- It is intended for local merchants to easily conduct transnational business freely without any regulation or control.
- In case currency is fully capital account convertible, then anybody from anywhere in the world can invest in any asset in that currency.
- Thus a US citizen could buy a flat in India, allow it to appreciate & sell the same & take the contribution as well as the profit out of India to the US freely.
- Since this is not allowed in India & the government has its own rules & policies to regulate foreign investments, we say that India does not have full Capital A/c Convertibility.
- CAC also allow the people & companies not only to convert one currency into another but also a free cross-border movement of those currencies, without the interventions of the law of the country concerned.
- Thus, Indian could convert their rupees into dollar & park it in the US if there was capital a/c convertibility here.
- Imagine if a large number of Indians were to do this out of an irrational fear that India might go to war with Pakistan.
- This would lead to an irrational demand for the dollar & would cause a free fall in the value of the Indian rupee, thereby determanetally affecting the economy.
- For full CAC, the economy should be extremely stable so that its citizen never made to feel insecure about their economy & drive them into irrationally converting their currencies & investing them abroad.
- Under the Tarapore committee recommendation, this was possible only when the following conditions were satisfied.
- The average rate of Inflation should vary between 3%-5%
- All type of liquid capital assets must be able to be freely exchanged, between any two nations, with standardized exchange rates.
- The amount must be significant amount (in excess of $500,000)
- Capital inflows should be invested in semi-liquid assets, to prevent churning & excessive outflow.
- Institutional investors should not use CAC to manipulate fiscal policy or exchange rate.
According to the RBI, as the Indian rupee is not fully convertible, it is not possible to go in for the dual listing of shares, which allows people to buy shares in the stock exchange of one country & sell in the another country.
e.g. An African citizen could buy the stock in Africa, & sell it in India, collect the rupee, convert it into RAND & takes them into the African economy- all these without any control, permissions & regulations.
This unhindered capital flow is not currently favored by the Indian Government.