CURRENCY CONVERTIBILITY

Rupee convertibility or capital account convertibility is a very simple concept. All it means is that if you take your rupee to a bank or foreign exchange dealer and want to exchange it into another currency, such as the US dollar or the euro, it they should be done exchange the money with no questions asked whatsoever. There should also be no limit on the amount that can be exchanged into another currency as there is now. Currently there is some amount of rupee convertibility is allowed to some extent in India but not full capital account convertibility. There have been several committees to discuss when and how India can go become fully convertible on the capital account, the latest being the `Committee on Fuller Capital Account Convertibility' under the former RBI Deputy Governor, Mr S. S. Tarapore. The merits are: It paves the way for companies to access funds from outside without hindrance. It makes it far easier for foreign companies to invest in India. It sends a signal to international investors as well as the financial world that India is confident of itself in the economic and financial arena and has the capability to withstand anything that is thrown at her. Since it exposes makes India more exposed to the vagaries of the international financial sector, it forces the government to become more disciplined on the fiscal side of things. It forces the financial sector to be become more efficient, more disciplined, and much stronger.

The demerits are: It exposes the country India to the volatility of the world financial system. The rupee can possibly become more volatile. That said, there are infinitely more merits than demerits to going becoming convertible on the capital account. The As far as the demerits are concerned, they are only demerits so only as long as the financial system and government accounts are shoddy. If they it become world class financial system, the it can easily manage volatility can be managed without any problem. TARAPORE COMMITTEE1.

Establishment The first Taraporecommittee report on capital account convertibility (CAC), whichca me 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 completeconvertibility by 1999-2000. The highlights of the report including the preconditions to be achieved for the full float of money are as follows:-

Tarapore I (1997): Preconditions for Full Capital Account Convertibility

(a) Fiscal Consolidation -- reducing the Centres Gross Fiscal Deficit to 3.5 per cent of GDP,establishing a Consolidated Sinking Fund for public debt and a public debt office, andintroducing a system of fiscal transparency.

(b) Mandated inflation rate -- inflation to be maintained within 3.0-5.0 per cent in the medium term.

(c) Consolidation in the Financial Sector -- full deregulation of interest rates, strengthening the financial system by bringing down gross non-performing assets (NPAs) of the banking sector to 5.0 per cent of total advances and the average effective CRR to 3.0per cent.

(d) Exchange rate policy -- monitoring the exchange rate within a band of +/- 5.0 per cent around the neutral real effective exchange rate (REER), non-intervention by RBI within the band, disclosing the neutral REER regularly along with its base period, ensuring that forward exchange markets reflect interest rate differentials.

(e) Balance of Payments -- sustained increase in the current receipts/GDP ratio and reduction in debt service ratio to 20.0 per cent.

(f) Adequacy of reserves -- reserves at no less than six months of imports and no less than three months of imports plus 50 per cent of debt service payments plus one month of exports and imports; short term debt and portfolio stock at no more than 60 per cent of reserves and the net foreign assets /currency ratio at no less than 40 per cent.

(g)Strengthening of the financial system -- uniform regulatory system for banks andfinancial institutions, reserve requirements on non-resident liabilities of banks on par with their domestic liabilities, RBI prescribed prudential norms for rupee mismatches, banks adopting best practices of risk management and following international accounting and disclosure norms, and an effective regulatory regime for the financial sector capable of detecting warning signals.

TARAPORE COMMITTEE II

In the Year 2006 under Manmohan Singh Government the Tarapore Committee re-appointed to give suggestions 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)

The difficulty is that PNs have come to dominate FII inflows in recent years in 200506, they accounted for around 80% of all incremental FII inflows. It is the sheer magnitude of PN-related inflows that raises concerns Tarapore-II makes wideranging recommendations on the strengthening of the bankingsector.

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 thiswould help banks augment their capital.

Recommendations of Tarapore II (2006) for Fuller Capital Account Convertibility

i.

External commercial borrowings (ECB) (then subject to an annual ceiling of $18

billion)

-use restriction22 on ECB in Phase I; -year maturity outside the overall ceiling in Phase I; -year maturity outside the overall ceiling in Phase II;

and $1billion in Phase III;

ii.

Raising the limit of overseas investment by Indian companies from 200 per cent

of net worth to 250 per cent in Phase I, 300 per cent in Phase II, and 400 per cent in Phase III;

iii.

Prohibit foreign institutional investors (FII) from investing money through

participatory notes (PNs);

iv.

