this presentation describes how the capital account convertibility is in India.
What is Capital account?
What is Capital account convertibility?
Measures. Advantages and Disadvantages
2. What is Capital Account ?
What is Capital Account Convertibility ?
Measures
Advantages and Disadvantages.
A.G
3. Capital Account
It reflects change in ownership of nation’s assets
Foreign Investment in India(FDI, FII, ADR, direct
purchase of land ,assets etc.)
External Commercial Borrowing , External assistance
etc
Capital account= Change in foreign ownership of
domestic assets – Change in domestic ownership of
foreign assets
A.G
4. Capital Account Convertibility
Floating Exchange Rate
What it means ? – Freedom of Conversion
CAC allows anyone to freely move from local currency
into foreign currency and back.
Changes of ownership in foreign/domestic financial
assets and liabilities.
A.G
6. TARAPORE COMMITTEE
Preconditions
- Gross fiscal deficit to GDP ratio to come down from a 4.5 %n
1997-98 to 3.5% in 1999-00.
- A consolidated sinking fund has to be set up to meet government's
debt repayment needs; financed by RBI.
- Inflation rate to be at 3-5 per cent for the 3-year period 1997-
2000 .
- Gross NPAs of the public sector banking system needs to be
brought down.
-Average effective CRR needs to be brought down from the current
9.3% to 3% .
A.G
8. 18th march 2006
“Given the changes that have taken
place during the last two decades
there is a merit in moving towards
fuller capital account
convertibility with a transparent
framework…..I will therefore
request the Finance Minister and
RBI to revisit the subject and come
out with a format based on current
realities.”
A.G
9. Second Tarapore Committee on
Fuller Capital Account
Convertibility
S.S Tarapore again as chairman
Submitted its report on September 2006.
A.G
10. Roadmap For FCAC
Phase I : 2006-07 involves move from current capital
movement of individuals from $25000 to $50000.
Phase II : 2007-09 Further raised to $100000
Phase III : 2009-11 Raised to a maximum of $200000
A.G
11. In case of corporate the remittance would rise from
200 percent to 400 percent
In case of banks overseas borrowings are made more
liberal
In case of mutual funds overall ceilings should be
moved from $2 billion to $5 billion.
A.G
12. Advantages
Diversification
Foreigners Investment
Catalyst for financial market, institutional
development, competition, technologies and
discipline macro economic policies
Reduction in size of black money
Induces competition against Indian finance.
13. CAC also allows the people and companies
not only to convert one currency to another,
but also free cross-border movement of those
currencies, without the interventions of the
law of the country concerned.
Thus, Indians could convert their rupees into
dollars and park it in the US if there was
capital account convertibility here.
Imagine if a large number of Indians were to
do this out of an irrational fear that India
might go to war with Pakistan!
However, a word
of warning…
A.G
14.
15. East Asian Crisis
THAILAND
During 1985-96 was growing at highest rate of 9%
Real estate sector was booming
High interest rate
Export growth was very high
Thailand Baht was pegged at 25 to US $.
A.G
16. Reason for Failure
US had increased interest rate to curb inflation this made
US investors to take their money from Thailand and invest
in US.
Citizens of Thailand also lost confidence in Thailand Baht.
It reached its lowest point of 56 units per $.
This made foreign loan costlier
Biggest corporation “Finance One” collapsed.
Fear among foreign investors.
Leads to political instability and people loosing their jobs.
Notas do Editor
A capital account refers to capital transfers and acquisition or disposal of non-produced, non-financial assets, and is one of the two standard components of a nation's balance of payments. The other being the current account, which refers to goods and services, income, and current transfers.
So when foreigner invest in India it represents an inbound flow and counts as surplus item and if a nation’s citizen are investing in foreign countries it represents an outbound flow and counts as deficit.
It is also know as floating exchange rate. It means the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates. It refers to the removal of restraints on international flows on a country's capital account, enabling full currency convertibility and opening of the financial system.
Advantages:- 1. it is a major feature of developed economy.
2. It offers foreign investors a lot of comfort as they can re-convert local currency into foreign currency anytime they want to and take their money away.
3.It makes easier for domestic companies to tap foreign markets
At the moment, India has current account convertibility. This means one can import and export goods or receive or make payments for services rendered. However, investments and borrowings are restricted.
4. Fear of economic crisis jus like East Asian economic crisis is suggested by economicst if india embrace capital account convertibility without adequate preparation.
Steps:- The Reserve Bank of India has appointed a committee to set out the framework for fuller Capital Account Convertibility.
When convertibility of rupee on current account was successful and when RBI had around 25 billion dollar reserves it was ready to take next step capital account convertibility.
RBI appointed in 1997 the committee on CAC with former deputy governor of RBI S.S Tarapore as its chairman.
Tarapore committee recommended that before adopting CAC India should fulfill 3 crucial preconditions.
Fiscal deficit should be reduced to 3.5% and government should set up a consolidated sinking fund to reduce government debt.
Government should fix annual inflation target between 3 and 5% this was called mandated inflation target and give full freedom to RBI to use its monetary weapons to achieve the inflation target.
Indian financial sector should be strengthened for this gross non-paying assets should be reduced to 5% the average effective CRR should be reduced to 3% and weak banks should either be liquidated or be merged with other strong banks.
And remember these all were to be achieved in 3 year period.
But these preconditions were not achieved fully even after 8 years when committee was formed.
As we can see that fiscal deficit as percentage of GDP is 3.5 % recommended by committee and its position in 2005-06 is 4.1%.
While the inflation target and gross NPA was within the range of what committee recommended.
Still RBI did not lower the CRR which was 5% 2% above the CRR recommended by committee.
So why did this happen?
Basically the committee failed to appreciate political instability in country at that time AND complete absence of political will and vision to carry the process of economic reforms and economic liberalization and also East Asia financial crisis at this time shelved the recommendation of Tarapore Committee.
So second tarapore committee was formed on fuller capital account convertibility.
In a speech at RBI on 18th march 2006 our former pm stated that “Given the changes that have taken place during the last two decades there is a merit in moving towards fuller capital account convertibility with a transparent framework…..I will therefore request the Finance Minister and RBI to revisit the subject and come out with a format based on current realities.”
After this promptly within 2 days RBI constituted the committee on fuller capital account convertibility.
Tarapore committee assumed that there is already ongoing process of capital account liberalisation which needs further deepening hence used the term fuller CAC . It further assumed that india’s forex reserves would only increase and suggested raising the ceilings for fresh investment abroad by companies bank individuals.
. It further assumed that india’s forex reserves would only increase and suggested raising the ceilings for fresh investment abroad by companies bank individuals.
What will happen if all Indians convert their rupee into dollar and park into US.