Currency convertibility

CURRENCY CONVERTIBILITY

1) INTRODUCTION

India‟s development strategy was based on protection, self-reliance & import
substitution before the liberalization policy was accepted & initiated. Foreign capital
flows were not looked upon favorably & therefore not encouraged. If there is a
deficit in the current account it was financed mainly through deft flows & official
development assistance. The policy followed was one which discouraged foreign
investment. However, the adverse balance of payment & the economic crisis faced
by India forced India to adopt economic reforms.

Government restrictions can often result in a currency with a low convertibility.

For example, a government with low reserves of hard foreign currency often
restrict currency convertibility because the government would not be in a position to
intervene in the foreign exchange market (i.e. revalue, devalue) to support their own
currency if and when necessary.

Convertibility is the quality that allows money or other financial instruments to be
converted into other liquid stores of value. Convertibility is an important factor in
international trade, where instruments valued in different currencies must be
exchanged.

Currency Convertibility means the ability to freely exchange the currency of one
Member State into the currency of another Member State.

For example, a Barbadian should be able to easily purchase goods in a store in Port
of Spain with his Barbadian dollars and receive his change in Trinidad and Tobago
dollars.

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However, this does not always happen because of the existence of two different
exchange systems in CARICOM – Fixed and Floating. Currency convertibility
implies the absence of exchange controls or restrictions on foreign exchange
transactions.

The ease with which a country's currency can be converted into gold or another
currency. Convertibility is extremely important for international commerce. When a
currency in inconvertible, it poses a risk and barrier to trade with foreigners who
have no need for the domestic currency.

Government restrictions can often result in a currency with a low convertibility.

For example, a government with low reserves of hard foreign currency often
restrict currency convertibility because the government would not be in a position to
intervene in the foreign exchange market (i.e. revalue, devalue) to support their own
currency if and when necessary.

An international monetary system has been in existence since monies have been
traded, its analyses have been traditionally started from the late 19th century when
the gold standard began

Convertibility essentially means the ability of residents and non-residents to
exchange domestic currency for foreign currency, without limit, whatever be the
purpose of the transactions.

The Movement of Capital for the full functioning of the CSME depends to a large
degree on two conditions already pointed out in the Revised Treaty provisions –

Abolishing exchange controls and
The free convertibility of currency within the CSME.

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2) MEANING & DEFINITION

The ease with which a country's currency can be converted into gold or another
currency. Convertibility is extremely important for international commerce. When a
currency is inconvertible, it poses a risk and barrier to trade with foreigners who
have no need for the domestic currency.

The ability to exchange money for gold or other currencies. Some governments
which do not have large reserves of hard currency foreign reserves try to restrict
currency convertibility, since they are not in a position to handle large currency
market operations to support their currency when necessary.

The state of or the ease with which a currency may be exchanged for a foreign
currency. Currency convertibility is vitally important in the foreign exchange
market; higher convertibility means that a currency is more liquid and, therefore,
less difficult to trade.

Factors affecting convertibility include the availability of foreign currency reserves
in a given country and domestic regulations seeking to protect local investors from
bad investment decisions in, say, a currency undergoing a period of hyperinflation.

Currency convertibility refers to the freedom to convert the domestic currency into
other internationally accepted currencies and vice versa at market determined rates
of exchange.

A few socialist governments even issue inconvertible currencies, such as the Cuban
peso, in order to protect their citizens from perceived capitalist infiltration.

Currency Convertibility refers to the degree to which one currency can be exchanged
for another. Some currencies trade less freely on the open market and exchanges, in
these cases, can be more difficult to process.
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Currency Convertibility is the ease with which a country's currency can be converted
into gold or another currency. Convertibility is extremely important for international
commerce. When a currency in inconvertible, it poses a risk and barrier to trade with
foreigners who have no need for the domestic currency.

Currency convertibility implies the absence of exchange controls or restrictions on
foreign exchange transactions.

Currency convertibility means “the freedom to convert one currency into other
internationally accepted currencies”. There are two popular categories of currency
convertibility, namely :

 Convertibility for current international transactions; and

 Convertibility for international capital movements.

