Liberalisation of Capital Account and Convertibility Issue:

Broadly speaking and irrespective of sector specificity, a liberalised system is one where the role of the government has been  curtailed and the system is governed by market forces. In BOP on capital account, liberalisation implies removal/ relaxation of controls/restraints on capital account transactions. This also indicates a move towards free currency  convertibility. 

With the astronomical growth of private capital flows  at the global level along with  its  attendant  risk  of  flight capital,  the  issue of capital  account convertibility has  remained much focused  in several countries. A series of currency crises  in Europe, Mexico East Asia Russia Brazil, Turkey and Argentina, as mentioned earlier, raised  a pertinent  question even about the desirability of capital account liberalisation and filler convertibility. Nonetheless, based on the international experience, it is more or less agreed now that the pre-conditions for liberalised capital account are strong domestic financial  system and  sound macroeconomic  policies  and appropriately conceived phase out period  of  such  liberalisation.

In terms of  sequencing, liberalisation of capital account should follow the current account. India faced BOP crisis  in  1990-91. While the short- term policy response was an  IMF policy package, our policymakers at  the same time  strived hard  to ensure a diversified capital account regime over a longer period. For one  thing, this essentially meant planning for a rising share of non-debt liabilities  and a low proportion of short-term debt  in total foreign liabilities. And  second, to achieve this perspective, a liberal yet appropriate policy frame related to FDI, portfolio investment and ECB was pursued. Thus we can say that  the move towards full capital account liberalisation has been approached with cautious optimism in India. 

More or less similar sentiment has  been  echoed  in RBI Annual Report 2004-05  : India has chosen to proceed cautiously and  in a gradual manner, calibrating the pace of capital  account  liberalisation with underlying macroeconomic developments, the state of readiness of the domestic financial system and the dynamics of  international financial markets. Unlike  in  the  case of  trade integration, where benefits to all countries are demonstrable, in the case of financial integration a "threshold" in terms of preparedness and resilienceaf the economy  is impotent for a country  to get full benefits.