Capital Account Convertibility means that the currency of a country can be converted into foreign exchange without any controls or restrictions. The Report of the Tarapore Committee on Capital Account Convertibility (1997) provided the following working definition of CAC: “freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange.
The capital account reflects net change in ownership of national assets. This includes all kinds of investment assets like shares, debt, and property, or even corporate assets like the goods produced by an Indian subsidiary of a foreign company. When foreigners purchase assets in India, the money is treated as capital inflows. When Indian nationals purchase assets in foreign country by converting Indian Rupees in to foreign currency, it is treated as capital outflow. In other words, Indians can convert their Rupees into Dollars or Euros or any other foreign currency and Vice Versa without any restrictions placed on them. Currently, in India, there are limitations to how much capital can flow in and out of the country. So, India’s capital account is only partially convertible. When there are no restrictions, our capital account would be fully convertible.
Advantage and disadvantage of full convertibility:
In a way, capital account convertibility removes all the lock up on international flows. This allows developing countries to access more money for investments. The free movement of global capital to India or any emerging economies brings in foreign advanced technology, skills and many other related positive externals. When foreign companies set up subsidiaries in India and produce goods locally, it adds more jobs, improves productivity and spreads technological knowledge. In turn it helps to boost economic growth of the country.
Critics, however, do not believe that free capital account is necessary for higher economic growth. They argue that the gain in economic growth is ‘potential’ but the dangers involved in the scheme are ‘real’. “Any deterioration in fiscal conditions, inflation management, balance of payments, or any other macroeconomic shock may cause a cessation or reversal of capital flows.” This means a limited convertibility is more than enough for emerging economies to ensure growth while also limiting the risks.
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