CAPITAL

ACCOUNT
CONVERTIBILI
TY
 Jay p

Suchet
Bhatnagar
01

Pranay Vivek
Patil Sharma
49 32

Members

Jay Vinit
Thakker Lagade
44 17

Jay Parikh
22
 Jay p

Balance of Payment
“The Balance of Payments of a country is a
systematic accounting record of all economic
transactions during a given period of time between
the residents of the country and residents of
foreign countries.”
 Jay p

Components of Balance of Payment

1. The current account.

2. The capital account.
 Jay p

Current Account
 The current account consists of all the international
transactions which are settled in the same financial year.
 The current account is the sum of the balance of trade, net
factor income and net transfer payments.
 Jay p

Capital Account

 An account that tracks the movement of funds for investments and

loans into and out of a country.
 Capital account transactions are asset transactions between Indian
and foreign countries. They occur, for example, when a Japanese
pension fund buys Indian government securities or when an India
buys stock in a Japanese firm.
 The two primary players in the capital account are businesses and
governments.
 Jay p

What is currency Convertibility?

 Jay p

CONVERTIBILITY

 Current Account convertibility: refers to currency convertibility required in the

case of transactions relating to exchange of goods and services, money transfers and
all those transactions that are classified in the current account.

 Capital Account convertibility: refers to convertibility required in the transactions of

capital flows that are classified under the capital account of the balance of payments.
 Jay p

CAPITAL ACCOUNT
CONVERTIBILITY
 Freedom to residents to convert local financial assets
into foreign assets, and/or to take on foreign liabilities
and invest proceeds in India or abroad.
 Freedom to non residents to create rupee assets or
liabilities and alter them.
 In other words, I would be free to keep money in a
Swiss Bank!
 Jay p

Why capital account convertibility?

 Capital account convertibility is considered to be one of
the major features of a developed economy. It helps attract
foreign investment. It offers foreign investors a lot of
comfort as they can re-convert local currency into foreign
currency any time they want to and take their money away.
 At the same time, capital account convertibility makes it
easier for domestic companies to tap foreign markets.
 Jay p

Cont..
Capital account convertibility

Full CAC Limited CAC

 Jay P

OBJECTIVES OF FULL CAPITAL

ACCOUNT CONVERTIBILITY

 Economic Growth

 Improvement in Financial Sector

 Diversification of investment
 JAY T

India Status
 Jay T

India’s Status
 Rupee had become fully convertible on current
account on 1991
 Rupee is Partially convertible on Capital account
 Jay T

Pros of Capital Account

Convertibility for India
 It allows domestic residents to invest abroad and have a globally
diversified investment portfolio, this reduces risk and stabilizes the
economy.
 It opens the gate for international savings to be invested in India. It
reduces the cost of capital. Eg: When steel imports are made easier,
steel becomes cheaper in India. Similarly, when inflows of capital
into India are made easier, capital becomes cheaper in India.
 Convertibility would reduce the size of the black money in
economy, and improve law and order, tax compliance and corporate
governance.
 As with trade liberalization led to lower prices and superior quality
of goods produced in India, capital account liberalization will
improve the quality and drop the price of financial assests in India.
 Jay T

Cons of Capital Account

Convertibility for India
 Herd Behaviour or Capital Flight Eg : Asian Crisis
and Argentina Crisis

 Misallocation of capital inflows Eg: Stock Market

rather than Building Industries

 Export of domestic savings (the rich can convert

their savings into dollars or pounds in foreign banks
or even assets in foreign countries)
 Jay T

 Entry of foreign banks can create an unequal

playing field, whereby foreign banks “cherry-
pick” the most creditworthy borrowers and
depositors.
 “Hot Money” (Capital shifts from country to
country in search of higher speculative returns)
 Jay T

CERTAIN ASPECTS RELATED TO

THE CAC
 Tarapore Committee Recommendation
 Asian Crisis
 Argentina Crisis
 FERA & FEMA ACT
 FDI Caps on Various Sectors
 Special reference of China
 Vivek

TARAPORE COMMITTE
 Vivek

RECOMMEDATIONS OF TARAPORE COMMITTE ON CAPITAL ACCOUNT

CONVERTIBILITY

A committee on capital account convertibility, 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. At the moment it is still a report and
central bank has to accept the recommendations of the committee.

