Capital Account Convertibility

Capital Account Convertibility or CAC is a monetary policy that centers around the ability to conduct transactions of local financial assets into foreign financial assets freely and at market determined exchange rates. [ [http://inhome.rediff.com/money/2006/sep/04faq.htm FAQ: Capital a/c convertibility and how it affects you] ] It is sometimes referred to as "Capital Asset Liberation".

In layman's terms, it is basically a policy that allows the easy exchange of local currency (cash) for foreign currency at low rates.Fact|date=February 2008 This is so local merchants can easily conduct transnational business without needing foreign currency exchanges to handle small transactions.Fact|date=February 2008 CAC is mostly a guideline to changes of ownership in foreign or domestic financial assets and liabilities. Tangentially, it covers and extends the framework of the creation and liquidation of claims on, or by the rest of the world, on local asset and currency markets.Benu Schneider. Issues in Capital Account Convertibility in Developing Countries. Speech delivered to Overseas Development Institute, 2000.]

History

CAC was first coined as a theory by the Reserve Bank of India in 1997 by the Tarapore Committee, in an effort to find fiscal and economic policies that would enable developing Third World countries transition to globalized market economies.Vijay Joshi, Ian Malcolm, David Little. India's Economic Reforms, 1991-2001. Published 1996 Oxford University Press. ISBN 0198290780] However, it had been practiced, although without formal thought or organization of policy or restriction, since the very early 90's. Article VIII of the IMF’s Articles of Agreement is agreed by most economists to have been the basis for CAC, although it notably failed to anticipate problems with the concept in regard to outflows of currency.

However, before the formalization of CAC, there were problems with the theory. Free flow of assets was required to work in both directions. Although CAC freely enabled investment in the country, it also enabled quick liquidation and removal of capital assets from the country, both domestic and foreign. It also exposed domestic creditors to overseas credit risks, fluctuations in fiscal policy, and manipulation.Zoubida Allaoua. India: sustaining rapid economic growth. Published 1997 World Bank Publications. ISBN 0821339923]

As a result, there were severe disruptions that helped to contribute to the East Asian crisis of the mid 90's. In Malaysia, for example, there were heavy losses in overseas investments of at least one bank, in the magnitude of hundreds of millions of dollars. These were not realized and identified until a reform system strengthened regulatory and accounting controls.Prema-Chandra Athukorala. Crisis and Recovery in Malaysia: The Role of Capital Controls. Published 2003 Edward Elgar Publishing. Pg 44 ISBN 1843764555] This led to the Tarapore Committee meeting which formalized CAC as utilizing a mixture of free asset allocation and stringent controls.Zoubida Allaoua. India: sustaining rapid economic growth. Published 1997 World Bank Publications. ISBN 0821339923]

Tenets

CAC has 5 basic statements designed as points of action:L. Bethell. The West and the Third World: Trade, Colonialism, Dependence and Development. Published 1999 Blackwell Publishing. ISBN 0631194398]

* All types of liquid capital assets must be able to be exchanged freely, between any two nations, with standardized exchange rates.
* The amounts must be a significant amount (in excess of $500,000).
* Capital inflows should be invested in semi-liquid assets, to prevent churning and excessive outflow.
* Institutional investors should not use CAC to manipulate fiscal policy or exchange rates.
* Excessive inflows and outflows should be buffered by national banks to provide collateral.

Application

In most traditional theories of international trade, the reasoning for capital account convertibility was so that foreign investors could invest without barriers. Prior to its implementation, foreign investment was hindered by uneven exchange rates due to corrupt officials, local businessmen had no convenient way to handle large cash transactions, and national banks were disassociated from fiscal exchange policy and incurred high costs in supplying hard-currency loans for those few local companies that wished to do business abroad.

Due to the low exchange rates and lower costs associated with Third World nations, this was expected to spur domestic capital, which would lead to welfare gains, and in turn lead to higher GDP growth. The tradeoff for such growth was seen as a lack of sustainable internal GNP growth and a decrease in domestic capital investments.Vijay Joshi. India: macroeconomics and political economy, 1964-1991. World Bank Publications ISBN 082132652]

When CAC is used with the proper restraints, this is exactly what happens. The entire outsourcing movement with jobs and factories going oversees is a direct result of the foreign investment aspect of CAC. The Tarapore Committee's recommendation of tying liquid assets to static assets (i.e., investing in long term government bonds, etc) was seen by many economists as directly responsible for stabilizing the idea of capital account liberalization.

Controversy

Despite changes in wording over the years, and additional safeguards, there is still criticism of CAC by some economists. American economists, in particular, find the restriction on inflows to Third World countries being invested in improvements as negative, since they would rather see such transactions put to direct use in growing capital.Zoubida Allaoua. India: sustaining rapid economic growth. Published 1997 World Bank Publications. ISBN 0821339923] Benu Schneider. Issues in Capital Account Convertibility in Developing Countries. Speech delivered to Overseas Development Institute, 2000.]

References


Wikimedia Foundation. 2010.

Look at other dictionaries:

  • Capital account — In financial accounting, the capital account is one of the accounts in shareholders equity. Sole proprietorships have a single capital account in the owner s equity. Partnerships maintain a capital account for each of the partners. In economics,… …   Wikipedia

  • Indian rupee — Infobox Currency currency name in local = रुपया hi icon image 1 = image title 1 = 1000 rupee note image 2 = Coins of india.jpg image title 2 = Coins of various denominations iso code = INR using countries = flag|India inflation rate = 12.14 %… …   Wikipedia

  • India — /in dee euh/, n. 1. Hindi, Bharat. a republic in S Asia: a union comprising 25 states and 7 union territories; formerly a British colony; gained independence Aug. 15, 1947; became a republic within the Commonwealth of Nations Jan. 26, 1950.… …   Universalium

  • Reserve Bank of India — Infobox Central bank bank name in local = भारतीय रिज़र्व बैंक image 1 = RBI Tower.jpg image title 1 = The RBI headquarters in Mumbai image 2 = image title 2 = headquarters = coordinates = established = April 1, 1935 president = Duvvuri Subbarao… …   Wikipedia

  • CAC — may refer to:Arts* California Arts Council, a state agency governed by an 11 member council appointed by the Governor and the state Legislature to advance the state through the arts and creativity * Columbia Arts Center, an arts center located in …   Wikipedia

  • March 2006 in India — NOTOC [March 2006 : ← January February March April May June July August September October November December →March 31, 2006* At least 18 Indians are among the 57 people killed when a traditional wooden boat on a dinner cruise sinks off the… …   Wikipedia

  • Argentine Currency Board — The Argentine Currency Board pegged the Argentine peso to the U.S. dollar between 1991 and 2002 in an attempt to eliminate hyperinflation and stimulate economic growth. While it initially met with considerable success, the board s actions… …   Wikipedia

  • international payment and exchange — ▪ economics Introduction international exchange also called  foreign exchange        respectively, any payment made by one country to another and the market in which national currencies are bought and sold by those who require them for such… …   Universalium

  • Neoliberalism — For the school of international relations, see Neoliberalism in international relations. Part of the Politics series on Neoliberalism …   Wikipedia

  • Russia — /rush euh/, n. 1. Also called Russian Empire. Russian, Rossiya. a former empire in E Europe and N and W Asia: overthrown by the Russian Revolution 1917. Cap.: St. Petersburg (1703 1917). 2. See Union of Soviet Socialist Republics. 3. See Russian… …   Universalium


Share the article and excerpts

Direct link
Do a right-click on the link above
and select “Copy Link”

We are using cookies for the best presentation of our site. Continuing to use this site, you agree with this.