Capital Account Convertibility: Global Economic Growth

Posted in Finance Articles, Total Reads: 2935 , Published on 25 June 2011

Since the 20th century, the world has become a smaller place for everyone. With advancements in technology like internet & mobile phones, quicker & cheaper air travel, extensive use of information systems etc have reduced the world and made it a common place for all. With all these advancements, trade amongst nations has increased manifold, tourism is on the rise, and hence there is tremendous exchange of currencies at the global level. This is where the concept of capital account convertibility lies.


Capital Account Convertibility

When any currency can be exchanged for any other currency at the market price then that currency is said to be convertible. Payments relating to foreign trade, travel, tourism and other global level services are known as current account transactions. On the other hand, transactions which deal with financial assets are collectively known as capital account transactions. While majority of the countries have made their currencies fully convertible, there are a few countries which haven't accepted capital account convertibility.


Capital account convertibility would benefit countries because it would provide nations with huge funds, which would boost economic growth. Apart from that it would improve a country's financial system as it would have better access to the world financial markets. This would further lead to people of that nation occupying and acquiring international securities and assets and thereby increasing the prosperity for the country.


However, before taking a huge and a critical leap of implementing capital account convertibility, governments want to make sure they have strong and stable financial system. Governments should accept it if there is a lower fiscal deficit (around 3.5%), controlled inflation in an economy (between 3% to 5%) and a strong financial & banking system. Strengthening these aspects and stabilizing the markets are preconditions before countries opt for capital account convertibility. Also, the Central bank should monitor the exchange rate band and intervene whenever it feels it’s necessary.


If a country accepts capital account convertibility, it would prove a boon for the economic growth. Companies would be able to issue global depository receipts without taking permission from their central banks. This would ensure more freedom and better control by companies is managing funds on the global level. This will also enable the citizens to make financial capital transfers to other countries, maintain foreign currencies, take loans from people who are not relatives etc. The world would become a common playground for banks and financial institutions as they would be able to borrow and invest in overseas markets. Transactions in foreign currencies would also further boost trade and relations between nations. One of the biggest benefits would be transactions in gold amongst financial institutions and banking systems would be allowed.


Certain factors which stop the acceptance and implementation of capital account convertibility are the fear of instability, capital flight and fluctuating financial markets. However, with economic stability and no fiscal constraints, capital account convertibility can fuel economic growth for a country.


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