Raise the annual subceiling within overall ECB ceiling of FII investment in debt

instruments For Government securities and treasury bills, from $2 billion to 6 per cent of total grossissuance by Centre and States in Phase I and further to 8 per cent of such issuance in PhaseII and 10 per cent of such issuance in Phase III; For corporate debt, from $1.5 billion to 15 per cent of fresh issuance Phase II and further to 25per cent of fresh issuance in Phase III;

v.

Allow non-resident corporates to invest in Indian stock markets through SEBI-

registeredentities; vi. Allow foreign institutions and corporates beyond multilateral institutions (such as

International Finance Corporation and Asian Development Bank) to raise rupee bonds inIndia;

vii.

Linking domestic banks borrowings from overseas banks and correspondents to

paid upcapital and free reserves and not to unimpaired Tier I capital, and putting the limit at 50 percent in Phase I, 75 per cent in Phase II, and 100 per cent in Phase III;

viii.

Extending the permission for investment overseas by SEBI-registered Indian

investorsbeyond mutual funds to all SEBI-registered portfolio management schemes and raising theannual aggregate ceiling on such investment from $2 billion to $3 billion in Phase I, $4 billionin Phase II and $5 billion in Phase III;

ix.

Raise the annual limit on free remittance by resident individuals from $25,000 to

$50,000 inPhase I, $100,000 in Phase II, and $200,000 in Phase III; x. Allow non-residents (NRs) other than non-resident Indians (NRIs) also to open

FCNR(B)deposit accounts without tax benefits in Phase I, and also NR(E)RA deposit accountswithout tax benefits in Phase II; and

xi.

Allow non-residents (NRs) other than NRIs to invest in companies in Indian stock

exchangesthrough SEBI-registered mutual funds, and portfolio management schemes.

Currency Crisis in 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 tothe last quarter of 1998. The major macroeconomic causes for the crisis were identifiedas: current account imbalances with concomitant savingsinvestment imbalance,overvalued exchange rates, high dependence upon potentially short-term capital flows.These macroeconomic factors were exacerbated by microeconomic imprudence such asmaturity mismatches, currency mismatches, moral hazard behaviour of lenders a nd borrowers and excessive leveraging. The Mexican crisis in 1994 95 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 suffered 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 privateforeign capital suddenly dried up. After the Russian crisis in 1998, capital flows toBrazil came to a halt. Difficulties in meeting huge requirements for public sector borrowing in 1993 and early1994, 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 excessiveappreciation of the exchange rate causes exporting industries to become unviable, andimports 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. Short-term debt flows react quickly and adversely during currency crises. Receivables are typically postponed, and payables accelerated, aggravating the balance of payments position. Domestic financial institutions, in particular banks, need to be strong and resilient. Thequality and proactive nature of market regulation is also critical to the success of efficient functioning of financial markets during times of currency crises.

Capital Account Convertibility

What is capital account convertibility?

In India, the foreign exchange transactions (transactions in dollars, pounds, or any other currency) are broadly classified into two accounts: current account transactions and capital account transactions. If an Indian citizen needs foreign exchange of smaller amounts, say $3,000, for travelling abroad or for educational purposes, she/he can obtain the same from a bank or a money-changer. This is a "current account transaction". But, if someone wants to import plant and machinery or invest abroad, and needs a large amount of foreign exchange, say $1 million, the importer will have to first obtain the permission of the Reserve Bank of India (RBI). If approved, this becomes a "capital account transaction". This means that any domestic or foreign investor has to seek the permission from a regulatory authority, like the RBI, before carrying out any financial transactions or change of ownership of assets that comes under the capital account. Of course there are a whole range of financial transactions on the capital account that may be freed form such restrictions, asis the case in India today. But this is still not the same as full capital account convertibility.

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) Thus, in simpler terms, it means that irrespective of whether one is a resident or non-resident of India one's assets and liabilities can be freely (i.e. without permission of any regulatory authority) denominated (or cashed) in any currency and easily interchanged between that currency and the Rupee.

Merits & demerits

The upsides of CAC are summarized as here under:

CAC could facilitate the Indian need to attract global capital as we need to augment our domestic savings with external savings to boost out investment rates

Ordinary Indian residents would get an increased choice of investment, which could enhance their welfare. Further, by offering a diverse global market for investment purposes, an open capital account permits domestic investors to protect the real value of their assets through risk reduction

An open capital account could bring with it greater financial efficiency, specialization and innovation by exposing the financial sector to global competition.

The downsides of CAC are summarized as here under:

A free capital account could lead to the export of domestic savings, which for capital scarce developing countries like India could be ruinous. Given the fact that one hand we seem to invite FDI i.e. import foreign savings into India, any step that could lead flight of domestic capital is highly contradictory to the national policy of attracting higher savings through FDI route into India.

