CHAPTER 1.

INTRODUCTION
Convertibility
Convertibility means the system where anything can be converted into any other stuff without any
question asked about the purpose.
Balance of Payment
Balance of payment (BoP) is a statistical statement that summarizes, for a specific period, transactions
between residents of a country and the rest of the world. BoP positions indicate various signals to
businesses. BoP comprises current account, capital account and financial account.
Signals that the BoP account of a country gives out, for example, large current account transactions
indicate towards openness of an economy. This was the case with India as reduction in trade
restrictions and duties led to increase in both exports and imports after 1991. Also large capital account
transactions may indicate well-developed capital markets of an economy.
Capital and current account balances for India were quite stable between 1991 and 2001. After 2001,
primarily because of increased exports of IT services and transfers, current account balance went into
surplus. But due to increasing imports and an increasing oil bill, it started deteriorating after 2004 and
went into deficit.
Sound fundamentals and a large untapped market coupled with a deregulated regime allowed foreign
investors to invest in India, thereby increasing capital inflows after 2000. However, the global
meltdown has led to an outflow of capital, which has led to a sudden fall in the capital account balance
after 2007.
Reserves were built up over the years mainly because of capital inflows. But a recent deficit in current
account and capital outflow led to a fall in 2008-09.
Healthy BoP positions or surplus in capital and current account keeps confidence in the economy and
among investors. However, healthy BoP positions may be different for different countries. For
example, surplus in current account is often more important for developed countries than surplus in
capital account as most of them have sufficient capital to fund their investments. On the other hand,
developing countries like India may place more importance on capital account as reserves and funding
for investment is crucial for them at present.

Large balances often attract foreign investors into an economy, thus bringing in precious foreign
exchange. Often credit ratings are based on BoP positions, thereby affecting the flows of credit to
businesses. Businesses can make predictions about exchange rates by studying BoP positions. A
healthy BoP position can signal domestic currency appreciation, hence encouraging businesses to
engage in future contracts accordingly. Also, the BoP position influences the decisions of policy
makers, which are crucial for any business.
Indias Balance of Payment
India presently has a deficit in its current account of BoP, which has increased substantially after
reforms in 1991. In 1991-92, current account deficit was $1,178 million, which rose to $17,403 million
in 2007-08, and accounted for $36,469 million for the last three quarters of 2008. After the reforms in
1991, Indias position of merchandise trade (exports and imports of goods) kept on deteriorating, but
its position on invisibles (services, current transfers etc) improved during the period. However, one of
the major factors for increasing current account deficit in the last few years has been a rising oil import
bill. Some countries like Japan and Germany have current account surpluses, while the USA and UK
have deficits.
India has done fairly well on the capital account side. In 2007-08 it had a capital account surplus of
$108,031 million. In the same year it increased its foreign exchange reserves by $92,164 million,
which provided stability to the economy. Foreign investments have increased manifold since 1991,
peaking in 2007-08 to $44,806 million.
Indias overall current account and capital account deficit is $20,380 million for AprilDecember 2008,
which is expected to rise to a figure between $25 and 30 billion by the year ending March 31, 2009.
There has been dip in reserves from $309,723 million in March 2008 to $253,000 million in March
2009. Reasons for this are portfolio flows from foreign institutional investors and the appreciation of
the US dollar. But this may not pose a significant threat to the Indian economy and businesses because
of large pool of reserves that are still providing enough cushion. However, some businesses like those
related to equities and realty are hit when outflows from these sectors occur. Not only is there fall in
asset prices and erosion of investment value, but economic activity also gets reduced in these sectors.
However, recent profitability/growth numbers have indicated signs of a revival. Also political change
and expected stability might bring in foreign exchange and may improve Indias capital account
position and reserves. This may lead to the appreciation of the Indian rupee and may affect exporters

and importers accordingly. At the same time, reserves infuse stability into the system, which in turn has
positive effects on businesses and investments.
Current account convertibility refers to currency convertibility required in the case of transactions
relating to exchange of goods and services, money transfers and all those transactions that are
classified in the current account. On the other hand, capital account convertibility refers to
convertibility required in the transactions of capital flows that are classified under the capital account
of the balance of payments.
Current Account Convertibility
Current account convertibility refers to freedom in respect of Payments and transfers for current
international transactions. In other words, if Indians are allowed to buy only foreign goods and services
but restrictions remain on the purchase of assets abroad, it is only current account convertibility. As of
now, convertibility of the rupee into foreign currencies is almost wholly free for current account i.e. in
case of transactions such as trade, travel and tourism, education abroad etc.
The government introduced a system of Partial Rupee Convertibility (PCR) (Current Account
Convertibility) on February 29, 1992 as part of the Fiscal Budget for 1992-93. PCR is designed to
provide a powerful boost to export as well as to achieve as efficient import substitution. It is designed
to reduce the scope for bureaucratic controls, which contribute to delays and inefficiency. Government
liberalized the flow of foreign exchange to include items like amount of foreign currency that can be
procured for purpose like travel abroad, studying abroad, engaging the service of foreign consultants
etc. What it means that people are allowed to have access to foreign currency for buying a whole range
of consumables products and services. These relaxations coincided with the liberalization on the
industry and commerce front which is why we have Honda City cars, Mars chocolate and Bacardi in
India.
Capital Account Convertibility
There is no formal definition of capital account convertibility (CAC). The Tarapore committee set up
by the Reserve Bank of India (RBI) in 1997 to go into the issue of CAC defined it as the freedom to
convert local financial assets into foreign financial assets and vice versa at market determined rates of
exchange.
In simple language what this means is that CAC allows anyone to freely move from local currency into
foreign currency and back.

