Capital Account Convertibility

Topics: International economics, Foreign exchange market, Macroeconomics Pages: 34 (10365 words) Published: August 23, 2013




This report has been prepared to discuss the issue of Capital Account Convertibility (CAC) and India’s experience with it. The concept of CAC and its history and its implications has been discussed. The recommendations of the Tarapore Committee (the committee set up for looking into the issue of CAC) have been presented. Lastly, the progress made towards CAC in India and its implications have been discussed.


Continuing on the way of economic liberalization and economic reforms and against the pressure by left and democratic parties, the prime minister announced on March 18, 2006 his government’s resolve to move towards full capital account convertibility of Indian rupee ignoring even the advice of his pro-liberal friends. In order to operationalise this, a committee named as Tarapore II under the leadership of S.S.Tarapore, ex-deputy governor, RBI was constituted by the RBI which commenced its work from May 1, 2006 and has since submitted its report on August 31, 2006 to RBI.

This new report has generated a fresh debate on the fuller capital account convertibility (FCAC) and its real implications, particularly for countries like India. This is more so as the new Tarapore Committee II, have themselves admitted in their report that various countries including European Union still continue with several restrictions on FCAC. Even IMF, which has mooted the idea of changing its Charter to include FCAC in its mandate, has shelved the idea in view of its possible dangers. Moreover, the link between FCAC and growth is yet to be firmly established by any stretch of empirical evidence.

First of all, we should try to gather the meaning of full capital account convertibility, as distinct from partial capital account convertibility or convertibility of current account.


By “Capital Account Convertibility” (or CAC in short), we mean “the freedom to convert the local financial assets into foreign financial assets and vice-versa at market determined rates of exchange. It is associated with the changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by the rest of the world. …” (Report of the Committee on Capital Account Convertibility, RBI, 1997).

It is sometimes also known as Capital Asset Liberation.

In simple language what this means is that CAC allows anyone to freely move from local currency into foreign currency and back. It is basically a policy that allows the easy exchange of local currency (cash) for foreign currency at low rates so that local merchants can easily conduct transnational business without needing foreign currency exchanges to handle small transactions. CAC is mostly a guideline to changes of ownership in foreign or domestic financial assets and liabilities. Tangentially, it covers and extends the framework of the creation and liquidation of claims on, or by the rest of the world, on local asset and currency markets.

It is different from CURRENT ACCOUNT CONVERTIBILITY which 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 other foreign currency for export of goods and services and pays dollars for import of goods and services make sundry remittances, access foreign currency for travel, studies abroad, medical treatment and gifts etc.

As of now, we all are probably aware that the convertibility of Indian rupee into foreign currencies and vice versa is almost wholly free for current account transactions like trade, tourism, travel, education abroad and in India, and remittances into and...

References: 3. ‘Capital account revisited’ Business Line- March 27, 2006.
4. ‘Should India pursue Capital Account Convertibility’ Business Line-March 27, 2006.
5. ‘Capital Account Convertibility is a challenge’ The Times Of India- July 19, 2007.
6. ‘CPM against Full Capital Account Convertibility’ The Times Of India- July 19, 2007.
7. ‘Fuller Capital Account Convertibility: a euphemism for disaster’ People’s Democracy- November 5, 2006.
8. ‘Capital Account Convertibility: Neo-Liberalism’s new threat to India’ People’s Democracy- April 2, 2006.
9. ‘Reject Tarapore panel report, says CPM(M)’ The Hindu- September 5, 2006.
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