Fuller Capital Account Convertibility - 1

Yesterday, I started reading report of Tarapore Committee on Fuller Capital Account Convertibility (FCAC), which was lying on my monitor from very long period and completed reading nearly 25% of the report. I thought of writing about that, so here is what I read or you guys can say what I understood!!!

This committee formed because once in some RBI meeting Prime Minister, Manmohan Singh urged Finance Ministry to revisit subject of FCAC under present conditions. So at that time this committee was set up by then RBI governor Dr. Y.V.Reddy.

Now coming to CAC, it can be defined as, “freely conversion of domestic currency to foreign currency in accordance of market forces without the interference of central bank”.

What are objectives of FCAC?

1. I can say (from whatever I grasped from reading this report) attracting FDI (Foreign Direct Investment) is the main objective. FDI is not monetary but also tends to be associated with non financial aspects, such as transfer of technology, infusion of management and supply chain practices, etc, which is growth booster of the country. Example is China, whose growth is mainly due to FDI inflows into the country by policies like no sectoral limits, decentralized decisions, labor laws & SEZs.

2. Improve the efficiency of the financial sector through greater competition, thereby minimizing intermediation costs.

3. Opportunities for diversification of investments by residents.

Risks of FCAC

1. Asian Currency started due to current account imbalances with simultaneous savings-investment imbalance, overvalued exchange rates, and high dependence upon potentially short-term capital flows.

2. Some other crisis round the world like Mexican crisis (1994-95), Brazil (1998), Russian crisis (1998), Argentinean Crisis (2002), Turkey crisis (1993-94) due to overvalued currency, current account deficits, volatility in capital inflows. [An excessive appreciation of the exchange rate causes exporting industries to become unviable, and imports to become much more competitive, causing the current account deficit to worsen.]

3. Impossibility of the trinity (fixed exchange rate, open capital account and independent monetary policy).

4. Domestic financial institutions, in particular banks, need to be strong.

5. Short-term debt flows react quickly and adversely during currency crises. Receivables are typically postponed, and payables accelerated, aggravating the balance of payments position.

Bottom-Line:

I may or may not continue posting on this topic depending upon what feel about writing on this one!!!