Exchange Rate, capital account convertibility, foreign exchange, interest rates, Basel II: Banknet India

Basically, the Committee failed to appreciate the political instability in the country at that time, and the complete absence of political will and vision to carry forward the process of economic reforms and economic liberalisation. The outbreak of Asian financial crisis at this time was also responsible for shelving the recommendation of Tarapore Committee. For this, interest rates should be folly deregulated, gross non-paying assets (NPAs) should be reduced to 5 per cent, the average effective CRR should be reduced to 3 per cent and weak banks should either be liquidated or be merged with other strong banks. As India continues to expand its role in the global economy, the rupee will likely become fully convertible. However, due to regulatory and financial challenges, this process may take several more years.

Capital controls are most prevalent in emerging market countries due to the higher uncertainty in their economic outlook. In the wake of the 1997 Asian financial crisis, many countries in the region imposed tight capital controls to reduce the threat of a run on their currency. There are ways to trade in foreign currencies which do not exchange internationally or whose trade is severely limited or legally restricted in the domestic market. Non-deliverable forward contracts (NDFs) can give a trader, for instance, indirect exposure to the Chinese renminbi, Indian rupee, South Korean won, new Taiwan dollar, and Brazilian real and other inconvertible currencies. When a country has poor currency convertibility, meaning it is difficult to swap it for another currency or store of value, it poses a risk and barrier to trade with foreign countries who have no need for the domestic currency. Full convertibility would mean the rupee exchange rate would be left to market factors without any regulatory intervention.

Is the Indian Rupee Fully Convertible?

All exports and imports made in accordance with this arrangement may be priced in rupees. Currency convertibility is an important part of global commerce because it opens up trade with other countries. Having a convertible currency allows a government to pay for goods and services in a currency other than its own.

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This could make it more difficult for the central bank (RBI) to maintain both exchange rate stability and a domestically oriented monetary policy. In a convertibility of rupee implies way, capital account convertibility removes all the restrains on international flows on India’s capital account. There is a basic difference between current account convertibility and capital account convertibility. In the case of current account convertibility, it is important to have a transaction – importing and exporting of goods, buying and selling of services, inward or outward remittances, etc. involving payment or receipt of one currency against another currency. In the case of capital account convertibility, a currency can be converted into any other currency without any transaction. Smaller amounts can be freely exchanged or converted, which is useful for smaller transactions like foreign travel or buying goods from other countries.

Meaning of Currency Convertibility:

Convertibility is the ease with which a country’s currency can be converted into gold or another currency through global exchanges. It indicates the extent to which the regulations allow inflow and outflow of capital to and from the country. Article VIII of the IMF’s Articles of Agreement is agreed by most economists to have been the basis for CAC, although it notably failed to anticipate problems with the concept in regard to outflows of currency. The second Tarapore Committee had drawn up a roadmap for 2011 as the target date for fuller capital convertibility of rupee and mentioned that the conditions were quite favourable.

In a later stage, certain select NBFCs would also be permitted to act as ADs in foreign exchange market. Since prices in competitive environment reflect that prices of those goods are lower in which the country has a comparative advantage, this will encourages exports. On the other hand, a country will tend to import those goods in the produc­tion of which it has a comparative disadvantage. Thus, currency convertibility ensures specialisation and international trade on the basis of comparative advantage from which all countries derive benefit. Another merit of currency convertibility ensures production pattern of different trading countries in accordance with their comparative advantage and resource endowment. It is only when there is currency convertibility that market exchange rate truly reflects the purchasing powers of their currencies which is based on the prices and costs of goods found in different countries.

1. In this way, deficit in balance of payments get automatically corrected without intervention by the Government or its Central bank.
2. Under convertibility of a currency there are authorised dealers of foreign exchange which constitute foreign exchange market.
3. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology.
4. It has done so by finalising currency swap agreements between the central banks of China and 43 other countries, which assure the markets that there will not be an oversupply of the renminbi.
5. Secondly, if current account convertibility is not properly managed and monitored, market exchange rate may lead to the depreciation of domestic currency.
6. However, currencies such as the Brazilian real, Argentinian peso, and Chilean peso are considered non-convertible because it is virtually impossible to convert them into another legal tender, except in limited amounts on the black market.

Similarly, under currency convertibility, importers and other who require foreign exchange can go to these banks dealing in foreign exchange and get rupees converted into foreign exchange. For the time being, the rupee’s acceptance will potentially be limited to countries that have a deficit with India. India will need to enrol other trade partners that will be able to use their rupees to buy goods from India.

Thus, partial convertibil­ity of rupee on current account meant a dual exchange rate system. When a currency is internationalised, both residents and non-residents can buy and sell domestic currency-denominated financial instruments such as stocks, bonds, and other securities. This means that the demand and supply of the country’s currency can be influenced not just by domestic but also external factors (outside the country). If this happens in the case of the rupee, the RBI will have limited control over the money supply within its own borders, which could make it difficult to maintain stable interest rates that are in line with the requirements of the domestic economy. To encourage the use of theIndian currency in cross-border trade is one of the major goals of the Foreign Trade Policy (FTP) 2023 of India which comes into effect from April 1, 2023.

Amid talks towards finalising a free trade agreement with India, Bangladesh is also considering the settlement of bilateral trade in Indian rupees. Currencies that are almost impossible to convert into legal tender are considered to be «non-convertible.» They include the Brazilian real, the Argentine peso, and the Chilean peso. The correct answer is Freely permitting the conversion of the rupee to other major currencies and vice versa. The Government should also set up a Consolidated Sinking Fund (CSF) to reduce Government debt. Dr. Nitish Kumar Arya is an Assistant Professor of Economics in the University Economics Department Bhupendra Narayan Mandal University, Madhepura, Bihar, India. He is working in Public Economics and Public policy with a special focus on contemporary economic issues.

1. (b) Indian residents would be permitted to have foreign currency denominated deposits with banks in India, to make financial capital transfers to other countries within certain limits, to take loans from non-relatives and others upto a ceiling of $ 1 million, etc.
2. In 1992, liberal economic reforms were introduced that impacted the way forex transactions were conducted.
3. For the rapid growth of world trade and capital flows between countries convertibility of a currency is desirable.
4. Under Bretton Woods system fixed exchange rate system was adopted by various countries.
5. In the context of heavy depreciation of the currency not only there is capital flight but inflow of capital in the economy is discouraged as due to depreciation of the currency profitability of investment in an economy is adversely affected.

The period was too short and the pre-conditions and the macroeconomic indicators could not be achieved in such short period. (b) Indian residents would be permitted to have foreign currency denominated deposits with banks in India, to make financial capital transfers to other countries within certain limits, to take loans from non-relatives and others upto a ceiling of $ 1 million, etc. The entire outsourcing movement with jobs and factories going overseas is a direct result of the foreign investment aspect of CAC. The Tarapore Committee’s recommendation of tying liquid assets to static assets (i.e., investing in long term government bonds, etc.) was seen by many economists as directly responsible for stabilizing the idea of capital account liberalization. Currency Convertibility is a vital aspect of a nation’s economic framework, determining the ease with which its currency can be exchanged for foreign currencies.