CAC (Capital Account Convertibility) in the Indian Economy

CAC (Capital Account Convertibility) for Indian Economy refers to the abolition of all limitations with respect to the movement of capital from India to different countries across the globe. In fact, the authorities officially involved with CAC (Capital Account Convertibility) for Indian Economy encourage all companies, commercial entities and individual countrymen for investments, divestments, and real estate transactions in India as well as abroad. It also allows the people and companies not only to convert one currency to the other, but also free cross-border movement of those currencies, without the interventions of the law of the country concerned. Following are the pre-requisites for Capital Account Convertibility in India:
The Tarapore Committee appointed by the Reserve Bank of India (RBI) was meant for recommending methods of converting the Indian Rupee completely. The report submitted by this Committee in the year 1997 proposed a three-year time period (19992000) for total conversion of Rupee. However, according to the Committee, this was possible only when the following few conditions are satisfied:

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The average rate of inflation should vary between 3% to 5% during the debt-servicing time Decreasing the gross fiscal deficit to the GDP ratio by 3.5% in 1999-2000

Evolution of CAC in India economic and financial scenarios:

In 1994 August, the Indian economy adopted the present form of Current Account Convertibility, compelled by the International Monetary Fund (IMF) Article No. VII, the article of agreement. The primary objective behind the adoption of CAC in India was to make the movement of capital and the capital market independent and open. This would exert less pressure on the Indian financial market. The proposal for the introduction of CAC was present in the recommendations suggested by the Tarapore Committee appointed by the Reserve Bank of India.

Reasons for the introduction of CAC in India:

The logic for the introduction of complete capital account convertibility in India, according to the recommendations of the Tarapore Committee, is to ensure total financial mobility in the country. It also helps in the efficient appropriation or distribution of international capital in India. Such allocation of foreign funds in the country helps in equalizing the capital return rates not only across different borders, but also escalates the production levels. Moreover, it brings about a fair allocation of the income level in India as well.

The forecasts made by the Tarapore Committee regarding Indian CAC are as follows:
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A prescribed average inflation rate of 3% to 5% will exist for a three-year time period, from1997-98 and 1999-2000.

The non-performing assets will experience a decline to 12%, 9% and 5% by the years 199798, 1998-99 and 1999-2000 respectively, with respect to the total or aggregate advances.

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By the years 1997-98, there will be a complete deregulation of the structure of interest rate. The gross fiscal deficit will fall from 4.5% in 1997-98 to 4.0% in 1998-99 and further to 3.5 % in 1999-2000, with respect to the GDP.

Benefits and drawbacks of CAC:

To sum up, CAC is concerned about the ownership changes in domestic or foreign financial assets and liabilities. It also represents the formation and liquidation of financial claims on or by the remaining world. It enables relaxation of the Capital Account, which is under tremendous pressure from the commercial sectors of India. Along with the financial capitalists, the reputed commercial firms in India jointly derive and enjoy the benefits of the CAC policy, which speculate the stock markets through investments. In fact, the CAC policy in India is pursued primarily to gain the speculator's and the punter's confidences in the stock markets. However, CAC does not serve the purposes of the real sectors of Indian economy, like eradication of poverty, escalation of the employment rates and other inequalities.In spite of CAC being present in Indian economy, there will be a co-existence of financial crises. Despite several benefits, CAC has proved to be insufficient in solving the Indian financial crises, the complete solution of which lies in having a regulated inflow of capital into the economy.

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Q: Why is India moving towards full capital account convertibility, even though it knows about financial market volatility and the recent crisis? Chandrasekhar: India has adopted a peculiar position on the issue of convertibility. Just before the East Asian financial crisis of 1997 broke, India was all set to make the rupee fully convertible on the capital account. A road map for full convertibility had been drawn up. This would have allowed residents in India to convert their wealth into foreign exchange and transfer it abroad. The crisis sent out a clear signal that this is bad policy and can pave the way for instability and even a currency crisis. That signal prevented the government from opting for such a misguided policy. Since then Indian policy makers have been proud of the fact that cautious policies with regard to capital flows and financial integration had helped the country avoid financial crises and reduce the impact of the 2008 crisis on the country. Yet there is a strong segment of government opinion which is still in favour of full convertibility. This is only partly because of the beliefs (i) that India is different and can handle convertibility much better than other developing countries; and (ii) that convertibility is a requirement for India to move from developing to developed country status. More importantly, it is the result of pressure from wealth holders within the country who want the option of transferring wealth abroad both to earn returns and hedge against any possible weakening of the rupee. That this could be at the expense of instability that undermines the living standards of the less well-to-do obviously does not bother them. However, at the present moment, the problem India faces is one of excessive inflows of foreign capital, which is resulting in an appreciation of the rupee. Such appreciation adversely affects the competitiveness of Indian exports. Hence, there is a strong lobby that not only wants the central bank to intervene and stall rupee appreciation, but also to adopt policies that can moderate the surge in capital inflows. This is holding back the transition to full capital account convertibility for the time being.