CHAPTER 2. COMPONENTS OF CURRENT ACCOUNT

Covered in the current account are all transactions (other than those in financial items) that involve
economic values and occur between resident non-resident entities. Also covered are offsets to current
economic values provided or acquired without a quid pro quo. Specifically, the major classifications
are goods and services, income, and current transfers.
Goods
General merchandise covers most movable goods that residents export to, or import from, non
residents and that, with a few specified exceptions, undergo changes in ownership (actual or imputed).
Structure and Classification
Goods for processing covers exports (or, in the compiling economy, imports) of goods crossing the
frontier for processing abroad and subsequent re-import (or, in the compiling economy, export) of the
goods, which are valued on a gross basis before and after processing. The treatment of this item in the
goods account is an exception to the change of ownership principle.
Repairs on goods covers repair activity on goods provided to or received from non residents on ships,
aircraft, etc. repairs are valued at the prices (fees paid or received) of the repairs and not at the gross
values of the goods before and after repairs are made.
Goods procured in ports by carriers covers all goods (such as fuels, provisions, stores, and supplies)
that resident/nonresident carriers (air, shipping, etc.) procure abroad or in the compiling economy. The
classification does not cover auxiliary services (towing, maintenance, etc.), which are covered under
transportation.
Nonmonetary gold covers exports and imports of all gold not held as reserve assets (monetary gold) by
the authorities. Nonmonetary gold is treated the same as any other commodity and, when feasible, is
subdivided into gold held as a store of value and other (industrial) gold.
Services
Transportation covers most of the services that are performed by residents for nonresidents (and vice
versa) and that were included in shipment and other transportation in the fourth edition of the Manual.
However, freight insurance is now included with insurance services rather than with transportation.
Transportation includes freight and passenger transportation by all modes of transportation and other
distributive and auxiliary services, including rentals of transportation equipment with crew.
4

Travel covers goods and servicesincluding those related to health and educationacquired from an
economy by nonresident travelers (including excursionists) for business and personal purposes during
their visits (of less than one year) in that economy. Travel excludes international passenger services,
which are included in transportation. Students and medical patients are treated as travelers, regardless
of the length of stay. Certain othersmilitary and embassy personnel and nonresident workersare
not regarded as travelers. However, expenditures by nonresident workers are included in travel, while
those of military and embassy personnel are included in government services.
Communications services cover communications transactions between residents and nonresidents.
Such services comprise postal, courier, and telecommunications services (transmission of sound,
images, and other information by various modes and associated maintenance provided by/for residents
for/by non residents).
Construction services covers construction and installation project work that is, on a temporary basis,
performed abroad/in the compiling economy or in extra territorial enclaves by resident/nonresident
enterprises and associated personnel. Such work does not include that undertaken by a foreign affiliate
of a resident enterprise or by an unincorporated site office that, if it meets certain criteria, is equivalent
to a foreign affiliate.
Insurance services cover the provision of insurance to non residents by resident insurance enterprises
and vice versa. This item comprises services provided for freight insurance (on goods exported and
imported), services provided for other types of direct insurance (including life and non-life), and
services provided for reinsurance.
Financial services (other than those related to insurance enterprises and pension funds) cover financial
intermediation services and auxiliary services conducted between residents and nonresidents. Included
are commissions and fees for letters of credit, lines of credit, financial leasing services, foreign
exchange transactions, consumer and business credit services, brokerage services, underwriting
services, arrangements for various forms of hedging instruments, etc. Auxiliary services include
financial market operational and regulatory services, security custody services, etc.
Computer and information services covers resident/nonresident transactions related to hardware
consultancy, software implementation, information services (data processing, data base, news agency),
and maintenance and repair of computers and related equipment.
Royalties and license fees covers receipts (exports) and payments (imports) of residents and nonresidents for (i) the authorized use of intangible non produced, nonfinancial assets and proprietary
rightssuch as trademarks, copyrights, patents, processes, techniques, designs, manufacturing rights,
5

franchises, etc. and (ii) the use, through licensing agreements, of produced originals or prototypes
such as manuscripts, films, etc.
Other business services provided by residents to nonresidents and vice versa cover merchanting and
other trade-related services; operational leasing services; and miscellaneous business, professional, and
technical services.
Personal, cultural, and recreational services covers (i) audiovisual and related services and (ii) other
cultural services provided by residents to non-residents and vice versa. Included under (i) are services
associated with the production of motion pictures on films or video tape, radio and television
programs, and musical recordings. (Examples of these services are rentals and fees received by actors,
producers, etc. for productions and for distribution rights sold to the media.) Included under (ii) are
other personal, cultural, and recreational servicessuch as those associated with libraries, museums
and other cultural and sporting activities.
Government services i.e. covers all services (such as expenditures of embassies and consulates)
associated with government sectors or international and regional organizations and not classified under
other items.
Income
Compensation of employees covers wages, salaries, and other benefits, in cash or in kind, and includes
those of border, seasonal, and other non-resident workers (e.g., local staff of embassies).
Investment income covers receipts and payments of income associated, respectively, with residents
holdings of external financial assets and with residents liabilities to nonresidents. Investment income
consists of direct investment income, portfolio investment income, and other investment income. The
direct investment component is divided into income on equity (dividends, branch profits, and
reinvested earnings) and income on debt (interest); portfolio investment income is divided into income
on equity (dividends) and income on debt (interest); other investment income covers interest earned on
other capital (loans, etc.) and, in principle, imputed income to households from net equity in life
insurance reserves and in pension funds.

Current transfers
Current transfers are distinguished from capital transfers, which are included in the capital and
financial account in concordance with the SNA treatment of transfers. Transfers are the offsets to
changes, which take place between residents and nonresidents, in ownership of real resources or
financial items and, whether the changes are voluntary or compulsory, do not involve a quid pro quo in
economic value.
Current transfers consist of all transfers that do not involve
a. transfers of ownership of fixed assets;
b. transfers of funds linked to, or conditional upon, acquisition or disposal of fixed assets;
c. forgiveness, without any counterparts being received in return, of liabilities by creditors.
All of these are capital transfers.
Current transfers include those of general government (e.g., current international cooperation between
different governments, payments of current taxes on income and wealth, etc.), and other transfers (e.g.,
workers remittances, premiumsless service charges, and claims on non-life insurance).

CHAPTER 3. COMPONENTS OF CAPITAL ACCOUNT

1. Foreign Investment(FDI, FII)
2. Banking Capital (NRI Deposits)
3. Short term credit
4. External Commercial Borrowings(ECB)

CHAPTER 4. CURRRENT ACCOUNT CONVERTIBILITY

Current account convertibility opens up the domestic economy to foreign capital. Foreign capital
augments

investible

resources

of

the

home

country

and

facilitates

faster

growth.

