The Debate on Capital Account Convertibility in India
Team Name: The conquerors
Institute Name: NMIMS
Team Members:
Name: Jigar Shah Kavitha Rajan
Email: jigar.shahft09@nmims.org kavitha.rajanft09@nmims.org
Phone: 9819952441 99672457453
`
The Debate on Capital Account Convertibility in India
Executive Summary
Capital Account Convertibility is considered the hallmark of a developed economy. CAC, as defined by Tarapore committee is the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange.
CAC is in line with the classical theory of economics where markets clear itself and attain equilibrium prices by creating demand for the given supply levels. This assumes the presence of an invisible hand enabling the market clearance. But patrons of the Keynesian economics believe that the markets are governed more by market sentiments than fundamentals in the short term. This short term perspective of the investors can destabilize the economy and create volatility in the market. Hence it is important that the country has strong macroeconomic factors to support the volatility.
In late 1980’s India faced a balance of payment crisis due to fiscal imbalances.
India’s credit rating was downgraded and access to external funds became bleak. By early 1991, foreign exchange reserves were almost depleted, and India was on the verge of default. IMF came to the rescue and provided the necessary funds to pull India out of the crisis. In 1994, as a part of Article VIII of IMF, India implemented Current Account Convertibility and accepted to implement Capital
Account Convertibility.
Under the supervision of IMF other developing economies had implemented
CAC. They had fixed exchange rate system pegged to the USD. When the Dollar rose, consequently the ASEAN currencies grew too, resulting in lower exports.
This resulted in a decline in export earnings of these countries and thus increasing their trade and current account deficit. The crisis first
Institute Name: NMIMS
Team Members:
Name: Jigar Shah Kavitha Rajan
Email: jigar.shahft09@nmims.org kavitha.rajanft09@nmims.org
Phone: 9819952441 99672457453
`
The Debate on Capital Account Convertibility in India
Executive Summary
Capital Account Convertibility is considered the hallmark of a developed economy. CAC, as defined by Tarapore committee is the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange.
CAC is in line with the classical theory of economics where markets clear itself and attain equilibrium prices by creating demand for the given supply levels. This assumes the presence of an invisible hand enabling the market clearance. But patrons of the Keynesian economics believe that the markets are governed more by market sentiments than fundamentals in the short term. This short term perspective of the investors can destabilize the economy and create volatility in the market. Hence it is important that the country has strong macroeconomic factors to support the volatility.
In late 1980’s India faced a balance of payment crisis due to fiscal imbalances.
India’s credit rating was downgraded and access to external funds became bleak. By early 1991, foreign exchange reserves were almost depleted, and India was on the verge of default. IMF came to the rescue and provided the necessary funds to pull India out of the crisis. In 1994, as a part of Article VIII of IMF, India implemented Current Account Convertibility and accepted to implement Capital
Account Convertibility.
Under the supervision of IMF other developing economies had implemented
CAC. They had fixed exchange rate system pegged to the USD. When the Dollar rose, consequently the ASEAN currencies grew too, resulting in lower exports.
This resulted in a decline in export earnings of these countries and thus increasing their trade and current account deficit. The crisis first
References: http://www.rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage=&ID=468 (Committee report on Fuller CAC, 2006) http://www.rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage=&ID=169 (Tarapore committee report on CAC, 1997) Capital Account Convertibility: A Neglected Consideration (A paper by Arvind Subramanian Senior Fellow, Peterson Institute for International Economics) http://203.197.126.103/community/FinClub/dhan/dhan4/art44-se.pdf