INTRODUCTION

Economic growth and development of a nation is almost always coupled with the progress of its tradable sector. In times of today all economies are finding themselves integrated to each other in some or other way through forces of liberalisation and globalisation. In context of these sweeping advancements capital account convertibility has been widely persuaded by developed and developing countries around the world. India too is persistently poignant on the path of liberalisation, by opening up its markets and loosening its controls over economic and financial matters. During the recent turmoil in world financial market and its cascading disruptive effects, the role of financial integration assumes importance. A common outshoot of such financial crises generated locally or regionally is that they spread faster to other connected markets and economies to the extent such markets and countries are integrated with the originator country. The emerging/developing/non-developed countries bear their share of the brunt mostly due to their dependence on the advanced economies by way of trade or financial partnerships. There exists the famous adage: If the US sneezes, rest of the world catches pneumonia. As of late, the severity of this phenomenon might have been reduced owing largely to emergence of alternate economic powers that are characterized by high rate of sustained growth and also to what economists call the De-Coupling Effect that some of these economies have been able to insulate themselves from shockwaves in other countries in such a way that susceptibility to such external disruptions has lessened, the domestic balance remaining largely unaltered. However, in the age of increasing global integration, growing countries can not afford to stay highly insulated, closed or de-coupled from other economies. To accelerate such integration, countries resort to various approaches, financial integration being a prime one among them. And financial integration presupposes capital account liberalization. At one end of the
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spectrum is fully restricted capital account; at the other, a fully convertible capital account. Many of the developed countries practice the later. The least developed countries have a too low extent of capital account liberalization. The emerging countries largely fall midway they have partially open and liberalized capital account. Among the emerging economies, India occupies a dominant space. According to IMF and other reports, India would come in the top three of the economically most powerful economies by 2050. It has a much higher growth rate (more than 8% per annum) compared to many developed countries.

WHAT IS RUPEE CONVERTABILITY?

Currency convertibility refers to the freedom to convert the domestic currency into other internationally accepted currencies and vice versa at market determined rates of exchange. Rupee convertibility means the system where any amount of rupee can be converted into any other currency without any question asked about the purpose for which the foreign exchange is to be used. Though impressionistic reports suggest that the rupee is already convertible in the unofficial markets, this is an fact not the case. Free convertibility refers to officially sanctioned market mechanism for currency conversion. Non-convertibility can generally be defined with reference to transaction for which foreign exchange cannot be legally purchased (e.g. import of consumer goods etc), or transactions which are controlled and approved on a case by case basis (like regulated imports etc). A move towards free convertibility implies a reduction in the number / volume of the above types of transaction.

Convertibility can be related as the extent to which a country's regulations allow free flow of money into and outside the country. For instance, in the case of India till 1990, one had to get permission from the Government or RBI as the case may be to procure foreign currency, say US Dollars, for any purpose. Be it import of raw material, travel abroad, procuring books or paying fees for a ward who pursues higher studies abroad. Similarly, any exporter who exports goods or services and brings foreign currency into the country has to surrender the foreign exchange to RBI and get it converted at a rate pre-determined by RBI. After liberalization began in 1991, the government eased the movement of foreign currency on trade account. I.e. exporters and importers were allowed to buy and sell foreign currency, as long as the items that they are exporting and importing were not in the banned list. They need not get permission on a CASE TO CASE basis as was prevalent in the earlier regime. This was the first concrete step the economy took towards making our currency convertible on trade account. In the next two to three years, government liberalized the flow of foreign exchange to include items like amount of foreign currency that can be procured for purposes like travel abroad, studying abroad, engaging the services of foreign consultants etc. This set the first step towards getting our currency convertible on the current account. What it means is that people are allowed to have access to foreign currency for buying a whole range of consumable products and services. These relaxations coincided with the liberalization on the industry and commerce front - which is why we have Honda City cars, Mars chocolate bars and Bacardi in India. There was also simultaneous relaxation on the restriction on the funds that foreign investors can bring into India to invest in companies and the stock market in the country.

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TYPES OF CONVERTABILITY
1) Current Account Convertibility Current account convertibility refers to freedom in respect of Payments and transfers for current international transactions. In other words, if Indians are allowed to buy only foreign goods and services but restrictions remain on the purchase of assets abroad, it is only current account convertibility. Current account convertibility allows residents to make and receive trade-related payments, i.e. receive foreign currency for export of goods and services and pay foreign currency for import of goods and services like travels, medical treatment and studies abroad. As of now, convertibility of the rupee into foreign currencies is almost wholly free for current account i.e. in case of transactions such as trade, travel and tourism, education abroad etc.

2) Capital Account Convertibility Capital account convertibility refers to the freedom to convert the local financial assets into foreign financial assets. Capital Account convertibility in its entirety would mean that any individual, be it Indian or foreigner will be allowed to bring in any amount of foreign currency into the country and take any amount of foreign currency out of the country without any restriction. It is sometimes referred to as capital asset liberation or CAC. CAC is mostly a guideline to changes of ownership in foreign or domestic financial assets and liabilities. Tangentially, it covers and extends the framework of the creation and liquidation of claims on, or by the rest of the world, on local asset and currency markets.

