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Convertibility of Current Account & Capital Account
This article deals with ‘Convertibility of Current Account & Capital Account .’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .
Why restrictions on Convertibility ?
- Central Bank cant manage floating exchange rate regime all the time otherwise Forex reserve will get empty. Hence , quantitative restrictions are placed on conversion of ₹ to foreign currency.
- Two can be two type of restrictions i.e. on Current Account & on Capital Account .
Current Account Convertibility
- Current account convertibility means freedom to convert currency, both in terms of outflows and inflows, for current transactions .
- In case of India, Current Account is fully convertible (since 1994) & there are no quantitative restrictions. This means, ₹ is fully convertible into another currency for current account transactions & vice versa is also true .
Capital Account Convertibility
- Full capital account convertibility means :
- A foreign investor can convert any amount of foreign currency to Indian Rupee and invest in any asset in India without any restriction. This investor is also able to sell the investment without any restriction, convert the resulting Indian Rupee amount to a foreign currency and take it out of the country.
- A domestic investor can convert Indian Rupee to foreign currency and invest in any asset abroad without any restriction.
- Domestic investor can raise any amount from External Market and convert it in India to invest that amount in India.
- ₹ is not fully convertible on capital account . But after the recommendations of the S.S. Tarapore Committee (1997) on Capital Account Convertibility, India has been moving in the direction of allowing full Capital Account Convertibility .
- There are following
limitations on Capital Account Convertibility
- Indian corporates are allowed full convertibility upto $ 500 million per annum for oversea ventures .
- Individuals are allowed to invest in foreign assets, shares, etc., upto the level of $ 2,50,000 per annum .
Liberalised Remittance Scheme (LRS)
- LRS was started by Government in 2004.
- Under the scheme, an Indian resident (including minor) is allowed to take out upto $2,50,000 from India either for current account or capital account transaction . (e.g. paying for college fees abroad, buying shares, bonds, properties, bank accounts abroad.)
- Issue : Panama papers allege certain various Bollywood celebrities used LRS window to shift money from India to tax havens for tax avoidance.
Debate : Should there be Full Capital Account Convertibility ?
There is ongoing debate that there should be full capital account convertibility .
Arguments in favour of full Capital Account Convertibility
- If capital account is fully convertible , then India can attract more FDI,FPI and ECB to India , creating new jobs & pushing economic growth.
- It will increase the choices for investments– Investors get the opportunity to base their investment and consumption decisions on world interest rates and world prices for tradeable.
- Various committees like SS Tarapore Committee has also accepted this.
Arguments against Capital Account Convertibility
- IMF study says that there is no correlation between full Capital Account convertibility & business growth.
- It could lead to the export of domestic savings .
- Companies would get money in $ via ECB & that would be returned in $s only. But this is not favourable in times of Exchange rate volatility.
- If our currency fall , then whole system can collapse as happened in East Asian Crisis of 1997 . India & China were able to survive the crisis because both didn’t have full capital account convertibility.
- Various committees like HR Khan Committee has rejected full Capital Account Convertibility.
Side Topic : East Asian Financial Crisis
- Before 1997 , All East Asian Economies used to deliberately keep their currencies undervalued in order to boost export. (like China is doing now)
- All these countries had full capital account convertibility. Foreign investment was quite high and GDP growth was in double digits.
- But then came Asian Crisis
- Thailand’s steel & automaker companies filed bankruptcy . Foreign investors panicked and started to pull out $s from similar companies from all South East Asian Nations . As a result, their currencies & economies collapsed . Eg : Indonesian Rupiah collapsed from 1$ = 2,000 to 1$ = 18,000 Indonesian Rupiah.
- This led to High inflation culminating in rioting & political instability .
- On the other hand, India and China survived this tumultuous period due to the fact that their capital account wasn’t fully convertible . Hence, investors can’t pulloff their investments overnight due to restrictions under Capital Account convertibility.
SS Tarapore Committee (1997)
Recommendations of the committee
- He was in favour of Full Capital Account convertibility but he also had a fear that crisis like East Asian Crisis can happen in India too . For this he advised that there should be some conditions before doing that
- Conditions
| Conditions | India’s situation |
| Forex to sustain 6 months imports | Yes, India has forex of more than $460 billion (i.e. Can sustain 11 months imports) |
| Fiscal Deficit of 3.5% of GDP | Target for 2020 is 3.5% (but will be breached due to Corona pandemic induced slowdown) |
| Inflation should be between 3-5% (for 3 years) | Under new Monetary Policy Framework, it should be contained between 2-6% |
| Bank NPA should be less than 5% | They are above 10% |