DMPQ- Explain the concept of capital account convertibility. Compare the advantages and disadvantages of full capital account convertibility.

. Capital Account Convertibility is a feature of a nation’s financial  regime that centers on the ability to conduct transactions of local financial assets (money, stocks, bonds,  real estate, FDI, FII, account receivable, inventory etc) into foreign financial assets freely and at market  determined exchange rates. In layman’s terms, full capital account convertibility allows local currency to  be exchange for foreign currency without any restriction on the amount. Capital account convertibility is  considered to be one of the major features of a developed economy.

Advantages of capital account convertibility

  • It helps attract foreign investment. It offers foreign investors a lot of comfort as they can re-convert local currency into foreign currency any time they want to and take their  money away.
  • At the same time, capital account convertibility makes it easier for domestic companies to tap foreign markets.
  • Greater access for resident companies to foreign capital and debt markets – reduce cost of capital.

Disadvantages of capital account convertibility

  • While during good times, investment flow into the country, in times of financial crisis, unchecked outflows may lead to destabilization of economy and developing countries  cannot handle such shocks. Crisis in Asian economies – called Asian Tigers – is one of the  burning example.
  • It also means that country might lose domestic saving as individual might want to invest in foreign markets.

 

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