Cost of capital for domestic firms is lowered and access to global capital markets is enhanced. Just as
there are gains from international trade in goods and services, there are gains from trade in financial
assets. It allows residents to hold globally diversified portfolios improving their risk return trade off. It
lowers the funding cost for resident borrowers.
Economists talk of capital output ratio. In order for the GDP to grow at 8-9 percent, 25 percent more
investment is required. Twenty to 25 percent of the countrys gross income should be invested in
various infrastructural assets. Indias investment rate has not been more than 20-25 percent of GDP at
best of times. The remaining five to six percent must come from foreign investments otherwise we will
not be able to achieve a high growth rate. Our savings rate should be 32-34 percent but in actuality it is
only 26 percent. The gap has to be filled by foreign investment.
Take the case of Japan, Scandinavia and Europethere the opportunities for investment are limited.
They are looking for more attractive investments abroad which will give say, eight percent return as
against the three percent they get in their own country. So money is lying idle in those countries.
Developing countries are short of funds; therefore, the opening up of capital account does augment the
investible resources of the home country. Our companies can access the capital and their cost of capital
will come down. If we are to rely only on domestic capital, the cost would be high. Some investments
will simply not be undertaken.
Export and import of goods and services is good for the welfare of all countries engaged in it. For
example, software services from India, we do it much better than developed countries. But we have to
import a lot of goods either because other countries produce it better. Then why not apply the same
logic to capital. The major fear is not only about foreigners investing here but what if domestic
investors start investing abroad. But why should they do it. As a wise investor, who will be tempted to
invest abroad and earn three percent when the same investment can yield eight percent in the domestic
market? Why should you park your investments abroad if the rate of return is low? Rate of return on
investment has come to two percent in Japan.

In India it is 4.6 percent. Unless we fear a massive crisiseither a political or economic collapse, the
fear about capital account convertibility is not justified. Our political system is working well,
government is functioning well, and no major political crises are also foreseen? We also do not expect
an economic crisis as in Thailand. Foreign capital in India constitutes a very small part of the total
capital. Particularly short term capital that has a maturity of six month. That constitutes a much small
portion. Even if all of that leaves tomorrow, Indian economy is not going to collapse. Our total foreign
debt as a percentage of GDP is very small. Short term debt component in that is still smaller. So this
fear about taking foreign capital away from India if capital account convertibility comes is totally
unjustified. Today India and China offer the best investment opportunity globally in manufacturing,
services and infrastructure. Because of wrong policies in power, roads, ports, investments are not
flowing in. Current account convertibility also means, competition among financial intermediaries,
improves efficiency, cuts transaction costs, deepen financial markets.
Specialisation in financial services guided by core competence may be increased, increasing allocative
efficiency. Capital account convertibility imposes certain disciplines on federal, state governments and
policy makers. Domestic tax regimes and other fiscal parameters must converge to international
standards to prevent capital flight from home. Competition is the best way to increase efficiency in
public sector banks and other private banks. Our banking sector requires a dose of competition. Banks,
investment companies, mutual funds and insurance sector will only benefit from competition.
Capital accounts convertibility will also lead to specialization in products offered by banks. It also puts
a cap on uncontrolled budget deficits, uncontrolled government expenditure thereby putting certain
discipline in the Finance Ministry.
Large deficits show up on current account as debits and running up large current account deficits will
lose the confidence of foreign investors in meeting our liabilities. When there is current account
deficit, it means imports are more than exports. In normal situations it should not exceed 1.5-2 % of
GDP. Anything beyond that is not sustainable and quite dangerous also. In Thailand, the current
account deficit for three years was nine percent of GDP. If we have to keep current account under
control then budget deficits should also be under control. They must raise more resources by way of
taxation not by way of borrowing. Borrowing creates problems for the future as interest burden will
increase. Large deficits will also lead to depreciation of currency. Imposes discipline on domestic
macroeconomic policy making. Monetary policy must work within the constraints of uncovered
interest rate regime must be in tandem with what is happening and cannot be arbitrary.

10

Right now the countrys capacity to attract foreign capital is substantial. Once the capital account is
convertible then the monetary policy, interest rate policy, fiscal policy must converge to international
standards a there cannot be any undue restriction on flow of money.
Financial markets will become volatile with interest rates, exchange rates fluctuating every minute.
Banks, companies, individuals will have to learn to live with it. Financial derivatives have been
evolved to manage these volatilities. Financial products to hedge the risks have to be in place.
When foreign capital flows freely in the country in times of a political or economic crisis it can be
taken back as freely by investors. In crisis times, every investor is not rational. They follow a herd
mentality. The remedy for this is prudent economic management, prudent political management, but
keeping political capital out is not the answer.

11

CHAPTER 5. CAPITAL ACCOUNT CONVERTIBILITY

Capital Account Convertibility (CAC) means freedom to convert domestic financial assets into
overseas financial assets at market-determined rates. Simply put, the regime of full convertibility
allows any Indian resident to go to a foreign exchange dealer or bank and freely convert rupees into
dollars, pounds or Euros to acquire assets abroad. The overseas assets can be anything; equity, bonds,
property or ownership of overseas firms.
It refers to the abolition of all limitations with respect to the movement of capital from India to
different countries across the globe. In fact, the authorities officially involved with CAC (Capital
Account Convertibility) for Indian Economy encourage all companies, commercial entities and
individual countrymen for investments, divestments, and real estate transactions in India as well as
abroad. It also allows the people and companies not only to convert one currency to the other, but also
free cross-border movement of those currencies, without the interventions of the law of the country
concerned.
Capital Account convertibility in its entirety would mean that any individual, be it Indian or Foreigner
will be allowed to bring in any amount of foreign currency into the country. Full convertibility also
known as Floating rupee means the removal of all controls on the cross-border movement of capital,
out of India to anywhere else or vice versa. Capital account convertibility or CAC refers to the
freedom to convert local financial assets into foreign financial assets or vice versa at marketdetermined rates of interest. If CAC is introduced along with current account convertibility it would
mean full convertibility.
Complete convertibility would mean no restrictions and no questions. In general, restrictions on
foreign currency movements are placed by developing countries which have faced foreign exchange
problems in the past is to avoid sudden erosion of their foreign exchange reserves which are essential
to maintain stability of trade balance and stability in their economy. With Indias forex reserves
increasing steadily, it has slowly and steadily removed restrictions on movement of capital on many
counts.
The last few steps as and when they happen will allow an Indian individual to invest in Microsoft or
Intel shares that are traded on NASDAQ or buy a beach resort on Bahamas or sell home or small
industry and invest the proceeds abroad without any restrictions.

12

Accounting of total inflow and outflow of Funds is as follows: Increase in foreign ownership of domestic assets Increase of domestic ownership of foreign
assets = FDI + Portfolio Investment + Other investments.
At present, there are limits on investment by foreign financial investors and also caps on FDI ceiling in
most sectors, for example, 74% in banking and communication, 49% in insurance, 0% in retail, etc.
Need for Capital Account Convertibility
1.

Capital account convertibility is considered to be one of the major features of a developed

economy. It helps attract foreign investment. It offers foreign investors a lot of comfort as they can
re-convert local currency into foreign currency anytime they want to and take their money away.

2.

