2. Agenda Definition About Tarapore Committee Point of Action Reasons of CAC in India CAC for Indian Economy Pros and Cons of CAC Forecasts Conclusion Capital Account Convertibility Group 9 Schumpeter Hall 2
3. Definition: “Capital Account Convertibility or CAC is a monetary policy that centers around the ability to conduct transactions of local financial assets into foreign financial assets freely and at market determined exchange rates. It is sometimes referred to as Capital Asset Liberation.” Capital Account Convertibility Group 9 Schumpeter Hall 3
4. Tarapore Committee A committee on capital account convertibility was setup by the Reserve Bank of India (RBI) under the chairmanship of former RBI deputy governor S.S. Tarapore to "lay the road map" to capital account convertibility. In 1997, the Tarapore Committee had indicated the preconditions for Capital Account Convertibility. The three crucial preconditions were Fiscal consolidation A mandated inflation target Strengthening of the financial systemThe five-member committee has recommended a three-year time frame for complete convertibility by 1999-2000 Capital Account Convertibility Group 9 Schumpeter Hall 4
5. points of action All types of liquid capital assets must be able to be exchanged freely, between any two nations, with standardized exchange rates The amounts must be a significant amount (in excess of $500,000) Capital inflows should be invested in semi-liquid assets, to prevent churning and excessive outflow Excessive inflows and outflows should be buffered by national banks to provide collateral Capital Account Convertibility Group 9 Schumpeter Hall 5
6. Despite changes in wording over the years, and additional safeguards, there is still criticism of CAC by some economists. American economists, in particular, find the restriction on inflows to Third World countries being invested in improvements as negative, since they would rather see such transactions put to direct use in growing capital Capital Account Convertibility Group 9 Schumpeter Hall 6
7. Reasons for the introduction of CAC in India To ensure total financial mobility in the country It also helps in the efficient appropriation or distribution of international capital in India Such allocation of foreign funds in the country helps in not only equalizing the capital return rates across different borders, but also escalates the production levels It brings about a fair allocation of the income level in India as well Capital Account Convertibility Group 9 Schumpeter Hall 7
8. CAC for Indian Economy It refers to the abolition of all limitations with respect to the movement of capital from India to different countries across the globe. In fact, the authorities officially involved with CAC (Capital Account Convertibility) for Indian Economy encourage all companies, commercial entities and individual countrymen for investments, disinvestments and real estate transactions in India as well as abroad. It also allows the people and companies not only to convert one currency to the other, but also free cross-border movement of those currencies, without the interventions of the law of the country concerned Capital Account Convertibility Group 9 Schumpeter Hall 8
9. Benefits and drawbacks of CAC: CAC is concerned about the ownership changes in domestic or foreign financial assets and liabilities It also represents the formation and liquidation of financial claims on or by the remaining world It enables relaxation of the Capital Account, which is under tremendous pressure from the commercial sectors of India. Along with the financial capitalists, the reputed commercial firms in India jointly derive and enjoy the benefits of the CAC policy, which speculate the stock markets through investments. In fact, the CAC policy in India is pursued primarily to gain the speculator's and the punter's confidences in the stock markets CAC does not serve the purposes of the real sectors of Indian economy, like eradication of poverty, escalation of the employment rates and other inequalities Capital Account Convertibility Group 9 Schumpeter Hall 9
10. Pre-Conditions Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5 per cent in 1997-98 to 3.5% in 1999-2000 A consolidated sinking fund has to be set up to meet government's debt repayment needs; to be financed by increased in RBI's profit transfer to the govt. and disinvestment proceeds. Inflation rate should remain between an average 3-5 per cent for the 3-year period 1997-2000 Gross NPAs of the public sector banking system needs to be brought down from the present 13.7% to 5% by 2000 Capital Account Convertibility Group 9 Schumpeter Hall 10
11. At the same time, average effective CRR needs to be brought down from the current 9.3% to 3% External sector policies should be designed to increase current receipts to GDP ratio and bring down the debt servicing ratio from 25% to 20% Capital Account Convertibility Group 9 Schumpeter Hall 11
12. The forecasts made by the Tarapore Committee A prescribed average inflation rate of 3% to 5% will exist for a three-year time period, from1997-98 to 1999-2000 The non-performing assets will experience a decline to 12%, 9% and 5% by the years 1997-98, 1998-99 and 1999-2000 respectively, with respect to the total or aggregate advances By the years 1997-98, there will be a complete deregulation of the structure of interest rate The gross fiscal deficit will fall from 4.5% in 1997-98 to 4.0% in 1998-99 and further to 3.5 % in 1999-2000, with respect to the GDP Capital Account Convertibility Group 9 Schumpeter Hall 12
13. Conclusion India needs huge resources, especially to upgrade its infrastructure. Domestic savings alone are not enough. More (net) foreign funds would come in only if they are sure of free entry and exit Indian businesses (especially, the established companies) would be able to access cheaper foreign funds that would improve their international cost competitiveness Unhindered access to foreign funds would facilitate Indian companies taking over firms abroad and developing more Indian MNCs in the process Capital Account Convertibility Group 9 Schumpeter Hall 13
14. Indian banks would be able to borrow foreign funds at lower rates which would, in turn, enable them to lend at a lesser rate to Indian small and medium enterprises which may not otherwise be able to borrow directly from the international capital market Cutting delays in foreign exchange trading would reduce transaction costs and improve efficiency in Indian business. Finally, ordinary Indian investors would be able to further diversify their asset portfolios by investing abroad, thereby improving their risk-return profile Capital Account Convertibility Group 9 Schumpeter Hall 14
