI should, however, put in place the appropriate infrastructure, including a robust

accounting framework; a robust independent risk management framework in banks, including an

appropriate internal control mechanism; appropriate senior management oversight and

understanding of the risks involved; comprehensive guidelines on derivatives, including prudential

limits wherever necessary; and appropriate and adequate disclosures. prudential limits wherever

necessary; and appropriate and adequate disclosures.

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CHAPTER 8. CURRENCY CRISIS

Emerging Market Economies (EME)

The East Asian currency crisis began in Thailand in late June 1997 and afflicted other countries

such as Malaysia, Indonesia, South Korea and the Philippines and lasted up to the last quarter of

1998. The major macroeconomic causes for the crisis were identified as: current account

imbalances with concomitant savings-investment imbalance, overvalued exchange rates, high

dependence upon potentially short-term capital flows. These macroeconomic factors were

exacerbated by microeconomic imprudence such as maturity mismatches, currency mismatches,

moral hazard behaviour of lenders and borrowers and excessive leveraging.

The Mexican crisis in 1994–95 was caused by weaknesses in Mexico's economic position from an

overvalued exchange rate and current account deficit at 6.5 per cent of Gross Domestic Product

(GDP) in 1993, financed largely by short-term capital inflows.

Brazil was suffering from both fiscal and balance of payments weaknesses and was affected in the

aftermath of the East Asian crisis in early 1998 when inflows of private foreign capital suddenly

dried up. After the Russian crisis in 1998, capital flows to Brazil came to a halt.

Difficulties in meeting huge requirements for public sector borrowing in 1993 and early 1994, led to

Turkey's currency crisis in 1994. As a result, output fell by 6 percent; inflation rose to three-digit

levels, the central bank lost half of its reserves, and the exchange rate depreciated by more than 50

per cent. Turkey faced a series of crisis again beginning 2000 due to a combination of economic and

noneconomic factors.

Some Lessons from Currency Crisis in Emerging Market Economies: -

Most currency crises arise out of prolonged overvalued exchange rates, leading to unsustainable

current account deficits. As the pressure on the exchange rate mounts, there is rising volatility of

flows as well as of the exchange rate itself. An excessive appreciation of the exchange rate causes

exporting industries to become unviable, and imports to become much more competitive, causing

the current account deficit to worsen.

Large unsustainable levels of external and domestic debt directly led to currency crises. Hence, a

transparent fiscal consolidation is necessary and desirable, to reduce the risk of currency crisis.

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Short-term debt flows react quickly and adversely during currency crises. Receivables are typically

postponed, and payables accelerated, aggravating the balance of payments position.

CAC and South-East Asian Crisis

The Asian Crisis of 1997-98 originated from Thailand. The Baht was at that time pegged with US

Dollar. As dollar appreciated, so did Baht, and exports decreased, export competitiveness also reduced,

leading to increased current account deficit and trade deficit. Thailand was heavily reliant on foreign

debt – with its huge CAD being dependent on foreign investment to stay afloat. Thus there was an

increased forex risk.

As US increased its domestic interest rate, the investors started investing more in the US. It led to

capital flight. Forex reserves rapidly depleted, and the Thai economy tumbled down. At this juncture,

Thai government decided to dissociate Baht from the US currency and floated Baht. Concurrently, the

export growth in Thailand slowed down visibly.

Combination of these factors led to heavy demand for the foreign currency, causing a downward

pressure on Baht. Asset prices also decreased. But, that time Thailand was dominated by “crony

capitalism”, so credit was widely available. This resulted in hike of asset prices to an unsustainable

level – and as asset prices fell, there was heavy default on debt obligations. Credit withdrawal started.

This crisis spread to other countries as a contagion effect. The exchange markets were flooded with the

crisis currencies as there were few takers. It created a depreciative pressure on the exchange rate. To

prevent currency depreciation, the governments were forced to hike interest rates and intervene in

forex markets, buying the domestic currencies with their forex reserves. However, an artificially high

interest rate adversely affected domestic investment, which spread to GDP, which declined, and

eventually economies crashed.

