Capital account convertibility (CAC) means freedom to convert currency, both in terms of outflows and inflows, for capital transactions. Capital account convertibility (CAC) refers to a country’s financial system where there are minimal restrictions on the exchange of its domestic currency for foreign currencies. This applies to transactions involving financial assets, such as stocks, bonds, and real estate.
In simpler terms, CAC allows for the free flow of capital into and out of a country. This means that businesses and individuals can easily convert their local currency into foreign currency and vice versa, for investment purposes or other capital account transactions.
Find out complete details regarding capital account convertibility, Full capital account convertibility. After Providing What is current account convertibility and its Advantages,
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Capital account convertibility :
Capital account convertibility means ability to convert the foreign exchange in to Indian rupees and vice versa on account of all capital transactions at a rate determined by the free flow of market and not by a country’s monetary controlling authority (RBI in India)
The main difference between current account convertibility and capital account convertibility lies in their names itself. Capital account convertibility allows you to convert the foreign exchange with our having any Imports and exports of goods and services, which are covered by current account convertibility.
Full capital account-convertibility allows local currency to be exchanged for foreign currency without any restriction on the amount.
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Tarapore Committee which was appointed by RBI on capital account-convertibility defined capital account convertibility as the freedom to convert local financial assets with foreign financial assets and vice-versa at market determined rates of exchange.
The main intention of Capital account convertibility is to allow the free flow of exchange without any restriction. In India there was no full capital account convertibility still.
Advantages :
(1) Unrestricted mobility of Capital :
Capital account convertibility allows free mobility of Capital into a country from foreign investors. It allows converting the foreign exchange brought into as Capital to convert into rupees at market-determined rates, which makes the investors encouraging. It allows the foreign investors to easily move in and move our from an economy. This enables domestic companies to raise funds from abroad.
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(2) Ability to invest in abroad easily :
Capital account convertibility allows the individuals of a nation to invest in abroad by easily converting their rupees into foreign exchange at the rates determined by the Market. This enables those potential domestic investors to acquire & own the assets in abroad.
(3) Improved access to global financial markets :
One can easily invest in the equity and debt markets of another economies along side a reduction in the cost of capital.
Disadvantages :
(1) Easier access to Hawala money :
As it allows to convert any foreign receipt into Indian rupees at market determined rates there may be chance that domestic economy will be flooded with foreign exchange which in long run may damage the financial health of an economy.
(2) High volatility of markets :
During the times when the financial markets of an economy are doing good, a country may receive huge foreign investment. But during adverse times the reverse scenario may happen. For example when the federal reserve Bank of America gave a sign that they are going increase the interest rates the foreign Institutional investors who invested their dollars in the Indian stock market had with drawn their investment from India which adversely impacted the rupee value.
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