Currency convertibility implies the absence of exchange controls or
restrictions on foreign exchange transactions.

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3) ADVANTAGES

Encourages export: - Exporters are motivated to increase their exports since
there is possibility of making more profits under currency convertibility
conditions. As a result of convertibility on current account, higher profits will
be earned since market exchange rate will give higher returns as compared to
the officially fixed exchange rate. From the given exports, they earn more
foreign exchange.

Encourage Import Substitution: - since the market determined exchange rate is
higher than the officially fixed exchange rate, imports become more
expensive. This makes countries to go in for import substitution.

Incentives to Send Remittances from Abroad:- Indian workers employed
abroad & NRIs find it convenient to send remittances of foreign exchange
without hassle. This also encouraged illegal remittances like „hawala money‟
& smuggling.

Self-adjusting Process in the Correction of Surplus or Deficits in Balance of
Payments:- In case, a country faces a deficit due to overvalued exchange rate,
the currency of the country will depreciate. This will encourage exports by
lowering the prices & discourages imports by raising their prices. In this
manner the deficit or surplus in the BoP gets corrected without the
intervention of the government.

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Countries are Enabled to specialize in the Production of Goods for which
they have a Comparative Advantage:- each country will be able to engage in
the production of goods in accordance with their comparative advantage &
resource endowments. When there is currency convertibility, market exchange
rate truly reflects the purchasing power of their currencies which is based on
the prices & costs of goods in different countries. In a competitive
environment, lower prices of goods which reflect the comparative advantage
will enable countries to increase exports. Thus currency convertibility will
lead to specialization & international trade on the basis of comparative
advantage. This will be beneficial for all countries in trade.

Integration of World Economy:- currency convertibility enables better
integration of the world economy. The easy availability of foreign exchange
helps in the growth of trade & increased capital flows between countries. This
will enables the growth of all countries which is important in the context of
globalization.

It forces the financial sector to be become more efficient, more disciplined,
and much stronger

It paves the way for companies to access funds from outside without
hindrance. It makes it far easier for foreign companies to invest in India.

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Since it exposes makes India more exposed to the vagaries of the international
financial sector, it forces the government to become more disciplined on the
fiscal side of things.
It sends a signal to international investors as well as the financial world that
India is confident of itself herself in the economic and financial arena and has
the capability to withstand anything that is thrown at it her.
Since it exposes makes India more exposed to the vagaries of the international
financial sector, it forces the government to become more disciplined on the
fiscal side of things.

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4) DISADVANTAGES

Currency convertibility can give rise to problems of inflation in domestic economy.
The market determined exchange rate is generally higher than the officially fixed
exchange rate. This leads to a rise in prices of essential imports which can results in
a situation of cost push inflation in an economy.

If the people monitoring is not done, convertibility can results in the depreciation of
the domestic currency. Undue depreciation of a currency can make people loose
confidence in the currency itself. This can adversely affect the trade & capital flows
of a country.

Under capital account convertibility, a country is given the freedom to transact in
financial assets with foreign countries without restrictions. Such an arrangement is to
enable increased investment activities. But there are risks attached to it. A very
likely possibility is that of capital flight at the first sign of an internal economic
problem.

The short-term capital flights termed as “hot money” transfers can destabilize an
economy unless precautionary or counter measures are taken to achieve stability.

Speculative activities may increase under free convertibility, making the exchange
rates highly volatile. Speculation can lead to depreciation of currencies & flight of
capital. This is proved by the experience of the South East Asian countries like
Thailand, Malaysia, in the year 1997-199, which experienced severe depreciation of
currency & capital flight.

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India is moving very cautiously towards capital account convertibility due to various
risks which can create macroeconomic imbalance in the in the economy. Though the
rupee is not freely convertible on the capital account, in certain transactions full
convertibility prevails.

For example, foreigners, non-resident Indians engaged in investing on portfolio or
direct investments are given freedom to bring in & repatriate their funds. It is felt
that a strengthening of the reserve position & structural strengthening will make
India ready to adopt full convertibility on the capital account.

It exposes the country India to the volatility of the world financial system. The rupee
can possibly become more volatile.

