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Bloomberg

De-jargoned: Capital account convertibilityIt means freedom to convert currency, both in terms of outflows and inflows, for capital transactions

Rajesh Kumar

International movement of capital is not al ways free. Controls are

used by the state to insulate the economy from erratic flow of capita

which can lead to financial instability.

In India, for example, there are restrictions on movement of foreign

capital and the rupee is not fully convertible on capital account.

Capital account convertibility (CAC) means freedom to convert

currency, both in terms of outflows and inflows, for capital

transactions. Whether India should allow full convertibility on capita

account is being discussed for some time now. My hope is that we

will get to full capital account convertibility in a short number of

years, said Raghuram Rajan, governor of the Reserve Bank of Ind

(RBI) on 10 April, as reported by PTI.

A BRIEF HISTORY

In the budget speech of 1997-98, the then finance minister P.

Chidambaram argued in favour of laying out a roadmap for capital

account convertibility. I also believe that the time has come for preparatory work towards capital account convertibility. This is a cherished

goal. For the present, I am asking RBI to appoint a group of experts to lay out the road map towards capital account convertibility, prescri

the economic parameters which have to be achieved at each milestone and work out a detailed time table for achieving the goal, said

Chidambaram. Consequently, in 1997, RBI constituted an expert committee.

In absence of a formal definition of CAC, the committee recommended a working definition for its report as: CAC refers to the freedom to

convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. It is associated withchanges of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by, the

rest of the world. CAC can be, and is, coexistent with restrictions other than on external payments. It also does not preclude the imposition o

monetary/fiscal measures relating to foreign exchange transactions which are of a prudential nature.

In 2006, the then Prime Minister, Manmohan Singh, in a speech at RBI, had talked about revisiting the subject. A committee was again

constituted by the central bank to suggest a roadmap for fuller capital account convertibility.

THE PRESENT SITUATION

Capital flows have been liberalized over the years but moving to full CAC requires better macroeconomic management, among other thing

For example, the 1997 committee on CAC recommended bringing down the fiscal deficit to 3.5% of the gross domestic product and inflation

between 3% and 5% (average for three years) by 1999-2000. These conditions are not easily attainable, as both fiscal deficit and inflation

have been on the higher side even in recent years. Without adequate safeguards, full CAC can pose a risk to financial stability, especially

the current global environment.