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The economic liberalisation in India refers to on-going reforms in India that started in 1991.
After Independence in 1947, India adhered to socialist policies due to which there was low
annual growth rate of around 3.5% during 1950-80s. At the same time, Pakistan grew by 5%,
Indonesia by 9%, Thailand by 9%, and South Korea by 10% and Taiwan by 12%. 

In the 1980s, Prime Minister Rajiv Gandhi initiated some reforms. In 1991, after the
International Monetary Fund (IMF) had bailed out the bankrupt state, the government of P.
V. Narasimha Rao and his finance minister Manmohan Singh started breakthrough reforms.
The new policies included opening for international trade and investment, deregulation,
initiation of privatization, tax reforms, and inflation-controlling measures. The overall
direction of liberalisation has since remained the same, irrespective of the ruling party,
although no party has yet tried to take on powerful lobbies such as the trade unions and
farmers, or contentious issues such as reforming labour laws and reducing agricultural
subsidies.

As of 2009, about 300 million people, equivalent to the entire population of the United States
have escaped extreme poverty. The fruits of liberalisation reached their peak in 2007, when
India recorded its highest GDP growth rate of over 9%. With this, India became the second
fastest growing major economy in the world, next only to China. Organisation for Economic
Co-operation and Development (OECD) report states that the average growth rates 7.5% will
double the average income in a decade and more reforms would speed up the pace. Indian
government coalitions have been advised to continue liberalisation. India grows at slower
pace than China, which has been liberalising its economy since 1978. McKinsey states that
removing main obstacles "would free India¶s economy to grow as fast as China¶s, at 10 per
cent a year".
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o The primary objective behind the adoption of CAC in India is to make the movement of
capital and the capital market independent and open. This exerts less pressure on the
Indian financial market. This happens because of the following understated reasons:
 It abolishes all the limitations with respect to the movement of capital from India to
different countries across the globe thereby facilitating trade.
 Authorities officially involved with CAC (Capital Account Convertibility) for Indian
Economy encourage all companies, commercial entities and individual countrymen
for investments, divestments, and real estate transactions in India as well as abroad.
 It facilitates easy cross -border movement of currencies, without the interventions of
the law of the country concerned.

o The CAC policy in India is pursued primarily to gain the speculator's and the punter's
confidences in the stock markets. 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.

o Also, CAC is widely regarded as one of the hallmarks of a developed economy. It is also
seen as a major comfort factor for overseas investors since they know that anytime they
change their mind they will be able to re-convert local currency back into foreign
currency and take out their money.

CAC is beneficial for India as the inflow of foreign investment increases and the transactions
are much easier and occur at a faster pace. CAC also initiates risk spreading through
diversification of portfolios. Moreover, India will gain access to newer technologies which
translate into further development and higher growth rates. Thus, for the above reasons India
is going for CAC.
As we have discussed so far, Capital Account Convertibility is a monetary policy which
basically deals with Capital Asset Liberation in our country. In other words, it is the ability to
conduct transactions of local financial assets into foreign financial assets without any
hindrance and at a exchange rate which is determined by the market depending upon the the
demand and supply. It is sometimes referred to as Capital Asset Liberation.

In order to strengthen the financial system, the Reserve Bank of India (RBI) formed a
committee on capital account convertibility which was headed by former RBI deputy
governor S.S. Tarapore and 4 other members.

Depending upon the preconditions, certain predictions were forecasted by this Tarapore
Committee regarding Indian CAC. These were.

 An average inflation rate of 3% to 5% may continue for the period from1997-2000.

 There will be a complete deregulation of the configuration of interest rate by the years
1997-98.
 In comparison to the GDP. the gross fiscal deficit may fall from 4.5% in 1997-98 to
4.0% in 1998-99 and further to 3.5 % in 1999-2000
 In view of the total or aggregate advances the non-performing assets may experience
a decline to 12%, 9% and 5% by the years 1997-98, 1998-99 and 1999-2000
respectively.

Following were the recommendations of this committee:

o There should be a phased liberalisation of capital controls.

o The committee were in a view that any kind of liquid capital assets can be exchanged
freely, between any two nations, with standardized exchange rates
o The amounts for this transaction must be a considerable amount or to be precise it
should be in excess of $500,00.
o In order to prevent churning and excessive outflow capital inflows should be invested
in semi-liquid assets.
o National banks should provide collateral and hence buffer the excessive inflows and
outflows from the country in order to safeguard this interest of capital account
convertibility.
Some of the economists in India as well as across the world still found some problem with
these suggestions which were given here. American economists, in particular, find the
restriction on inflows to Third World countries being invested in improvements as loss.
Beside this even India was bound to face similar kind of restrictions. This aroused the further
area of improvement in this regard and hence FCAC came into picture later in 2006.

