So far economists and monetary experts have been arguing about the negatives of an early entry of capital account convertibility (CAC) as India is still not fully prepared for it. But there are many pluses to CAC.

Today India is still looked upon as a poor country with low capital flows compared to other rich nations. It is apparent that we would have a higher marginal productivity of capital compared to other countries that have high capital flows.

But why is India not attracting high capital flows despite being the most favoured destination. This is because we have restrictions on foreign flows. If these restrictions are removed India would not only attract more flows which would help not only enhance domestic investment but would also help improve competition. Domestic capital can also get enhanced through such flows. But how does one regulate such flows especially since global markets are not perfect. Global capital flows are very sensitive and subjective in nature. It is not so much the foreign direct investment flows which is a problem -- since its component in total flows is marginal -- it is the portfolio investment for which there is no accounting practice and monitoring techniques to actually calculate the amount that is the rankling factor.

So if India wants to introduce CAC at this stage of development it will have to keep a check on the portfolio inflows which if not controlled can prove disastrous. Chile learnt it the hard way. Today it controls portfolio flows very tightly. The main crux of the Asian crisis was the uncontrolled portfolio flows. Today most of the East Asian countries only invite foreign direct investment and are not too much in favour of portfolio inflows which are erratic in nature and not of a permanent type.

Looking at the volume of portfolio investments we can see that when laws were liberalised in the late 1990s the East Asian economies witnessed an inflow jump from $6 billion to $ 36 billion. But when the crisis hit these economies these flowed out at the same rate. Only China and Taiwan which had controls on the type of investments flowing in could survive.

If India is moving on to a free economy a regulatory body is needed to ensure free play. FDI is actual money and it can be accounted for but there is no regulatory agency to supervise portfolio capital flows.

Portfolio capital is beyond the control of any government and no limits can be fixed in this respect. The money multiplier in this investment is so large that any small change can create a financial chaos destabilising the entire financial system of developing countries.

George Soros the master of finance has also warned about such calamities. World Bank and IMF were initially very enthusiastic about economies moving onto CAC. But looking at the Asian crisis they have suddenly become very conservative and cautious in their approach.

India is already current account convertible and capital account convertible for foreign investors and NRIs. FDI is now automatic in almost all the sectors except a few. FIIs can invest in the stock, currency and gilt markets. Today the government has liberalised its previous stand and domestic companies can to an extent invest abroad. $100 million limit for M&As has also been recently announced. But investment by domestic companies in the foreign currency, gilt and stockmarkets is allowed with a lot of restrictions and permissible only for special purposes. Capital can be mobilised through the GDR/ADR route but only till a permissible limit.

Today if CAC is introduced it will bring in the much required flows which are at miserably low levels. This can improve the competition climate. But what India lacks in the true sense is infrastructure, legal support , exit policy and true commitment by the government. CAC cannot help solve these issues.

CAC if introduced would induce higher capital outflows legally and since investment is more lucrative abroad as it yields higher returns it will flow out rather than remain within the country. This would result in heavy outflow of currency which would make speculation of currency a very costly exercise.