That said, there are infinitely more merits than demerits to going becoming
convertible on the capital account. The As far as the demerits are concerned, they are
only demerits so only as long as the financial system and government accounts are
shoddy. If they it become world class financial system, the it can easily manage
volatility can be managed without any problem.

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5) EXTERNAL AND INTERNAL CONVERTIBILITY

When all holdings of the currency by non-residents are freely exchangeable into any
foreign (nonresident) currency at exchange rates within the official margins than
that currency is said to be externally convertible.

All payments that residents of the country are authorized to make to non-residents
may be made in any externally convertible currency that residents can buy in foreign
exchange markets.

If there are no restrictions on the ability of a country to use their holdings of
domestic currency to acquire any foreign currency and hold it, or transfer it to any
nonresident for any purpose, that country‟s currency is said to be internally
convertible.

Thus external convertibility is the partial convertibility and total convertibility
is the sum of external and internal convertibility.

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6) TYPES OF CURRENCY CONVERTIBILITY

1. Capital Account Convertibility :-
Currency convertibility refers to the freedom to convert the domestic currency into
other internationally accepted currencies and vice versa. Convertibility in that sense
is the obverse of controls or restrictions on currency transactions. While current
account convertibility refers to freedom in respect of „payments and transfers for
current international transactions‟, capital account convertibility (CAC) would mean
freedom of currency conversion in relation to capital transactions in terms of inflows
and outflows. Article VIII of the International Monetary Fund (IMF) puts an

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obligation on a member to avoid imposing restrictions on the making of payments
and transfers for current international transactions. Members may cooperate for the
purpose of making the exchange control regulations of members more effective.
Article VI (3), however, allows members to exercise such controls as are necessary
to regulate international capital movements, but not so as to restrict payments for
current transactions or which would unduly delay transfers of funds in settlement of
commitments.

Advantages of CAC

More capital available to the country, and the cost of capital would decline.
The freedom to trade in financial assets.
Difficult for a country to follow unwise macroeconomic policies.
Tax levels would move closer to international levels .
It will grow competition among financial institutions.

Disadvantages of CAC

It could lead to the export of domestic savings.
Expose the economy to larger macroeconomic instability.
Premature liberalization could initially stimulate capital inflows that would
lead to appreciation of real exchange rate and thereby destabilize an economy
undergoing the fragile process of transition and structural reform.
It may bring low quality investment .
It may generate the financial bubble.

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2. Current Account Convertibility :-

Current account convertibility allows residents to make and receive trade-related
payments, i.e. receive foreign currency for export of goods and services and pay
foreign currency for import of goods and services like travels, medical treatment and
studies abroad. Current account convertibility allows free inflows and outflows for
all purposes other than for capital purposes such as investments and loans. In other
words, it allows residents to make and receive trade-related payments -- receive
dollars (or any other foreign currency) for export of goods and services and pay
dollars for import of goods and services, make sundry remittances, access foreign
currency for travel, studies abroad, medical treatment and gifts, etc.

Current account convertibility refers to freedom in respect of Payments and transfers
for current international transactions. In other words, if Indians are allowed to buy
only foreign goods and services but restrictions remain on the purchase of assets
abroad, it is only current account convertibility. As of now, convertibility of the
rupee into foreign currencies is almost wholly free for current account i.e. in case of
transactions such as trade, travel and tourism, education abroad etc.

The government introduced a system of Partial Rupee Convertibility (PCR) (Current
Account Convertibility) on February 29,1992 as part of the Fiscal Budget for 1992-
93. PCR is designed to provide a powerful boost to export as well as to achieve as
efficient import substitution. It is designed to reduce the scope for bureaucratic
controls, which contribute to delays and inefficiency. Government liberalized the
flow of foreign exchange to include items like amount of foreign currency that can
be procured for purpose like travel abroad, studying abroad, engaging the service of

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foreign consultants etc. What it means that people are allowed to have access to
foreign currency for buying a whole range of consumables products and services

Current account convertibility is popularly defined as the freedom to buy or sell
foreign exchange for:-

a. The international transactions consisting of payments due in connection with
foreign trade, other current businesses including services and normal short-term
banking and credit facilities

b. Payments due as interest on loans and as net income from other investments

c. Payment of moderate amounts of amortization of loans for depreciation of
direct investments

d. Moderate remittances for family living expenses

e. Authorized Dealers may also provide exchange facilities to their customers
without prior approval of the RBI beyond specified indicative limits, provided, they
are satisfied about the bonafides of the application such as, business travel,
participation in overseas conferences/seminars, studies/ study tours abroad, medical
treatment/check-up and specialized apprenticeship training.