The five-member committee has recommended a three-year time frame for complete
convertibility by 1999-2000. The highlights of the report including the preconditions
to be achieved for the full float of money are as follows:-

Objective: maintaining price stability and ensuring adequate flow of credit to

productive sectors.
 Vivek

Contd……

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.

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.
 Vivek
Until 1997……

Southeast Asia maintained High Interest Rates to foreign

investors.

Investors investing for High Rate of Returns.

Large inflow of money and experienced a dramatic run-up

in Asset prices

Widely acclaimed by financial institutions including the IMF

and World Bank

That phase was known as “Asian Economic Miracle".

 Vivek

What Happened in Mid 90’s…..

Thailand, Indonesia and South Korea had large private current account deficits
and the maintenance of fixed exchange rates.

Encouraged external borrowings which led to Foreign Risk

Two factors began to change in economic environment

U.S. economy recovered from a recession and began to raise U.S. interest rates
to head off inflation.

South asian Currencies was pegged to U.S Dollars

Higher U.S. dollar caused their own exports to become more expensive and less
competitive in the global markets.

Southeast Asia's export growth slowed dramatically in the spring of 1996,

deteriorating their current account position.
 Vivek
Thailand Crisis……

Unit of money in Thailand is called “BAHT”

1997 – Baht was pegged to Dollar that means

1$ = 25 Baht

15 May 1997 – Thai Currency (Baht) was hit by massive speculative attacks.

Thailand's economy developed into a bubble fueled by "hot money".

Global investors who begin to sell Southeast Asian currencies and sets off a tumble
both in currencies and local stock markets.

30 June 1997 – Prime Minister said not to devalue the currency baht and spark that
ignited the Asian financial crisis.

Thailand's booming economy came to a halt amid massive layoffs in finance, real
estate, and construction.
 Vivek

6 Lakh Foreign Workers returned to their own country.

2 July 1997 - Thai government was eventually forced to float the Baht

Baht devalued swiftly and lost more than half of its value.

Jan 1998 - That means now it was 1$ = 56 Baht.

Stock market dropped 75%

Finance One, the largest Thai finance company until then, collapsed

11 August 1997 - IMF unveiled a rescue package $17 billion subject to conditions
such as passing laws relating to bankruptcy (reorganizing and restructuring)
 Vivek

20 August 1997 - $3.9 billion bailout package.

By 2001, Thailand's economy had recovered.

The increasing tax revenues allowed the country to balance its budget and repay its
debts to the IMF in 2003, four years ahead of schedule.

The Thai baht continued to appreciate to 29 Baht to the Dollar in October 2010.
 Vivek

Indonesia Crisis began in July and August 1997……

Indonesia Currency Unit - Rupiah.

1$ - 2,600 rupiah roughly

large number of Indonesian corporations had been borrowing in U.S. dollars.

July 1997, Indonesia's monetary authorities widened the rupiah trading band from
8% to 12%

The rupiah suddenly came under severe attack in August

14 August 1997, the managed floating exchange regime was replaced by a free-
floating exchange rate arrangement

IMF came forward with a rescue package of $23 billion

The rupiah and the Jakarta Stock Exchange touched a historic low in September
 Vivek

Companies that had borrowed in dollars had to face the higher costs imposed upon
them by the rupiah's decline.

Many reacted by buying dollars through selling rupiah, undermining the value of
the latter further.

January 1998 - Rate plunged to over 11,000 rupiah to 1 USD.

June-July 1998 – Over 14,000 to 1 USD.

31 December 1998, the rate was almost exactly 8,000 to 1 USD

 VINI
T

Argentina Crisis
 Vinit

Intial Economic Reforms

• In 1991 Major economic reforms were done like business
deregulation, liberalization of prices and foreign trade,
privatization, public administration reform and financial sector
reform.
• Peso was pegged to Dollar at 1:1 Ratio.
• In 1992 and 1993 Sound fiscal Measures were taken removal of
tax exemptions and subsidies, increases in valueadded taxes,
improvements in tax administration, improvements in civil
service efficiency.
• It was supported by privartisation of 90 % of state enterprises
which help bringing in $20 billion to fiscal budget account.
• Despite the fact that argentina held a large debt of $64 billion or
39% of GDP by then.
 Vinit

