Convert the Capital !

Whenever I turn the pages of my passport, which of course is blue Indian one, I stop at a particular page. Now days when passports have latest RFID tags and biometric data, mine has this second last page where Foreign exchange transactions have to be recorded. I am sure most of the Indian passports, like mine, have this page blank. It serves nothing except to remind us of our old times when we had tough current account convertibility norms. There was limit to amount of Indian Rupees that could be converted to foreign exchange for travel and other such related expenses. Of course we have come a long way from then. We have a huge foreign exchange reserve(154.209bn US $ as on April 7, 2006). There is no limit to Indian currency that one can convert to foreign exchange for purpose of travel, educational, medicinal expense, etc. The current account is totally convertible.

The capital account is still not fully convertible. Recently the issue gained focus when Prime Minister & Finance Minister of India said that India is very close to capital account convertibility. When this happens then there would be no restrictions on converting domestic currency (Rs) to foreign currency and vice versa. Indians can convert their savings in rupees to some other foreign currency according to the return opportunities. They can also invest in shares and assets abroad (at present the limit is US $ 25,000 per year). Same is true for Indian companies; they can raise capital from abroad and invest in assets there.

So what is the debate over capital account convertibility? Is India mature and ready for it? Capital account convertibility, one of favourite and pet topic of international financial institutions like IMF, has always been aggressively pushed by them.

There are many benefits associated with capital account convertibility like cheap capital for investment and hence developmental activity, better investment and risk hedging options, imports becoming cheaper, etc.

The disadvantages can be easily summed up by the East Asian and Mexican crisis. They are perfect example of how capital account convertibility can go wrong. Of course we have one of the best central bank of world, Reserve bank of India. But is that enough? What essentially follows the regime of full capital account convertibility is Banks and other financial institutions starts to invest in risky assets or takes high exposure of short tem debts. A little change in currency rates can lead to a debilitating blow in such case.

The securities scam of 1992 for the first time highlighted how far Indian banks can collude in scams. With passing of years it was thought that both our banks and monitoring bodies have matured. But this proved to be short-lived and false with the recent IPO scandal which displayed glaring systemic weakness and exploitation of these by our financial institutions. With the propensity of Indian banks to go any length for profits and absence of mature regulatory and monitory bodies, can one be sure of the banks in the full capital account convertibility regime? The answer might well be the answer to India being ready for full capital account convertibility.