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"India is now ready for capital account

convertibility: pros and cons




Group Members: Ritu Sharma ()
Kamalnain Chandhok (58)
Meenal Rastogi (63)
Mridula Raghav (65)
Sagun (107)


CAPITAL ACCOUNT CONVERTIBILITY


Capital account convertibility refers to a policy change that permits capital
to flow more freely in and out of a country.
Capital account convertibility (CAC) refers to the freedom of converting
local financial assets into foreign financial assets and vice versa at market
determined rates of exchange.
Widely regarded as one of the hallmarks of a developed economy. It is also
seen as a major comfort factor for overseas investors since they know that
at anytime they will be able to re-convert local currency back into foreign
currency and take out their money.
\
What?
Types
Partial CAC: It is Restricted CAC. Caps are Specified, Restrictions and Special Approval
in Conversion of Currency.
Full CAC : Full capital account convertibility allows local currency to be exchanged for
foreign currency without any restriction on the amount, movement of funds in and out
of India without any restrictions and `no questions asked' basis.
CAPITAL ACCOUNT CONVERTIBILITY


Example: India, Indian rupee is only partially convertible due to the Indian Central
Banks control over international investments flowing in and out of the country. While
most domestic trade transactions are handled without any special requirements, there
are still significant restrictions on international investing and special approval is often
required in order to convert rupees into other currencies.


Example: USA, In Full CAC anybody could walk into a bank and instruct to transfer
money anywhere (exception will be restricted countries and/or region specified from
time to time) and allow banks to receive funds from any entity from abroad for credit
as per instructions of the remitter.
There are no restrictions or limitations on the amount of dollars that can be traded
on the international market, and the U.S. Government does not artificially impose a
fixed value or minimum value on the dollar in international trade.
Partial Capital Account Convertibility
Full Capital Account Convertibility
When is full CAC possible
Preconditions for introducing full CAC like:

a) Fiscal deficit of the GDP should go down.

b) The annual rate of inflation should remain low and
constant. It was maintained and achieved.

c) The foreign exchange reserves of the country should be
sufficient for six months imports. At present, foreign
exchange reserves are equal to two years import cover.

d) Non-performing assets of banks should not be more than
five percent of the deposits

CAC & Indian Scenario
End of Balance of Payment (BoP) crises
Plenty of Foreign Currency Reserves
Efficiency in Financial System
Development of Securities Market
Worldwide Presence and Friendly Relations
with Trading Counterparts
Committee on Capital Account Convertibility (Tarapore Committee)
A Committee on CAC was set up under the chairmanship of Dr.
Tarapore which submitted its report in May 1997
A roadmap was suggested keeping in view the dangers of
greater capital flows in terms of volatility
Hence, following preconditions were laid down before FCAC
could be attained ,
First, a reduction in the fiscal deficit to gross GDP ratio to 3.5%;
Second, an inflation target of 3-5%;
And lastly, measures to strengthen the financial sector, and
especially the banking sector
Other measures were, ratio of NPAs to advances to be reduced
to 5% and the CRR to 3%.
Reduction in the external debt service ratio to about 20%


Tarapore Committee
Recommendations Contd.
The country has not, however, implemented capital
account convertibility as per the schedule envisaged in the
report. This was due to the Asian currency crisis of 1997
As for now the inflows from abroad have been freed to a
large extent, outflows associated with these inflows, such
as interest, profits, sale proceeds and dividends, are
completely free of any restriction
Current earnings of NRIs like dividends are fully repatriable
The outflows from residents remain more restricted
But direct investment abroad is permissible through joint
ventures and wholly owned subsidiaries
Second Tarapore Committee

The report of this committee was made public by RBI on 1
st

September 2006.
Three phased adoption of CAC scheme:
2006-07 (Phase I)
2007-08 and 2008-09 (Phase II)
2009-10 and 2010-11 (Phase III)
Some of the recommendations of the Committee:-
Ceiling of ECB to be raised for automatic approval
Allow NRIs to invest in capital market
Provide tax benefits to NRI
Prohibit FIIs from investing fresh money raised to participatory
notes