In this backdrop, the most vicious argument offered by the opponents of full CAC had been the role of

free currency convertibility. In the absence of any capital control, no restrictions were kept on capital

outflow, and thus the herd behavior of investor led to economic cash of the entire region.

Thus the Asian currency has taught the following observations and lessons:

1) Most currency crises arise out of prolonged overvalued X-rate regime. As the pressure on the X-

Rate increases, there is an increased volatility of the capital flows as well as of the X-Rate itself. If the

X-rate appreciates too high, the economy’s export sector becomes unviable by losing export-

competitiveness at a global level. Simultaneously, imports become more competitive, thus CAD

increases and becomes unsustainable after a certain limit.

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2) Large and unsustainable levels of external and domestic debt had added to the crises, too. Thus, the

fiscal policies need to be more transparent and forward looking.

3) During the crises, short term flows reacted quickly and negatively. Either receivables were

postponed by debtors and/or payables were accelerated by creditors. Thus BOP situation worsened.

4) Domestic financial institutions need to be strong and resilient to absorb and minimize the shocks so

that the internal ripple effect is least.

5) Gradual CAC is the safest way to adopt. However, even a gradual CAC cannot fully eliminate the

risk of crisis or pressure on forex market.

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CHAPTER 9. FINANCIAL INTEGRATION

The commonly accepted definition of Financial Integration [1] states that all potential participants in a

market:

Are subject to a single set of rules when dealing with financial products and/or services.

Have equal access to this specific set of financial instruments/services.

Are treated equally when they operate in the market.

Alternately, we can classify financial integration into two forms (USAID, 1998):

Horizontal Integration: This relates to the interlinking among domestic financial market segments.

Vertical integration: This refers to integration between domestic market and regional or

international financial markets.

An integrated financial market is characterized by following traits:

Financial markets are efficient (A market is called efficient if the rate prevailing at any point of

time reflects all the existing information available in the market).

Rates are market-determined.

Rates of Return are related to some benchmark/reference rate (such as LIBOR).

There is resource flow from one segment of the market to others. Thus arbitrage

Opportunities are ruled out.

Rates of various financial market segments tend to move in tandem.

The international financial system is in a state of introspection, jolted by several financial crises caused

by violent capital movements over the last two decades. On their part, Indian policy-makers are also in

a state of revisionism and are moving the country to greater capital account openness after several

decades of extensive controls.

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CHAPTER 10. FULL CAPITAL ACCOUNT CONVERTIBILITY- PROS &

CONS

1) An arbitrary (i.e. pre-capital mobility) distribution of capital among different nations is not

necessarily efficient, and all countries, irrespective of whether they borrow or lend, stand to gain from

the reallocation caused by freer capital mobility. National income goes up in the country experiencing

capital outflows due to higher interest incomes, while that in the debtor country increases as the

interest paid is less than the increase in output.

2) Capitalists in the labour-abundant economies tend to lose with a fall in the marginal productivity of

capital, and the opposite happens in labour-scarce countries, so that developing nations, which are

usually capital-scarce, are doubly blessed under unhindered mobility of capital — the inflow of capital

raises the national income and produces a healthy, egalitarian impact on income distribution as well.

3) It is argued that if there is only a small correlation between the returns on investment in different

countries, risk can be reduced by the ownership of income-earning assets across different countries.

Free mobility of capital, thus, helps reduce the risks that each country is subjected to.

4) Finally, it is argued that when full capital account convertibility is in place, government profligacy

and distortionary policies are likely to be followed by currency crises that threaten to make the

government highly unpopular. Therefore, under capital account convertibility, the salubrious effects of

capital mobility are magnified through a change in domestic policy in the right direction.

This rosy picture painted by traditional neo-liberal thinking is sullied when we look at what actually

happened to developing nations that have gone the full-capital account convertibility way in the 1980s

and 1990s.

1) In a widely quoted study, Dani Rodrik (1998) finds little evidence of any significant impact of

capital account convertibility on the growth rate of a country. Worse, a 1999 World Bank survey of 27

capital inflow surges between 1976 and 1996 in 21 emerging market economies found that in about

two-thirds of the cases, there was a banking crisis, currency crisis or twin crises in the wake of the

surge.

