Making The Elephant Dance Through Capital Account Convertibility

1950 words - 8 pages

Capital Account Convertibility is one of the ways to integrate a nation's economy with the global economy, to deepen and integrate financial markets, to increase access to global savings, to discipline domestic policy makers and to allow greater freedom to individual decision-making and proliferation of Information Technology. India must meet these pre-conditions before implementing full convertibility of rupee on Capital Account.The inevitable globalization process has set in motion a mega change, which has motivated a big elephant, Indian Economy, to move with the changing world, by initiating the economic reforms way back in 1991. Later, the same force has started insisting on the elephant to dance. But, can an elephant dance? Yes it can dance, if it is provided with sufficient food (further reforms) along with melodious music (proper regulation). In fact, there are many ways to make the elephant dance; the first and foremost of them is Capital Account Convertibility (CAC).CAC implies freedom to convert rupees into foreign currency for transactions on capital account. CAC refers to the freedom to convert local financial assets into foreign financial assets and vice versa at market-determined exchange rates. It is associated with changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by, the rest of the world. CAC is introduced only after experimenting with the current account convertibility for a reasonable time, stabilization programs have been successfully carried out and favorable conditions have been ensured.The introduction of CAC helps a country in attracting certain types of capital flows from abroad. It also enables residents to hold internationally diversified investment portfolios, thereby, having more risk bearing capacity. On the other hand CAC is one of the essential parameters for any country to integrate their economy with global economy. It helps in deepening and integrating financial markets, raising the access to global savings, disciplining domestic policy makers and allowing greater freedom to individual decision making and proliferation of Information Technology. In fact, CAC can be considered as one of the best solutions for all economic ills affecting a country like India.Currently, resident Indians can buy shares and debentures of Indian companies only. With CAC, they can also purchase shares and debentures of foreign companies. Thus, Indian households can choose between investments in Indian and foreign companies. This implies that Indian companies will face even greater difficulties in mobilizing capital from primary market. In a capital starved economy, this may stifle the growth. Therefore, it becomes imperative to opt for CAC cautiously. On the contrary there are also so many problems with CAC. Convertibility could increase price rates because of the increase in the import prices. Under full convertibility if the free market exchange rate...

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