nitinpahuja
Nitin Pahuja
Capital Account Convertibility- A rationale move
Working definition of CAC
CAC refers to the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. It is associated with changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by, the rest of the world.
The rationale for opening the capital account
Dismantling capital controls generates economic benefits through increased opportunities for trade and cross-border portfolio diversification in both assets and liabilities. It also imposes macroeconomic discipline on national governments.2 Allowing assets and liabilities portfolio diversification across borders enables a country's borrowers to access lower borrowing costs and its savers to earn higher yields. Moreover, competition among financial intermediaries will squeeze intermediation margins; as a result, costs of funds to borrowers will decrease and returns to lenders will rise.
However, there is another school of thought which argues that asymmetric information—a situation in which one party to a transaction has less information than the other—pervades financial markets, and that this greatly undermines their efficiency as mechanisms for allocating resources. There is, moreover, good reason to think that asymmetric information is particularly prevalent internationally, because geography and cultural distance complicate the acquisition of information.3 However, with the spread of internet and IT enabled services, this argument must have become weaker in recent years.
To sum it up capital account convertibility is an opportunity for India and demands a cautious yet assertive approach to its incorporation so that the Indian economy can spread its wings on the global horizon.
Working definition of CAC
CAC refers to the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. It is associated with changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by, the rest of the world.
The rationale for opening the capital account
Dismantling capital controls generates economic benefits through increased opportunities for trade and cross-border portfolio diversification in both assets and liabilities. It also imposes macroeconomic discipline on national governments.2 Allowing assets and liabilities portfolio diversification across borders enables a country's borrowers to access lower borrowing costs and its savers to earn higher yields. Moreover, competition among financial intermediaries will squeeze intermediation margins; as a result, costs of funds to borrowers will decrease and returns to lenders will rise.
However, there is another school of thought which argues that asymmetric information—a situation in which one party to a transaction has less information than the other—pervades financial markets, and that this greatly undermines their efficiency as mechanisms for allocating resources. There is, moreover, good reason to think that asymmetric information is particularly prevalent internationally, because geography and cultural distance complicate the acquisition of information.3 However, with the spread of internet and IT enabled services, this argument must have become weaker in recent years.
To sum it up capital account convertibility is an opportunity for India and demands a cautious yet assertive approach to its incorporation so that the Indian economy can spread its wings on the global horizon.