Capital account convertibility makes it easier for domestic companies to tap foreign markets. At
the moment, India has current account convertibility. This means one can import and export goods
or receive or make payments for services rendered. However, investments and borrowings are
restricted.

3.

It also helps in the efficient appropriation or distribution of international capital in India. Such
allocation of foreign funds in the country helps in equalizing the capital return rates not only across
different borders, but also escalates the production levels. Moreover, it brings about a fair allocation
of the income level in India as well.

4.

For countries that face constraints on savings and capital can utilise such flows to finance their
investment, which in turn stokes economic growth.

5.

Local residents would be in a position to diversify their portfolio of assets, which helps them
insulate themselves, better from the consequences of any shocks in the domestic economy.

6.

For global investors, capital account convertibility helps them to seek higher returns by sharing
risks.

7.

It also offers countries better access to global markets, besides resulting in the emergence of
deeper and more liquid markets.

13

8.

Capital account convertibility is also stated to bring with it greater discipline on the part of
governments in terms of reducing excess borrowings and rendering fiscal discipline.

Capital Convertibility and its effects on India

As most of us know, resident Indians cannot move their money abroad freely. That is, one has to
operate within the limits specified by the Reserve Bank of India and obtain permission from RBI for
anything concerning foreign currency.
For example, the annual limit for the amount you are allowed to carry on a private visit abroad is
$10,000: of which only $5,000 can be in cash. For business travel, the yearly limit is $25,000.
Similarly, you can gift or donate up to $5,000 in a year.
The RBI raises the limit if you are going abroad for employment, or are emigrating to another country,
or are going for studies abroad: the limit in both these cases is $100,000.
You are also allowed to invest into foreign stock markets up to the extent of $25,000 in a year.
For the average Indian, these 'limits' seem generous and might not affect him at all. But for heavy
spenders and those with visions of buying a house abroad or a Van Gogh painting, it will mean a lot.
But with the markets opening up further with the advent of capital account convertibility, one would be
able to look forward to more and better goods and services.
Evolution of CAC in India economic and financial scenarios
In early 1990s India was facing foreign reserve crisis, the foreign reserves were only sufficient to pay
off two weeks import; therefore India was forced to liberalize the economy. In 1994 August, the Indian
economy adopted the present form of Current Account Convertibility, compelled by the International
Monetary Fund (IMF) Article No. VII. The primary objective behind the adoption of CAC in India was
to make the movement of capital and the capital market independent and open. This would exert less
pressure on the Indian financial market. The proposal for the introduction of CAC was present in the
recommendations suggested by the Tarapore Committee appointed by the Reserve Bank of India.
Benefits of CAC

14

1) It leads to more inflow of capital into domestic financial system. Thus firms have access to more
capital, and this reduces their cost of capital. A reduced COC induces firms to invest more, expand
more and thus output, employment and income expand in medium- to long-run.
2) Full CAC leads to freedom to trade in financial assets. Investors can choose from a wider range of
financial products across multiple countries.
3) Entry of foreign financial institutions results in eventual efficiency in domestic financial system,
since such entry increases the number of players in the market, and fosters competition. In some cases,
the market could see a transition from the near-monopoly to near-perfectly competitive market. In
order to survive stiffer competition, (domestic) firms are forced to become more efficient. This also
ensures compliance with international standards of reporting, disclosure and best practices.
4) As a consequence of full CAC, tax levels converge to international levels.
5) As more capital flows in, domestic interest rates are reduced, thus cost of governments domestic
borrowing is reduced, and so fiscal deficit shrinks.
Disadvantages of CAC
1) An open capital account causes an export of domestic savings abroad, to more attractive
destinations. In capital-starved countries, such outbound savings flight can be ill afforded.
2) Increased capital inflows also lead to appreciation of real exchange rate. It shifts resources from
tradable to non-tradable sectors.
3) Premature liberalization and CAC lead to an initial stimulation of capital outflows, which by
appreciating the real exchange rate, destabilizes the economy.
4) Another possible side-effect is generation of financial bubbles. A sudden burst could replicate the
Asian crisis once again.
5) But the oft-cited argument against CAC is concerning movements of short-term capital. It is
considered to be extremely volatile, highly sensitive to domestic and/or international economic,
political and financial events, and once such an event starts, the extent increases as in a chain-reaction
such investors invest their capital only lured by the prospect of short-term windfall gains
precipitated by interest-rate differentials (in most cases). And once some investors withdraw their
capital, the herd mentality is displayed other arms length investors also follow suit and withdraw
their money. This is known as capital flight. Once capital flight takes place, international investors
lose confidence on the host countrys economy. Creditworthiness diminishes, too.

15

And the most dangerous consequence of capital flight is that the government has to deploy its Forex
Reserves to the investors who withdraw the capital, and this brings the domestic economy to a highly
vulnerable state. This may well start a financial disruption and/or currency crisis.

It may be noted that full capital account convertibility doesnt necessarily lead to a financial crisis, but
it makes the country in question more susceptible to such crises. The symptoms of such financial
vulnerability are: Inadequate capital base, large bad loans (NPA), inappropriate risk management
techniques and (politically) connected lending.
Countries where such symptoms exist should exercise utmost caution while deciding whether or not to
adopt Full CAC, since these are most vulnerable to any shock, and take more time to recover from any
external threat.

16

CHAPTER 6. TARAPORE COMMITTEE

Tarapore Committee-I
The first Tarapore committee report on capital account convertibility (CAC), which came out in May
1997, wanted CAC to be phased in over three years (1997-2000). The five-member committee has
recommended a three-year time frame for complete convertibility by 1999-2000. The highlights of the
report including the preconditions to be achieved for the full float of money are as follows: Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5 per cent in 1997-98 to
3.5% in 1999-2000.
A consolidated sinking fund has to be set up to meet government's debt repayment needs; to be
financed by increased in RBI's profit transfer to the govt. and disinvestment proceeds.
Inflation rate should remain between an average 3-5 per cent for the 3-year period 1997-2000
Gross NPAs of the public sector banking system needs to be brought down from the present 13.7%
to 5% by 2000. At the same time, average effective CRR needs to be brought down from the
current 9.3% to 3%.
RBI should have a Monitoring Exchange Rate Band of plus minus 5% around a neutral Real
Effective Exchange Rate RBI should be transparent about the changes in REER.
External sector policies should be designed to increase current receipts to GDP ratio and bring
down the debt servicing ratio from 25% to 20%.
Tarapore Committee -II
In the Year 2006 under Manmohan Singh Government the Tarapore Committee reappointed to give
suggestion on adoption of Fuller Capital Account Convertibility (FCAC). The Committee has given
the following recommendation and the whole process was divided into 3 phases:
Phase - I (2006-07)
Phase - II (2007-09)
Phase - III (2009-11)
Tarapore-II makes wide-ranging recommendations on the strengthening of the banking sector. At
times, it appears to over-step its brief. It is one thing to argue that governments holdings in public
sector banks should be brought down to 33% as this would help banks augment their capital

