RAS question
Capital account convertibility means:
Correct answer: (C) Free conversion of domestic currency for capital account transactions.
Capital account convertibility means the freedom to convert domestic currency for capital-account transactions such as investment, borrowing and lending abroad.
Explanation
Capital account convertibility is about the capital account of the balance of payments, not ordinary trade payments. The RBI explains that the current account covers exports and imports of goods and services, factor income and unilateral transfers, while the capital account records changes in foreign assets and liabilities. Convertibility means the ability to convert domestic currency into foreign currency, and vice versa, for the relevant balance-of-payments transaction. Therefore, for capital account convertibility, the rupee can be converted for capital transactions such as investment, borrowing and lending abroad. India has full current account convertibility but only partial capital account convertibility; the Tarapore Committee framed the idea as freedom to convert local financial assets into foreign financial assets and vice versa.
Why the other options are wrong
- (A) A fixed exchange rate concerns how the exchange rate is set or maintained, whereas capital account convertibility concerns permission to convert currency for capital-account transactions.
- (B) Free conversion only for trade transactions belongs to current account convertibility because trade in goods and services is part of the current account, not the capital account.
- (D) Currency devaluation is a reduction in a currency's value, while capital account convertibility is about allowing conversion for investment, borrowing and lending transactions.
Concept
This tests the balance-of-payments distinction between current account and capital account convertibility. It recurs in RAS because external-sector policy questions often turn on whether a transaction is trade-related or capital-flow-related.