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What is capital account convertibility?
In the year 1997, Tarapore committee set up by RBI for the first time came up with the concept of capital account convertibility (CAC) that enables free conversion of domestic or local assets or currency into foreign assets and currency and vice versa at market-determined exchange rates. In a way, CAC facilitates entities including residents and firms to freely purchase assets such as bonds, equity, real-estate property in the overseas market.
Advantages of CAC
To the economy :
Liberalizing of norms for capital transactions enables free flow of funds for an economy. In case if the current economic condition of the domestic nation is not healthy, the inflow of funds could boost the sentiment. The funds could be used for financing various investment plans of the economy. Otherwise, also the foreign capital could be deployed for activities promoting growth.
As CAC allows inflow of foreign currency, the foreign exchange reserves of the nation witness an increase. CAC is also known to reduce excess borrowings of an economy and thereby imparts fiscal
discipline.
To local residents :
The facility of CAC enables residents of a nationality to diversify their investment portfolio across markets and thus shields them against country-specific risk.
Disadvantages of CAC
As CAC allows free conversion of domestic currency into foreign currency, there is a potential risk of outflow of currency and high interest rates that could in fact jeopardize the economic stability of a nation.
Capital Account Convertibility in India
In India, CAC is made use of for accessing foreign direct investment funds, investments for NRIs and overseas investors, and also provides for companies' investments in foreign markets through JVs. CAC in India also leeways retails investors and mutual funds to invest in bonds as well as equities with some rules and limitations.
Taking note of both the positive and negative moves in the economy, post-liberalization of the capital account transactions for different entities, government is constantly reviewing and further relaxing the regime governing capital account transactions.
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