Captial Convertibility

It is often said that with great powers comes great responsibilities. This is the case with Full Capital Account Convertibility in India. Although there are numerous benefits, still is India mature enough to have such responsibility.

Recently, Reserve Bank of India Governor Raghuram Rajan said that India may have full capital account convertibility in few years. Capital account convertibility means that local financial assets can be converted into foreign financial assets, and vice versa, without any regulatory approvals. These views have been echoed by junior finance minister Jayant Sinha and deputy Governor of RBI, Khan. That means the mood of the establishment is on this track only.

The issue of capital convertibility has been raging for last two decades. Right now India uses base rate concept, which would be scrapped and substituted by a benchmark like Libor for pricing credit such as loans and bonds.

Under the current regime, foreigners can invest in portfolio, but when it comes to debt ownership, there are limits. While Indians need to take regulatory approvals to purchase assets overseas or for investments, beyond a limit. Apart from this, there are sectoral caps for investments which need approvals.

The capital account convertibility was first discussed his 1997 budget speech by then finance minister P. Chidambaram. Once again in 2006, then Prime Minister, Manmohan Singh, raised the topic. Some of the ground work has been done, but still much is still left to be done.

Here is a brief SWOT analysis of Full Capital Account Convertibility.


Rupee is partially convertible right now. Slowly and steadily we are moving in that direction only. So far, India has not suffered any major hiccups
For capital markets, full capital account convertibility implies that the host country has fundamentally sound and disciplined policies to preserve the currency’s value, which in turn means that bond rate could be lower than it is without full convertibility
More convertible currency would facilitate faster growth through higher foreign long term investment. It is no coincidence that countries with fully convertible currency attract major chunk of global foreign investment
This would improve efficiency of the financial sector through greater competition, which is prerequisite for India to become top 3-4 economies in the world in next 25 years
India has already taken steps like introduction of credit derivatives to bring more liquidity into the market. Other such steps would also benefit the market


Almost unanimous view of most experts is that India is not yet ready and nobody is ready to give any kind of timeline for the about readiness
In mid-2013, RBI had to intervene to stabilize fast sliding rupee. Once rupee is fully convertible, it will not be able to pull strings that easily, in case of any internal or external financial calamity
In India, many times macroeconomic policies are changed very frequently to suit government interests or economic situations. First and foremost requirement of a full convertible currency is policy stability and consistency


Capital account convertibility would help corporate debt market to grow and provide a more cost effective way to raise to money
Masala bonds (the first-ever issue of rupee-denominated global bonds) issued by a multilateral agency International Finance Corporation (IFC) in 2013 was huge success. Similar bonds were later issued by IFC and ADB. These show that there are foreign investors who are willing to invest in rupee, even if it is not fully convertible. With fully convertible currency, number of such investors will increase many fold
One of the advantages of rupee-denominated bonds is that domestic issuers do not have to bear the currency risk. Masala bonds were sold at nearly 2 percentage points below the benchmark 10-year government bond shows that this is a good proposition for Indian firms
Rupee denominated instruments help in limiting the external vulnerabilities arising from foreign currency denominated liabilities


When rupee dominated bonds will be traded in international markets, the views on the rupee formed there will have effect on currency rates in the country as well
Capital convertibility means that the government will have limited ability in controlling the movement of the currency. This will in turn exposes the economy to erratic flow of capital, which could lead to financial instability (one of the main reasons for 1997 Asian financial crisis)
According to the committee formed to recommend ways leading to full capital convertibility, the fiscal deficit should be 3.5% of the gross domestic product and inflation between 3% and 5% (average for three years). For emerging economy like India, these conditions are very difficult to maintain consistently
Lot of work needs to be done at the macroeconomic level, which is very difficult in the Indian context

It is said that with great powers comes great responsibilities. This is the case with full capital convertibility. Although there are numerous benefits, still is India mature enough to have such responsibility. Once implemented, India has to act as a mature country, not like a-still-evolving-emerging-country, which sometimes it still does. Only time will tell, if we can truly act as a responsible nation or not.