Is India is ready for fuller capital account convertibility?

Capital account convertibility is usually considered as the hallmark of the developed country. Monitory authorities of every country in the world like to go for the CAC ultimately in their course of development. There are lot of hurdles in this path as it is has become evident from the 1997 Asian currency meltdown.

Capital account convertibility is the most complex financial entity to discuss. It is not having any precise definition. Broadly it is defined as the freedom given to the citizen to convert local assets in to the foreign assets and freedom given to the global citizen to buy any class of assets such as stocks, bonds, real estate etc.

CAC itself is a vogue term. It has so many levels of implementations. It not a single event but it is the long drawn process so that the monitory authorities give the gradual relaxation of the limits that they have imposed on the capital flows. For example limit on the outward remittances for the domestic citizen is raised for so many times in recent years. It is now up to one tenth of millions of US dollars per person per year. RBI has taken this step to boost the outward flow of capital. RBI has also lifted almost all restriction on the companies for acquisitions abroad. So that it will spur the outward capital flows.

So many countries have previously tried to go for the capital account convertibility. Every nation, which went for the CAC has the varied results. For some it has been the beneficial to their economy and for some it has turned in to the disaster.

India tried for the fuller CAC for two times. Indian government has constituted two committees both under the leadership of S.S. Tarapore. One in 1997 and other in 2006.

The first time the plans got spooked due to the great south and East Asian currency meltdown. After this crisis government disbanded the idea implementing CAC at that time.

Now government is reviving the idea of the fuller capital account convertibility as it want to make India the financial powerhouse, as the situation is ripe now. So the committee is constituted under S.S. Tarapore, which has given recommendation for the fuller CAC.

So main point for discussion is whether India is ready for the Fuller Capital Account Convertibility?

So my answer is our nation is not ready for the Fuller Capital Account Convertibility.

So I would like to explain my argument in the following way:

So many politicians have raised the concern against the capital outflow and massive currency depreciation.

On the contrary the real problem in implementation of FCAC lies in the massive capital inflow. It is evident from the rapid accumulation of the capital in recent years. It is leading in to rapid rise in the money supply. Due to this India has faced rapid rise in the inflation rate, rising asset prices etc. So it is now leading in to the overheating of the Indian economy.

The most important point is that India still has not yet braced up the idea of fuller capital account convertibility.

There is cap in the external commercial borrowing, cap on the overseas investment in the bond market, etc. Still there is significant restriction on the inflow of capital in India.

The accumulation of the foreign exchange reserves in the last one-year is about 40 billion USD due to large-scale intervention of RBI to prevent rapid appreciation of our domestic currency.

Due to the RBI felt the heat of inflation which arose due to rising money supply growth up to almost 20% Y-o-Y. So recently RBI went for non-intervention in the forex markets due to this value of our domestic currency increased against the dollar about 12 % Y-o-Y.

Now i would like to give one proof to support my argument that RBI is not going to raise the cap on the ECB or any other kind of the overseas borrowing and the contrary it want to restrict the current flows to prevent economy from overheating. So the exact paradoxical thing RBI is doing as compared to the recommendations that S.S. Tarapore Committee has given on for achieving the Fuller Capital Account Convertibility. This act of RBI is the exact role reversal even though they are doing it according to the prevalent situation.

And the global scenario is also adverse for implementation of FCAC. US economy is coping with twin deficits that is fiscal and current account deficit which is running at the level of 800 US billion dollars a year since last few years. The net international investment position is negative by about 2.8 trillion US dollars almost equal to the foreign exchange reserves accumulated by Asian countries. This is the situation when the US economy is its peak of their interest rate cycle. Now US is on the verge of recession as already it is facing slowdown due to rapidly plunging housing market. Even when the interest rates are at the there peak then also dollar has already hit multiyear low against pound and other major currencies in the world and all time low against Euro. If US fed starts lowering the interest rates to keep away its economy from recession then the great slide of US dollar will happen against almost all currencies in the world.

In such situation the investor will always try to escape from dollar denominated assets. They will always find safe heaven in the emerging markets. These markets have to sustain the huge capital flows so to India.

Already with this small amount of capital flow has created lot of inflation and almost 12% appreciation of the Rupee. It is almost impossible for our economy to sustain the rising capital flows without causing any damage to its economy.

We already have lost the competitiveness in the export market viz other developing countries like China etc as we are coping with the appreciation of Rupee, but other competing Asian countries have not faced such kind of appreciation in their currency. It will further slow our exports and our imports will rise, as imported goods will become cheaper. It will further aggravate our grave situation on current account deficit front. This all leads to volatile currency. Such volatility will deter the long-term investors away from the Indian markets. It will lead to the loss of confidence of the foreign investors about the fundamentals of the Indian economy.

My opinion is the current situation is not appropriate for going Fuller Capital Account Convertibility.

So comments, suggestions, questions, and counter arguments on this article are welcome. I request you to make this topic widely discussed on all fronts.

Bye bye

Dr. Gullapalli H.S.