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.