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COMPONENTS OF CURRENT ACCOUNT CONVERTIBILITY

Covered in the current account are all transactions (other than those in financial items) that involve economic values and occur between resident non-resident entities. Also covered are offsets to current economic values provided or acquired without a quid pro quo. Specifically, the major classifications are goods and services, income, and current transfers. 1. Goods and services Goods General merchandise covers most movable goods that residents export to, or import from, non residents and that, with a few specified exceptions, undergo changes in ownership (actual or imputed). Goods for processing covers exports (or, in the compiling economy, imports) of goods crossing the frontier for processing abroad and subsequent re-import (or, in the compiling economy, export) of the goods, which are valued on a gross basis before and after processing. The treatment of this item in the goods account is an exception to the change of ownership principle. Repairs on goods covers repair activity on goods provided to or received from non residents on ships, aircraft, etc. repairs are valued at the prices (fees paid or received) of the repairs and not at the gross values of the goods before and after repairs are made. Goods procured in ports by carriers covers all goods (such as fuels, provisions, stores, and supplies) that resident/nonresident carriers (air, shipping, etc.) procure abroad or in the compiling economy. The classification does not cover auxiliary services (towing, maintenance, etc.), which are covered under transportation.

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Nonmonetary gold covers exports and imports of all gold not held as reserve assets (monetary gold) by the authorities. Nonmonetary gold is treated the same as any other commodity and, when feasible, is subdivided into gold held as a store of value and other (industrial) gold.

Services Transportation covers most of the services that are performed by residents for nonresidents (and vice versa) and that were included in shipment and other transportation in the fourth edition of the Manual. However, freight insurance is now included with insurance services rather than with transportation. Transportation includes freight and passenger transportation by all modes of transportation and other distributive and auxiliary services, including rentals of transportation equipment with crew. Travel covers goods and servicesincluding those related to health and education acquired from an economy by non resident travelers (including excursionists) for business and personal purposes during their visits (of less than one year) in that economy. Travel excludes international passenger services, which are included in transportation. Students and medical patients are treated as travelers, regardless of the length of stay. Certain othersmilitary and embassy personnel and non resident workersare not regarded as travelers. However, expenditures by non resident workers are included in travel, while those of military and embassy personnel are included in government services Communications services covers communications transactions between residents and nonresidents. Such services comprise postal, courier, and telecommunications services

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(transmission of sound, images, and other information by various modes and associated maintenance provided by/for residents for/by non residents). Construction services covers construction and installation project work that is, on a temporary basis, performed abroad/in the compiling economy or in Extra territorial enclaves by resident/non resident enterprises and associated personnel. Such work does not include that undertaken by a foreign affiliate of a resident enterprise or by an unincorporated site office that, if it meets certain criteria, is equivalent to a foreign affiliate. Insurance services covers the provision of insurance to non residents by resident insurance enterprises and vice versa. This item comprises services provided for freight insurance (on goods exported and imported), services provided for other types of direct insurance (including life and non-life), and services provided for reinsurance. Financial services (other than those related to insurance enterprises and pension funds) covers financial intermediation services and auxiliary services conducted between residents and nonresidents. Included are commissions and fees for letters of credit, lines of credit, financial leasing services, foreign exchange transactions, consumer and business credit services, brokerage services, underwriting services, arrangements for various forms of hedging instruments, etc. Auxiliary services include financial market operational and regulatory services, security custody services, etc. Computer and information services covers resident/non resident transactions related to hardware consultancy, software implementation, information services (data processing, data base, news agency), and maintenance and repair of computers and related equipment. Royalties and license fees covers receipts (exports) and payments (imports) of residents and non-residents for (i) the authorized use of intangible non produced,

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nonfinancial assets and proprietary rightssuch as trademarks, copyrights, patents, processes, techniques, designs, manufacturing rights, franchises, etc. and (ii) the use, through licensing agreements, of produced originals or prototypessuch as manuscripts, films, etc. Other business services provided by residents to nonresidents and vice versa covers merchanting and other trade-related services; operational leasing services; and miscellaneous business, professional, and technical services. Personal, cultural, and recreational services covers (i) audiovisual and related services and (ii) other cultural services provided by residents to non-residents and vice versa. Included under (i) are services associated with the production of motion pictures on films or video tape, radio and television programs, and musical recordings. (Examples of these services are rentals and fees received by actors, producers, etc. for productions and for distribution rights sold to the media.) Included under (ii) are other personal, cultural, and recreational servicessuch as those associated with libraries, museumsand other cultural and sporting activities. Government services i.e. covers all services (such as expenditures of embassies and consulates) associated with government sectors or international and regional organizations and not classified under other items.

2. Income Compensation of employees covers wages, salaries, and other benefits, in cash or in kind, and includes those of border, seasonal, and other non-resident workers (e.g., local staff of embassies).

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Investment income covers receipts and payments of income associated, respectively, with residents holdings of external financial assets and with residents liabilities to nonresidents. Investment income consists of direct investment income, portfolio investment income, and other investment income. The direct investment component is divided into income on equity (dividends, branch profits, and reinvested earnings) and income on debt (interest); portfolio investment income is divided into income on equity (dividends) and income on debt (interest); other investment income covers interest earned on other capital (loans, etc.) and, in principle, imputed income to households from net equity in life insurance reserves and in pension funds.

