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Question

One of the important goals of the economic liberalization policy is to achieve high convertibility of the Indian rupee. Which of the following is not a benefit of rupee convertibility?

A Convertibility of the rupee will stabilize its exchange value against major currencies of the world. Correct Answer Incorrect Answer
B It will attract more foreign capital inflow in India Correct Answer Incorrect Answer
C Encouragement to exports Correct Answer Incorrect Answer
D It will raise import prices and cause Cost-push Inflation Correct Answer Incorrect Answer
E Integration of Indian economy with global Economy Correct Answer Incorrect Answer

Solution

Capital Account Convertibility of ₹: · Freedom to convert local financial assets into foreign ones at market-determined exchange rates · Leads to free exchange of currency at lower rates and an unrestricted mobility of capital · Beneficial for a country because inflow of foreign investment increases · The flip side, though, is that it could destabilize an economy due to massive capital flows in and out of the country Capital account refers to expenditures and investments in hard assets, physical premises, and factories as well as investments in land and other capital-intensive items. Current account refers to investments that are short term in duration and hence, they fall under the current account head India has full current account convertibility but partial capital account convertibility as on 2019. India has partial convertibility (40:60) in the capital account, but inside this overall policy, enough reforms have been made, and to certain levels of foreign exchange requirements. Pros and cons of Capital account Convertibility:

Advantages

Disadvantages

Availability of large funds by improved access to international financial markets. Market determined exchange rates being higher than officially fixed exchange rates can raise import prices and cause Cost-push inflation.
Reduction in cost of capital. Improper management of CAC can lead to currency depreciation and affect trade and capital flows.
The incentive for Indians to acquire and hold international securities and assets. The advantages have been found to be short lived as per studies, and also International financial institutions are skeptical about CAC post-2008 crisis.
Greater financial competitiveness. Speculative activity can lead to capital flight from the country as in case of some South East Asian economies during 1997-98.
Will help Indian corporate to use External commercial borrowing route without RBI or Govt approval. Imposing control would become difficult in a globalized environment once CAC is introduced.
Indian residents can hold and transact foreign currency denominated deposits with Indian banks.
A Certain class of financial institutions and later NBFCs can access global financial market.
Banks and financial institutions can trade in Gold globally and issue loans.

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