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7) NONCONVERTIBLE CURRENCY

Also known as a "blocked currency".

Any currency that is used primarily for domestic transactions and is not openly
traded on a forex market. This usually is a result of government restrictions, which
prevent it from being exchanged for foreign currencies.

As the name implies, it is virtually impossible to convert a nonconvertible currency
into other legal tender, except in limited amounts on the black market. When a
nation's currency is nonconvertible it tends to limit the country's participation in
international trade as well as distort its balance of trade.

A barrier to economic development arising from a nation‟s inability to convert its
currency on foreign exchange markets, thus its inability to acquire the foreign capital
it needs to achieve improvements in productivity, income and human welfare among
its people.

Almost all nations allow for some method of currency conversion; Cuba and North
Korea are the exceptions.

They neither participate in the international FOREX market nor allow conversion of
their currencies by individuals or companies. As a result, these currencies are known
as blocked currencies; the North Korean won and the Cuban national peso cannot be
accurately valued against other currencies and are only used for domestic purposes
and debts.

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Such nonconvertible currencies present a major obstruction to international trade for
companies who reside in these countries.

Convertibility is the quality of paper money substitutes which entitles the holder to
redeem them on demand into money proper.

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8) HOW IT WORKS IN INDIA?

Capital and current account convertibility in pretext to Indian economy.

The Committee, chaired by former RBI governor S S Tara pore, was set up by
the Reserve Bank of India in consultation with the Government of India to
revisit the subject of fuller capital account convertibility in the context of the
progress in economic reforms, the stability of the external and financial
sectors, accelerated growth and global integration. Reserve Bank of India, and
will have the following terms of reference:

Undertake a review of the extant regulations that straddle current and capital
accounts, especially items in one account that have implication for the other
account, and iron out inconsistencies in such regulations.

Examine existing repatriation/surrender requirements in the context of current
account convertibility and management of capital account.

Identify areas where streamlining and simplification of procedure is possible
and remove the operational impediments, especially in respect of the ease with
which transactions at the level of authorized entities are conducted, so as to
make liberalization more meaningful.

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Ensure that guidelines and regulations are consistent with regulatory intent.

Review the delegation of powers on foreign exchange regulations between
Central Office and Regional offices of the RBI and examine, selectively, the
efficacy in the functioning of the delegation of powers by RBI to Authorized
Dealers (banks).

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9) RUPEE CONVERTIBILITY

Convertibility of a currency implies that a currency can be transferred into another
currency without any limitations or any control. A currency is said to be fully
convertible, if it can be converted into some other currency at the market price of
that currency. Convertibility can be related as the extent to which a country's
regulations allow free flow of money into and outside the country.

For instance, in the case of India till 1990, one had to get permission from the
Government or RBI as the case may be to procure foreign currency, say US Dollars,
for any purpose. Be it import of raw material, travel abroad, procuring books or
paying fees for a ward who pursues higher studies abroad. Similarly, any exporter
who exports goods or services and brings foreign currency into the country has to
surrender the foreign exchange to RBI and get it converted at a rate pre-determined
by RBI.

At present, Indian rupee is partly convertible on current Account. That is
convertibility in the case of transactions relating to exchange of goods and services,
money transfer.

In 1997, the Tara pore committee on capital Account convertibility was constituted
by the Reserve Bank. This committee indicated three preconditions for capital
Account convertibility, they are Fiscal consolidation, a mandated inflation target,
strengthening of the financial system.

During March 2006, Prime Minister said that India is moving towards fuller capital
account convertibility. In response to this the Reserve Bank of India set up the Tara
pore Committee to work out another roadmap for current account convertibility.