3. Current transfers Current transfers are distinguished from capital transfers, which are included in the capital and financial account in concordance with the SNA treatment of transfers. Transfers are the offsets to changes, which take place between residents and nonresidents, in ownership of real resources or financial items and, whether the changes are voluntary or compulsory, do not involve a quid pro quo in economic value. Current transfers consist of all transfers that do not involve (i) transfers of ownership of fixed assets; (ii) transfers of funds linked to, or conditional upon, acquisition or disposal of fixed assets; (iii) forgiveness, without any counterparts being received in return, of liabilities by creditors. All of these are capital transfers. Current transfers include those of general government (e.g., current international cooperation between different governments, payments of current taxes on income and wealth, etc.), and other transfers (e.g., workers remittances, premiumsless service

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charges, and claims on non-life insurance). A full discussion of the distinction between current transfers and capital transfers.

COMPONENTS OF CAPITAL ACCOUNT CONVERTIBILITY

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 in the world, 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. Institutional investors should not use CAC to manipulate fiscal policy or exchange rates. Excessive inflows and outflows should be buffered by national banks to provide collateral

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PARTIAL RUPEE COVERTIBILITY

The government introduced a system of Partial Rupee Convertibility (PCR) (Current Account Convertibility) on February 29,1992 as part of the Fiscal Budget for 1992-93. PCR is designed to provide a powerful boost to export as well as to achieve as efficient import substitution. It is designed to reduce the scope for bureaucratic controls, which contribute to delays and inefficiency. Government liberalized the flow of foreign exchange to include items like amount of foreign currency that can be procured for purpose like travel abroad, studying abroad, engaging the service of foreign consultants etc. What it means that people are allowed to have access to foreign currency for buying a whole range of consumables products and services. These relaxations coincided with the liberalization on the industry and commerce front which is why we have Honda City cars, Mars chocolate and Bacardi in India. Considerable evidence has accumulated over the years that for most countries, deregulation of foreign trade transactions must precede deregulation of international capital account flows. For an economy in transition from a controlled to a market based one, international capital movements can be highly destabilizing and disruptive. It is essential that capital flows be regulated under a separate controlled regime during the initial movement towards convertibility. The PCR system introduced to combine the advantage of relatively suitable managed float and the BOP- balancing property of a freely floating rate. This involves creation of two exchange rate channels: a. A market channel in which the exchange rate is determined by market forces of supply and demand of foreign exchange where access if free for all transactions (other than those specified as not free).

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b. An official channel where the exchange rate continues to be determined by RBI on the base of the value of rupee in relation to the basket of currencies and fixed, but access to the market is restricted. With view to giving effect to the PCR, RBI introduced a system called the Liberalized Exchange Rate Management System (LERMS) effective from 1st March 1992. Till 1st March 1992 all foreign exchange remitted into India was implicitly handed over to RBI by Authorized Dealers (ADs) and then RBI made a Foreign exchange available for approved purpose. Under new system, the RBIs retention ratio has been reduced from 100% to 40% of all foreign exchange remittances received with effect from 1.3.1992. The ADs apply the official exchange rate in calculating the value of rupees to be paid to the remitter for this 40% and surrender the exchange to the RBI. The remaining 60% of the value of the remittance is purchased by AD at a market-determined exchange rate. AD s, retain this 60% portion for sale to other AD s, authorized broker or buyer of foreign exchange.

Transactions at official rate: The government has notified that payment obligations for the import of the items specified below to the extent authorized by the Ministry of Finance can be made available at the official exchange rate: i. ii. iii. iv. v. vi. Import for Government departments needs. Crude Oil. Diesel. Kerosene. Fertilizer. Import of Life-saving drugs and equipment.
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vii.

In respect of imports under advance licenses and imprest licenses and import for replenishment of raw materials for gem and jewellery exports.

viii.

All transactions relating to official grants and relating to the IMF.

All Other payment transactions for import of goods and services will have to take place exclusively at the market exchange rate. The rational for treating certain import items to qualify for official rate of exchange are Two-fold: a. Some of the above types of transaction are in the nature of non commercial operations of the Government, which are relatively inelastic from the Domestic supply/demand perspectives. Thus, purchase of public goods like departmental non-commercial imports, defence equipments equipment, space research etc come under this category. b. Some other items covered under the special set of transaction at the official rate have a potentially significant cost-push effect on the economy like Crude oil and fertilizers. These are goods whose domestic demands and supply price elasticities are low and which from a significant input to an economy.

FULL CAPITAL ACCOUNT CONVERTIBILITY

Capital Account convertibility in its entirety would mean that any individual, be it Indian or Foreigner will be allowed to bring in any amount of foreign currency into the country. Full convertibility also known as Floating rupee means the removal of all controls on the cross-border movement of capital, out of India to anywhere else or vice
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versa. Capital account convertibility or CAC refers to the freedom to convert local financial assets into foreign financial assets or vice versa at market-determined rates of interest. If CAC is introduced along with current account convertibility it would mean full convertibility. Complete convertibility would mean no restrictions and no questions. In general, restrictions on foreign currency movements are placed by developing countries which have faced foreign exchange problems in the past is to avoid sudden erosion of their foreign exchange reserves which are essential to maintain stability of trade balance and stability in their economy. With Indias Forex reserves increasing steadily, it has slowly and steadily removed restrictions on movement of capital on many counts. The last few steps as and when they happen will allow an Indian individual to invest in Microsoft or Intel shares that are traded on NASDAQ or buy a beach resort on Bahamas or sell home or small industry to Mr. James bond and invest the proceeds abroad without any restrictions.

