7. (b) What are the advantages and disadvantages of full convertibility of Indian rupee? Do you believe that capital account convertibility is feasible under the present circumstances in India? Discuss.

Advantages and Disadvantages of Full Convertibility of Indian Rupee

Full convertibility of the Indian Rupee encompasses both current and capital account convertibility. While current account convertibility is already in place, the discussion primarily revolves around moving towards full capital account convertibility.

Advantages of Full Convertibility:

• Enhanced International Trade and Investment: Full convertibility reduces exchange rate uncertainties and transaction costs for businesses, making international trade and investment more attractive. This can boost exports and imports, fostering economic growth.
• Increased Foreign Capital Inflows: It signals greater financial openness and stability, attracting more Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) into India. This can provide much-needed capital for infrastructure development and industrial expansion.
• Improved Access to Global Financial Markets: Indian companies would have easier access to international capital markets, enabling them to raise funds at lower costs and diversify funding sources. Individuals could also invest more freely in foreign assets.
• Greater Financial Discipline and Efficiency: Increased global competition would push domestic financial markets to become more efficient, competitive, and innovative. It encourages better risk management practices among financial institutions.
• Prevention of Capital Flight: In some cases, convertibility can reduce incentives for illegal capital flight, as legitimate channels for moving funds become readily available.
• Potential for Rupee Internationalization: A fully convertible rupee could gain wider acceptance as a global currency, reducing India's reliance on major international currencies for trade and financial transactions.

Disadvantages of Full Convertibility:

• Exchange Rate Volatility: The most significant risk is increased volatility in the exchange rate due to speculative capital flows. Sudden outflows, triggered by global crises or domestic instability, can lead to sharp depreciation of the Rupee.
• Vulnerability to External Shocks: Full convertibility exposes the economy to global financial contagion. External economic downturns or policy changes in major economies can have rapid and severe impacts on India's financial markets.
• Loss of Monetary Policy Autonomy: The central bank's ability to independently manage monetary policy (e.g., interest rates, money supply) might be constrained, as its actions could be influenced by international capital movements.
• Risk of Capital Flight: While it can prevent illegal capital flight, it also facilitates rapid legitimate capital flight during periods of economic uncertainty, potentially leading to a balance of payments crisis.
• Increased Foreign Debt Burden: Easier access to foreign capital might encourage excessive borrowing by domestic entities, increasing the country's external debt burden and making it vulnerable to currency fluctuations.
• Impact on Domestic Industries: Increased competition from foreign goods and services due to easier imports could negatively affect some domestic industries, especially nascent or less competitive sectors.
• Speculative 'Hot Money' Flows: The economy could be prone to short-term, speculative capital flows that seek quick profits, leading to market bubbles and instability without contributing to long-term productive investment.

Feasibility of Capital Account Convertibility under Present Circumstances in India

India has been cautiously moving towards capital account convertibility since the economic reforms of 1991. The S.S. Tarapore Committee, constituted by the RBI in 1997 and again in 2006, provided crucial roadmaps and preconditions for achieving full CAC. The Tarapore Committee (1997 and 2006) laid down several preconditions for full CAC, including:

• Fiscal Consolidation: A sustained reduction in the fiscal deficit to GDP ratio to a prudent level (e.g., 3-3.5% of GDP).
• Low and Stable Inflation: Inflation rates should converge to internationally acceptable lower levels (e.g., 3-5%).
• Strengthening of the Financial System: This includes a robust banking system with low Non-Performing Assets (NPAs), adequate capital adequacy, and effective regulatory and supervisory frameworks.
• Adequate Foreign Exchange Reserves: Sufficient reserves to manage potential currency volatility and capital outflows.
• Strengthening of Debt Management: Efficient management of public debt.

Under the present circumstances (late 2025), a full capital account convertibility for India faces both enabling factors and significant challenges:

Enabling Factors:

• Robust Foreign Exchange Reserves: India's foreign exchange reserves have crossed the $700 billion mark in September 2024, providing a substantial buffer against external shocks. As of November 28, 2025, reserves stood at $686.227 billion.
• Improved Macroeconomic Stability: India has demonstrated resilience amidst global headwinds, with a relatively stable macroeconomic environment compared to many emerging economies. The current account deficit (CAD) has also shown moderation, easing to 1.3% of GDP in Q2 2025-26.
• Deepening Financial Markets: Indian financial markets, including equity and debt markets, have deepened significantly over the years, with increased participation from both domestic and foreign investors. Foreign Institutional Investor (FII) assets under custody surpassed $1 trillion in October 2024.
• Enhanced Regulatory Frameworks: The RBI and SEBI have continuously strengthened regulatory and supervisory frameworks for financial markets, which are crucial for managing risks associated with capital flows.
• Gradual Liberalization Measures: India has already undertaken several steps towards partial convertibility, such as increasing limits for overseas investments by individuals (Liberalized Remittance Scheme - LRS) and corporations, easing External Commercial Borrowing (ECB) norms, and introducing the Fully Accessible Route (FAR) for FPIs in government securities.

Challenges and Concerns:

• Persistent Fiscal Deficit: Despite efforts, achieving a sustained fiscal deficit within the recommended range (3-3.5% of GDP) remains a challenge. High government borrowing can crowd out private investment and fuel inflation.
• Inflation Management: While inflation has moderated, global commodity price volatility (e.g., crude oil) and domestic supply-side issues continue to pose risks, making it difficult to consistently maintain low and stable inflation.
• Global Economic Volatility: The current global economic landscape is characterized by geopolitical tensions, trade protectionism, and monetary policy divergence among major central banks. These factors increase the risk of volatile capital flows.
• Banking Sector Health: While NPAs have declined, continuous vigilance is required to ensure the long-term health and resilience of the banking sector, particularly public sector banks.
• "Taper Tantrum" Risks: The experience of the 2013 "Taper Tantrum" highlighted India's vulnerability to sudden reversals of capital flows when major central banks alter their monetary policies.
• Exchange Rate Management: The RBI currently intervenes in the forex market to manage excessive volatility. Full convertibility would reduce its ability to do so, potentially leading to sharper currency movements.

Given these factors, India is not yet fully prepared for immediate and complete capital account convertibility. A cautious, calibrated, and phased approach, as recommended by the Tarapore Committee, remains prudent. Continuous monitoring of macroeconomic indicators, further strengthening of financial sector reforms, and building greater resilience against external shocks are essential prerequisites before taking further decisive steps towards full capital account convertibility.