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Full currency convertibility of the Indian rupee means, can travel abroad and buy
dollars over the counters, currency convertibility refers to the absence of any
restriction on the holding of foreign currency by residents and of the national
currency by foreigners, and on free conversion between currencies. Can incur
expenses abroad using the credit card and pay for the dollars (or pounds, or euro‟s)
expanded in rupees.

This helps to invest in specified foreign shares and mutual funds. And also it attracts
many foreign tourists, which can be contributed to the GDP.

Therefore, fuller convertibility of Indian rupee helps to attract FDI and also helps
Indian's to invest abroad.

After the economic liberalization process started in India in 1991, a Liberalised
Exchange Rate Mechanism was introduced in 1992.This allowed partial
convertibility of Indian rupee, thus introducing dual exchange rate. After that full
convertibility on trade account started from 1993.It was followed by Full
convertibility on current account from 1994.However after the Mexico crisis in early
1990s or the mammoth East Asia Crisis where there was sudden flow of capital
internationally debilitating the economies of the involved nations, India was
reluctant to adopt capital account convertibility.

However the Tara pore committee, appointed in 1997, recommended phased
implementation of capital account convertibility with certain prerequisites like fiscal
deficit to be 3.5% of GDP,CRR to be brought down to 3%, gross NPA of public
sector banks to be 5% of the total assets, inflation rate to be around 3.5%.The
committee was reappointed almost a decade later and submitted almost the same
recommendations with some modifications.

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It must be remembered that the movement towards fuller CAC should be a process
and not an event. Macroeconomic stability is a must before achieving full CAC. Any
adhoc arrangement from the fixed regime maintained for a long period of time might
disturb the foreign exchange market and disrupt the economic progress.

At present, Indian rupee is partly convertible on current Account. That is
convertibility in the case of transactions relating to exchange of goods and services,
money transfer.

Convertibility of rupees is known as freedom of exchange of rupee with other all
international currency. It means that rupee can covert in USA dollars more easily
and USA dollars can convert in Indian currency for buying and selling of goods and
services. after study everything, I am writing, "it is conspiracy to lower the value of
Indian currency that in real sense. In 1996, there were just Rs. 38 for every one
dollar but after liberalized convertibility of rupee, one dollar exchange rate has
reached up to Rs. 45 in 17th Jan. 2011. When convertibility of Rupee was started, it
was claimed that our export will increase because our Indian companies will easy to
trade in foreign country due to easy exchange without any govt. restriction. But, it
opens doors for importing useless things and moreover it is very sad for India that
gold is not make as standard exchange currency. China is smart than India, under
his new foreign exchange policy, convert all his foreign exchange in gold. Now, his
Chinese yuan is equal to Indian Rs. 6.89.

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RUPEE AS A CONVERTIBLE CURRENCY:-

The recent decision of the government to have full convertibility of the Indian Rupee
which will affect everyone in the country but is remotely understandable by a few, is
one such important decision, which is designed to please the international financial
institutions and the 10 percent of the population of India who are either rich or of
upper middle class.

It is essential to judge a policy by examining both the costs and benefits of it. The
government is talking about the illusory benefits of this convertibility, which will
basically remove all obstacle to the free flow of money and as a result goods and
services also can move freely.

The government, in a fully convertible regime, will not be able to control these flows
directly. Indirect controls will be implemented by changing interest rates and taxes
but the effectiveness of this control according to the international experiences is
uncertain.

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9.1) HISTORY OF RUPEE CONVERTIBILITY

Up to 1991, when India faced a major foreign exchange crisis, there had been
very rigid controls on both the capital account as well as the current account.

Current account convertibility was introduced in India in August 1994.

After start of liberalization in1991, India had accepted the IMF rules for
currency reforms.

In 1997 the government had set up a committee (Tarapore committee) to spell
out a road map for the full convertibility of the rupee.

Committee suggested three phases of adopting full convertibility of rupee in
capital account.

 First phase in 2006 -2007
 Second phase in 2007-2009
 Third phase in 2009- 2011

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9.2) ADVANTAGES OF RUPEE CONVERTIBILITY

The benefits of free flows of money in a fully convertible regime means foreigners
would be able to invest in the Indian stock markets, buy up companies and property
including land (unless there are restrictions).