HISTORY OF RUPEE CONVERTABILITY

The exchange rate regime in India has transited gradually from the fixed exchange rate regime in the pre-1991 period to the flexible exchange rate regime in the post-1991 period. Rupee was historically linked with the UK pond sterling. However, till 1971 Indian rupee was linked with the US dollar to meet the requirement of IMF membership. To provide greater stability to rupee India started fixing the value of rupee in terms of basket of currency since 1975. In the aftermath of BOP crisis, in 1992 Liberalized Exchange Rate Management System (LERMS) was introduced whereby exporters were required to surrender
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40% of their foreign exchange earnings at the officially determined rate. The rest could be converted at market determined rate. The importers, on the other hand, had to procure all their foreign exchange requirements at the official rate. LERMS were replaced by Unified Exchange Rate in 1993 and rupee was made convertible on the current account in August 1994. Since then there is gradual move towards capital account convertibility in India. In 1997 a committee under stewardship of S.S.Tarapore submitted its report on 'Capital Account Convertibility' which provided the initial roadmap for the liberalisation of capital account transactions. Taking the lessons from international experience, committee recommended a set of preconditions to be achieved prior to liberalisation of capital account. It was the time when banking sector reforms were also instigated on the proposition of Narasimhan committee. To facilitate foreign exchange transactions India has replaced more restrictive act of FERA, 1974 by more facilitating approach in the form of FEMA, 2000. Till now, all the rules pertaining to foreign exchange are governed by FEMA. All the current account transactions are permitted under FEMA and no prior permission of RBI is required for any such transactions, while there remain restrictions on capital account. Under FEMA some capital account transactions are completely permitted, some are totally prohibited while some are allowed within a fixed ceiling. Sectoral rules have also been shaped and enforced with FEMA rules. On the success of the measures adopted, the issue of capital account liberalisation was re-examined by Tarapore committee II. Setup in year 2006 it was an extension of the previous committee. The committee on the capital account convertibility has suggested five year time frame (2006 to 2011) for movement towards fuller convertibility in India. During this period the country needs to strengthen macroeconomic framework and bring in place sound financial system and markets and prudential regulatory and supervisory architecture by meeting FRBM

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targets, greater autonomy and transparency to the RBI in conduct of monetary policy, reducing the share of government in the capital of public sector banks, maintaining the current account deficit Following the East Asian crisis, even the most ardent votaries of CAC in the World Bank and the IMF realised that the dangers of going in for CAC without adequate preparation could be catastrophic. Since then the received wisdom has been to move slowly but cautiously towards CAC with priority being accorded to fiscal consolidation and financial sector reform above all else. Indian companies were allowed to raise funds by way of equities (shares) or debts. The fancy terms like Global Depository Receipts (GDRs), Euro Convertible Bonds (ECBs), Foreign currency syndicated loans became household jargons of Indian investors. Listing in NASDAQ or NYSE became new found status symbols for Indian companies. However, Indian companies or individuals still had to get permission on a case to case basis for investing abroad. In 2000, the forex policy was further relaxed that allowed companies to acquire other companies abroad without having to go through the rigmarole of getting permission on a case to case basis. Further, Indian debt based mutual funds were also allowed to invest in AAA rated government /corporate bonds abroad. This got further relaxed with Indians being allowed to hold a portion of their foreign exchange earnings as foreign currency, subject to a limit in the recent monetary policy in October 2002.

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PROGRESS THROUGH CAPITAL ACCOUNT CONVERTIBILITY

A hybrid between control and liberalisation of the capital account, has served country well for nearly a decade. India has witnessed a significant surge in cross border capital flows through CAC. The strong capital movements to India in the recent period reflect the momentum in following: A) Progress At Country Level (1) End of Balance of Payment (BoP) crisis: In 1991 India was struggling with the crisis in its balance of payments. Importing was essential for the country while the government's conservative approach towards exports pushed country into severe balance of payment deficit. Capital account liberalisation has been the strongest medium in curbing such crisis. There was an ongoing trade deficit from the year 1990-91, but a positive capital account has provided cushion against all odds and overall balance of payments are in surplus. (2) Plenty of Foreign Currency Reserves: India has envisaged a plentiful surge in its reserves. The liberalisation of capital account has helped country in recovering from reserve shortage. The doting supply of dollars to Reserve Bank exchequer is a healthy sign for economy, as reserves can be utilised during the times of adversity. The reserve position is shown in the graph:

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(3) Efficiency in Financial System: Capital Account Convertibility is incomplete without fiscal consolidation, sound policies and financial prudence. RBI and Government of India have been very conservative and watchful during whole process of liberalisation. This has improved total financial performance of economy. Banks today have greater access to additional capital (foreign borrowing), autonomy in operations (easening of control by RBI) and intensive competition (opening of private and foreign banks and Non Banking Finance Corporations). There is larger room for financial efficacy, specialisation and innovation in financial system.