2) Since the early 1970s, there have been several crises triggered by speculative capital movements:

the Southern Cone financial crisis in the late 1970s; the Mexican crisis of 1994-95 and the `Tequila

Effect'; the East Asian crisis of 1997; the collapse of the Brazilian real and its impact on the rest of

Latin America; the Russian crisis of 1998 and the Argentine crisis of 2001.

27

Here are the theoretical counter-arguments why full convertibility is correlated with the crises and

why, even otherwise, it is not such a good thing:

1) Contrary to the assumption of the neo-classical model, a large volume of capital inflows into

developing countries has actually been used for speculative purposes rather than for financing

productive investments.

2) Capital account convertibility exposes the economy to all sorts of exogenous impulses generated

through financial channels, as domestic and foreign investors try to shift their funds into or out of a

country. Since financial markets adjust very quickly, even minor disturbances may exacerbate into

major ones.

3) Under flexible exchange rates, capital inflows lead to an appreciation of the domestic currency

directly. On the other hand, in a fixed exchange rate regime, increased capital inflows lead to monetary

expansion and price inflation (unless there is substantial unutilised capacity), which also causes a real

appreciation. In both cases, therefore, capital inflows tend to cause a real appreciation and the

possibility of swollen current account deficits because of cheaper imports and uncompetitive exports

which, if not controlled in time, will lead to loss of confidence and capital flight.

4) Because of the massive volume and high mobility of international capital, it has been observed that

the government tries to play it safe by keeping interest rates high, thus discouraging domestic private

investment. The government also desists from spending on public investment because, through an

expansion in government spending, it could send signals of impending increases in fiscal deficits that

have the potential of destabilising capital markets and inducing capital flight.

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CHAPTER 11. POLICY IMPLICATIONS FOR INDIA

The experience with liberalisation of inward capital flows in India has been similar to the economies of

Latin America and East Asia, only the magnitude of these flows has not been large enough to cause

serious macro and micro management problems.

Based on the experience of other countries, the following issues are of concern for India:

1) Flexibility in exchange rate: To prevent a nominal appreciation because of the capital inflows, the

RBI has been adding billions of dollars to its reserves; the foreign exchange reserves with the RBI are

a whopping $69 billion.

2) However, intervening foreign currency purchases to stabilise the exchange rate and accumulation of

forex reserves have implications for domestic monetary management, which can be seriously impaired

by divided short-term monetary responses during a capital surge.

3) On the other hand, the option of a more flexible exchange rate would cause an appreciation in the

value of the rupee, which may hurt exports.

4) Hence, the usual macroeconomic trilemma (Obstfield, M and A. M Taylor 2001) where only two of

the three objectives of a fixed exchange rate — capital mobility and an activist monetary policy — can

be chosen. Since the government has already liberalised inflows of capital to a large extent, the

authorities could attempt to deal with this problem in one of the following ways: It could begin

relaxing capital controls, allowing individuals to exchange rupees for dollars. Indeed, some piecemeal

measures in this direction have already been taken. But this, perhaps, is a risky proposition.

4) For one thing, the embrace of full convertibility is itself likely to bring more dollars into the country

in the initial phase and add to the existing upward pressure on the rupee. More important, given the

lack of regulatory capacity, such convertibility runs the risk of a future financial crisis that may scuttle

the growth process.

5) Alternatively, the government could tap this opportunity to liberalise imports. Further liberalisation

will stimulate imports and create the necessary demand for dollars, mopping up the excess supply of

dollars and relieving the government of the burden of low-yielding foreign exchange reserves.

6) In as much as the imports are used as inputs for further exports, the move will kill two birds with

one stone — it will relieve the upward pressure on the rupee, and bring the usual efficiency gains. In

this regard, therefore, import liberalisation seems to be a distinctly better option.

