Capital Account Convertibility (CAC)

Capital Account Convertibility (CAC) refers to the freedom to move capital (financial assets) across a country’s borders without restrictions. This includes flows like foreign investment, loans, deposits, and the purchase/sale of financial assets.

• Capital Account Convertibility (CAC) refers to the complete freedom to convert local financial assets to foreign financial assets and vice versa at the existing market exchange rate.
• It is a situation in which domestic residents can invest in foreign financial assets, and foreigners can make investments in domestic financial assets without any restrictions.
• Under the perfect CAC, there is perfect mobility of capital between the countries and the rest of the world.
• In the CAC, there is free flow of capital between the countries where there is no restriction in terms of the volume, sector, or nature of the business.

Importance/Rationale of CAC

1. To attract foreign investment to complement the domestic saving.
2. To diversify the risk of the individual and institution through investment diversification in domestic and foreign assets.
3. To improve competition, innovation, and technology transfer in the financial market.
4. To support maintaining a favourable balance of payments.
5. To develop and expand the private sector for growth and development.
6. To maximise government revenue by increasing economic activities.
7. To improve the credit rating and image of the country in the global financial market.
8. To create more employment opportunities and support for poverty reduction.
9. To promote trade and investment through easy access to foreign markets.

Challenges/Issues of CAC

1. Exchange rate volatility
2. Chances of capital flight
3. Threat for local investor
4. Possibility of exchange rate crisis and insolvency.
5. Increases the regularity cost of the central bank and SEBON.
6. Chances of policy lobbying and corruption by the large foreign investor.
7. Threat to foreign investment and trade due to exchange rate uncertainty.

Status of CAC in Nepal

1. There is partial CAC in Nepal where FDI is allowed in most sectors, but there is restriction in some sectors, like arms and ammunition, small and cottage industries.
2. FPI (Foreign Portfolio Investment) is not allowed in Nepal, though the Industrial Policy 2011 and FITTA (Foreign Investment and Technology Transfer Act 2019) have the provision of FPI.
3. Nepalis are not allowed to make investments abroad, but recently, a limited investment in the IT sector has been allowed.
4. There is a minimum limit for FDI to Nepal, which is not less than Nrs. 20 million.

Why Nepal does NOT have full CAC?

Nepal is a developing economy, and full convertibility can be risky. Major reasons include:

• Protection of foreign exchange reserves
• Weak financial market depth
• Risk of capital flight
• Need to maintain financial stability
• Pressure on the exchange rate (Nepalese Rupee is pegged with the Indian Rupee)

Other posts:

• What is Dumping in Economics?
• Foreign Investment in Nepal
• Status of Foreign Trade in Nepal