(4) Development of Securities Market: Gush of Foreign Institutional Investment (FII) has helped in multifold enlargement of security market. The market capitalisation of BSE and NSE has significantly risen. Derivates, bonds, commodities now constitute the major trading instruments besides equity shares. Sensex (above 20,000) and Nifty (above 6,000) touched new heights due to huge investment in the listed stocks. The position of BSE Sensex is shown in the graph:

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(5) Worldwide Presence and Friendly Relations with Trading Counterparts: Flow of investment is a distinctive medium of developing global relationships. Indian MNCs and service organisations are conducting business operations in almost 140 countries across the globe. India is 19th largest exporting country in the world according to 2011 estimates. Indian IT services, handicrafts, cuisine and jewellery are world famous and contribute to major chunk of revenue from international operations. It all has become reality with the financial liberalisation. India is the founder member of WTO, IMF and World Bank. It is a member of BRICS and G-20 at WTO trade negotiations. Government has entered into multilateral trade agreements and tax avoidance treaties with the trading counterparts. Immigration norms have also been untangled. All this has given a global presence to the country and friendly relations too are in progress.

B) PROGRESS AT CORPORATE LEVEL 1) Indian corporate sector is inundated with broader access to low cost capital through External Commercial Borrowings. In addition, companies have the prospect of expanding their capital base through issue of American Depository Receipts, Global Depository Receipts and corporate bonds. 2) Diversification of risk and economies of scale through business performance in different realms. 3) Increase in profit after tax through intercontinental operations (manufacturing, sales, services and Intellectual Property Rights).
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4) Gains in technology through joint ventures, international license and import of technology from the specialised manufacturer. 5) Access to worldwide pool of intellectuals, managers, technical personnel etc and their specialised knowledge and skills.

C) PROGRESS AT CUSTOMER LEVEL Indian customers have gained in plenteous ways, and are getting superior quality, competitive prices and added features in the goods available in the market. They have a bundle of offerings in every sector from fast moving consumer goods (FMCGs) to automobiles, furniture to food, health clubs to telecommunication, clothes to electronics and so on. This has amplified the price wars and there has been an eminent improvement in customer services and customer information through 24/7 help lines and World Wide Web technology.

CAPITAL ACCOUNT CONVERTIBILITY AND MENACE

It is a discernible fact that a number of empirical studies do not find evidence that greater openness of capital account and higher flows of capital lead to advanced growth (Prasad et al 2000). Some economists believe that the opening up of capital account is the last mile connectivity to the globalised world; to others it symbolise a shortcut to economic

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ruination. India's most recent negative experiences with the capital account liberalisation are as follows: (1) Depreciating Rupee: With the liberalisation of capital account large amount of money is flowing in and out of the economy. Subsequently rupee has become highly volatile and slipped to its all time low (1$=57.33). India's imports are greater than its exports and former has further declined due to financial crisis in Euro zone. Reserve Bank is not able to peg rupee at harmless levels, consequently imports have become too expensive and the risk of widening trade deficit is obvious. Reserve Bank has to buy or sell dollars in substantial amount to maintain the value of rupee at reasonable levels. Weakening rupee has also created problems in setting appropriate interest rates. Graph shows the value of Indian rupee pegged to US dollar.

It is clear from the graph that in August 2011, value of 1 USD was INR 44 and by June 2012 this value has become 57 rupee, the lowest value ever. (2) Volatility in Stock Markets: International financing and investment shifts from country to country in search of higher speculative returns. Stock markets have undergone this

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phenomenon rapidly. In good times of the economy (good rating, healthy IIP, high GDP, political stability) foreign institutional investors are on buying spree, but in bad times FII quickly lose their confidence in market and there is an abnormal selling. Investors experience huge losses some become bankrupt too. Given in the graph drastic ups and downs in stock market indicators:

Source: BSE

(3) Debilitating Impact on Inflation: Capital convertibility has lead to exchange rate volatility of the Rupee resulting in macroeconomic instability caused through the risk of rapid and large capital outflows as well as inflows. When capital flows are large money supply increases and RBI comes up with tightening of monetary policy. Also, India imports approximately 75% of its crude requirements. Given the fact that the oil prices have been well above the USD 90 per barrel and extremely volatile, this has further widened the trade deficit of India and has resulted in soaring energy prices. This has upset the economy and has a
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debilitating impact on inflation within India. Such speculative capital flows have made domestic monetary policy virtually ineffective.

(4) Asset Liability Mismatch of Banks: In global experience with convertibility, banking envisages to be another weaker link. Banks are facing an inequality between their assets and liabilities. Banks generally refuse to lend a company which has a debt equity ratio of more than 2. Indian banks presently have high debt because of cheap borrowing through ECBs. Moreover high interest rate in market on borrowings has led to slump in demand of loans and advances. Decline in loans and advances on the asset side of balance sheet has increased the pressure to sustain the same maturity period for deposits and the asset liability management has come under strain.

