Recent announcements by high offices in the country that India will soon be in league with the club of nations having full capital account convertibility fulfils a long-awaited promise, as was officially endorsed in the Tarapore committee?s recommendations in 1977. The crisis in south-east Asia came up within months during the same year, reversing the direction of policy-making in India. The announcements on full convertibility point to some positive signals in the economy which seem to have prepared the ground for the development which would permit the resident Indian to convert rupee into any foreign currency and in any country without any restrictions. The other restrictions on capital flows, by foreigners and non-residents, had been scrapped earlier.

The official stance relies on the ?strong fundamentals? in the economy ? stable prices, GDP growth exceeding 8 per cent, the surpluses in trade balance over the last few years and the unprecedentedly high stock of official reserves at nearly $140 billion. Finally the steady inflow of capital with a pro-active management of exchange rate, monetary policy as well as inflation targets provide additional grounds for the optimism to prompt the proposal.

It is thus time to celebrate, not only for the moneyed elite in India who had been justifiably waiting to reorganize their portfolio, but also for the ruling elite who can now seek membership, like Mexico or Turkey, in rich country clubs like the Organization for Economic Cooperation and Development. In addition, the expected reductions in the capital account surpluses may help the government achieve a corresponding cut in the fiscal deficit and the goal of the Fiscal Responsibility and Budget Management Act by lowering the current account deficit.

There remain, however, a few pointers which dispel the optimism surrounding the endorsement of full convertibility at the moment. One of them is the possibility of opening the floodgates of legalized capital transfers abroad by domestic residents in order to avail of the lower tax rates abroad, or even parking such funds in tax havens like Mauritius. The requisite legal hurdles are likely to be overcome without much difficulty, and the process may soon turn out to be a bonanza for changing the colour of money owned by the rich .

Monetary and fiscal surveillance of the economy, which till now has been successfully guided by national exigencies, would have to face additional hurdles in terms of the newly achieved mobility of domestic capital following full covertibility. This would entail the ?trilemma? faced by countries in managing the exchange rate while following an autonomous monetary policy with full capital account convertibility. Would the country?s central bank be able to avoid a run on the exchange rate if the tools of national monetary management (say the market stabilization scheme and the liquidity adjustment facility, which are currently used to sterilize the expansions in money supply resulting from the augmented official reserves) are rendered ineffective?

Possibilities of money transfers by residents on a legal basis would also make it obligatory, if not mandatory, on part of the monetary authorities to maintain a parity between domestic and foreign interest rates. The added responsibility would further erode the social priorities for credit disbursements in the economy which are being steadily dismantled in terms of financial de-regulation. To identify the market-oriented priorities of credit today, the respective flows of loans towards housing and real estates moved up by 44.6 per cent and 90.3 per cent during 2004-05, which contrasts with the moderate increases of around 35 per cent and 15 per cent respectively for agriculture and small sector industry during the year, notwithstanding the fact that these provide a major share of employment in the country.

Stock exchanges have been experiencing a bull run for some time. These are well funded, both with domestic credit and net inflows of foreign institutional investors? funds. The latter speaks for closer integration with major international capital markets, as can be observed from the rising correlations of equity indices. While the continuity of these flows of portfolio finance, as in any other international financial centre, is subject to the expected movements in the relative rates of risk-adjusted returns, these inflows count heavily in India, both with their weight in net inflows of foreign finance as in additions to the stock of officially held reserves.

Net inflows of FII at $8.2 billion during 2004-05 was more than two-thirds of the aggregate net inflow of foreign capital at $12.1 billion during 2004-05. During the same year, FII flows added $12.7 billion to India?s official reserves out of $31.6 billion contributed by aggregate net flows of capital. The remaining part of net capital inflows are accounted for by the current increase in debt-creating flows of capital, largely due to the recent spurts in imports and the related trade deficit which has re-surfaced. Would the government be able to manage the exchange rate and avoid a financial crisis if the domestic residents too join the bandwagon along with the FIIs in time of a crisis?

The rather reckless recommendations of the ruling elite in support of a quick implementation of full convertibility for the country is being contested. The arguments provided here need serious consideration. These facts do not stem from a blind adherence to controls and state-craft as may be alleged, but from a careful scrutiny of facts documented in official statistics. The analysis alerts the policy-makers to the possible pitfalls which the country cannot ignore .