Excessive inflows and outflows should be buffered by national banks to provide collateral. When any currency can be exchanged for any other currency at the market price then that currency is said to be convertible.
History[ edit ] Capital account convertibility a boon or was first coined as a theory by the Reserve Bank of India in by the Tarapore Committeein an effort to find fiscal and economic policies that would enable developing Third World countries transition to globalized market economies.
On the other hand, they can repatriate the money that they have invested in the stock market, as was the case in recent months.
They also tie up with local companies because in times of crisis, they can exit the joint venture easily and get back their monies invested in the merged entity.
On the other hand, capital account convertibility or fully convertible currencies are those where just about anybody can convert the local currency for foreign currency without any questions or restrictions placed on such conversions. So for example the rate of interest on borrowings in developing nations like India is 10 percent to 14 percent whereas in developed countries like the USA it is between 3 to 5 percent, capital account convertibility results in companies taking advantage of this huge gap between the rate of interest between developing and developed nations.
This is also the reason why capital controls are imposed in times of economic crises to prevent a capital Capital account convertibility a boon or from these countries.
Under capital account convertibility regime a foreign national can convert the foreign currency into domestic currency and also he or she can freely buy and sell the assets like real estate, stocks, bonds and so on.
Capital account refers to expenditures and investments in hard assets, physical premises, and factories as well as investments in land and other capital-intensive items. The reason why it is called capital account convertibility is that the conversion of domestic currencies into foreign currencies is allowed in the capital account and not only the current account.
The entire outsourcing movement with jobs and factories going overseas is a direct result of the foreign investment aspect of CAC.
Capital account convertibility would benefit countries because it would provide nations with huge funds, which would boost economic growth. Free flow of assets was required to work in both directions.
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.
Hence as far currency is concerned capital account convertibility initially is a boon and indirectly helps the imports of the country getting cheaper because appreciation in currency results in imports of the country getting cheaper.
A precondition for many countries to get IMF International Monetary Fund or World Bank assistance is to make their currencies capital account convertible so that foreign investors have the exit option quickly and without hassles in times of economic crises.
However, before the formalization of CAC, there were problems with the theory. Advantages and Disadvantages of Capital Account Convertibility Vinish Parikh March 6, Capital account convertibility is a debatable topic because many people think that it is good for the economy while others think that it is detrimental to the economy.
As for other countries in South East Asia that were fully convertible, the Asian financial crisis of was a wakeup call for them as investors fled the country and capital flight accelerated leading to a near collapse of the economies in the region with the exception of Singapore. However, with economic stability and no fiscal constraints, capital account convertibility can fuel economic growth for a country.
Governments should accept it if there is a lower fiscal deficit around 3. Capital inflows should be invested in semi-liquid assets, to prevent churning and excessive outflow.
Partially and Fully Convertible Currencies Partially convertible currencies are those where the currency can be converted in the current account. This is where the concept of capital account convertibility lies.
If you are interested in writing articles for us, Submit Here Share this Page on: Institutional investors should not use CAC to manipulate fiscal policy or exchange rates. However, before taking a huge and a critical leap of implementing capital account convertibility, governments want to make sure they have strong and stable financial system.
The effect of this is that many foreign companies do not hold assets like buildings, premises, and other items that fall in the capital account.
Certain factors which stop the acceptance and implementation of capital account convertibility are the fear of instability, capital flight and fluctuating financial markets.
This would further lead to people of that nation occupying and acquiring international securities and assets and thereby increasing the prosperity for the country. The impact of convertibility on economies is felt in the way assets held in the domestic country can be repatriated with ease or partially.
The world would become a common playground for banks and financial institutions as they would be able to borrow and invest in overseas markets.
It also exposed domestic creditors to overseas credit risks, fluctuations in fiscal policy, and manipulation.
Payments relating to foreign trade, travel, tourism and other global level services are known as current account transactions. Capital Account Convertibility means that the currency of a country can be converted into foreign exchange without any controls or restrictions.
Another advantage of capital account convertibility is that it helps in increasing the confidence of the foreign investors as they can freely buy and sell assets and also convert the domestic currency into foreign currency anytime they want which results in an improved outlook for the economy of the country by the foreign investors.
Due to the low exchange rates and lower costs associated with Third World nations, this was expected to spur domestic capital, which would lead to welfare gains, and in turn lead to higher GDP growth.
These were not realized and identified until a reform system strengthened regulatory and accounting controls. Controversy[ edit ] Despite changes in wording over the years, and additional safeguards, there is still criticism of CAC by some economists.
Further, ordinary citizens can convert their domestic currencies to dollars for expenses like going abroad for work, tourism, and education.
In Malaysiafor example, there were heavy losses in overseas investments of at least one bank, in the magnitude of hundreds of millions of dollars.What is Capital Account Convertibility? Capital Account Convertibility means that the currency of a country can be converted into foreign exchange without any controls or restrictions.
In other words, Indians can convert their Rupees into Dollars or Euros and Vice Versa without any restrictions. 7/30/ Capital Account Convertibility A Boon Or A Bane Economics Essay Capital Account Convertibility A Boon Or A Bane Economics Essay Currency Convertibility means ease with which a particular currency or domestic currency can be converted into any other international currency and vice versa.
Currency convertibility requires a readily available supply of the physical currency which is why some countries impose capital controls on money leaving its country. Capital account convertibility is a feature of a nation's financial regime that centers on the ability to conduct transactions of local financial assets into foreign financial assets freely or at country determined exchange rates.
It is sometimes referred to as capital asset liberation or CAC. Convertibility of Capital Account Allowing capital to flow freely in or out of a country without controls or restrictions – is known as capital account Convertibility. Capital account convertibility is a debatable topic because many people think that it is good for the economy while others think that it is detrimental to.Download