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Capital Account Convertibility (CAC)

Capital Account Convertibility refers to the freedom to convert local financial
assets into foreign financial assets and vice versa at market determined rates of
exchange.
Capital account convertibility is thus the freedom of foreign investors to purchase
Indian financial assets (shares, bonds etc.) and that of the domestic citizens to
purchase foreign financial assets.
It provides rights for firms and residents to freely buy into overseas assets such as
equity, bonds, property and acquire ownership of overseas firms besides free
repatriation of proceeds by foreign investors.
Countries prefer capital account convertibility to promote the inflow of foreign
capital.
Despite the various risk associated with capital flows like fluctuations in various
segments of the financial market, countries like India goes for it to get the
advantage of having additional foreign capital.

Features and Implications of Capital Account Convertibility (CAC):

1. Implies progressive integration of the domestic financial system with
international financial flows.
2. Regarded as one of the hallmarks of a developed economy.
3. Signals openness of the economy
4. Comfort factor for overseas investors. Encourages global capital flows
into the country.
5. Indian businesses-access to cheaper external credit (Global rates+
Country risk)-without having to ask permission of the RBI.
6. High Risk-High Gain-Good Times-Chance of huge inflows of foreign
capital; Bad Times-Chance of an enormous out flow of capital
7. Chance of "export of domestic savings"- for capital scarce developing
countries this could curb domestic investment
8. Exposes an economy to extreme volatility on account of "hot money
"flows.

Dr.S.S.Tarapore Committee on Capital Account Convertibility (CAC) 2006:

The Tarapore Committee (1997) had defined capital account convertibility as "The
freedom to covert local financial assets into foreign financial assets and vice versa
at market determined rates of exchange.
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In other words, it means allowing Indians to purchase both the physical and
financial assets abroad and vice-versa.
The first committee, the report of which was released on June 3, 1997, had
recommended a three-year timeframe (1997-2000) for complete convertibility,
subject to the fulfilment of preconditions.
The second committee had proposed a five-year timeframe, from 2006-2011, to
move towards convertibility in three phases: 2006-07 (Phase-I), 2007-08 & 2008-09
(Phase-II) and 2009-10 & 2010-11 (Phase-III).
The committee had made several recommendations:
1. Removal of tax benefits to NRIs.
2. Greater autonomy to RBI.
3. Complete check on fiscal deficit, gross fiscal deficit must be contained at
3.5% of gross domestic product (GDP) before going fully convertible.
4. Disallowing investment channel led through a particular country (like
Mauritius).
5. Reduction of government stake in banks from 51 per cent to 33 per cent.
6. Allowing industrial houses, a stake in existing banks or allowing them to open
new banks.
7. Allowing enhanced presence of foreign banks.
8. 10 per cent voting limit for investment in banks should be scrapped.
9. Non-resident corporate should be allowed to invest in Indian markets.
10. All individual NRIs should also be allowed to invest in Indian Market.
11. Revenue deficit of both central and states should be eliminated by 2008-09
and building a revenue surplus of 1 per cent by Financial Year 2011.
12. Raising the ceiling on External Commercial Borrowing (ECB).
13. Banning Participatory Notes (PNs) and phasing out the existing PNs within
one year.
14. Enhancing the ceiling on government debt from $2 billion to 10 per cent of
issuance and $1- 5 billion to 25 per cent of new issuances in a year of
corporate debt.
15. Building adequate reserve and limiting the current account deficit to under
3% of GDP.
16. All banks should be brought under Companies Act.
However, government has not implemented the full report of the committee but
various recommendations like raising the ceiling on External Commercial Borrowing
(ECB) etc has been implemented gradually in last five years.

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