Tarapore Committee on Capital Account Convertibility

Jumping into capital account convertibility game without considering the downside of the step can harm the economy. The Committee on Capital Account Convertibility (CAC) or Tarapore Committee was constituted by the Reserve Bank of India for suggesting a roadmap on full convertibility of Rupee on Capital Account. The committee submitted its report in May 1997. The committee observed that there is no clear definition of CAC. The CAC as per the standards, refers to the freedom to convert the local financial assets into foreign financial assets or vice versa at the market determined rates of exchange.

The Tarapore committee observed that the Capital controls can be useful in insulating the economy of the country from the volatile capital flows during the transitional periods and also in providing time to the authorities, so that they can pursue discretionary domestic policies to strengthen the initial conditions.

The CAC Committee recommended the implementation of Capital Account Convertibility for a 3 year period viz. 1997-98, 1998-99 and 1999-2000. But this committee had laid down some pre conditions as follows:

  1. Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5 per cent in 1997-98 to 3.5% in 1999-2000.
  2. A consolidated sinking fund has to be set up to meet government’s debt repayment needs; to be financed by increased in RBI’s profit transfer to the govt. and disinvestment proceeds.
  3. Inflation rate should remain between an average 3-5 per cent for the 3-year period 1997-2000.
  4. Gross NPAs of the public sector banking system needs to be brought down from the present 13.7% to 5% by 2000. At the same time, average effective CRR needs to be brought down from the current 9.3% to 3%
  5. RBI should have a Monitoring Exchange Rate Band of plus minus 5% around a neutral Real Effective Exchange Rate RBI should be transparent about the changes in REER
  6. External sector policies should be designed to increase current receipts to GDP ratio and bring down the debt servicing ratio from 25% to 20%
  7. Four indicators should be used for evaluating adequacy of foreign exchange reserves to safeguard against any contingency. Plus, a minimum net foreign asset to currency ratio of 40 per cent should be prescribed by law in the RBI Act.

The above committee’s report was not translated into any actions. India is till a country with partial convertibility. However, some important measures in “that direction” were taken and they are summarized as below:

  1. The Indian Corporate were allowed full convertibility in an automatic route up to the $ 500 million overseas ventures. This means that the limited companies were allowed to invest in foreign countries.
  2. Indian corporate were allowed to prepay their external commercial borrowings via automatic route if the loan is above $ 500 million.
  3. Individuals were allowed to invest in foreign assets , shares up to $ 2, 00, 000 per year.
  4. Unlimited amount of Gold was allowed to be imported.

“The last measure, i.e. allowing unlimited amount of Gold is equal to allowing the full convertibility in capital account via current account route”

The Second Tarapore Committee on Capital Account Convertibility

Reserve Bank of India appointed the second Tarapore committee to set out the framework for fuller Capital Account Convertibility. The committee was established by RBI in consultation with the Government to revisit the subject of fuller capital account convertibility in the context of the progress in economic reforms, the stability of the external and financial sectors, accelerated growth and global integration.

The report of this committee was made public by RBI on 1st September 2006. In this report, the committee suggested 3 phases of adopting the full convertibility of rupee in capital acount.

  1. First Phase in 2006-7
  2. Second phase in 2007-09
  3. Third Phase by 2011.

Following were some important recommendations of this committee:

  1. The ceiling for External Commercial Borrowings (ECB) should be raised for automatic approval.
  2. NRI should be allowed to invest in capital markets
  3. NRI deposits should be given tax benefits.
  4. Improvement of the Banking regulation.
  5. FII (Foreign Institutional Investors) should be prohibited from investing fresh money raised to participatory notes.
  6. Existing PN holders should be given an exit route to phase out completely the PN notes.
  • At present the rupee is fully convertible on the current account, but only partially convertible on the capital account.
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