   
The pre-conditions were concerned with fiscal consolidation, a mandated inflation target,
strength of the financial sector and health of the external sector. The committee
recommended that the fiscal deficit should come down to 2.5% of GDP by 1999-00. In
relation to inflation, the committee recommended that the parliament should target a medium-
term inflation scenario.
Various suggestions were made for the refurbishment of the banking and financial sector. It
suggested for a neutral real effective rate by the RBI which could fluctuate within a band of
+/- 5%. Lastly, the balance of payments must be very strong to sustain any large outflow of
foreign exchange.


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Post to the recommendations of Tarapore Committee, the Indian government reduced its
restrictions in Foreign Direct and Portfolio Investments and foreign borrowings and allowed
dealers in Foreign Exchange to account flow of funds in a few cases without any prior
approval from the Reserve Bank of India.
The following measures were taken by the RBI:

o Allowing the dealers to hedge overseas loan exposure for their clients through swaps
and forward covers and to repatriate money without its approval
o October 1997 ± Allowing of free import of gold through eight banks and three
agencies
o Companies were allowed to open offices abroad. Current and Capital account
expenditure of these companies was allowed up to the limit of their foreign exchange
earnings.
 o November 1997 ± RBI takes steps in three particular areas namely; Money Market,
Increasing the number of primary dealers and allowing foreign currency denominated
bonds to residents.

Learning from the South-east Asian crisis and various other aspects, the Indian government
adopted a go-slow policy. The following measures were taken by the RBI post 1999:

o Allowing foreign company branches in India to remit profit to their head office
through authorized dealers.
o In 1999-00, Dealers were allowed to Foreign Exchange cover up to 15% to FII¶s.
o In 2000-01, Indian companies were permitted to takeover foreign companies.
o In 2001-02, In respect of general insurance, settlement of claims of foreign currency
was allowed.
o In 2002-03, Indian banks were allowed to open short-term deposit accounts of Non-
Residents.

Post 2003-04 various measures were taken to liberalize the capital account transactions.


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By looking at the Macro-economic variables currently, it is evident that these factors are
moving in favour of moving on to the CAC. There are also a few factors that do not support
the same.

With the increase in the foreign investments in India, there is a balance of payment surplus.
This presents a case for a fast move towards the CAC. But there are other factors such as
fiscal deficit, inflation, suggest for a wait and watch. So, the government must be watchful in
taking any steps towards CAC.

 

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The external sector started growing strong enough to withstand any adversity, the Govt. of
India set up another committee to suggest measures for a rapid move towards CAC in March
2006. This committee was known as Fuller Capital Account Convertibility (Tarapore
Committee II) and the report was submitted in July 2006. The committee detailed a five year
time framework for movement towards Fuller Convertibility in three phases ranging from FY
2006-07 to FY 2010-11, which were subject to meeting of specific targets.

The committee recommended for:

o Raising the ceiling of external commercial borrowings by abolishing restrictions on

the end use.
o Monitoring of import-linked short-term loans
o Raising of ceiling on corporate overseas investment in phases from 200% to 400% of
net worth.
o Allowing EEFC account holders to access foreign currency accounts with cheque
facility
o Prohibiting FIIs from investing funds raised through participatory notes
o Allowing non-resident corporate to invest in stock markets
o Raising the annual limit for remittances abroad in phases from $2.0 billion to $5.0
billion

The FCAC has its advantages in many cases, like, more cash can inflow into domestic
financial system. This will help firms to get access to more capital and then invest more
freely. It gives freedom to trade in financial asset across the globe. In most cases, the market
is tend to become more competitive than keeping a monopolistic model. In order to compete
and diversify in global market, FCAC can come handy in making the system more efficient
and comply to the international standards.

But, with advantages, there are certain drawbacks too that cannot be neglected. FCAC opens
up the capital account, so, it will cause export of domestic savings to more attractive
destinations. If the country is capital-sick, such a case will be upsetting move. Also, Currency
appreciation may take place due to increased capital inflow.
  


Through exhaustive analysis on pros and cons of FCAC, it can be said that there is always a
risk in long-term investment and going with FCAC is a suitable example. Once the risk is
mitigated, this policy can be useful for strengthening the financial model of India. Since, the
whole world is poised to follow transparent accounting model in coming future, there are
great avenues for the country like India for broadening their boundary of trade and generating
revenue for its progress.

Even Govt. of India accepted most of the suggestions and implemented many of them. As a
result of it, a sizeable growth in ECBs was seen. The current account deficit/GDP ratio was
maintained judiciously. Though after US subprime crisis, the situation has not be healthy, but
things are being contained and followed up to revive the coming years. India, with FCAC
will grow stronger and richer.