What Are The Risks Of Capital Account Convertibility

Convertibility means the ability of the residents to convert local currency into foreign currency at the ongoing exchange rates for redeeming their external obligations. The objectives of IMF (International Monetary Fund) regarding Convertibility was to assist in the establishment of multilateral system of payments in respect of current transactions between member countries and in the elimination of foreign exchange restrictions which hampers world trade.

Capital Account Convertibility

Capital Account Convertibility is a distinct characteristic of a country’s financial regime that focuses on the ability to carry out transactions of domestic financial assets into foreign financial assets freely and fairly and at country determined exchange rates. It is occasionally referred to as Capital Asset Liberation or (Capital Account Convertibility) CAC.

Risk of Capital Account Convertibility

There are strong opponents to Capital Account Convertibility principally on the following grounds:

  1. Credit rating institutions will play a vital role in decision making by the investors. The changed view of these institutions or changes in the interest or exchange rates must have destabilizing effect on the portfolio flows.
  2. It exposes banks liabilities and assets to more price and exchange risks. The effect of increased volatility of exchange rates will be felt on the banks open foreign currency position
  3. Bank may supplement their domestic deposit base with borrowing for offshore markets. The volatility in interest and exchange rates can be dangerous to weak and fragile banks.
  4. Fluctuation in interest rates may affect the cost of borrowing for emerging markets and alter the relative attractiveness of investing in these markets. Real exchange rate volatility may cause currency and maturity mismatches, creating large losses of bank borrowers.
  5. Due to increased competition, the margins for the banks may be reduced.

The question of whether Bangladesh should embark on the programme of capital account convertibility will depend critically on efficiently it can manage the economy, keep the budget deficit under control, maintain inflation within reasonable limits and closely monitor the exchange rates to guard against wild fluctuations and generally maintain financial discipline.

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