Captial account convertibility, tarapore committee

1. Capital Account Convertibility
(CAC)
Dr Raju indukoori

2. Foreign Currency Conversion
• Foreign currency acquired through exports and other
inflow sources. Then Foreign currency should be
converted into domestic currency.
• Foreign currency is required for imports and other
outflow sources. So domestic currency should be
converted into foreign currency.

3. Exchange Rate
• The foreign currency has to be converted at a specific
exchange rate
• The conversion rate can be
–Fixed (Pegged)
–Flexible ( Floating)

4. Convertibility of Rupee
To what extent the foreign currency can be converted
in Indian Rupee is known as convertibility. It has 3
forms
1) Fully convertible
2) Partial convertible
3) Non Convertible

5. Current Account Convertibility
• All the foreign currency transactions related to foreign trade
or exports and imports can be converted into respective
currencies at market determined prices
• Exchange rates are determined by market forces (Demand
and Supply)

6. Capital Account Convertibility
• It is the exchange of currencies on account of capital transactions
without any restrictions from the government or the central bank of
the country.
• Thus Fuller Capital Account Convertibility (FCAC) means that a
Indian resident can invest in any asset or property out of India
without any restrictions. Same applies to a foreign resident in India.
• Earlier as per the convertibility rule, the rupee can be converted on
current account as implemented since 1994. So, it can be changed
freely into foreign currency for purposes like trade-related
expenditures. However, it cannot be converted freely for activities
such as acquiring overseas assets

7. Contd…
• Article VIII of the International Monetary Fund (IMF) puts an
obligation on a member to avoid imposing restrictions on the
making of payments and transfers for current international
transactions. Members may cooperate for the purpose of
making the exchange control regulations of members more
effective. Article VI (3), however, allows members to exercise
such controls as are necessary to regulate international capital
movements
• India had committed to CAC more than a decade ago. But
certain parameters are to be fulfilled like fiscal gap shall have
to be 3.5% or below, debt servicing ratio to be 20% or below.

8. 8
Exchange Rate Volatility Stabilization
Sterilized Interventions
• Prevent Currency Depreciation by selling foreign currency
• Prevent Currency Appreciation by buying foreign currency
Unsterilized Interventions
• Prevent Currency Depreciation by indirect selling or
restricting selling of foreign currency
• Prevent Currency Appreciation by indirect buying or
restricting buying of foreign currency
12/16/2020 Dr Raju Indukoori

9. TARAPORE COMMITTEE
A committee on capital account convertibility (CAC) was setup by
the Reserve Bank of India (RBI) under the chairmanship of former
RBI deputy governor S.S. Tarapore to "lay the road map" to capital
account convertibility. In 1997, the Tarapore Committee had
indicated the preconditions for Capital Account Convertibility. The
three crucial preconditions were fiscal consolidation a mandated
inflation target and strengthening of the financial system.
The five-member committee has recommended a three-year time
frame for complete convertibility by 1999-2000.

10. TARAPORE COMMITTEE
The highlights of the report including the preconditions to be achieved for the full
float of money are as follows
1. Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5 per
cent in 1997-98 to 3.5% in 1999-2000.
2. A consolidated sinking fund has to be set up to meet government's debt
repayment needs; to be financed by increased in RBI's profit transfer to the
govt. and disinvestment proceeds.
3. Inflation rate should remain between an average 3-5 per cent for the 3-year
period 1997-2000
4. Gross NPAs of the public sector banking system needs to be brought down from
the present 13.7% to 5% by 2000. At the same time, average effective CRR
needs to be brought down from the current 9.3% to 3%
5. External sector policies should be designed to increase current receipts to GDP
ratio and bring down the debt servicing ratio from 25% to 20%

11. Why CAC
• Given the huge investment needs of the country and that domestic
savings alone will not be adequate to meet this aim, inflows of
foreign capital become imperative.
• The logic for the introduction of complete capital account
convertibility in India, according to the recommendations of the
Tarapore Committee, is to ensure total financial mobility in the
country.
• It also helps in the efficient appropriation or distribution of
international capital in India.

12. Why CAC
The objectives of FCAC are
1) to facilitate economic growth through higher investment by minimising
the cost of both equity and debt capital
2) to improve the efficiency of the financial sector through greater
competition, thereby minimising intermediation costs
3) to provide opportunities for diversification of investments by residents.

13. Contd…
• As per the reports, India has drafted a plan on fuller capital account
convertibility. And accordingly, a three-phase plan has been chalked
out till 2010-11 which would allow greater movement of capital in
and out of the local currency. RBI Governor has reassured that India
is preparing for full convertibility .
• However, at the present moment, the problem India faces is one of
excessive inflows of foreign capital, which is resulting in an
appreciation of the rupee. Such appreciation adversely affects the
competitiveness of Indian exports. Hence, there is a strong lobby
that not only wants the central bank to intervene and stall rupee
appreciation, but also to adopt policies that can moderate the surge
in capital inflows. This is holding back the transition to full capital
account convertibility for the time being.

14. CRITICISM
1. It is the result of pressure from wealth holders within the country
who want the option of transferring wealth abroad both to earn
returns and hedge against any possible weakening of the rupee. That
this could be at the expense of instability that undermines the living
standards of the less well-to-do obviously does not bother them.
2. Current levels of forex reserves will not be able to cope with the rising
demand of forex.
3. India has experienced both ‘floods’ and ‘sudden stops’ of capital
flows. Net capital flows to India increased from as low as US$ 7 billion
in 1990-91 to US$ 45 billion in 2006-07, and further to US$ 107 billion
during 2007-08, the year just before the crisis. They dropped to as low
as US$ 7 billion in 2008-09 at the height of the crisis. Capital flows are
estimated to have recovered to around US$ 50 billion in 2009-10.
Hence controls are desirable to that extent.

15. Thank you
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