Capital account convertibility implies freedom of currency conversion related to capital inflows and outflows. Compared to current account convertibility, capital account convertibility is a complex issue because of the peculiar feature of capital account transactions. An important one is the high frequency and volume of international capital movements across borders which may produce many macroeconomic effects in host countries like India. Capital account convertibility is thus the freedom of foreign investors to purchase Indian financial assets (shares, bonds etc.) and that of the domestic citizens to purchase foreign financial assets. It provides rights for firms and residents to freely buy into overseas assets such as equity, bonds, property and acquire ownership of overseas firms besides free repatriation of proceeds by foreign investors.
In 1991, India allowed complete current account convertibility in phases but it has since maintained limitations on capital account convertibility. As of 2021, individuals can exchange INR for foreign currency upto 250,000 USD without any intervention from RBI. This is called as “liberalised remittance scheme”. There are many advantages and threats from complete capital account convertibility-
Advantages-
Sign of stable and mature markets- Free and open entry to an enormous number of global market participants would increase the risk of losing regulatory control due to large market size and a huge flow of capital. Opening up to a fully convertible currency is a solid sign that a country and its markets are stable and mature enough to handle the free and unrestricted movement of capital, which attracts investments making the economy better.
Increased liquidity in Financial markets- As per Tarapore committee, complete capital account convertibility can open up the country’s markets to global players including investors, businesses, and trade partners. This allows easy access of capital through FDI and FII. Banks can also borrow more efficiently through ECB route.
Control over Inflation- According to Tarapore committee, capital account convertibility can resolve supply side bottlenecks through higher investments and higher production in the country. Reduction of supply side bottlenecks can reduce Inflation in the country.
Disadvantages-
Exchange rate volatility- Capital account convertibility increases exchange rate volatility of Indian rupee. In case of depreciation of rupee, the long term liabilities increase substantially.
Balance of trade exports- A rising, unregulated rupee makes Indian exports less competitive in the international markets. Export-oriented economies like India and China prefer to keep their exchange rates lower to retain the low-cost advantage. Once the regulations on exchange rates go away, India risks losing its competitiveness in the international market.
According to the Governor of RBI, Shaktikanta Das, India will continue to approach capital account convertibility as a process rather an event, which means that it cannot be liberalised completely in one go. In the present scenario, the level of liberalisation of capital account is in sync with the need of India’s forex market.