Pros and Cons of Capital Account Convertibility

Capital Account and Current Account are two essential components of Balance of Payments which is the difference between the aggregate inflows and outflows of a country's services, goods, expenditure abroad by Indians, expenditure in India by foreign nationals, Investments abroad, Investments in India by Non Indians, Transfer payments, Interest paid and received etc.

Current Account mainly deals with the trade related aspects which are known as the visible items and the services which are known as the invisible items. It also includes the transfer payments, expenditure of foreigners in India and vice versa.

Capital Account on the other hand refers to the Investments made by Foreign Nationals and Foreign institutions in India, along with the Inter country grants received by India. The Investments made in India and grants received constitute the credits and the Investments made abroad by India and grants by India to other countries constitute the debits.

Current account or capital account convertibility refers to the conversion of local financial assets into foreign currency or the conversion of foreign financial assets into the local currency at the prevailing market exchange rate.

Capital account convertibility is a much important matter of concern as capital account convertibility in particular refers to the withdrawal of Investments by foreign Bodies.

How does it affect?

As capital account mainly deals with the Investments by foreign nationals in mamoth projects like Construction of Dams, ports, infrastructure development, Power projects, Energy Projects , Realty,Green Field Investments which generally require huge amounts.

From the Foreign Investor Point of view- a cent percent convertibility or Full convertibility of capital account will confer him the right to withdraw his investments completely whenever he feels like, which in turn may cripple the progress of the domestic economy due to the stagnation of work owing to paucity of funds. Many developing countries generally resort to partial convertibility where in the Foreign Investor can only partially with draw his investments when a need arises, thus mitigating the risk to a great extent. As the cumulative figures of Capital Investments by foreigners amount to billions of rupees,Developing nations opt for a partial convertibility .

For example- Indian Stock Market which was at 21K in mid Jan this Year shed around 65% of its wealth owing to Inflationary and Recessionary pressures. A fuller capital account convertibility could have resulted in further more damage to it along with further withdrawal of FII and FDI activity.

Prospects of Full Convertibility-

It will result in a substantial increase in Inflows of Foreign Investments into India, thus infusing more funds and providing ample scope of an accelerated progress but at the same time it leaves a huge risk of foreign investors backing out incase of any untoward events or incidents.

India always adopts a conservative approach( just like the attitude of its people) by allowing partial capital account convertibility, Tarapore Committee made a thorough analysis of capital account convertibility and suggested that India should allow fuller capital account convertibility.
On the other hand USA whcih has gone through a recession nine times and recovered, since 1930's follows a full capital account convertibility leaving it more proned to risk.

But always remember - "It is better Safe than sorry".

For a Crystal clear understanding of Capital account Composition check out the following link.

http://in.youtube.com/watch?v=QE6819vVrCA