OPTIMIZING THE PACE OF CAPITAL ACCOUNT CONVERTIBILITY

The paper formalises the relationship between monetary and exchange ra te policy during the process of financial opening; and shows that a ra pid opening of the capital account could render an economy vulnerable to speculative attacks. The model is, then applied in the current Indi an context to determine the optimal pace of capital account convertibi lity (CAC). The results, obtained using control theory, indicate the u rgent need for phasing in CAC gradually because any attempt at 'shock therapy' by exceeding this pace could, under the present circumstances , result in an economic stagnation characterised by low growth, high r eal rates df interest and overshooting exchange rates.