Capital convertibility could lead to exchange rate volatility of the Rupee resulting in macroeconomic instability caused through the risk of rapid and large capital outflows as well as inflows. Moreover, such speculative capital flows may make domestic monetary policy virtually ineffective. Also one needs to understand that India imports approximately 75% of her crude requirements. Given the fact that the oil prices have been well above the USD 60 per barrel and extremely volatile, any volatility in the FE position of India could result in soaring energy prices. This could upset the economy and have a debilitating impact on inflation within India.

The CAC would not suit an economy like India, undergoing the process of structural reforms, which needs controls and regulations for some more foreseeable future.

Types of capital accounts transactions?

Portfolio investments Stocks Bonds Bank loans Derivatives

Direct investments Real Estate Production Facilities

Equity investment Other investments Holdings in loans Bank Accounts Currencies

How does the govt. control CAC

India has a long history of using capital controls as they were a key element in the countrys quasi-socialist, import-substitution economic strategy prior to 1991. They were first introduced in the late 1950s and became comprehensive and draconian by the midseventies. In the 1980s, controls on external borrowing, including short-term borrowing, were selectively eased. However, it can be argued that this lopsided easing of controls eventually contributed to the external crisis of 1991. The country embarked on the path of liberalization after this crisis. Industrial licensing was abolished, import quotas and tariffs were lowered and so on. As part of this effort, the authorities lowered restrictions on foreign investment flows, both for FDI and for portfolio investments. Other controls were retained but were steadily eased as the economy in general and external accounts in particular showed improvement. By the end of the decade, restrictions on current account transactions had ceased to be binding and those on foreign capital were no longer especially cumbersome. Nonetheless, controls remain on debt-creating inflows (external borrowings) and on investments abroad by residents. The highlights of this system as given below:

Foreign Direct Investment: Before 1991, FDI was allowed only on a case-by-case basis. The restrictions were so severe that there very little inflow (Suzukis involvement with carmaker Maruti is a notable exception). The reforms of 1991 provided for automatic approval of a 51 per cent stake in a wide range of industries. Proposals for a higher share were considered by the Foreign Investment Promotion Board. The system was still more restrictive than it sounds as there were various other bureaucratic hurdles.

Nonetheless, it was better than before. In 1996, the list of open industries was increased and the foreign limit was increased to 74 per cent in many cases.

Portfolio Investment: In 1992, the authorities also decided to allow foreign portfolio investment in primary and secondary equity markets. This was open only to Foreign Institutional Investors (FIIs) who were registered with the regulators. In 1997, it was decided that foreign investors could also buy government bonds. The system was also smoothened in many ways. In recent years we have witnessed a sharp increase in FII investments into the country. Note that FII registration may remain a requirement even after removal of capital controls (for reasons of taxation, supervision and foreign ownership limits).

External Commercial Borrowings (ECBs): As we have already mentioned, restrictions on external borrowings were eased in the 1980s and this may have contributed to the external crisis of 1991. Therefore, the Indian authorities remain somewhat suspicious of debt-creating sources of capital. Following the 1991 crisis, ECB restrictions were tightened and have since been eased at a very gradual pace. Despite some liberalization in recent years, there are still quite a few limitations in place. In the Appendix we have attached a RBI circular issued in August 2005 about ECBs which shows the types of controls that remain in place. We have deliberately printed the whole list in order to give the reader a sense of how capital controls are imposed in practice.

Resident Outflows: The area where controls remain quite stringent is on outward remittances by resident individuals and institutions both for investment purposes and

for current transactions such as foreign travel. These restrictions have been in place for decades in one form or another, and had fuelled black markets of various kinds gold smuggling in the seventies and eighties, the hawala system since the eighties and so on. Indian passports typically had extra pages at the back that recorded the amount of dollars purchased. During the crisis of 1991, the controls were temporarily made even more severe. They were then eased through the nineties. At present, resident Indians are allowed to buy USD25,000 worth of foreign exchange every year. The constraints on Indian institutional investment abroad have also been gradually eased. Nonetheless, these are perhaps the most serious restrictions left, and would be effectively binding in the event of a macroeconomic crisis of any kind.

As one can see from the above discussion, capital controls are more liberal now than they have been in two generations. For most current account transactions and for foreign investment, they are no longer binding. Even for external borrowing and resident outflows, the restrictions are now far easier than they were in the nineties. The question now arises should the authorities take the last step and get rid of the framework altogether? In order to answer this question we need to consider the constraints placed on policy-making by free international capital movement. These constraints can be especially severe in emerging markets because of systemic rigidities. We think the new committee should take this into account when recommending a way forward.

