Fourth, and most important, convertibility induces competition against Indian finance. Currently, finance is a monopoly in mobilising the savings of Indian households for the investment plans of Indian firms. No matter how inefficient Indian finance is, households and firms do not have an alternative, thanks to capital controls. Exactly as we saw with trade liberalisation, which consequently led to lower prices and superior quality of goods produced in India, capital account liberalisation will improve the quality and drop the price of financial intermediation in India. This will have repercussions for GDP growth, since finance is the ‘brain’ of the economy.

How can capital controls be evaded?

The current account has seen sharp growth since 1991 and spectacular growth since 2000 after which it has increased by nearly 2.5 times as both imports and exports have risen sharply. In 2004-05, inflows and outflows on the current account added up to $313 billion, or 48 per cent of GDP.

As a country’s trade integration with the world increases, there are innumerable nodes through which money flows in and out. To account for the purpose of each flow gets difficult. For example, gems and jewellery are among India’s biggest exports. Who is to say whether the true value of a polished gem is $100 or $1 million?

What will CAC mean for Indian households and companies?

They will be able to freely buy and sell rupees legally in India and abroad, to invest in foreign equity to give loans, take loans, accept foreign investment. There will be no questions asked when rupees are converted into dollars or yen, no forms to fill, no limits to be adhered to. The rupee will be a hard currency.

... contd.