17

18

CHAPTER 7. FULLER CAPITAL ACCOUNT CONVERTIBILITY

Capital Account convertibility in its entirety would mean that any individual, be it Indian or Foreigner
will be allowed to bring in any amount of foreign currency into the country.
Full convertibility also known as Floating rupee means the removal of all controls on the cross-border
movement of capital, out of India to anywhere else or vice versa.
Capital account convertibility or CAC refers to the freedom to convert local financial assets into
foreign financial assets or vice versa at market-determined rates of interest. If CAC is introduced along
with current account convertibility it would mean full convertibility.
Complete convertibility would mean no restrictions and no questions. In general, restrictions on
foreign currency movements are placed by developing countries which have faced foreign exchange
problems in the past is to avoid sudden erosion of their foreign exchange reserves which are essential
to maintain stability of trade balance and stability in their economy. With Indias Forex reserves
increasing steadily, it has slowly and steadily removed restrictions on movement of capital on many
counts.
Capital account convertibility means that an investor is allowed to move freely from the local currency
to a foreign currency. India has limited capital account convertibility to prevent shocks to the capital
account and maintain a stable exchange rate, by stipulating sectoral norms that ensure a lock-in period
for investments.

FDI Norms
The press notes simplify the method for calculating FDI and broadly state that as long as Indian
promoters hold a majority stake (more than 51 per cent) in any operating-cum-investing company, it
can bring investment up to 49.9 per cent through FDI. This company would be treated as an Indian
company and it can invest through a joint venture in any other company that may be engaged in
industries in which FDI has a sectoral limit.
Several companies like retailer Pantaloon and media house UTV have restructured their organizations
to raise FDI in their businesses through step-down joint ventures FDI is prohibited in multi-brand
retail and is restricted to 26 per cent for media

19

In one sweep, therefore, any sectoral cap of 49 per cent and below has become meaningless in so far as
downstream investment by a company with foreign investment below 50 per cent and qualifying as an
Indian owned and controlled company, the DEA argued in a letter, sources said.
Such a company can apply for cable TV operations (49 per cent cap), FM broadcasting license (20 per
cent cap), licensed defence items manufacture (26 per cent cap), printing news papers (26 per cent cap)
up linking TV news channels (26 per cent cap) etc. Whether this stance has been approved as such or is
an unintended liberalisation is not clear, the DEA letter said.

Objectives

Economic Growth: The Introduction of FCAC will help in the economic development of the
country through capital investment in the country. This leads to employment generation in the
country, infrastructure development, global competition etc.

Improvement in Financial Sector: There would be improvement in the financial sector as huge
capital flow into the system, which will help the companies to perform better. It will boost liquidity
into the system.

Diversification of Investment: It will also help in the diversification of Investment by ordinary

people, wherein they can invest abroad without any restriction and diversify their portfolio.

Risks Involved In FCAC

Market Risk

Credit Risk

Liquidity Risk

Derivative Transaction Risk

Operational Risk

Market risks such as interest rate and foreign exchange risks become more complex as financial
institutions and corporates gain access to new securities and markets, and foreign participation changes
the dynamics of domestic markets. For instance, banks will have to quote rates and take unhedged
open positions in new and possibly more volatile currencies. Similarly, changes in foreign interest rates
will affect banks interest sensitive assets and liabilities. Foreign participation can also be a channel
through which volatility can spill-over from foreign to domestic markets.
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21

Credit risk will include new dimensions with cross-border transactions. For instance, transfer
risk will arise when the currency of obligation becomes unavailable to borrowers. Settlement risk
(or Herstatt risk) is typical in foreign exchange operations because several hours can elapse
between payments in different currencies due to time zone differences. Cross-border transactions
also introduce domestic market participants to country risk, the risk associated with the economic,
social, and political environment of the borrowers country, including sovereign risk.
With FCAC, liquidity risk will include the risk from positions in foreign currency denominated
assets and liabilities. Potentially large and uneven flows of funds, in different currencies, will
expose the banks to greater fluctuations in their liquidity position and complicate their assetliability management as banks can find it difficult to fund an increase in assets or accommodate
decreases in liabilities at a reasonable price and in a timely fashion.
Risk in derivatives transactions becomes more important with capital account convertibility as
such instruments are the main tool for hedging risks. Risks in derivatives transactions include
both market and credit risks. For instance, OTC derivatives transactions include counterparty
credit risk. In particular, counterparties that have liability positions in OTC derivatives may not be
able to meet their obligations, and collateral may not be sufficient to cover that risk. Collecting
and analyzing information on all these risks will become more challenging with FCAC because
the number of foreign counterparts will increase and their nature change.
Operational risk may increase with FCAC.4 For instance; legal risk stemming from the
difference between domestic and foreign legal rights and obligations and their enforcements
becomes important with fuller capital account convertibility. For instance, differences in
bankruptcy codes can complicate the assessment of recovery values. Similarly, differences in the
legal treatment of secured transactions for repos can lead to unanticipated loss.
Regulatory issues include the risk of regulatory arbitrage as differences in regulatory and
supervisory regimes among countries may create incentives for capital to flow from countries
with higher standards to those with lower ones. FCAC can also bring a proliferation of new
instruments and market participants, complicating the task of financial supervisors and regulators.
The entry of large and complex institutions operating in different countries will increase the need
for cooperation and coordination between domestic regulatory and supervisory agencies and also
with their foreign counterparts.

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Challenges in Adopting FCAC

Risk Management

Interest Rate & Liquidity Risk Management

Derivative Risk Management

o To better manage liquidity risk, the report recommends that banks monitor their liquidity position
at the head/corporate office level on a global basis, including both at the domestic and foreign
branches. In addition the liquidity positions should be monitored for each currency.
o Regarding market risk, the report recommends that banks adopt a duration gap analysis and
consider setting appropriate internal limits on their interest rate risk exposures. The Tarapore
report also suggests that the RBI link the open position limits to banks capacity to manage foreign
exchange risk as well as their unimpaired Tier I capital.
o Banks will require more derivatives instruments to mitigate the possible risks from fuller capital
account convertibility. These should include interest rate futures and options, credit derivatives,
commodity derivatives, and equity derivatives, which are not effectively available to banks at the
moment. The RBI should, however, put in place the appropriate infrastructure, including a robust
accounting framework; a robust independent risk management framework in banks, including an
appropriate internal control mechanism; appropriate senior management oversight and
understanding of the risks involved; comprehensive guidelines on derivatives, including prudential
limits wherever necessary; and appropriate and adequate disclosures. prudential limits wherever
necessary; and appropriate and adequate disclosures.

