Capital account convertibility refers to a policy change that permits capital to flow more freely in and out of a country. Capital account convertibility (CAC) refers to the freedom of converting local financial assets into foreign financial assets and vice versa at market determined rates of exchange. Widely regarded as one of the hallmarks of a developed economy. It is also seen as a major comfort factor for overseas investors since they know that at anytime they will be able to re-convert local currency back into foreign currency and take out their money. \ What? Types Partial CAC: It is Restricted CAC. Caps are Specified, Restrictions and Special Approval in Conversion of Currency. Full CAC : Full capital account convertibility allows local currency to be exchanged for foreign currency without any restriction on the amount, movement of funds in and out of India without any restrictions and `no questions asked' basis. CAPITAL ACCOUNT CONVERTIBILITY
Example: India, Indian rupee is only partially convertible due to the Indian Central Banks control over international investments flowing in and out of the country. While most domestic trade transactions are handled without any special requirements, there are still significant restrictions on international investing and special approval is often required in order to convert rupees into other currencies.
Example: USA, In Full CAC anybody could walk into a bank and instruct to transfer money anywhere (exception will be restricted countries and/or region specified from time to time) and allow banks to receive funds from any entity from abroad for credit as per instructions of the remitter. There are no restrictions or limitations on the amount of dollars that can be traded on the international market, and the U.S. Government does not artificially impose a fixed value or minimum value on the dollar in international trade. Partial Capital Account Convertibility Full Capital Account Convertibility When is full CAC possible Preconditions for introducing full CAC like:
a) Fiscal deficit of the GDP should go down.
b) The annual rate of inflation should remain low and constant. It was maintained and achieved.
c) The foreign exchange reserves of the country should be sufficient for six months imports. At present, foreign exchange reserves are equal to two years import cover.
d) Non-performing assets of banks should not be more than five percent of the deposits
CAC & Indian Scenario End of Balance of Payment (BoP) crises Plenty of Foreign Currency Reserves Efficiency in Financial System Development of Securities Market Worldwide Presence and Friendly Relations with Trading Counterparts Committee on Capital Account Convertibility (Tarapore Committee) A Committee on CAC was set up under the chairmanship of Dr. Tarapore which submitted its report in May 1997 A roadmap was suggested keeping in view the dangers of greater capital flows in terms of volatility Hence, following preconditions were laid down before FCAC could be attained , First, a reduction in the fiscal deficit to gross GDP ratio to 3.5%; Second, an inflation target of 3-5%; And lastly, measures to strengthen the financial sector, and especially the banking sector Other measures were, ratio of NPAs to advances to be reduced to 5% and the CRR to 3%. Reduction in the external debt service ratio to about 20%
Tarapore Committee Recommendations Contd. The country has not, however, implemented capital account convertibility as per the schedule envisaged in the report. This was due to the Asian currency crisis of 1997 As for now the inflows from abroad have been freed to a large extent, outflows associated with these inflows, such as interest, profits, sale proceeds and dividends, are completely free of any restriction Current earnings of NRIs like dividends are fully repatriable The outflows from residents remain more restricted But direct investment abroad is permissible through joint ventures and wholly owned subsidiaries Second Tarapore Committee
The report of this committee was made public by RBI on 1 st
September 2006. Three phased adoption of CAC scheme: 2006-07 (Phase I) 2007-08 and 2008-09 (Phase II) 2009-10 and 2010-11 (Phase III) Some of the recommendations of the Committee:- Ceiling of ECB to be raised for automatic approval Allow NRIs to invest in capital market Provide tax benefits to NRI Prohibit FIIs from investing fresh money raised to participatory notes