23 March 2006

What is Capital Account Convertibility

Capital Account Convertibility
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Many countries regulate the inflow and outflow of the capital in to its market. This basically means that the central regulatory body decides the amount of Foreign Direct Investment (FDI) as well as the amount of Foreign Disinvestments (selling of assets). This process obviously involves currency conversion. That is, foreign currency to local currency while investing and local currency to foreign currency (selling local currency). As the conversion is regulated this can be called Regulated Account Convertibility.
If the regulation of the currency conversion for investment is removed or in other words a full conversion of the local currency from and to other currency is allowed then the country is said to practice Capital Account Convertibility (CAC).
Under current rules, India's rupee is only partially convertible to foreign currencies. The central bank (RBI) allows a free flow of foreign exchange for trade in goods and services, but it regulates who may exchange rupees for other currencies for investment purposes and the circumstances under which they may do so. The current rules regulate currency conversion for foreign entities that want to invest in India and Indians who want to invest overseas.Although FDI in certain market is allowed without cap, disinvestments (Selling invested Rupee and converting it to foreign currency) at the moment is regulated by RBI, in India. The problem India may face is when rumours, calamities etc hamper investor confidence, they may sell all assets in Rupee and convert it to say Euro or Dollar. This forces the forex value of the Rupee down. (Such depreciation against major currencies increases the cost of imports).
Analysts worry that India is not yet ready for such a system. Many counties suffered during 'East Asian crisis of 1980s'. India did not face the problem as Account Convertibility was regulated.

Raghavendra Kattinakere S

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