 Based on sound economic reforms, GDP

accelerated to 10% in 1992, to 5% in both 1993 and
1994. Inflation was brought down to 4% by 1994.
 However, unemployment rate increased from 7% in
1991 to 11% in 1994.
 This reflected the fact that GDP growth was driven
mainly by increases in consumption caused by an
overvalued Peso, rather than by significant
expansion of productive activities.
 Vinit

Vulnerability to External Shocks

 In 1994–95 when Mexican crisis took place it
affected Argentina’s International reserves which
led to reduction in its monetary base.
 Vinit

Contd.
Tightened Commercial
Bank liquidity

Interest rate increased

Asset prices fell

Bank deposits fall

 Vinit

Overvaluation of currency
Unemployment

Affected Reduced growth

Production of exports

Overvaluation of
currency
 Vinit

Policy Failures after 1995

 GDP fall to -2.8% in 1995.
 Unemployment rate increased from 11% in 1994 to
18 % in 1995 to again further to 22% in 2002
 The consolidated fiscal deficits were –1.9% in
1994, –3.1% in 1995, –3.6% in 1996, –2.4 % in
1997, –2.5% in 1998 and –4.7% in 1999.
These deficits were financed by public borrowings
thereby public debt increased by $45 billion
bringing the total to $90billion.
 Vinit

 According to the statistics of the Ministry of Economy of

Argentina, current account deficits were highly negative,
reaching –11% of GDP in 1994, –5% of GDP in 1995, –7%
of GDP in 1996, –12% of GDP in 1997, –15% of GDP in
1998, and –12% of GDP in 1999.
 In most developing countries, a sustained current account
deficit in excess of 3% of GDP can be considered
imprudent.
 Vinit

The Unfolding of the Crisis

 The peg to the Dollar was changed to onehalf
Dollars and onehalf Euros, with the expectation
that this change may help correct the
overvaluation of the Peso.
 The government set preferential exchange rates for
exporters to encourage exports.
 Increased import tariffs on consumption goods and
reduced taxes on production.
 Vinit

 The measures of Argentina lacked credibility, particularly on

fiscal deficits Investors' sentiments hardened even more and
they were unwilling to continue to provide refinancing.
 As a result, in December 2001, the central and provincial
governments of Argentina defaulted on their $132 billion
foreign debt, the largest debt default in history.
 In November 2002, Argentina defaulted on its World Bank
loans. The IMF stopped further lending to Argentina.
 During 2001–2002, the stock market collapsed, with the stock
exchange MSCI index dropping from 2000 in 1999 to 400 in
2002.
 Vinit

Conclusion
 The main policy failures incurred by the Argentinean Government
during the 1990's could be summarized as follows:
 Argentina failed to maintain a sufficiently prudent fiscal policy that
effectively restrained increases in public debt.
 The government failed to set a proper parity between the Peso and
the Dollar when the convertibility plan was introduced. As a result,
the Argentinean Peso was overvalued from its inception,making the
country less competitive.
 This led to low export growth, high imports and large current
account deficits.
 The currency board arrangement made Argentina even more
vulnerable to international crises, particularly the 1994 Mexico
crisis. For political and historical reasons, the country failed to
softland its fixed exchange rate in 1994 and devalue the currency to
remain competitive, as other countries did.
 Suchet

FERA AND
FEMA
 Suchet

FERA
 Foreign exchange regulation act 1973
 Regulated in India
 Libralisation (FERA to FEMA)
 Promulgated in 1973
 Into Force in 1 January 1974

Aimed at regulating foreign exchange

 Suchet

Why it was introduced

 Suchet

Objectives of FERA
 To regulate certain Payments
 To regulate dealing in foreign exchange and
securities
 To regulate import and export of currency
 To conserve the foreign exchange resources of the
country and to ensure their proper utilization in the
interest of economic development of the country
 Suchet

 To regulate holding transfer or disposal of

immovable property abroad by persons resident in
India
 To regulate participation by residents in India in
the trading commercial and industrial activities
abroad in sort of joint venture
 To regulate purchase of foreign goods in India
 To regulate employment of foreign nation
 Suchet

Restrictive provision for FERA

Restriction on dealing in Foreign exchange
 Reserve bank of India(RBI)
 Sec 8
 No person other than an authorized dealer, Shall
deal in foreign exchange other than authorized
dealer
 Suchet

Restriction On Import and Export of

certain currency and bullion
 Sec13
 No person can bring or send into India any foreign
exchange or any Indian currency other than
 Foreign exchange obtain by him from am
authorized dealer or from any other money
Leander
 Suchet

