Capital Account

Convertibility
(CAC)
With respect to Tarapore
Committee report

CAC 1
 Definition:

“Capital Account Convertibility or CAC is a monetary policy that centers

around the ability to conduct transactions of local financial assets into foreign
financial assets freely and at market determined exchange rates. It is sometimes
referred to as Capital Asset Liberation.”

CAC 2
 Tarapore Committe

A committee on capital account convertibility was 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. In 1997, the Tarapore Committee had indicated the
preconditions for Capital Account Convertibility. The three crucial
preconditions were fiscal consolidation, a mandated inflation target and
strengthening of the financial system.
The five-member committee has recommended a three-year time frame for
complete convertibility by 1999-2000

CAC 3
 CAC has 5 basic statements designed as points of action:

• All types of liquid capital assets must be able to be exchanged

freely, between any two nations, with standardized exchange rates.
• The amounts must be a significant amount (in excess of $500,000).

• Capital inflows should be invested in semi-liquid assets, to prevent

churning and excessive outflow.
• Excessive inflows and outflows should be buffered by national
banks to provide collateral.

CAC 4
Despite changes in wording over the years, and additional
safeguards, there is still criticism of CAC by some
economists. 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

CAC 5
 Reasons for the introduction of CAC in India:

• The logic for the introduction of complete capital account convertibility

in India, according to the recommendations of the Tarapore Committee, is
to ensure total financial mobility in the country.
• It also helps in the efficient appropriation or distribution of international
capital in India.
• Such allocation of foreign funds in the country helps in equalizing the
capital return rates not only across different borders, but also escalates the
production levels.
• Moreover, it brings about a fair allocation of the income level in India as
well.

CAC 6
 CAC (Capital Account Convertibility) for Indian
Economy

It refers to the abolition of all limitations with respect to the

movement of capital from India to different countries across the
globe. In fact, the 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 also allows the people and companies not only to
convert one currency to the other, but also free cross-border
movement of those currencies, without the interventions of the law
of the country concerned
CAC 7
 Benefits and drawbacks of CAC:
• To sum up, CAC is concerned about the ownership changes in domestic or
foreign financial assets and liabilities.
• It also represents the formation and liquidation of financial claims on or by the
remaining world.
• 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. In fact, the
CAC policy in India is pursued primarily to gain the speculator's and the punter's
confidences in the stock markets.
• However, CAC does not serve the purposes of the real sectors of Indian
economy, like eradication of poverty, escalation of the employment rates and other
inequalities.
CAC 8
 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.
• A consolidated sinking fund has to be set up to meet government's debt
repayment needs; to be financed by increased in RBI's profit transfer to the
govt. and disinvestment proceeds.
• 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.

CAC 9
• At the same time, average effective CRR needs to be brought down from
the current 9.3% to 3%
RBI should have a Monitoring Exchange Rate Band of plus minus 5%
around a neutral Real Effective Exchange Rate RBI should be transparent
about the changes in REER
• External sector policies should be designed to increase current receipts to
GDP ratio and bring down the debt servicing ratio from 25% to 20%
• Four indicators should be used for evaluating adequacy of foreign
exchange reserves to safeguard against any contingency. Plus, a minimum
net foreign asset to currency ratio of 40 per cent should be prescribed by
law in the RBI Act.

CAC 10
 The forecasts made by the Tarapore Committee regarding Indian
CAC are as follows:

• A prescribed average inflation rate of 3% to 5% will exist for a

three-year time period, from1997-98 and 1999-2000.
• The non-performing assets will experience a decline to 12%, 9% and
5% by the years 1997-98, 1998-99 and 1999-2000 respectively, with
respect to the total or aggregate advances.
• By the years 1997-98, there will be a complete deregulation of the
structure of interest rate.
• The gross fiscal deficit will fall from 4.5% in 1997-98 to 4.0% in
1998-99 and further to 3.5 % in 1999-2000, with respect to the GDP

CAC 11
 Conclusion
• But detractors would highlight some other facts. The Centre plus States' combined fiscal deficit is
still around 8 per cent of GDP, way above the earlier Tarapore Committee stipulation of 3.5 per cent.
China has maintained an annual growth rate of 8-10 per cent over more than a decade without going
in for CAC. Capital inflows into India have been primarily of portfolio funds that are inherently
volatile. The more stable and economically more beneficial FDI flows into India amounted to around
$6 billion in 2005. But this is only about 10 per cent of what China is receiving. All these imply that
time is not yet ripe for full CAC. Irrespective of the timing, what are the possible benefits and costs
of full CAC? The supposed benefits include the following.
• First, India needs huge resources, especially to upgrade its infrastructure. Domestic savings alone
are not enough. More (net) foreign funds would come in only if they are sure of free entry and exit.
Second, Indian businesses (especially, the established companies) would be able to access cheaper
foreign funds that would improve their international cost competitiveness. Third, unhindered access
to foreign funds would facilitate Indian companies taking over firms abroad and developing more
Indian MNCs in the process.

CAC 12
• Fourth, Indian banks would be able to borrow foreign funds at lower rates
which would, in turn, enable them to lend at a lesser rate to Indian small
and medium enterprises which may not otherwise be able to borrow
directly from the international capital market.
• Fifth, cutting delays in foreign exchange trading would reduce transaction
costs and improve efficiency in Indian business. Finally, ordinary Indian
investors would be able to further diversify their asset portfolios by
investing abroad, thereby improving their risk-return profile.

CAC 13
Group Members:
• Anirban

• Niharika

• Mani

• Swati

• Jatin

• Rahul

• Anshul

• Niddhi
CAC 14
Thank You

CAC 15