Ask an Economist: India's Capital Account Convertibility

C.P. Chandrasekhar

Triple Crisis Blog has invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: Why is India moving towards full capital account convertibility, even though it knows about financial market volatility and the recent crisis?

Chandrasekhar: India has adopted a peculiar position on the issue of convertibility. Just before the East Asian financial crisis of 1997 broke, India was all set to make the rupee fully convertible on the capital account. A road map for full convertibility had been drawn up. This would have allowed residents in India to convert their wealth into foreign exchange and transfer it abroad. The crisis sent out a clear signal that this is bad policy and can pave the way for instability and even a currency crisis. That signal prevented the government from opting for such a misguided policy.

Since then Indian policy makers have been proud of the fact that cautious policies with regard to capital flows and financial integration had helped the country avoid financial crises and reduce the impact of the 2008 crisis on the country. Yet there is a strong segment of government opinion which is still in favour of full convertibility. This is only partly because of the beliefs (i) that India is “different” and can handle convertibility much better than other developing countries; and (ii) that convertibility is a requirement for India to move from developing to developed country status.

More importantly, it is the result of pressure from wealth holders within the country who want the option of transferring wealth abroad both to earn returns and hedge against any possible weakening of the rupee. That this could be at the expense of instability that undermines the living standards of the less well-to-do obviously does not bother them.

However, at the present moment, the problem India faces is one of excessive inflows of foreign capital, which is resulting in an appreciation of the rupee. Such appreciation adversely affects the competitiveness of Indian exports. Hence, there is a strong lobby that not only wants the central bank to intervene and stall rupee appreciation, but also to adopt policies that can moderate the surge in capital inflows. This is holding back the transition to full capital account convertibility for the time being.

2 Responses to “Ask an Economist: India's Capital Account Convertibility”

  1. P V Subrahmanyam says:

    What is the long term out come of increase in public debt ?
    Is the Condition in India serious to warrant significant changes in policy formulation ? Given that about 40% of our GDP is in black economy how far the numbers published by Government are credible?

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