A.

Capital Account: It consist of short term and long term capital transactions
1.Direct Foreign investments(both inward and outward)

2.Investment in securities(both inward and outward)

3.Other investments(both inward and outward)

4.Government loans(both inward and outward)

5.Short term investments(both inward and outward)

B,Capital Account transactions:

1. Portfolio investments involves trade in securities like stocks, bonds, bank loans, derivatives etc

2.Direct investment involves purchase of real estate, production facilities or equity investments

3.Other investment involves holdings in loans, bank accounts and currencies

C.capital account convertibility

Capital account convertibility is thus the freedom of foreign investors to purchase Indian financial assets
(shares, bonds etc.) and that of the domestic citizens to purchase foreign financial assets. It provides
rights for firms and residents to freely buy into overseas assets such as equity, bonds, property and
acquire ownership of overseas firms besides free repatriation of proceeds by foreign investors.

D.Why capital account convertibility?

• Countries prefer capital account convertibility to promote the inflow of foreign capital. Despite
the various risk associated with capital flows like fluctuations in various segments of the
financial market, countries like India goes for it to get the advantage of having additional foreign
capital.

E.Status of capital account convertibility in India

There is partial capital account convertibility in India. Though tremendous capital account liberalisation
measures were taken place since the launch of economic reforms, introduction of full capital account
convertibility is yet to be implemented. In the case of current account there is full convertibility.
Altogether, there is the rupee is partially convertible

*The key aspect here is that many countries do not allow their currencies to be fully convertible if they
do not hold significant foreign exchange reserves. This is also the reason why capital controls are
imposed in times of economic crises to prevent a capital flight from these countries. Many Asian
countries have learnt from the bitter experience of the Asian financial crisis of 1997 and the Russian
Default of 1998 where full convertibility lead to a stampede of foreign investors fleeing the countries in
the aftermath of the economic crisis. The other aspect here is that even in the European Union, capital
controls are being planned to contain flight of capital to other countries as the Eurozone crisis deepens.

F.TARAPORE COMMITTEE-1
The Committee on Capital Account Convertibility (CAC) or Tarapore Committee was constituted by the
Reserve Bank of India for suggesting a roadmap on full convertibility of Rupee on Capital Account. The
committee submitted its report in May 1997. The committee observed that there is no clear definition of
CAC. The CAC as per the standards – refers to the freedom to convert the local financial assets into
foreign financial assets or vice versa at the market determined rates of exchange.  Here is what this
committee observed:

• The Capital Account Convertibility, if the Government wants, can be introduced for a 3 year
period viz. 1997-98, 1998-99 and 1999-2000. However, there are some pre conditions as
follows:

• First bring you Gross fiscal deficit to GDP ratio from 4.5 per cent in 1997-98 to 3.5% in 1999-
2000.

• Create a consolidated sinking fund which can meet the government’s debt repayment needs. It
can be financed by increased in RBI’s profit transfer to the govt. and disinvestment proceeds.

• Bring the Inflation rate between an average 3-5 per cent for the 3-year period 1997-2000.

• Bring down the Gross NPAs of the public sector banking system 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.

• External sector policies should be designed to increase current receipts to GDP ratio and bring
down the debt servicing ratio from 25% to 20%

• Four indicators should be used for evaluating adequacy of foreign exchange reserves to
safeguard against any contingency. Plus, a minimum net foreign asset to currency ratio of 40 per
cent should be prescribed by law in the RBI Act.

G.TARAPORE COMMITTEE-11
Reserve Bank of India appointed the second Tarapore committee to set out the framework for fuller
Capital Account Convertibility. The committee was established by RBI in consultation with the
Government to revisit the subject of fuller capital account convertibility in the context of the progress in
economic reforms, the stability of the external and financial sectors, accelerated growth and global
integration. The report of this committee was made public by RBI on 1st September 2006. In this report,
the committee suggested 3 phases of adopting the full convertibility of rupee in capital account.

• First Phase in 2006-7

• Second phase in 2007-09

• Third Phase by 2011.

• Following were some important recommendations of this committee:

• The ceiling for External Commercial Borrowings (ECB) should be raised for automatic approval.

• NRI should be allowed to invest in capital markets

• NRI deposits should be given tax benefits.

• Improvement of the Banking regulation.

• FII (Foreign Institutional Investors) should be prohibited from investing fresh money raised to
participatory notes.

• Existing PN(Participatory note) holders should be given an exit route to phase out completely
the PN notes. A participatory note, commonly known as a P-note or PN, is an instrument issued
by a registered foreign institutional investor   (FII) to an overseas investor who wishes to invest
in Indian stock markets without registering themselves with the market regulator, theSEBI

H.The Tarapore Committee mentioned the following benefits of capital

account convertibility to India:
• 1. Availability of large funds to supplement domestic resources and thereby promote economic
growth.

• 2. Improved access to international financial markets and reduction in cost of capital.

• 3. Incentive for Indians to acquire and hold international securities and assets, and

• 4. Improvement of the financial system in the context of global competition.

• 5. Freedom to convert local financial assets into foreign ones at market-determined exchange
rates

• 6. Leads to free exchange of currency at lower rates and an unrestricted mobility of capital
I.Preconditions for Capital Account Convertibility:
• The Tarapore Committee recommended that, before adopting capital account convertibility
(CAC), India should fulfill three crucial pre-conditions:

• (i) Fiscal deficit should be reduced to 2% per cent of GDP. The Government should also set up a
Consolidated Sinking Fund (CSF) to reduce Government debt.

• (ii) The Governments should fix the annual inflation target below 4 per cent. This was called
mandated inflation target — and give foil freedom to RBI to use monetary weapons to achieve
the inflation target.

• (iii) The Indian financial sector should be strengthened. For this, interest rates should be folly
deregulated, gross non-paying assets (NPAs) should be reduced to 5 per cent, the average
effective CRR should be reduced to 3 per cent and weak banks should either be liquidated or be
merged with other strong banks.