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CHAPTER 8. CURRENCY CRISIS

Emerging Market Economies (EME)

The East Asian currency crisis began in Thailand in late June 1997 and afflicted other countries
such as Malaysia, Indonesia, South Korea and the Philippines and lasted up to the last quarter of
1998. The major macroeconomic causes for the crisis were identified as: current account
imbalances with concomitant savings-investment imbalance, overvalued exchange rates, high
dependence upon potentially short-term capital flows. These macroeconomic factors were
exacerbated by microeconomic imprudence such as maturity mismatches, currency mismatches,
moral hazard behaviour of lenders and borrowers and excessive leveraging.

The Mexican crisis in 199495 was caused by weaknesses in Mexico's economic position from an
overvalued exchange rate and current account deficit at 6.5 per cent of Gross Domestic Product
(GDP) in 1993, financed largely by short-term capital inflows.

Brazil was suffering from both fiscal and balance of payments weaknesses and was affected in the
aftermath of the East Asian crisis in early 1998 when inflows of private foreign capital suddenly
dried up. After the Russian crisis in 1998, capital flows to Brazil came to a halt.

Difficulties in meeting huge requirements for public sector borrowing in 1993 and early 1994, led
to Turkey's currency crisis in 1994. As a result, output fell by 6 percent; inflation rose to three-digit
levels, the central bank lost half of its reserves, and the exchange rate depreciated by more than 50
per cent. Turkey faced a series of crisis again beginning 2000 due to a combination of economic and
noneconomic factors.

Some Lessons from Currency Crisis in Emerging Market Economies:

Most currency crises arise out of prolonged overvalued exchange rates, leading to unsustainable
current account deficits. As the pressure on the exchange rate mounts, there is rising volatility of
flows as well as of the exchange rate itself. An excessive appreciation of the exchange rate causes
exporting industries to become unviable, and imports to become much more competitive, causing
the current account deficit to worsen.

Large unsustainable levels of external and domestic debt directly led to currency crises. Hence, a
transparent fiscal consolidation is necessary and desirable, to reduce the risk of currency crisis.

24

Short-term debt flows react quickly and adversely during currency crises. Receivables are
typically postponed, and payables accelerated, aggravating the balance of payments position.

CAC and South-East Asian Crisis

The Asian Crisis of 1997-98 originated from Thailand. The Baht was at that time pegged with US
Dollar. As dollar appreciated, so did Baht, and exports decreased, export competitiveness also reduced,
leading to increased current account deficit and trade deficit. Thailand was heavily reliant on foreign
debt with its huge CAD being dependent on foreign investment to stay afloat. Thus there was an
increased forex risk.
As US increased its domestic interest rate, the investors started investing more in the US. It led to
capital flight. Forex reserves rapidly depleted, and the Thai economy tumbled down. At this juncture,
Thai government decided to dissociate Baht from the US currency and floated Baht. Concurrently, the
export growth in Thailand slowed down visibly.
Combination of these factors led to heavy demand for the foreign currency, causing a downward
pressure on Baht. Asset prices also decreased. But, that time Thailand was dominated by crony
capitalism, so credit was widely available. This resulted in hike of asset prices to an unsustainable
level and as asset prices fell, there was heavy default on debt obligations. Credit withdrawal started.
This crisis spread to other countries as a contagion effect. The exchange markets were flooded with the
crisis currencies as there were few takers. It created a depreciative pressure on the exchange rate. To
prevent currency depreciation, the governments were forced to hike interest rates and intervene in
forex markets, buying the domestic currencies with their forex reserves. However, an artificially high
interest rate adversely affected domestic investment, which spread to GDP, which declined, and
eventually economies crashed.
In this backdrop, the most vicious argument offered by the opponents of full CAC had been the role of
free currency convertibility. In the absence of any capital control, no restrictions were kept on capital
outflow, and thus the herd behavior of investor led to economic cash of the entire region.
Thus the Asian currency has taught the following observations and lessons:
1) Most currency crises arise out of prolonged overvalued X-rate regime. As the pressure on the XRate increases, there is an increased volatility of the capital flows as well as of the X-Rate itself. If the
X-rate appreciates too high, the economys export sector becomes unviable by losing exportcompetitiveness at a global level. Simultaneously, imports become more competitive, thus CAD
increases and becomes unsustainable after a certain limit.
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2) Large and unsustainable levels of external and domestic debt had added to the crises, too. Thus, the
fiscal policies need to be more transparent and forward looking.
3) During the crises, short term flows reacted quickly and negatively. Either receivables were
postponed by debtors and/or payables were accelerated by creditors. Thus BOP situation worsened.
4) Domestic financial institutions need to be strong and resilient to absorb and minimize the shocks so
that the internal ripple effect is least.
5) Gradual CAC is the safest way to adopt. However, even a gradual CAC cannot fully eliminate the
risk of crisis or pressure on forex market.

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CHAPTER 9. FINANCIAL INTEGRATION

The commonly accepted definition of Financial Integration [1] states that all potential participants in a
market:
Are subject to a single set of rules when dealing with financial products and/or services.
Have equal access to this specific set of financial instruments/services.
Are treated equally when they operate in the market.
Alternately, we can classify financial integration into two forms (USAID, 1998):
Horizontal Integration: This relates to the interlinking among domestic financial market segments.
Vertical integration: This refers to integration between domestic market and regional or
international financial markets.
An integrated financial market is characterized by following traits:
Financial markets are efficient (A market is called efficient if the rate prevailing at any point of

time reflects all the existing information available in the market).

Rates are market-determined.
Rates of Return are related to some benchmark/reference rate (such as LIBOR).
There is resource flow from one segment of the market to others. Thus arbitrage
Opportunities are ruled out.
Rates of various financial market segments tend to move in tandem.

The international financial system is in a state of introspection, jolted by several financial crises caused
by violent capital movements over the last two decades. On their part, Indian policy-makers are also in
a state of revisionism and are moving the country to greater capital account openness after several
decades of extensive controls.

