What is capital account convertibility?

Answer 1

In India, the foreign exchange transactions (transactions in dollars, pounds, or any other currency) are broadly classified into two accounts: current account transactions and capital account transactions. If an Indian citizen needs foreign exchange of smaller amounts, say $3,000, for travelling abroad or for educational purposes, she/he can obtain the same from a bank or a money-changer. This is a "current account transaction". But, if someone wants to import plant and machinery or invest abroad, and needs a large amount of foreign exchange, say $1 million, the importer will have to first obtain the permission of the Reserve Bank of India (RBI). If approved, this becomes a "capital account transaction". This means that any domestic or foreign investor has to seek the permission from a regulatory authority, like the RBI, before carrying out any financial transactions or change of ownership of assets that comes under the capital account. Of course there are a whole range of financial transactions on the capital account that may be freed form such restrictions, asis the case in India today. But this is still not the same as full capital account convertibility.

By "Capital Account Convertibility" (or CAC in short), we mean "the freedom to convert the local financial assets into foreign financial assets and vice-versa at market determined rates of exchange. It is associated with the 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. …" (Report of the Committee on Capital Account Convertibility, RBI, 1997) Thus, in simpler terms, it means that irrespective of whether one is a resident or non-resident of India one's assets and liabilities can be freely (i.e. without permission of any regulatory authority) denominated (or cashed) in any currency and easily interchanged between that currency and the Rupee.