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7) Banking and capital market regulatory system: The relatively greater contribution of portfolio

capital towards India's capital account, and the fact that these inflows could increase to significant

levels in the future as India's financial markets get integrated globally, show that an important sphere

of concern is their skilful management to facilitate smooth intermediation.

8) Banks intermediate a substantial amount of funds in India — over 64 per cent of the total financial

assets in the country belong to banks. However, many Indian banks are undercapitalised, and their

balance sheets characterised by large amounts of non-performing assets (NPAs).

9) Unless banking standards are duly brushed up, viable competition introduced and government

interference reduced, it would be reckless to go in for full capital account convertibility, which requires

flexibility, dynamism and foresight in the country's banking and financial institutions.

10) Transparency and discipline in fiscal and financial policies: It is well known that the last thing that

a government wanting to gain the confidence of investors should do is to be fiscally imprudent.

However, New Delhi does not seem to be paying heed to this consideration at all.

The ratio of gross fiscal deficit to GDP (including that of states) increased to 10.4 per cent in 1999-

2000 from 6.2 per cent in 1996-97 and 8.5 per cent in 1998-99, and has hovered around the 10 per cent

figure since then. Such high fiscal deficits can prove to be unsustainable and frighten away investors.

11) Hence, there is an immediate need for putting brakes on government expenditure, and until that has

been satisfactorily done; opening up the capital account fully would carry with it a big risk of sudden

loss of faith of investors and capital flight.

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CHAPTER 12. CONCLUSION

Whatever the apparent theoretical benefits of capital account convertibility, they have not yet been

indicated by the actual empirical evidence; rather, the experience of the countries in the developing

world that have experimented with capital account convertibility has been that of increased market

volatility and financial crises.

Moreover, at least a part of the large inflows of capital into India are a consequence of the recessionary

conditions elsewhere. The country's macroeconomic fundamentals, though better than before, are not

good enough to warrant long-lasting confidence from foreign investors. The reform process is not

proceeding with adequate speed, banks are saddled with large volumes of non-performing assets, the

financial system is not deep or liquid enough and the country ranks high in the list of corrupt nations.

Once the conditions in the rest of the world improve, and the interest rate differentials between India

and the rest of the world narrow further, this capital may move on to greener pastures. Hence, one

cannot bank on the continuous supply of foreign capital to finance whatever outflows occur from the

country.

Therefore, we believe that India should be extremely cautious in liberalising capital outflows any

further.

While it should leave no stone unturned to promote inward FDI, which, because of its very nature, is

less susceptible to sudden withdrawals and also tends to promote productive use of capital and

economic growth, it should be wary of short-term capital flows that have the potential to destabilise

financial markets

The `slow and steady' stance that the RBI has taken towards capital account convertibility is to be

appreciated.

It must be emphasised that only over time will the Indian economy be mature enough to be

comfortable with full capital account convertibility — financial markets will deepen, macroeconomic

and regulatory institutions grow more robust and the government will learn from past mistakes.

The Government would do well to focus at present on the fundamental processes of institutional

development and policy reform because, in the long run, these would serve the country better than an

early move towards full capital account convertibility.

Economists realize that directly jumping into fuller capital account convertibility without taking into

consideration the downside or the disadvantages of the steps could harm the economy.

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The East Asian economic crisis can be a classic example to cite for those who are opposed to fuller

capital convertibility. The further question that should be raised is that why is India so desperate in

pushing ahead with the liberalization agenda. So what if there have been enormous global

developments and developments in the last few years. It should be bore in mind at the very outset that

attracting greater capital inflow into the country can barely provide a reason for greater or full

convertibility. Capital inflows in India are far in excess of what is needed to finance the current

account of the balance of payments. According to the report,

‘During the 2005-2006, the current account deficit has been comfortably financed by the net capital

flows with over U.S. $15 billion added to the foreign exchange reserves.