Indian people and companies can import anything they would like, buy shares of
foreign companies and property in foreign lands and can transfer money as they
please without going through the Hawala business.

Indians who have not paid their taxes or repaid their loans taken from the Indian
banks will be free to transfer their money to foreign countries outside the jurisdiction
of the Indian authority.

The expected benefits for India would depend on the attractiveness of the country as
a safe destination for short-term investments. Long-term investments do not depend
on convertibility.

China has no convertibility, instead a fixed exchange rate for the last 12 years. Yet,
China is the most important destination for long-term foreign investments. Thus,
discussions about the full convertibility should be about the desirability of short-
term investments and their implications.

Short term investments i.e., foreign investments in shares and bonds of the Indian
companies and Indian government depend on the demonstration of profit of the
Indian companies and the continuous good health of the Indian economy in terms of
low budget deficits, low balance of payments deficits, low level of government
borrowings and low level of non-performing loan in the Indian banking system.

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From these points of view India cannot be a very attractive destination as the health
of the economy despite of the propaganda of the Indian government is very weak
with huge government debt, revenue deficits, Rs.150,000 Crores of uncollected taxes
and Rs.120,000 Crores of unpaid loans in the banks, increasing price of petroleum
and increasing balance of payments deficits of the country. With 80 percent of
people live on less than 2 dollars a day, and 70 percent of the people live on less
than 1 dollar a day, profitable market in India is also very small. If the Indian
companies working under these constraints cannot demonstrate good and continuous
profit, short-term investments will fly out very easily if there is any sign of
economic downturn when there is a fully convertible Rupee. The result will be
further increase in the balance of payments deficits and fall of the exchange rate of
Rupee, which will provoke Indians to take their money out of India.

Another advantage of full convertibility of Rupee for the Indian rich is that they can
import as they like and buy properties abroad as they were allowed to do so during
the days of British Raj. It has certain advantages for the Indian companies who will
be able to import both raw materials and machineries or set up foreign
establishments at will.

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9.3) DISADVANTAGES OF RUPEE CONVERTIBILITY

Full convertibility also has adverse consequences for the India‟s domestic producers
of these raw materials and machineries, as they have to compete against foreign
suppliers who like Chinese may have deliberate low rate of exchange for their
currencies thus making their goods low in price. Foreign suppliers also can be
supported by all kinds of subsidies by their government so as to make their prices
very low. Agricultural exports from Europe, USA, Thailand, and Australia can ruin
India‟s own agriculture.

There are many such historical examples in India. Within 20 years between 1860
and 1880, India‟s domestic manufacturing industries were wiped out by free trade
and convertible Rupee during the days of British Raj. Indian farmers during those
days could not cultivate their lands, as the imported food products were cheaper than
whatever they could produce. Demonstration of wealth by the Nawabs and
Maharajas of India in Paris and London during the days of British Raj has not done
any good for starving millions of India but was responsible for massive misuse of
India‟s foreign currency reserve created by the sweat and blood of the India‟s poor
in those days. Full convertibility of Rupee and free trade may bring back those dark
days.

The freedom for India‟s rich to buy companies and property abroad may lead to
massive diversion of funds from investments in the home economy of India to
investments abroad. This would amount to export of jobs to foreign countries
creating more and more unemployment at home. Japan in recent years suffers from
this phenomenon, where increasingly Japanese companies are transferring funds to
China for investments, taking advantage of the very low wage rate and low exchange
rate of Yuan, thus creating unemployment at home. Although China has massive

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surplus in the balance of payments, huge reserve of dollars and gigantic flows of
foreign investments, a non-convertible Yuan and controls on transfer of money have
kept China‟s exchange rate low enough so that Chinese goods can capture the
markets of every important country of the world.

The most dangerous consequence of convertibility is that Rupee will be under the
control of currency speculators. A fully convertible regime for the Rupee will
certainly include participation of Rupee in the international currency market and in
the „future market‟ of Rupee, the playground for the international speculators. It is
very much possible for the speculators to buy massive amount of Rupee to drive up
its exchange Rate.

