Controls Crucial During Transition Phase

The committees survey of international experience on capital account convertibility (CAC) shows that most countries have maintained or were required to impose some controls on capital inflows during the transition period.

The survey further revealed that countries which switched over to CAC with strong fundamentals have successfully managed it without any dramatic shifts in macro-economic policies. These countries were also less vulnerable to reversal of policies.

On the other hand, countries with weak initial conditions were forced to adopt drastic macro economic policies to facilitate the transition. Some of them faced interruptions and had to reintroduce capital controls.

Another factor that influence CAC is the conduct of an appropriate exchange rate policy. As for the capital account liberalisation process, the study brings out that the first step was the removal of restriction on inflows and related outflows by non residents and residents.

It also notes that corporates and non banks received preferential treatment among residents, followed by individuals and banks.

Initially the European Union assigned low priority to the liberalisation of capital movements.

Capital controls were to be eliminated only to the extent necessary to ensure proper functioning of common market. In the case of the European Union, the three broad categories of capital movements that have been identified are: capital operations including commercial credits, direct investments and other capital, operations in financial market securities and operations in money market instruments.

Liberalisation of capital movements in the European Union has proceeded in two stages. In the first stage liberalisation of those capital transactions were undertaken which were most directly necessary for proper functioning of the common market.

A safeguard clause has been provided that permits reintroduction of controls if capital movements seriously endanger the members exchange rate and monetary policy. The protective measures can be applied for up to six months.

The committee also viewed strengthening of the financial system as the most important precondition for CAC.

This was contrary to the widely held notion that a strong balance of payments position is more significant. Fiscal consolidation emerged as another precondition.