Managerial Economics

Should Rupee be made convertible on

Capital Account
 Presented by Group No.4
Dharmesh Heliya
Sujeet Shetty
Rakesh Patade
Amit Bobade
Prasanna Bhuvandas
Vipul Mohite
Nimish Samarth
Priyanka Kadam
Jasbir
Ashish
 Capital Account Convertibility
Tarapore Committee (1997) defined as:
“The freedom to convert local financial assets
into foreign assets and vise-versa at market
determined rate of exchange. It is associated
with 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”.
 Introduction
Balance of Payment:
A systematic record of a nation's total payments to foreign countries, including the price of
imports and the outflow of capital and gold, along with the total receipts from abroad,
including the price of exports and the inflow of capital and gold.
They are further divided into the following:
i)Capital Account
ii)Current Account

Definition of Current Account:

• It is the sum of the balance of trade (exports minus imports of goods and services), net
factor income (such as interest and dividends) and net transfer payments (such as foreign
aid).
Definition of Capital Account:
The capital account records all transactions between a domestic and foreign resident that
involves a change of ownership of an asset. It is the net result of public and private
international investment flowing in and out of a country. This includes foreign direct
investment, portfolio investment (such as changes in holdings of stocks and bonds) and
other investments (such as changes in holdings in loans, bank accounts, and currencies).
Background of CAC
 Pros of Capital Account
 Allows domestic residents to invest abroad.

 Our NRI population will benefit tremendously

 Opens the gate for international savings to be invested in India

 Reduce the size of the black economy, and improve law and
order, tax compliance and corporate governance.
 Cons of Capital Account
 Enormous outflow of capital

 Possibility of misallocation of capital inflows.

 Threat to domestic Investment

 Uneven playing field due to entry of foreign banks

 Exposes an economy to extreme volatility on account of “hot

money” flows.
Tarapore Committee
 Is it the right time for conversion
• Pre-conditions are to be met before the rupee is made
convertible in the capital account

• High level of fiscal deficit is not the right time to embark into
total capital account liberalization

• Easy transfer of funds can put an economy under great

pressures from foreign speculators and manipulators .
 Why conversion not done yet
contd..
• It will force the government to behave more
responsibly on fiscal balances.
 Why conversion not done yet
contd..
• 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.
 leads to better economic performance measured in
growth, efficiency and stability.
 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
 Why conversion not done yet
contd..
• CAC is widely regarded as a prestige characteristic of an economy.
 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.
 Capital account liberalization leads to the availability of a larger
capital stock to supplement domestic resources and thereby higher
growth.
 CAC allows residents to hold an internationally diversified portfolio,
which reduces the vulnerability of income and wealth to domestic
shocks.
 CAC has a disciplinary influence on domestic policies. It does not
allow monetary policy to take on an excessive burden of the
adjustments
 Why conversion not done yet
contd..
• Countries are exposed to great risk when they liberalize.
• People of the countries-----especially workers, small businesses,
and the poor----have no way of protecting themselves against these
risks.
• The argument that CAC allows residents to diversify risk by
investing abroad focuses on the benefits for a small group of
residents while it ignores the larger affects ion society as a whole.
• CAC can be stated in three words: it increases instability.
• CAC allows speculative capital to flood into a country. While the
money flows in, the currency appreciates. The capital inflows may
support short term growth, but they can also lead to an
unsustainable expansion of consumption, and to changes in the
structure of production.
South Asian Crisis Case study
Conclusion