Capital Account Convertibility

The term Capital Account Convertibility was coined by RBI and this term is almost synonymous with the RBI committee headed by SS Tarapore.

Capital account convertibility (CAC) means the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. This implies that Capital Account Convertibility allows anyone to freely move from local currency into foreign currency and back.

Basics

Capital account is made up of both the short-term and long-term capital transactions. The Capital Transaction may be Capital outflow or capital inflow. Convertibility on the capital account is usually introduced after a certain period of introducing the Current account convertibility. The most important effect of introducing the capital account convertibility is that it encourages the inflow of the foreign capital, because under certain conditions, the foreign investors are enabled to repatriate their investments, wherever they want.

However, the risk is that it may accelerate the flight of the capital from the country in unfavourable circumstances. For instance, an Indian can sell property here and take the Capital outside during such circumstances. This is the reason that Capital Account Convertibility is generally introduced after experimenting with the convertibility on current account.

Difference between Capital Account and Current Account Convertibility

Current account convertibility allows free inflows and outflows for all purposes other than for capital purposes such as investments and loans. It allows residents to make and receive trade-related payments such as dollars (or any other foreign currency) for export of goods and services and pay dollars for import of goods and services, make sundry remittances, access foreign currency for travel, studies abroad, medical treatment and gifts, etc. On the other hand, Capital Account Convertibility 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.

Current Situation in India

Presently, 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.