World Bank has said that embracing CAC without necessary precautions could be absolutely

disastrous. At this stage of the country’s economic growth, fuller convertibility on capital account

cannot be an objective per se, although it can be a step towards creating opportunities in achieving

more goals of economic policies. The major hindrance to fuller convertibility of the rupee is the fiscal

deficit of the centre and the states, which is around 10 percent of GDP, which is grossly high when we

talk of opening a capital account. ‘Opening a country’s capital account when it has unsustainably high

fiscal deficit can be likened to administering polio drops to a child suffering from high fever; it can

prove fatal. It should be clearly bore in mind that until India reaches with a figure of 3 percent of GDP,

it would be imprudent to give a sudden move to fuller convertibility of capital account and which is

not insurmountable, so to say. Though the committee has emphasized on reducing fiscal deficit, as a

necessary condition for fuller convertibility, it has not set a time-map for the same hitherto. Capital

account convertibility should be treated as a process and not an event. The plan for further

convertibility on capital account will depend, however on several factors, as well as on international

developments. The most native but at the same time most fundamental argument put forward for CAC

was that free markets are inherently better than restricted markets. Just as the government should

eliminate barriers to trade, they should also eliminate barriers to the free flow of capital because doing

so leads to better economic performance measured in growth, efficiency and stability. A second

argument was that CAC enhances stability as countries trap into a diversified source of funds. CAC

increases the welfare of domestic investors by allowing them to invest abroad and diversify risk. CAC

is widely regarded as a prestige characteristic of an economy. It gives confidence to the foreign

investors who are assured that anytime they change their mind, they can reconvert local currency back

into foreign currency and take it out. Lots of people assume that a liberal capital account is, by itself, a

desirable objective of economic policy.

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Capital account liberalization leads to the availability of a larger capital stock to supplement domestic

resources and thereby higher growth. To add, CAC allows residents to hold an internationally

diversified portfolio, which reduces the vulnerability of income and wealth to domestic shocks. It is

also argued that CAC has a disciplinary influence on domestic policies. It does not allow monetary

policy to take on an excessive burden of the adjustments. At the same time CAC enhances the

effectiveness of fiscal policy by:

a) Reducing real interest rate applicable to public sector borrowing

b) Bringing about an optimal combination of taxes through a reduction of the inflation tax and in the

rate of other taxes to international levels with beneficial effect for tax revenues

c) Reducing crowding out effect in the access to funds.

On the face of it, CAC seems to be a panacea to all financial problems and bottlenecks. But there is

hardly any empirical evidence and studies to support and substantiate the free flow of capital. Free

mobility of capital exposes a country to both sudden and huge inflows as well as outflows of foreign

capital, which can be potentially destabilizing the economic growth of a country. Thus, it is necessary

for a country to have experienced institutions to deal with such huge flows.

There is no doubt that economic indicators of Indian economy have improved quite a bit since 1997.

But so far as fuller CAC is concerned India has yet to go a long way ahead. International experience

shows that India should be very careful and calibrated while deciding towards fuller CAC.

In general, at this stage of the country’s development, CAC cannot be an objective per se but should be

considered as a means to achieving more fundamental objectives of economic policy.

From what was a nebulous concept a decade ago, could become a reality soon. If satisfied the above

cited problems, CAC could be the logical culmination of India 's journey towards globalization. It

should be carefully determined about whether the risks involved in fuller convertibility of capital

account seems to be greater than the rewards we get from it. To the mind of the researcher at this stage

of the country’s economic development, capital account convertibility cannot be a desired means per

se, but India can step forward by the means of it to maximize more economic goals.

The fact that fuller convertibility has been a subject of fierce debate from past five years and the

reasons in being so has been addressed throughout the course of this paper.

It has been also elaborated that the risks involved in fuller capital account convertibility are much more

that the fruits we get from it.

33

For India is it not the right time to go for full convertibility. Taking into consideration of the Asian

crisis, we need not touch the fire and set an example just like. It must be remembered that the move

towards capital account convertibility calls for a conformist and cautious approach.

The Asian financial crisis sealed the fate of that recommendation but the FM has once again revived

the issue

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CHAPTER 13. BIBLIOGRAPHY

www.iimahd.ernet.in

www.advfn.com

www.bms.co.in

www.gktoday.in

International Finance – Jai Mata Di Tutorials

www.thehindubusinessline.com

www.managementstudyguide.com

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