Duty person entitled to receive foreign

exchange
 Sec 16
 No person has a right to receive any foreign
exchange or to any other person entitled to recive
from outside India payment in rupee shall be
exempt form with the permission of reserve bank
of India
 Suchet

Laps of FERA

 Enforcement

 Penalty

 Offences(Prosecution)
 Suchet

Enforcement
 Sec 33: laid down that central government may, at
any time by notification direct the owner to submit
return regarding their transaction in foreign exchange
 Sec 40: With power to summon persons to give
evidences and produce documents
 Sec 45: with the power of police officer and other
officer to enter and search
 Sec 43: with the discloser of documents or
information
 Suchet

Penalty
 Sec50: Any person contravenes any of the
provision of the act or any other rules and
regulation, are liable of such penalties
 Suchet

Offence and Prosecution

 Sec56: laid down any other person contravenes
the provision of the Act, he shall upon to be
conviction by court
 Suchet

FEMA
 Foreign Exchange Management Act
 The entire focus was in dealing in foreign
Exchange
 Introduced in the year 1991 after liberalization
 Various facilities were extended to foreign
companies
 51% foreign subsidiaries
 It extends to the whole of India.
 Suchet

Current account transactions.

 Any person may sell or draw foreign exchange

 Impose reasonable restrictions for current account

transactions
 Suchet

Capital account transactions.

 any person may sell or draw foreign exchange to or
from an authorised person for a capital account
transaction
 The Reserve Bank may, in consultation with the
Central Government,
 A person resident in India , invest in foreign
currency,
 A person resident outside India ,invest in Indian
currency
 Suchet

FDI IN DIFFERENT
SECTOR
Sector FDI investment allowed Special Conditions
Hotel and Tourism 100%
Trading 100%
Power 100%
Drugs & Pharmaceuticals 100% venture does not attract
compulsory licensing

Private Banking 49% address to guidelines issued by

RBI.

Insurance Sector 26% license from Insurance

Regulatory and Development
Authority (IRDA).

Telecommunication 49 %

74% But require Government

regulation

Business Processing 100%

Outsourcing
 Pranay

China & Its

Capital account
convertibility.
 Pranay

The Renminbi
 What is it?
 Acceptance?
 Pegged?
 Is the exchange rate of RMB just a relative price?
 Pranay

Status of current account convertibility

in China
 Fullconvertibility achieved in 1994
 Subject to restrictions.
 Import permit.
 Pranay

Capital Account Convertibility

 Partially achieved
 Achieved for foreign direct investment (FDI)
 Long-term loans to foreign and multilateral
financial institutions (Achieved)
 Policy of balancing foreign assets with foreign
liabilities
 Pranay

CAC yet to be achieved**

 Long-term Renminbi-denominated loans.
 Long-term portfolio investment, both inbound and
outbound, in either equity or debt instruments.
 large pools of “hot money,” not permited.**
 Pranay

The goal
 The goal of Chinese foreign exchange policy is to
maintain and support Chinese economic growth.
 Achieving a stable and sustainable long-term
equilibrium in the supply and demand of foreign
exchange.
 The fact that the Renminbi is used as a store of
value by Chinese citizens.
 Pranay

Foreign Direct Investment in China

 China receives USD 50 billion a year (Recycled or
round triped)
 Quantitatively, is not critical to the Chinese
economy.
 Qualitatively, FDI is probably more important to
the Chinese economy.
 Jay T

Should India go
for FCAC ?

NO
 Jay T

Reasons
 Capital inflow can cause currency appreciation and worsening of the
Balance of Trade
 The rising prices and the appreciation of the rupee are adversely
affecting India’s exports and the Balance of Trade.
 Instability in the international markets due to the sub prime crisis and
fears of a US recession are adversely affecting the entire world,
including India.
 Instability in the oil prices which touched $150 a barrel are also fueling
inflationary pressures in the economy
 Also, corruption, bureaucracy and in general, a poor business
environment, are discouraging the inflow of investment.
 Poor infrastructure and socio-economic backwardness act as deterrents
to FDI inflow.
 India still needs to work on its fundamentals of providing universal
quality education and health services
 Jay T

 There is no point trying to add on to the clump at

the top of the pyramid if the base is too weak. The
pyramid will soon collapse!
 Hence, India should either wait for a while or
implement CAC in a phased, gradual and cautious
manner.
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