Should India go for full capital account convertibility

Abstract

The study seeks to analyze the issues related to full convertibility of the Indian currency as well as the implications if the same is implemented. The study also examines whether India has reached a stage of financial development when full capital account convertibility (CAC) could be introduced. Capital account convertibility can be, and is, coexistent with restrictions other than on external payments. It also does not preclude the imposition of monetary/fiscal measures relating to foreign exchange transactions, which are of a prudential nature. The issue is important because until the Asian crises of 1997-98, there was a growing consensus that free global financial flows were positive for all and more so for the developing countries. This was based on the proposition that it would help improve global allocation of financial resources. As the returns on capital were higher in developing countries, finance would flow, in general, from the developed countries to developing countries. In the aftermath of the Asian and other developing country crises, however, there has been some rethink and recognition that financial deregulation can’t run ahead of prudence. There is also the issue of the sequencing of financial liberalization. It is generally agreed that capital account convertibility should come at the end of this process. Though there was support for financial liberalization, opinions differed about the pace at which it could proceed. Some countries like Thailand abolished the controls quickly and opened up their economies while countries like India continued to proceed at slow pace. Until 1991, the Indian economy was subject to a high degree of financial repression and national and international controls. These controls were being lifted slowly when the Asian economic crisis struck. Though, India didn’t experience the shock and contagion as some South East Asian countries did, rethinking began whether or not controls should continue to be lifted and the pace at which this should be done. It was feared that lifting of all controls and thus making rupee fully convertible could expose India to shocks and contagion such as those experienced by Asian countries. At the same time, lack of full convertibility on capital account was acting as an impediment for free flow of capital resources. India is now in race with China and hence has to weigh the pros and the cons in taking a decision about full convertibility of its currency.Thus this study focuses on the issues and the implications of full account convertibility