RBI asks banks to prepare for major changes in capital account convertibility, BFSI News, ET BFSI
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India has come a long way in achieving increasing levels of convertibility on the capital account and has broadly achieved the desired outcome for the policy choices in terms of achieving a stable composition of foreign capital inflow, Sankar said while addressing the Foreign Exchange Dealers’ Association of India’s (FEDAI) annual day meeting.
Although the Indian rupee is fully convertible for current account transactions, only limited capital account transactions are permitted by the RBI.
“…India is on the cusp of some fundamental shifts in this space with increased market integration in the offing and freer non-resident access to debt on the table. The rate of change in capital convertibility will only increase with each of these and similar measures,” he said.
With that comes the responsibility to ensure that such flows are managed effectively with the right combination of capital flow measures, macro-prudential measures and market intervention, the deputy governor further said.
He futher said market participants, particularly banks, will have to prepare themselves to manage the business process changes and the global risks associated with capital convertibility.
The degree of Balance of Payment convertibility of a country usually depends on the level of its economic development and degree of maturity of its financial markets.
Therefore, advanced economies are almost fully convertible, while emerging market economies are convertible to different degrees, Sankar added.
The regulator’s job
“The regulator’s job is somewhat different. As someone once said, the job of a regulator is like the gas regulator in the kitchen – it cannot ensure the quality of the dish, but it can prevent the kitchen from blowing up.
“The quality of the dish – that is, the efficiency with which the investment needs of the country are met – is up to how well authorised dealers and other intermediaries adjust to the increasingly fuller capital account convertibility,” Sankar said.
The balance of payments (BOP) of a country records all economic transactions of a country (that is, of its individuals, businesses and governments) with the rest of the world during a defined period, usually one year. These transactions are broadly divided into two heads – current account and capital account.
The current account covers exports and imports of goods and services, factor income and unilateral transfers. The capital account records the net change in foreign assets and liabilities held buy a country.
What is capital account convertibility?
The balance of payments, a statement of all transactions made between a country and the outside world, consists of two accounts — current and capital account. While the current account deals mainly with import and export of goods and services, the capital account is made up of cross-border movement of capital by way of investments and loans.
Current account convertibility refers to the freedom to convert your rupees into other internationally accepted currencies and vice versa without any restrictions whenever you make payments.
Capital account convertibility means the freedom to conduct investment transactions without any constraints. It would mean no restrictions on the amount of rupees you can convert into foreign currency to enable you, an Indian resident, to acquire any foreign asset. Under it, there would be no restraints on NRIs bringing in any amount of dollars or dirhams to acquire an asset in India.
The Tarapore committee
The S S Tarapore committee’s report on fuller capital account convertibility in 2006 argued that even countries that had apparently comfortable fiscal positions have experienced currency crises and rapid deterioration of the exchange rate, when the tide turns.
The report had said that most currency crises arise out of prolonged overvaluation in exchange rates leading to unsustainable current account deficits. 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. Thus, it suggests transparent fiscal consolidation is necessary to reduce the chances of a currency crisis.
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