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9.4) PARTIAL CONVERTIBILITY OF RUPEE

Partial convertibility of Rupee was started in 1992 for current account. In simple
word, there is no control of Indian currency official. Any foreign company can do
business and can go to his country with this profit after exchanging all Indian
currency in their foreign currency. For example, According to its Directors‟ Report,
a public document filed with India‟s Registrar of Companies, “Google India Private
Ltd” reported revenues of Rs. 779.34 crore (around $172.03 million at current rates),
over the 15 month period from Jan 2009 to March 2010. For the same period, it
reported a profit after tax of 97.96 crore ($21.62 million), and received foreign
exchange of Rs. 666.25 crore, with a foreign exchange out go of Rs. 304.24 crore. In
this, example, we see that there is no our control our one foreign currency. From
economic point of view, if any country has largest amount of other countries
currency, that country will become economically sound. Suppose, if India has not
USA dollars for exchanging Rs. 304.24 crore to Google India Pvt. Ltd, at that time,
India has to take loan of same USA Dollars from USA and will pay interest on it.
So, it will increase adverse balance of payment.

It is true, with partial convertibility of Rupees, investment in foreign country has
become easy but it is also harmful for India, because same investment should be in
India instead any other country. All companies think the benefit of their residential
country from where they are operating their business. So, for India's interest, we
have to make some strict rules for stopping outflow of fund on the name of
convertibility of rupee or liberalization.

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The rupee has arrived. Long before the domestic currency gets the `convertible‟ tag,
it‟s being freely accepted and exchanged in Singapore, Malaysia, Indonesia, Hong
Kong, Sri Lanka and other countries. Till now, such transactions were confined to
select departmental stores which are favourite of Indian tourists; now more and more
shops, hotels and even money changers are willing to accept the local legal tender.

This means no double conversions, and therefore, extra cost while exchanging
Indian rupees. This may not be quite legal since in the international money market,
the rupee is still not a deliverable currency. Nonetheless, its acceptance is on the rise,
thanks to growing trade with India and a surge in tourist inflows.

It has certainly made things easier for the Indian tourists who can simply carry
rupees, and do away with travelers cheques. In most Asian countries, the nearest
`money exchange‟ shop will give them the local currency against rupees. Many feel
the trend has picked with hints that convertibility may be matter of time.

Travel agents, in India, say that since many Indians are travelling abroad, especially
to Asian countries, many banks and foreign exchange agents abroad have started
accepting Indian rupees. Tarmo Wong, a manager with `money exchange‟ shop in
one of the biggest hotels in Singapore, said, “We have orders to accept the Rs 500
and Rs 1,000 bills. We have been doing this for almost 6-8 months now.” Some of
the `money changers‟ in Singapore have a similar view.

Interestingly, in the small, but growing parallel market, the conversion rates have
become finer for the Indian traveler or the business tourist. Earlier, a handful of
outfits accepted the Indian rupee and usually the buy/sell spread was high.

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Most travelers (even today) convert their rupees in US dollars in India and then
exchange them again in local currencies of countries they visit. The cost of such
double conversion could be as high as 5%. Prakash Dagia, a regular business
traveler to countries like Indonesia, Bangladesh and Malaysia, said, “In the past few
months, the rupee has gained acceptance in almost all countries in Asia. The best
part is you can exchange it back to Indian rupees when you‟re flying back to India.”

Full currency convertibility of the Indian rupee means that you can travel abroad and
buy dollars you need over the counter. Partial currency convertibility already exists
in the system. For instance, you can spend through your credit card and pay the
money spent in foreign currency back in India in Indian rupees. Currency
convertibility refers to the absence of any restriction on the holding of foreign
currencies by residents and of the national currency by foreigners, and on free
conversion between currencies. It does not preclude restrictions on the type and
quantity of non-currency assets that residents can hold abroad or foreigners can hold
in the country.

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9.5) FULL CONVERTIBILITY OF RUPEE

The Prime Minister, Dr. Manmohan Singh in a speech at the Reserve Bank of India,
Mumbai, on March 18, 2006 referred to the need to revisit the subject of capital
account convertibility. To quote:

“Given the changes that have taken place over the last two decades, there is merit in
moving towards fuller capital account convertibility within a transparent
framework…I will therefore request the Finance Minister and the Reserve Bank to
revisit the subject and come out with a roadmap based on current realities”.