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CHAPTER 10. FULL CAPITAL ACCOUNT CONVERTIBILITY- PROS &

CONS
1) An arbitrary (i.e. pre-capital mobility) 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. 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.
2) 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 countries, so that developing nations, which are
usually capital-scarce, are doubly blessed under unhindered mobility of capital the inflow of capital
raises the national income and produces a healthy, egalitarian impact on income distribution as well.
3) It is argued that if there is only a small correlation between the returns on investment in different
countries, risk can be reduced by the ownership of income-earning assets across different countries.
Free mobility of capital, thus, helps reduce the risks that each country is subjected to.
4) Finally, it is argued that when full capital account convertibility is in place, government profligacy
and distortionary policies are likely to be followed by currency crises that threaten to make the
government highly unpopular. Therefore, under capital account convertibility, the salubrious effects of
capital mobility are magnified through a change in domestic policy in the right direction.
This rosy picture painted by traditional neo-liberal thinking is sullied when we look at what actually
happened to developing nations that have gone the full-capital account convertibility way in the 1980s
and 1990s.
1) In a widely quoted study, Dani Rodrik (1998) finds little evidence of any significant impact of
capital account convertibility on the growth rate of a country. Worse, a 1999 World Bank survey of 27
capital inflow surges between 1976 and 1996 in 21 emerging market economies found that in about
two-thirds of the cases, there was a banking crisis, currency crisis or twin crises in the wake of the
surge.
2) Since the early 1970s, there have been several crises triggered by speculative capital movements:
the Southern Cone financial crisis in the late 1970s; the Mexican crisis of 1994-95 and the `Tequila
Effect'; the East Asian crisis of 1997; the collapse of the Brazilian real and its impact on the rest of
Latin America; the Russian crisis of 1998 and the Argentine crisis of 2001.

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Here are the theoretical counter-arguments why full convertibility is correlated with the crises and
why, even otherwise, it is not such a good thing:
1) Contrary to the assumption of the neo-classical model, a large volume of capital inflows into
developing countries has actually been used for speculative purposes rather than for financing
productive investments.
2) Capital account convertibility exposes the economy to all sorts of exogenous impulses generated
through financial channels, as domestic and foreign investors try to shift their funds into or out of a
country. Since financial markets adjust very quickly, even minor disturbances may exacerbate into
major ones.
3) Under flexible exchange rates, capital inflows lead to an appreciation of the domestic currency
directly. On the other hand, in a fixed exchange rate regime, increased capital inflows lead to monetary
expansion and price inflation (unless there is substantial unutilised capacity), which also causes a real
appreciation. In both cases, therefore, capital inflows tend to cause a real appreciation and the
possibility of swollen current account deficits because of cheaper imports and uncompetitive exports
which, if not controlled in time, will lead to loss of confidence and capital flight.
4) Because of the massive volume and high mobility of international capital, it has been observed that
the government tries to play it safe by keeping interest rates high, thus discouraging domestic private
investment. The government also desists from spending on public investment because, through an
expansion in government spending, it could send signals of impending increases in fiscal deficits that
have the potential of destabilising capital markets and inducing capital flight.

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CHAPTER 11. POLICY IMPLICATIONS FOR INDIA

The experience with liberalisation of inward capital flows in India has been similar to the economies of
Latin America and East Asia, only the magnitude of these flows has not been large enough to cause
serious macro and micro management problems.
Based on the experience of other countries, the following issues are of concern for India:
1) Flexibility in exchange rate: To prevent a nominal appreciation because of the capital inflows, the
RBI has been adding billions of dollars to its reserves; the foreign exchange reserves with the RBI are
a whopping $69 billion.
2) However, intervening foreign currency purchases to stabilise the exchange rate and accumulation of
forex reserves have implications for domestic monetary management, which can be seriously impaired
by divided short-term monetary responses during a capital surge.
3) On the other hand, the option of a more flexible exchange rate would cause an appreciation in the
value of the rupee, which may hurt exports.
4) Hence, the usual macroeconomic trilemma (Obstfield, M and A. M Taylor 2001) where only two of
the three objectives of a fixed exchange rate capital mobility and an activist monetary policy can
be chosen. Since the government has already liberalised inflows of capital to a large extent, the
authorities could attempt to deal with this problem in one of the following ways: It could begin
relaxing capital controls, allowing individuals to exchange rupees for dollars. Indeed, some piecemeal
measures in this direction have already been taken. But this, perhaps, is a risky proposition.
4) For one thing, the embrace of full convertibility is itself likely to bring more dollars into the country
in the initial phase and add to the existing upward pressure on the rupee. More important, given the
lack of regulatory capacity, such convertibility runs the risk of a future financial crisis that may scuttle
the growth process.
5) Alternatively, the government could tap this opportunity to liberalise imports. Further liberalisation
will stimulate imports and create the necessary demand for dollars, mopping up the excess supply of
dollars and relieving the government of the burden of low-yielding foreign exchange reserves.
6) In as much as the imports are used as inputs for further exports, the move will kill two birds with
one stone it will relieve the upward pressure on the rupee, and bring the usual efficiency gains. In
this regard, therefore, import liberalisation seems to be a distinctly better option.

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7) Banking and capital market regulatory system: The relatively greater contribution of portfolio
capital towards India's capital account, and the fact that these inflows could increase to significant
levels in the future as India's financial markets get integrated globally, show that an important sphere
of concern is their skilful management to facilitate smooth intermediation.
8) Banks intermediate a substantial amount of funds in India over 64 per cent of the total financial
assets in the country belong to banks. However, many Indian banks are undercapitalised, and their
balance sheets characterised by large amounts of non-performing assets (NPAs).
9) Unless banking standards are duly brushed up, viable competition introduced and government
interference reduced, it would be reckless to go in for full capital account convertibility, which requires
flexibility, dynamism and foresight in the country's banking and financial institutions.
10) Transparency and discipline in fiscal and financial policies: It is well known that the last thing that
a government wanting to gain the confidence of investors should do is to be fiscally imprudent.
However, New Delhi does not seem to be paying heed to this consideration at all.
The ratio of gross fiscal deficit to GDP (including that of states) increased to 10.4 per cent in 19992000 from 6.2 per cent in 1996-97 and 8.5 per cent in 1998-99, and has hovered around the 10 per cent
figure since then. Such high fiscal deficits can prove to be unsustainable and frighten away investors.
11) Hence, there is an immediate need for putting brakes on government expenditure, and until that has
been satisfactorily done; opening up the capital account fully would carry with it a big risk of sudden
loss of faith of investors and capital flight.

