There are many more restrictions on Indians sending money abroad that does not have to do with importing goods or services. Purchasing a company is allowed but limits exist on the amount that can be sent. Global diversification of household portfolios is almost nonexistent.

What will full capital account convertibility do?

With full capital account convertibility, there will be no restrictions for foreigners seeking to buy Indian assets. Conversely, there will be no restrictions for Indian households or companies taking rupees out or using foreign exchange for doing global diversification.

Why do we need capital account convertibility?

There are three sets of reasons. First, it is good for India if foreigners invest in Indian assets — this makes more capital available for India’s development. That is, it reduces the cost of capital. When steel imports are made easier, steel becomes cheaper in India. Similarly, when inflows of capital into India are made easier, capital becomes cheaper in India.

Second, it is good for India if households are globally diversified in their portfolios; this reduces risk and stabilises the economy. A globally diversified equity portfolio has roughly half the risk of an Indian equity portfolio. So, even when conditions are bad in India, globally diversified households will be buoyed by offshore assets, will be able to spend more, thus propping up the Indian economy.

Third, controls on the capital account are rather easy to evade through unscrupulous means. Huge amounts of capital are moving across the border anyway. It is better for India if these transactions happen in white money. Convertibility would reduce the size of the black economy, and improve law and order, tax compliance and corporate governance.

... contd.