Q3. Describe the approaches of CAC.Ans:-
Approaches to Capital Account Convertibility (CAC)
Capital Account Convertibility (CAC) refers to relaxing controls on capital account transactions. It meansfreedom of currency conversion in terms of inflow and outflows with respect to capital account transaction.Most of the countries have liberalized their capital account by having an open account, but they do retain someregulations for influencing inward and outward capital flow. Due to global integration, both in trade andfinance, CAC enhances growth and welfare of country.The perception of CAC has undergone some changes following the events of emerging market economies
(EMEs) in Asia and Latin America, which went through currency and banking crises in 1990’s. A few counties
backtracked and re-imposed capital controls as part of crisis resolution. Crisis such as economic, social, humancost and even extensive presence of capital controls creates distortions, making CAC either ineffective orunsustainable. The cost and benefits from capital account liberalization is still being debated among academicsand policy makers. These developments have led to considerable caution being exercised by EMEs in openingup capital account. The Committee on Capital Account Convertibility (Chairman: Shri. S.S. Tarapore) whichsubmitted its report in 1997 highlighted the benefits of a more open capital account but at the same timecautioned that CAC could pose tremendous pressures on the financial system. India has cautiously opened itscapital account and the state of capital control in India is considered as the most liberalized it had been since
late 1950’s. The different ways of implementing CAC are as follows:
Open the capital account for residents and non-residents.2.
Initially open the inflow account and later liberalise the outflow account.3.
Approach to simultaneously liberalise control of inflow and outflow account.
Liberalization of current account transactions
Current account transaction refers to converting domestic currencies freely into foreign currency and viceversa. The domestic currency is said to be convertible on the current account. This is known as current accountconvertibility. The benefits of current account transaction are as follows:
Current account convertibility enhances the increase of capital inflow in to the country.
The confidence of a country will be enhanced when the country will manage its affairs withoutexchange restrictions which enhance the international confidence in the countries policies.
Relaxing the exchange restrictions has improved the Balance of Payment (BOP) in the country.
The exclusion of exchange restrictions tends to increase the capital inflows and thus promote efficient
allocation of inflows to the growth of the country’s economy.
RBI has introduced more relaxations in current account transactions. The authorized dealers (ADs) have beenpermitted to provide exchange facilities to their customers up to specified limit without prior approval of theRBI. The liberalization rules regarding current account transaction of RBI under FEMA 1999 are as follows:
Authorized Dealers of Category - I banks permits withdrawal of foreign exchange payments belowUSD 2million by the individuals and approval of Ministry of Commerce and Industry, GOI is notmandatory.
As per the Rule 4 of FEMA (current account transactions), it is mandatory to get approval of Ministryof Commerce and Industries for drawing foreign exchange remittances ,when the payment exceeds5% on local sales and 8% increase on exports.