The Debate on Capital Account Convertibility in India

Team Name: The conquerors
Institute Name: NMIMS
Team Members:
Name: Jigar Shah Kavitha Rajan
Email: jigar.shahft09@nmims.org kavitha.rajanft09@nmims.org
Phone: 9819952441 99672457453
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The Debate on Capital Account Convertibility in India
Executive Summary
Capital Account Convertibility is considered the hallmark of a developed
economy. CAC, as defined by Tarapore committee is the freedom to convert
local financial assets into foreign financial assets and vice versa at market
determined rates of exchange.
CAC is in line with the classical theory of economics where markets clear itself
and attain equilibrium prices by creating demand for the given supply levels. This
assumes the presence of an invisible hand enabling the market clearance. But
patrons of the Keynesian economics believe that the markets are governed more
by market sentiments than fundamentals in the short term. This short term
perspective of the investors can destabilize the economy and create volatility in
the market. Hence it is important that the country has strong macroeconomic
factors to support the volatility.
In late 1980’s India faced a balance of payment crisis due to fiscal imbalances.
India’s credit rating was downgraded and access to external funds became
bleak. By early 1991, foreign exchange reserves were almost depleted, and India
was on the verge of default. IMF came to the rescue and provided the necessary
funds to pull India out of the crisis. In 1994, as a part of Article VIII of IMF, India
implemented Current Account Convertibility and accepted to implement Capital
Account Convertibility.
Under the supervision of IMF other developing economies had implemented
CAC. They had fixed exchange rate system pegged to the USD. When the Dollar
rose, consequently the ASEAN currencies grew too, resulting in lower exports.
This resulted in a decline in export earnings of these countries and thus
increasing their trade and current account deficit. The crisis first... [continues]

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