Capital Account Convertibility

y The freedom to convert the local financial

assets into foreign financial assets and viceversa at market determined rate of exchange. Or
y Free and an unrestricted mobility of capital

in the country.

y India presently has current account convertibility,

which means that foreign exchange is easily available for import and export for goods and services.
y If an Indian citizen needs foreign exchange of smaller

amounts, $ 3000/- for travelling abroad or for educational purposes one can obtain the same amount from a bank or a money changer. This is current account transaction.

y India also has partial capital account convertibility;

such that an Indian individual or an institution can invest in foreign assets upto $25000.
y Foreigners can also invest along the same lines. 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, 74% in telecommunication etc.

y If someone wants to import plant and machinery or

invest abroad and needs a large amount of foreign exchange, $1 million, the importer will have to first obtain the permission of the RBI.
y If it is approved, this becomes a Capital account

transaction.
y It reflects that still there is no full Capital Account

Convertibility.

Limitation

y Capital Flight : Capital Account convertibility can

lead to the export of domestic savings. It would curb domestic investment in capital scarce developing country and it can actually destabilize the economy through massive capital flight from a country.

y Full Capital Account Convertibility exposes an

economy to extreme volatility on account of Hot Money money flows. When International finance capital shifts from country to country in search of higher speculative returns that is known as hot money, which leads economic crisis in developing countries. (if this capital is invested in long term investment.)