In this background we will try to discuss Capital Account Convertibility and its way ahead for India.
What is capital account convertibility?
In India, the foreign exchange transactions (transactions in dollars, pounds, or any other currency) are broadly classified into two accounts: current account transactions and capital account transactions. If an Indian citizen needs foreign exchange of smaller amounts, say $3,000, for traveling abroad or for educational purposes, she/he can obtain the same from a bank or a money-changer. This is a “current account transaction”. But, if someone wants to import plant and machinery or invest abroad, and needs a large amount of foreign exchange, say $1 million, the importer will have to first obtain the permission of the Reserve Bank of India (RBI). If approved, this becomes a “capital account transaction”. This means that any domestic or foreign investor has to seek the permission from a regulatory authority, like the RBI, before carrying out any financial transactions or change of ownership of assets that comes under the capital account.
In simple language what this means is that CAC allows anyone to freely move from local currency into foreign currency and back.
Why is CAC such an emotive issue?
CAC is 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 anytime they change their mind they will be able to re-convert local currency back into foreign currency and take out their money.
Why it's better for India to go slow. Pros and cons.
Gains from full mobility:
Those in favor of full capital account convertibility advance these arguments in its favor: •An arbitrary (i.e. without CAC) 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 on account of full Capital Account Convertibility. 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. •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...