What is the position in India today?

Convertibility of capital for non-residents has been a basic tenet of Indias foreign investment policy all along, subject of course to fairly cumbersome administrative procedures. It is only residents both individuals as well as corporates who continue to be subject to capital controls. However, as part of the liberalization process the government has over the years been relaxing these controls. Thus, a few years ago, residents were allowed to invest through the mutual fund route and corporates to invest in companies abroad but within fairly conservative limits.

Buoyed by the very comfortable build-up of forex reserves, the strong GDP growth figures for the last two quarters and the fact that progressive relaxations on current account transactions have not lead to any flight of capital, on Friday the government announced further relaxations on the kind and quantum of investments that can be made by residents abroad. These relaxations are to be reviewed after six months and if the experience is not adverse, we may see further liberalization and in the not-toodistant future full CAC.

What is Full capital account convertibility? Full capital account convertibility allows local currency to be exchange for foreign currency without any restriction on the amount. This is so 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. 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. 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.

1. Goods and services 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). 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). 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. Travel covers goods and servicesincluding those related to health and education acquired from an economy by non resident 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 non resident workersare not regarded as travelers. However, expenditures by non resident 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/non resident 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/non resident 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 non-residents for (i) the authorized use of intangible non produced, nonfinancial assets and proprietary rightssuch as trademarks, copyrights, patents, processes, techniques, designs, manufacturing rights, franchises, etc. and (ii) the use, through licensing agreements, of produced originals or prototypessuch as manuscripts, films, etc. Other business services provided by residents to nonresidents and vice versa cover merchant 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, museumsand 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. 2. 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.

3. Current transfers Current transfers are distinguished from capital transfers, which are included in the capital and financial account . 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 (i) transfers of ownership of fixed assets;(ii) transfers of funds linked to, or conditional upon, acquisition or disposal of fixed assets; (iii) 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).

According to the RBI: The Act defines the term 'current account transaction' as a transaction other than a capital account transaction and without prejudice to the generality of the foregoing such transaction includes, Payments due in connection with Foreign trade, Other current business Services, and Short-term banking and credit facilities in the ordinary course of business;

Payments due as and Expenses in connection with Foreign travel, Education and Medical care of parents, spouse and children. Interest on loans and Net income from investments, Remittances for living expenses of parents, spouse and children residing abroad,

In the above definition, the words without prejudice to the generality of the foregoing such transaction includes imply that even if the transactions listed above may fit into the definition of capital account transactions, such transactions shall be treated current account transactions. For example, resident of India imports goods from outside India on a short term credit (for a period of less than 6 months), he is creating a liability

outside India and thus, it can be treated a capital account transaction but, it is specifically included in the above definition as a current account transaction. As a general rule, any person may sell or draw foreign exchange if such sale or withdrawal is a current account transaction. Under the Act, Central Government may, in public interest and in consultation with the Reserve Bank, impose such reasonable restrictions for current account transactions as may be prescribed. Accordingly, the Central Government has issued the Foreign Exchange Management (Current Account Transaction) Rules, 2000. It contains the list of current account transactions for which drawal of foreign exchange is: Totally prohibited; Permitted, subject to the prior approval of concerned Ministry, Central Government; Permitted, subject to prior approval of the Reserve Bank of India;

No restrictions or limits are applicable for undertaking the transactions that are not covered by the above rules and the authorized dealers are free to release foreign exchange upon the satisfaction that the transactions will not involve and is not designed for the purpose of, violation of the Act, or any rules, regulations made thereunder. In today's changed scenario, Indian rupee has become fully convertible so far as current account transactions are concerned. This implies that foreign exchange is freely available to the residents for remittance on account of current account transactions for the various purposes like foreign travel, foreign education, and medical treatment abroad etc. The non-residents are also freely allowed to remit outside India the income or capital

gain generated in India. 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. Why go for 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, Europe there 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 on 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 Current account v/s capital account Current account convertibility 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 receives dollars (or any other foreign currency) for export of goods and services and pay dollars for import of goods and services, make sundry remittances, access foreign currency for travel, studies abroad, medical treatment and gifts etc.

On the other hand Capital account convertibility means free inflows and out flows on capital accounts too, like investments and loans, both ways to and fro the country at the market determined exchange rates.

CREDITS SALONI SHAH -52 AYUSHI JAIN -22 PRIYANKA SHAH-51 ANKUSH JAIN-19 ROHIT ASARPOTA-04 JAI KARANI -30