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Capital Account Convertibility
India has been relentlessly moving on the path towards liberalization, opening up its markets and loosening its controls over many economic matters so as to integrate with the global economy.
Despite the opposition to globalization from some quarters, India has been quite watchful in its approach to embracing global economy. The issue of capital account convertibility is one such where the nation has tread very cautiously.
A high-level committee to look into this matter, appointed by the Reserve Bank of India, on Friday recommended that India move to fuller capital account convertibility over the next five years and has laid down the roadmap for the move.
So what is capital account convertibility?
To put is simply, capital account convertibility (CAC) -- or a floating exchange rate -- means the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. This means that capital account convertibility allows anyone to freely move from local currency into foreign currency and back.
It refers to the removal of restraints on international flows on a country's capital account, enabling full currency convertibility and opening of the financial system.
A capital account refers to capital transfers and acquisition or disposal of non-produced, non-financial assets, and is one of the two standard components of a nation's balance of payments. The other being the current account, which refers to goods and services, income, and current transfers.
How are capital a/c convertibility and current a/c convertibility different?
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.
Why capital account convertibility?
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.
At the same time, 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.
But economists say that jumping into capital account convertibility game without considering the downside of the step could harm the economy. The East Asian economic crisis is cited as an example by those opposed to capital account convertibility.
Even the World Bank has said that embracing capital account convertibility without adequate preparation could be catastrophic. But India is now on firm ground given its strong financial sector reform and fiscal consolidation, and can now slowly but steadily move towards fuller capital account convertibility.
What is the Tarapore Committee?
The Reserve Bank of India has appointed a committee to set out the framework for fuller Capital Account Convertibility.
The Committee, chaired by former RBI governor S S Tarapore, was set up by the Reserve Bank of India in consultation with the Government of India to revisit the subject of fuller capital account convertibility in the context of the progress in economic reforms, the stability of the external and financial sectors, accelerated growth and global integration.
Economists Surjit S Bhalla, M G Bhide, R H Patil, A V Rajwade and Ajit Ranade were the members of the Committee.
The Reserve Bank of India has also constituted an internal task force to re-examine the extant regulations and make recommendations to remove the operational impediments in the path of liberalisation already in place. The task force will make its recommendations on an ongoing basis and the processes are expected to be completed by December 4, 2006. The Task Force has been set up following a recommendation of the Committee.
The Task Force will be convened by Salim Gangadharan, chief general manager, in-charge, foreign exchange department, Reserve Bank of India, and will have the following terms of reference:
Ð'* Undertake a review of the extant regulations that straddle current and capital accounts, especially items in one account that have implication for the other account, and iron out inconsistencies in such regulations.
Ð'* Examine existing repatriation/surrender requirements in the context of current account convertibility and management of capital account.
Ð'* Identify areas where streamlining and simplification of procedure is possible and remove the operational impediments, especially in respect of the ease with which transactions at the level of authorized entities are conducted, so as to make liberalisation more meaningful.
Ð'* Ensure that guidelines and regulations are consistent with regulatory intent.
Ð'* Review the delegation of powers on foreign exchange regulations between Central Office and Regional offices of the RBI and examine, selectively, the efficacy in the functioning of the delegation of powers by RBI to Authorised Dealers (banks).
Ð'* Consider any other matter of relevance to the above.
The Task Force is empowered to devise its work procedure, constitute working groups in various areas, co-opt permanent/special invitees and meet various trade associations, representative bodies or individuals to facilitate its work. It will make recommendations on an ongoing basis to rectify