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Introduction:

  • Capital Account Convertibility (CAC) refers to the freedom to conduct investment transactions without any restrictions on converting local currency into foreign currency.
  • It allows unrestricted currency conversion for capital inflows and outflows, often termed as Capital Asset Liberalization.

Body:

  • Current Scenario in India:
    • India currently has full convertibility in the current account but only partial convertibility in the capital account.
    • The Tarapore Committee Reports (1997 and 2006) outlined a phased approach towards full CAC, but the process has been gradual and cautious over the past three decades.
  • Merits of Full Capital Account Convertibility:
    • Enhanced Access to International Markets:
      • Full CAC could further liberalize the economy and attract foreign investments.
    • Increased Financial Efficiency:
      • By exposing the financial sector to global competition, full CAC could foster greater specialization and innovation, potentially reducing the cost of capital.
    • Broadened Investment Opportunities:
      • Residents could make investment and consumption decisions based on global interest rates and prices, enhancing their welfare.
      • Example: Indian investors would have the freedom to invest in foreign securities and assets.
    • Risk Hedging:
      • Full CAC would allow investors and savers to diversify their portfolios globally, protecting the real value of their assets.
  • Demerits of Full Capital Account Convertibility:
    • Capital Flight Risk:
      • Speculative activities could lead to significant capital outflows, similar to what occurred in some South-East Asian economies during the 1997-98 financial crisis.
    • Tax Evasion:
      • Full CAC could undermine the government’s ability to tax domestic financial activities, income, and wealth.
    • Inflationary Pressures:
      • Market-determined exchange rates under CAC could increase import prices, leading to cost-push inflation.
    • Economic Disruptions:
      • Mismanagement of CAC could result in currency depreciation, negatively impacting trade and capital flows.

Conclusion:

  • The preconditions for full CAC, as recommended by the Tarapore Committee (e.g., gross fiscal deficit below 3.5% of GDP, stable inflation, low CRR, and gross NPAs below 5%), have yet to be fully achieved in India.
  • Therefore, while the benefits of full CAC are substantial, it is crucial for India to address these preconditions carefully to fully realize the potential advantages of capital account convertibility.
Legacy Editor Changed status to publish May 13, 2025