(5) Flow of Black Money through Participatory Notes (P-Notes): SEBI allowed issue of PNotes to FII in 2006. Concerns have been raised on the secrecy afforded to investors through P-Notes. Different types of foreign entities are eligible for the issue of P-Notes but the identity of the actual investor may be mysterious to the regulatory bodies. Therefore some of the money invested in the market through P-Notes may be unaccounted wealth of affluent Indians hidden beneath the pretext of FII investment. Such funds could be tainted and linked with unlawful activities like corruption and smuggling. Hedge funds too may use P-Notes and sub accounts of FII to operate in stock market. Reserve Bank stance is towards prohibition of PNotes. (6) Does not serve the Purpose of Real Sectors: Capital Account Convertibility (CAC) primarily benefit industrialists and financial capitalists who invest in stock market for

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speculative gains. It is mainly pursued to please international organisations (IMF, WB, and WTO) and foreign investors. It hasn't addressed the real problems of the country like poverty, unemployment, income inequalities, infrastructure bottlenecks and many more. The irony is that burden is borne by the common man under a crisis, which has become an actuality these days. This comes up in the form of sharper reduction in subsidies, less budgetary allocations for social welfare programmes, high taxes and high inflation. The foreign speculators and domestic players walk out of the market by converting their assets into cash and insulate themselves from losses in such during economic problems.

CHALLENGES OF CAPITAL ACCOUNT CONVERTIBILITY AND THEIR MANAGEMENT

In the process of capital account liberalisation, Indian economy has been able to attract reasonable foreign investment without any major shocks. The benefits that have been derived with an open capital account have induced the growth and development of India's financial markets and external sector. Due to some or other reasons from inside and outside macroeconomic instability has lingered in the economy and things are not going well. Inflation rate is high from the year 2009 onwards. The average yearly inflation was 10.9% in 2009 and 11.7% in 2010. In 2011 the rate of inflation stood at 9.6%. Between the periods it rose to double digits too. RBI has revised monetary policy during the different time periods. Cash Reserve Ratio (CRR) was revised 13 times in the time frame of 2 years which is a benchmark in itself. Despite continuous efforts RBI is not able to tame inflation and it is still modest at the level of 8% according to latest estimates. The depreciation in the value of
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rupee to the level of 1 USD=57.33 INR has also raised serious questions and concern on the conduct and policies of Reserve Bank and Government of India. Global rating agencies Standard & Poor (s & P) and Fitch have revised India's rating from 'Stable' to 'Negative'. S&P has released a report strongly criticising the Government's inability to move ahead with economic reforms and referred to cracks in ruling coalition that they were holding up progress. Fitch has censured and added the general elections due in early 2014 could see politically driven pressure to loosen fiscal policy, which could further weaken India's public finance related to peers. The ratings and statement of S&P and Fitch raise the risk of Indian bonds slipping into junk category, hurting the country's image as an investment destination. The cost of overseas borrowing for Indian companies could also go up. The story is not yet over. Equity market is plummeting week after week because FII are on selling fling. Sensex is currently trading lower than 17,000 and Nifty near 5,000. Investor sentiments are down. Individual portfolios are making losses. Volatility and panic are the latest buzz words for the 'Dalal Street'. Food inflation is constantly maintaining its double digit levels causing a decline in domestic savings with banks. IIP has fallen to the level of 3.5% from 8.1% of the previous year. GDP growth in 2012- 13 is estimated at the aching level of 6.5% while fiscal deficit is at 5.9%. Reserve Bank's Governor D.Subbarao said 'fiscal deficit in 1991 was 7% and it is ruling at 5.9% in 2012.' Is it an alarming signal? Because, India was going through its meagre times in 1991 and latest GDP estimates too are worrisome. There are additional doubts about Government's ability to trim subsidy level to cut fiscal deficit, which could further increase the prices of essential commodities. A new retro tax GAAR (General Anti Avoidance Rule) is also proposed to be enacted in budget for fiscal 2013. GAAR aims to target tax evaders, partly by stopping Indian companies and investors from routing investments through Mauritius or other

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tax havens for the sole purpose of avoiding taxes. It has sparked an outcry among foreign investors. Thus the recent global turmoil, volatile capital flows and economic instability have considerably heightened the uncertainty surrounding the outlook for India, complicating the conduct of monetary policy and external management. The intensified pressures have necessitated stepped up operations in terms of capital account management and more active liquidity management with all instruments at command of Reserve Bank. Therefore in this scenario, it is suggested that India should adopt a go slow approach in moves to liberalise capital account. Instead, it is important for the country to be ready to deal with potentially large and volatile outflows along with spillovers. In this context, there is a need of manoeuvre for Reserve Bank to deal with present serious matters by deployment of monetary policy instruments, buying and selling operations of forex, complemented by prudential restrictions and measures for capital account management.

INDIAS PERFORMANCE AGAINST THE PRE-CONDITIONS

The previous discussion clearly indicates the following: On the fiscal front, India has performed poorly. The fiscal deficit/GDP ratio has not been contained within the prescribed limit. Concurrently, domestic liabilities/GDP ratio has been continuously rising Average inflation rate has stayed higher than the recommended band Debt-servicing ratio has not at all responded to the recommendation Average effective CRR has remained much higher than the floor However, the gross NPA ratio of public sector banks has come down remarkably
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Indias external sector has registered positive performance. The exports/GDP ratio and import/GDP ratio have gone up. CAD/GDP ratio has been contained within the 2-3% band on a continuous basis.

Thus Tarapore Committees recommendations have mostly not been implemented, since the prescribed conditions were not met. Time-frame wise, it is clear that the committees suggestions and recommendations were premature by at least 10 years, if not more.

