After reading this article you will learn about the convertibility of capital account in India.
In India the Capital Account Convertibility means “the freedom to convert the local financial assets into foreign financial assets and vice-versa at a market determined rate of exchange. It is associated with the changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by the rest of the world”.
Convertibility facilitates conversion of any currency into rupee or in any currency freely. In simple words rupee can be freely convertible into any foreign currency for acquisition of assets like shares, properties, and assets abroad. Banks can also accept deposits in any currency.
The Capital Account convertibility being linked with the monetary and economic policy is regulated by the Reserve Bank of India Convertibility is mainly related to Foreign Exchange transactions which are mostly government by the foreign exchange management Act 1999.
Section 2(i) defines a current account transaction as a transaction and without prejudice to the generality of the foregoing such transaction includes:
1. Payments due in connection with foreign trade, other current business, services, and short term banking and credit facilities in the ordinary course of business.
2. Payments due as interest on loans and as net income from investments.
3. Remittances for living expenses of parents, spouse and children residing abroad.
4. Expenses in connection with foreign travel, education and medical care of parents, spouse and children.
For the current account transactions any one can sell or draw foreign exchange to or from any authorised person. However the Regulatory body may restrict current account transactions/limit of transactions in case of need and keeping in view the public interest.
Taking everything into account and liberalised economic policies adopted by the government of India is fully convertible on the current account which means all payments and receipts concerning trade and services (export/import payments/receipts) are free from forex regulations.
One can make payment in any currency to other parts of world for goods/services purchased but not for capital creation. So if you want to pay your supplier $ 100 million for import of raw material you can do it freely. RBI will not come in the way of making such huge payment as it is a payment on the current account. But in case of buying any immoveable property like investment in real estate exceeding the cost of $ 100000/- the permission of RBI is required.
Acquiring an immoveable property tantamount to creation of capital asset and RBI has fixed an upper limit for such transactions. Like wise no foreign national can invest in real estate in India without the prior permission of the RBI.
Section 2(e) of the Foreign Exchange Management Act, 1999 defines a Capital Account Transaction as a transaction which alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India or assets or liabilities in India, and includes transactions referred to in subsection (3) of Section 6. Transactions under the capital account are restricted and controlled by a number of regulations.
For example Foreign Exchange Management (Permissible capital account transactions) Regulations 2000 and FEMA Act do not permit capital account transactions without obtaining specific permission from the Reserve Bank of India.
The system appears paradoxical as all capital account transactions are prohibited, unless specifically permitted. In case of current account transactions the fact is otherwise true that all current transactions are permitted unless specifically prohibited.
Investment in certain sectors – Foreign investment in India in any company, firm or proprietary concern engaged or proposing to engage in the following activities is completely prohibited:
i. Chit Funds,
ii. Nidhi Company,
iii. Agricultural or Plantation activities,
iv. Real Estate Business, and
v. Trading in transferable Development Rights.
However there is very little difference in current and capital account transactions in certain unspecified and undefined cases and is matter of further consideration for more clearly. However a difference between the two type of transactions i.e. current account transactions and capital account transactions can be understood by a very simple example.
If an Indian needs some foreign exchange for paying his fees for study abroad or wishes to visit his relatives settled abroad he can get foreign currency exchanged from any approved money-changer or from any bank. It is treated as Current Account Transaction.
But if any Indian citizen wants to import some heavy equipment, plant or machinery or wants to invest abroad and the amount involved is big it will be treated as a capital account transaction for which he shall be required to obtain the permission of Reserve Bank of India.
As per monetary policy of any country with regard to capital account convertibility to ensure ability to accept such transactions where local financial assets are transacted into foreign financial assets freely and at the same time also at the foreign exchange rate of interest prevailing in the market.
Convertibility of capital or current account depends how sound is the position of balance of payments with any country which solely depend how much foreign exchange reserve any country possesses.
Time is not for ahead in 1990es our country was depleted of foreign currency reserves so that an Indian citizen wishing to visit abroad was eligible for foreign exchange currency of only $ 2000/- only hardly sufficient to survive on a foreign land even for two days. During those days it was not possible to think about even partial convertibility of rupee. But the regulatory authorities were cautious enough to improve the situation.
Forget the days of FERA 1947 when it was just like impossible to import an item for personal use costing as low as $10/- for which RBI’s approval was required. Some changes were made in FERA in 1973 and latterly FEMA 2000 shifted its focus from conservation of foreign exchange to facilitating trade and payments.
With the result India has adopted current account convertibility for export and import of goods and services but in case of capital account convertibility it is only partially allowed. Upper limit has been fixed by the RBI and beyond that limit permission of RBI is required.
When we are talking about full convertibility on capital account we should be able to understand the difference between full and the fuller convertibility. The difference between full and fuller convertibility leaves much to be desired. As is well known, in the scenario of global recession there is always a chance of relatively unstable and volatile economic situation before any country and in view of this fact any country needs controls over capital flow.
In case of current account India is fully convertible but in case of creating capital assets outside India that too on credit basis it accounts for creation of capital liability on the country and adversely affects the balance of payment account of the country and it is for this reason that certain limits have been prescribed.
In case fuller convertibility is allowed there shall be no restrictions of any kind and the national economy and monetary policy shall also be adversely affected. There is glaring examples of what happened to the economy of several nations where fuller convertibility was permitted.
For example some countries in east Asia where some Foreign financial institutions had invested in real estate by miss utilising short term funds for long term investments and with the result which destabilized the entire economy of these countries. In view of this very fact the fuller (complete) convertibility on capital accounts is still under consideration of the government of India. Because it would mean no restrictions without any question.
But developing countries like India (now declared as developed country by the president of USA Mr. Barak Obama.) may face foreign exchange problems in keeping the sufficient foreign exchange reserves to maintain stability of trade balance and stability of its economy. With the increase in foreign exchange reserves the stipulated restrictions shall go on removing gradually.
Till date the capital account convertibility remains a major question for the government to decide whether full rather fuller convertibility on capital account shall or not be in the larger interest of the economy of our country, particularly when there are glaring examples of many countries which allowed full capital convertibility.
Objectives of Full Capital Account Convertibility:
1. Economic Growth:
The Introduction of FCAC will help in the economic development of the country through capital investment in the country. This leads to employment generation in the country, infrastructure development, global competition etc.
2. Improvement in Financial Sector:
There would be improvement in the financial sector as huge capital flow into the system, which will help the companies to perform better. It will boost liquidity into the system.
3. Diversification of Investment:
It will also help in the diversification of Investment by ordinary people, wherein they can invest abroad without any restriction and diversify their portfolio.