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CHAPTER 12. CONCLUSION

Whatever the apparent theoretical benefits of capital account convertibility, they have not yet been
indicated by the actual empirical evidence; rather, the experience of the countries in the developing
world that have experimented with capital account convertibility has been that of increased market
volatility and financial crises.
Moreover, at least a part of the large inflows of capital into India are a consequence of the recessionary
conditions elsewhere. The country's macroeconomic fundamentals, though better than before, are not
good enough to warrant long-lasting confidence from foreign investors. The reform process is not
proceeding with adequate speed, banks are saddled with large volumes of non-performing assets, the
financial system is not deep or liquid enough and the country ranks high in the list of corrupt nations.
Once the conditions in the rest of the world improve, and the interest rate differentials between India
and the rest of the world narrow further, this capital may move on to greener pastures. Hence, one
cannot bank on the continuous supply of foreign capital to finance whatever outflows occur from the
country.
Therefore, we believe that India should be extremely cautious in liberalising capital outflows any
further.
While it should leave no stone unturned to promote inward FDI, which, because of its very nature, is
less susceptible to sudden withdrawals and also tends to promote productive use of capital and
economic growth, it should be wary of short-term capital flows that have the potential to destabilise
financial markets
The `slow and steady' stance that the RBI has taken towards capital account convertibility is to be
appreciated.
It must be emphasised that only over time will the Indian economy be mature enough to be
comfortable with full capital account convertibility financial markets will deepen, macroeconomic
and regulatory institutions grow more robust and the government will learn from past mistakes.
The Government would do well to focus at present on the fundamental processes of institutional
development and policy reform because, in the long run, these would serve the country better than an
early move towards full capital account convertibility.
Economists realize that directly jumping into fuller capital account convertibility without taking into
consideration the downside or the disadvantages of the steps could harm the economy.

32

The East Asian economic crisis can be a classic example to cite for those who are opposed to fuller
capital convertibility. The further question that should be raised is that why is India so desperate in
pushing ahead with the liberalization agenda. So what if there have been enormous global
developments and developments in the last few years. It should be bore in mind at the very outset that
attracting greater capital inflow into the country can barely provide a reason for greater or full
convertibility. Capital inflows in India are far in excess of what is needed to finance the current
account of the balance of payments. According to the report,
During the 2005-2006, the current account deficit has been comfortably financed by the net capital
flows with over U.S. $15 billion added to the foreign exchange reserves.
World Bank has said that embracing CAC without necessary precautions could be absolutely
disastrous. At this stage of the countrys economic growth, fuller convertibility on capital account
cannot be an objective per se, although it can be a step towards creating opportunities in achieving
more goals of economic policies. The major hindrance to fuller convertibility of the rupee is the fiscal
deficit of the centre and the states, which is around 10 percent of GDP, which is grossly high when we
talk of opening a capital account. Opening a countrys capital account when it has unsustainably high
fiscal deficit can be likened to administering polio drops to a child suffering from high fever; it can
prove fatal. It should be clearly bore in mind that until India reaches with a figure of 3 percent of GDP,
it would be imprudent to give a sudden move to fuller convertibility of capital account and which is
not insurmountable, so to say. Though the committee has emphasized on reducing fiscal deficit, as a
necessary condition for fuller convertibility, it has not set a time-map for the same hitherto. Capital
account convertibility should be treated as a process and not an event. The plan for further
convertibility on capital account will depend, however on several factors, as well as on international
developments. The most native but at the same time most fundamental argument put forward for CAC
was that free markets are inherently better than restricted markets. Just as the government should
eliminate barriers to trade, they should also eliminate barriers to the free flow of capital because doing
so leads to better economic performance measured in growth, efficiency and stability. A second
argument was that CAC enhances stability as countries trap into a diversified source of funds. CAC
increases the welfare of domestic investors by allowing them to invest abroad and diversify risk. CAC
is widely regarded as a prestige characteristic of an economy. It gives confidence to the foreign
investors who are assured that anytime they change their mind, they can reconvert local currency back
into foreign currency and take it out. Lots of people assume that a liberal capital account is, by itself, a
desirable objective of economic policy.

33

Capital account liberalization leads to the availability of a larger capital stock to supplement domestic
resources and thereby higher growth. To add, CAC allows residents to hold an internationally
diversified portfolio, which reduces the vulnerability of income and wealth to domestic shocks. It is
also argued that CAC has a disciplinary influence on domestic policies. It does not allow monetary
policy to take on an excessive burden of the adjustments. At the same time CAC enhances the
effectiveness of fiscal policy by:
a) Reducing real interest rate applicable to public sector borrowing
b) Bringing about an optimal combination of taxes through a reduction of the inflation tax and in the
rate of other taxes to international levels with beneficial effect for tax revenues
c) Reducing crowding out effect in the access to funds.
On the face of it, CAC seems to be a panacea to all financial problems and bottlenecks. But there is
hardly any empirical evidence and studies to support and substantiate the free flow of capital. Free
mobility of capital exposes a country to both sudden and huge inflows as well as outflows of foreign
capital, which can be potentially destabilizing the economic growth of a country. Thus, it is necessary
for a country to have experienced institutions to deal with such huge flows.
There is no doubt that economic indicators of Indian economy have improved quite a bit since 1997.
But so far as fuller CAC is concerned India has yet to go a long way ahead. International experience
shows that India should be very careful and calibrated while deciding towards fuller CAC.
In general, at this stage of the countrys development, CAC cannot be an objective per se but should be
considered as a means to achieving more fundamental objectives of economic policy.
From what was a nebulous concept a decade ago, could become a reality soon. If satisfied the above
cited problems, CAC could be the logical culmination of India 's journey towards globalization. It
should be carefully determined about whether the risks involved in fuller convertibility of capital
account seems to be greater than the rewards we get from it. To the mind of the researcher at this stage
of the countrys economic development, capital account convertibility cannot be a desired means per
se, but India can step forward by the means of it to maximize more economic goals.
The fact that fuller convertibility has been a subject of fierce debate from past five years and the
reasons in being so has been addressed throughout the course of this paper.
It has been also elaborated that the risks involved in fuller capital account convertibility are much more
that the fruits we get from it.

34

For India is it not the right time to go for full convertibility. Taking into consideration of the Asian
crisis, we need not touch the fire and set an example just like. It must be remembered that the move
towards capital account convertibility calls for a conformist and cautious approach.
The Asian financial crisis sealed the fate of that recommendation but the FM has once again revived
the issue

35

CHAPTER 13. BIBLIOGRAPHY

www.iimahd.ernet.in
www.advfn.com
www.bms.co.in
www.gktoday.in
International Finance Jai Mata Di Tutorials
www.thehindubusinessline.com
www.managementstudyguide.com

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