SUITABILITY OF FULL CONVERTIBILITY IN INDIA

There are certain prerequisites for introduction of capital account full convertibility. The Economy must be nearer to the global standards in the matter of fiscal deficit, inflation rate, interest rates, foreign exchange reserves, etc. It is said that the economy can be said to be ripe for capital account convertibility only if interest rates are low and de-regulated and the inflation rate in the three consecutive years had been around three per cent. In addition, fiscal deficit should be low at around 3 per cent and foreign exchange reserves should be reasonably high. Further, the economy has to be in good shape, as full convertibility would result in bringing in the instabilities and fluctuations of the outside world into the economy, as it gets more connected to the outside world. Further, imperfections in the economy, like the urban-rural dichotomy and difference in the growth rates in various sectors like agriculture and industries, as well as services, must be removed. But post-CAC, they are expected to deal with multi-currency transactions. The risks involved are: Currency Risk: Effect of currency appreciation/depreciation
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Counterparty Credit Risk Transfer Risk: Generated from tracking financial position of all economies involved Legal Risk.

It is still doubtful whether the state-protected banks would be able to ward the risks off. India also falls short of most of the criteria suggested by the first Tarapore Committee. The 3-year phasing plan of CAC as conceived in 1997 has not been fully effective even 11 years down the line. Without the pre-conditions strongly in place, no country can safely adopt CAC (as mentioned earlier, capital controls are virtually irreversible so far as international investor confidence is concerned). Two crucial questions arise during evaluation of Indias readiness to adopt full convertibility: First, are the indicators which conform to the levels suggested by the Committee sustainable in future, or are significant deviations from current levels to be expected, say 10 years down the line? Second, when, if at all, the non-conforming criteria are expected to converge to the recommended level or band? Considering the above prerequisites it appears that the Indian economy is not yet prepared for switching over to the capital account convertibility. The only requisites which have been met are reasonably high level of foreign exchange reserves, mostly deregulated interest rates and relatively good condition of the economy as a whole. In most of the other areas there is lot more to be done. Interest rates as well as the inflation rate are higher than the required levels. Further, the imperfections of the economy are glaring as the services and industrial sectors are booming, but the agricultural sector which employs over 65 per cent of the total work force, is growing at a much lower rate of 2 to 3 per cent per annum.

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CONCLUSION

Capital Account Convertibility (CAC) has been regarded by modern economists as one of the hallmarks of a developed country, the enduring endgame in globalisation. One of the most persuasive arguments for capital account liberalization is that globalization has come to stay and that a developing country need to be part of the global financial integration of countries. It is argued that the need for increasing financial integration of the developing countries with financial markets of the industrialized world is completed through CAC. It is also reasoned by some that if countries allow convertibility on the current account, it should as a natural sequel allow convertibility on the capital account. And India having introduced convertibility on the current account, India should follow suit by introducing CAC. According to those who favour CAC, argue that full CAC will allow Indians to hold an internationally diversified portfolio that provides them with the added opportunity of diverse choices in wealth maximisation. Further, with full CAC it is necessary that we could move towards unrestricted flow of FDI in all sectors, i.e. without any limit as it is at present. This would by an extended logic lower costs associated with borrowings, as supply of capital within the economy would increase as much as it would increase the availability of capital for domestic investments. Financial integration through CAC, they add, will also provide the impetus for government to rationalize and converge into international benchmarks on maintaining direct and indirect tax structures, contain inflation, free interest rates of administrative controls and significantly lower fiscal deficits.

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All these, it has been repeatedly put forth, would naturally necessitate the move to a truly market determined exchange rates a step that is perhaps retraceable at a tremendous cost but nevertheless considered exciting for a developing country. It has been repeatedly argued by those who favour full convertibility on the capital account that India stands to gain as it can import capital at international costs to fuel her growth. Since the International costs of capital are lower that the domestic costs of capital, this would benefit the Indian economy. This is simply because when a currency becomes fully convertible on the capital account, financial costs, both domestic and international, tend to level out, especially when the domestic cost of capital is higher than the international cost of capital as it is in the Indian case. Similarly, by allowing resident Indians to invest in a varied portfolio, the risk factor is diversified. For instance, an Indian investor with a portfolio limited only to investment in India runs a higher risk as compared to an India who holds a diversified international portfolio. With the increased wealth of the individual, it is argued the nation too would benefit. Further, CAC facilitates specialisation in financial services in a country and thereby increases efficiency and productivity of capital as it gives impetus to the development of a wide range of derivatives and risk management products, thereby deepening and widening the financial markets. Needless to emphasize, in the likely inflow of foreign capital it is natural that the country would ensure that appropriate regulatory and supervisory machinery is put in place so as to ensure that only desirable transactions are carried out. All these mean that the efficiency of capital would increase within the economy. And precisely on all these points rest the case for CAC on the Rupee.

