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Where does India stand on fuller capital account convertibility?

Where does India stand on fuller capital account convertibility?
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First Published: Mon, Aug 06 2007. 01 36 AM IST

Updated: Mon, Aug 06 2007. 01 36 AM IST
Committees on capital account convertibility and comets have some things in common. For one, they both make a comeback after a certain period. They also leave behind dust clouds of confusion that keep people like Johnny busy till the time the next committee appears on the scene. The first committee on fuller capital account convertibility submitted its report way back in 1997. The second committee revisited the issue in 2006. It is almost a year since the second committee submitted its report, but Johnny is still trying to understand why experts on capital account convertibility talk in terms of language used by the traffic police. Johnny is wondering why terms such as ‘road map’ and ‘signposts’ are used while talking about convertibility. Jinny then arrives, and soon their discussion begins.
Johnny: Hi Jinny! Why are you late today? Any problem?
Jinny: I really hate city traffic lights. They always turn red when I am about to cross. I always get late because of them.
Johnny: I know that traffic lights can be irritating sometimes, but they serve a useful role in maintaining order.
Jinny: But traffic lights are not a very efficient way of regulating the flow of traffic. Building flyovers would be a better option. This way you can save the loss of productivity caused due to everything coming to a grinding halt at traffic lights.
Johnny: Well, I never thought about it like that. However, we can leave that debate for our city planners and come to another kind of traffic light that regulates the flow of capital in or out of the country. The second report on fuller capital account convertibility talks about road maps and signposts, but no flyovers. Can you throw any light on this?
Jinny: Let me start with the basics. Regulating the flow of capital is very much like regulating the flow of traffic on roads. Convertibility of a currency determines how easily capital can flow in or out of a country. A currency is fully convertible if it can be freely converted into currencies of other countries, and vice versa. You walk to your neighbourhood bank one fine day and ask for US dollars in exchange for Indian rupees. Your bank gives you the US dollars without asking any questions. Fuller convertibility implies that you are free to take money in or out of your country without any restrictions. Likewise, a foreigner is also free to take his money in or out of your country without any restrictions. This kind of free exchange means that your domestic economy is linked with the economies of other countries by a super express capital highway on which capital is free to move in or out without any roadblocks. However, very few countries have completely convertible currency in this sense.
Johnny: You mean no country is without traffic lights, there are always some restrictions in regulating the flow of capital??Where does India stand?in?terms?of?convertibility?
Jinny: We have been making a gradual move towards fuller convertibility since we started the economic reforms in 1991. Firstly, the rupee was made fully convertible on the current account from March 1994 onwards. Current account transactions are like our day-to-day shopping. It deals with all our exports and imports of goods and services. It also includes remittances, income and transfers that we send and receive. You may import goods and export services, or receive money from your sibling working abroad, all of which require conversion of one currency into another. Convertibility on current account implies that we can freely exchange our currency with any other currency for carrying out these transactions. However, reasonable restrictions in public interest are still imposed. For instance, a resident Indian can remit money only under the permissible limits.
Johnny: Well, it seems we have already built flyovers for regulating our current account inflows and outflows. Now tell me, how far can we convert currency for carrying out capital account transactions?
Jinny: Capital account deals with all transactions related to investments and borrowings. For example, all foreign direct investments, foreign institutional investments, investments by Indian companies abroad, deposits by non-resident Indians and so on fall within the category of capital account. At present, there are many restrictions on inflows and outflows of money on the capital account. For example, an Indian company can raise only $500 million of external commercial borrowing under the automatic route. Similarly, only foreign institutions are allowed to trade in Indian stock markets; non-resident individuals (except non-resident Indians) cannot do so. It has been observed that even countries having an open capital account retain some restrictions. So, fuller capital account convertibility does not mean zero capital regulation.
Our country, too, has been progressively moving towards greater capital account convertibility. The latest committee on capital account convertibility has suggested a road map of five years in three phases. Liberalization has begun with Phase I in 2006-07. The same will be followed through by Phases II and III in 2007-09 and 2009-11, respectively. It will be interesting to see how much progress we are able to make at the end of Phase III.
Jinny and Johnny will continue this discussion next week.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at realsimple@livemint.com
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First Published: Mon, Aug 06 2007. 01 36 AM IST