What is the danger for India?

As more money flows in and out of the country it becomes difficult to control the price of the rupee due to the large amounts involved. This could raise difficulties for the RBI which could have to buy or sell larger and larger amounts of dollars if it wished to manipulate the rupee dollar rate. It would end up building up even larger reserves than it has currently. These create difficulties in setting interest rates according to the needs of the Indian economy. Capital account convertibility means that eventually the rupee has to be allowed to become more flexible.

So, what is the one inargu-able reason for India to adopt convertibility?

With effective convertibility already in place for all except honest citizens, a policy that penalises honest Indian citizens becomes indefensible. Shifting to convertibility is, to a significant extent, about converting the de facto to the de jure. Moreover, the case for manipulating the exchange rate of the rupee by the RBI is weak. India is a strong and growing economy. When imports rise faster than exports and not being finaced by capital flows, we are likely to witness a weaker rupee. If the rupee were to be artificially propped up, it would be bad policy as it would make expensive imports cheap and encourage their consumption. As the economy grows and becomes larger, these mistakes would become even more expensive. These are good times when inflation is low, when our exports and imports are doing well, when fiscal deficits are on a path to correction and when India has mountains of foreign exchange reserves: near-perfect conditions for capital account convertibility.

... contd.