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The typical objection to a move to convertibility is that it would lead to an unsustainable loss of foreign exchange reserves and a balance of payments crisis. This objection obviously presupposes that the government has pegged the exchange rate, or at least has taken a view on how rapid a change is permissible. If the exchange rate is pegged (including a crawling peg), then an unsustainable outflow of funds, e.g. through a current account deficit, must be met by some contractionary monetary policy, which in many countries will often imply the need for a smaller government budget deficit. In either case it may lead to a decline in output and income in the short run and if it persists, it was widely believed, to slower growth in the long run. The alternative is to alter the rate of exchange between home and foreign currency by enough to stop the outflow either by allowing it to float, or by depreciating by so much that market participants believe it will depreciate no further. This would result in imported goods becoming so expensive in home currency that demand for them will fall significantly, and that exports become so profitable that their supply will increase significantly (or, depending on the significance of the country in the world product market, that the price of exports will fall sufficiently in foreign currency that foreign demand will be greatly stimulated). One of the primary arguments against this is the doubt that any exchange rate could clear the foreign exchange market, by which they really meant that the required depreciation might be very large. That in turn could have other undesirable consequences, such as a sharp increase in the domestic price level, driven by the rise in the prices of tradable goods, which might trigger higher inflationary expectations, either because the public cannot distinguish a once-for-all rise in the price level from an acceleration of inflation, or because the price increase would in fact
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trigger an inflationary process whereby wage-earners and others attempted to restore their real incomes by insisting on higher nominal wages and other incomes. In short, dismantling capital controls is generally presumed to generate economic benefits through increased opportunities for trade and cross-border investments, by imposing macroeconomic discipline on national governments as well as penalties. However, given the experiences of East Asian currency crisis, many economists have argued that unfettered globalization especially leading to full CAC is a high-risk policy adventure and consequently, not a model worth emulating. Factoring the experiences of the East Asian crisis some economists have vehemently argued that the concept of globalization has gone too far and has reached the point of being counter-productive.

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BIBLIOGRAPHY
Convertibility Of Rupee And Exchange Rate; Bombay Chartered Accountants' Society; 1997-2007 India And Capital Account Convertibility: A Journey Of Progress And Menace; Soamya Goel, Naresh Kumar And T. P. Singh Ishii, Shogo, and K. Habermeier, 2002, "Capital Account Liberalization and Financial Sector Stability," IMF Occasional Paper 211, (Washington: International Monetary Fund) Convertibility:India's Readiness in the context of Financial Integration; Sulagna Bhattacharya Schneider Benu, "Issues in Capital Account Convertibility in Developing Countries" London, Overseas Development Institute 'No immediate steps for rupee convertibility on capital account'; Business Standard; March 21, 2012 Exchange Rate Regimes and Currency Convertibility; Veena Pailwar Full Convertibility of the Indian Rupee : An analysis of the Feasibility; Ashima Johur; Judiciary Online Why Capital Account Convertibility in India Is Premature; John Williamson, Economic and Political Weekly May 13, 2006 Capital Account Liberalization and Stability of Capital markets in India an Empirical Analysis, Lekshmi R Nair, Institute for Financial Management and Research (IFMR) www.caclubindia.com/articles/convertibility-of-indian-rupee-1945.asp www.mbaknol.com/managerial-economics/current-account-convertibility http://www.thehindubusinessline.in/bline/2006/09/11/stories/2006091100800800.htm

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http://news.webindia123.com/news/articles/India/20061104/498646.html http://www.investopedia.com/terms/c/convertibility.asp#axzz2MGs626Pt http://www.thehindubusinessline.com/todays-paper/tp-mentor/pros-and-cons-ofconvertibility/article1686872.ece

http://www.wcfia.harvard.edu/sites/default/files/WCFIA_96-05.pdf http://www.halfmantr.com/display-ecomonic-issue/243-convertibility-of-rupee http://www.indianexpress.com/news/left-to-oppose-currency-convertibility/11954 http://www.dnaindia.com/money/report_so-what-does-rupeeconvertibilitymean_1019154

http://www.polsci.ucsb.edu/faculty/cohen/inpress/bretton.html http://www.time.com/time/business/article/0,8599,1852254,00.html http://www.dailyreckoning.com.au/bretton-woods-agreement/2006/11/29/ http://www.mbaknol.com/managerial-economics/current-account-convertibility/ http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/72250.pdf http://mrv.net.in/images/stories/convertibility/Capital.pdf

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Table of Contents
INTRODUCTION.......................................................................................................................... 8 WHAT IS RUPEE CONVERTABILITY?............................................................................. 9 TYPES OF CONVERTABILITY........................................................................................... 11 COMPONENTS OF CURRENT ACCOUNT CONVERTIBILITY ............................. 12 COMPONENTS OF CAPITAL ACCOUNT CONVERTIBILITY ............................... 17 PARTIAL RUPEE COVERTIBILITY ................................................................................... 18 FULL CAPITAL ACCOUNT CONVERTIBILITY .............................................................. 20 HISTORY OF RUPEE CONVERTABILITY .................................................................... 21 PROGRESS THROUGH CAPITAL ACCOUNT CONVERTIBILITY ........................... 24 CAPITAL ACCOUNT CONVERTIBILITY AND MENACE............................................ 27 CHALLENGES OF CAPITAL ACCOUNT CONVERTIBILITY AND THEIR MANAGEMENT ........................................................................................................................ 31 INDIAS PERFORMANCE AGAINST THE PRE-CONDITIONS ................................. 33 SUITABILITY OF FULL CONVERTIBILITY IN INDIA ........................................... 34 CONCLUSION ............................................................................................................................ 36 BIBLIOGRAPHY ........................................................................................................................ 40

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