As a developing economy, India has taken significant steps towards progress. One of them is ‘Liberalization’ or deregulation of government control over its economic policies. Initiated in 1991, liberalization was then introduced to facilitate transactions among various nations so as to integrate the world economy. The most impactful change that liberalization could bring was Capital Account Convertibility (CAC).
Capital Account records all transactions of capital nature in a country’s balance of payments. Capital account convertibility, as the name suggests, implies transforming domestic financial assets into overseas financial assets at the prevailing market prices/exchange rates without any restrictions, and vice versa. This gives rise to capital flows such as FDIs (Foreign Direct Investments) and portfolio investments. Financial assets such as bonds, equity, property etc. are easily traded among people/firm(s) among different countries. Such economic policies bring transparency in transactions, huge investments in various forms, and an opportunity to grow together and achieve a global equilibrium (a balance).
Such investments foster economic growth, increase the reservoir of foreign currencies, act as a cushion to financial shocks (internal and external), increase liquidity in the global market and finance budgetary deficits of the governments. Individuals get better and more promising returns for sharing higher risks. Emerging firms get most of the financial support through such diverse investments. Overall, capital account convertibility is a road that leads to development, the economy can rely on.
While introducing such changes seems pleasing, some economies may face huge financial outflow leading to large disinvestments in the domestic market. Differences in rates of return result in de-stabilized economies for a short period of time (the economies achieve equilibrium in the long run with the help of market mechanism). This generally happens with economies that are highly vulnerable to any kind of changes in their rigid macro-economic policies. Such economies can emerge as strong ones only after facing a short financial setback and become comfortable adapting to changes in their economic structure.
In India, the RBI (Reserve Bank of India) appointed Tarapore Committee, responsible for the implementation of Capital Account Convertibility. However, the macro economic situation of the economy is not matured enough to move for CAC. The Indian Rupee in the international market does not command such strength as would benefit the economy. On the other hand, there is apprehension that significant capital outflows may be witnessed in the economy to the detriment to the national interest.
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