CAPITAL ACCOUNT

CONVERTIBILITY
(CAC)
What is Capital Account ?

Represents any transaction that

involves a claim by one
national on another.
What is C A C ?

CAC means the right of

an individual to move
foreign currency in and
out of the country.
 Tarapore Committee
(1997 –RBI)

 Freedom to convert local financial assets

into foreign financial assets and vice-
versa at market determined rates of
exchange.

 CAS is the expression of Globalisation or

complete integration of domestic
economy with rest of the world.

 High degree of economic integration is

the Hallmark of developed economy.
 Merits
 Efficient Allocation of global
capital.
 Availability of large supply of
investible fund.
 Free flow of Technology,
Management skill.
 Portfolio Diversification.
A disciplining influence on
domestic policies.
 Ruthless task master of
domestic fiscal and monetary
policies – Requirement of more
proactive policy.
 Dynamic gains from financial
integration.
 Reducing crowding out effects
in the access to funds.
 Reduction in real interest rates
applicable to public borrowing.
 Optimal combination of taxes:
rationalisation & convergence
to international tax structure to
avoid capital flight.
 Demerits

 Orbitrage operation – Borrowing

cheap abroad and lending in
domestic market high rate – High
burden of external debt financial
instability, heavy investment in
physical & financial assets.
 Demerits

 Wrong signals about the host

country’s economic fundamentals
to the international investors.

 Controls are costly to maintain &

result in distortion in allocation of
financial & physical resources.
 Approach to C A C.
International organisations like

INTERNATIONAL MONETARY FUND

(IMF)

ORGANISATION FOR ECONOMIC

COOPERATION & DEVELOPMENT
(OECD)
EUROPEAN UNION (EU) &

WORLD TRADE ORGANISATION (WTO)

have developed a framework for the

liberalisation of capital account. Capital
account liberalisation emerges from
agreements under trade in financial
services & under WTO.
 Survey of International
Experience

The introduction of C A C by the

countries with strong fundamentals
successful – less vulnerable to back-
tracking and reimposition of controls.

The countries which moved towards

CAC without strong fundamentals in
the intitial stage had to face
interruptions.
 PRECONDITIONS

The survey also revealed

following preconditions for
success.

Strong Balance of payments

position.

Fiscal consolidation.
 PRECONDITIONS

Strong & vibrant financial

system.

Universally built-up adequate

reserves.

Appropriate policy frame from

exchange rate management.
Preconditions needed to be viewed
as process rather than as one time
indicators – Therefore,
implementation of CAC be spread
over a 3 year period:

1997 – 1998
1998 – 1999 and
1999 - 2000
RECOMMENDATIONS

 Fiscal  Reduction in
consolidation GFD/GDP
Ratio
from 4.5% to
3.5%
in 2000.

 Mandated
inflation rate for  3 to 5 percent.
the three years.
RECOMMENDATIONS
* Consolidation in Financial
Sector
 13.7 to 5.0
a) Gross NPA Reduction
percent

b) Average effective CRR -  9.3 to 3.0 percent

Reduction

c) Effective supervision

d) High Capital adequacy

RECOMMENDATIONS

Exchange Rate b)Transperancy

Policy in Exchange
Rate Policy in
terms of

a) Monitoring
exchange rate c) Declaration of
band of REER
monitoring
+1 - 5.0 per Band.
around REER
RECOMMENDATIONS
Balance of payments.  i) CAD = f(0)
[o=Openness]
which is current
receipt ratio to
GDP
- should be
enhanced to
Adequacy of Reserves. 15%.
Debt service ratio
should be
Strengthening of reduced from
Financial System. 25% to 20%.