Convertible currencies are defined as currencies that are readily bought, sold, and
converted without the need for permission from a central bank or government entity.
Most major currencies are fully convertible; that is, they can be traded freely without
restriction and with no permission required. The easy convertibility of currency is a
relatively recent development and is in part attributable to the growth of the
international trading markets and the FOREX markets in particular. Historically,
movement away from the gold exchange standard once in common usage has led to
more and more convertible currencies becoming available on the market. Because
the value of currencies is established in comparison to each other, rather than
measured against a real commodity like gold or silver, the ready trade of currencies
can offer investors an opportunity for profit.

The U.S. dollar is an example of a fully convertible currency. There are no
restrictions or limitations on the amount of dollars that can be traded on the
international market, and the U.S. Government does not artificially impose a fixed
value or minimum value on the dollar in international trade. For this reason, dollars
are one of the major currencies traded in the FOREX market.

Page 31


Although the Minister of Finance had indicated during his presentation of the 1992-
93 Budget that full convertibility of the rupee would be introduced in a span of 3 or
4 years, full convertibility was announced much earlier and in fact it is the highlight
of the 1993-94 Budget.

There is, however, a subtle difference in the full convertibility of the rupee
introduced in India and the concept of full convertibility prevailing in developed
countries like the U.K., U.S.A. etc. In developed countries, full convertibility means
that their currency is freely convertible anywhere in the world. Their home currency
can be converted into foreign currency without any restriction. One does not have to
disclose even the purpose of such conversion. For instance, U.S. Dollars can be
changed into Sterling Pounds in New York, Japanese Yen could be exchanged to
Deutsche Marks in Frankfurt, Australian Dollars can be converted into Candian
Dollars in Adelaide etc., The exchange rate is controlled by the position of supply
and demand in the market.

The full convertibility announced in the Union Budget of 1993-94, however, allows
convertibility only in the current account, which means the amount received by way
of sale proceeds of exports, paid for imports and the remittance by NRIs etc., alone
are convertible at market determined rates.

In the last year's Budget, a dual exchange rate was announced i.e., 60% at market
rates and 40% at the official rate. In the current Budget, the dual exchange rate has
become a unified exchange rate which is a 100% conversion of foreign exchange at
market rate. This is described as Full Convertibility. This does not mean that one can
get any amount of foreign exchange at market rate for meeting any of one's needs.
The Reserve Bank of India will permit sale of foreign exchange currency to anyone
only for those purposes which are stipulated by the Govt. of India. It does not permit

Page 32


conversion of one's savings in the country for investment in foreign countries, as
could be done by the citizens of developed countries like the U.K. or U.S.A. For
instance, if a citizen resident in India wishes to undertake a foreign travel, the
exchange for such travel can be had only as per the norms prescribed by the Govt.
under the Foreign Travel Scheme. Full convertibility of the Rupee we have adopted
for our country is tied up with exchange controls and restriction envisaged by the
provisions of the F.E.R. Act 1973 as amended.

Full convertibility has been introduced only as a measure of reforms to revitalize the
economy of our country and to bring it on to the path of liberalization. The New
Economic Policy ushered in by out Govt. is with a view to take India forward from a
control-ridden-inward-looking economy into a market - friendly, forward looking
progressive and dynamic economy. Full convertibility of the rupee, lower Customs
and Central Excise duties, relaxation of Import / Export restrictions, streamlining of
procedural rules governing taxations, streamlining of procedural rules governing
taxation laws etc.,. have opened out our economy with a view to expansion and
globalisation of our trading activities. These are measures taken to move India
forward in her march towards economic freedom.

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10) CONCLUSION

The volatile nature of capital inflow presents an alarming trend. Liberalizing capital
control may lead to huge dependence on foreign portfolio capital. Need is to
channelize the capital flow.

As recognized in the recent Tara pore Committee Report, financial institutions‟
ability to identify, measure, and manage risk will also depend on the availability of
instruments to manage risk, the liquidity of financial markets and the quality of
market infrastructure, and level of market discipline. Key segments of the Indian
capital markets remain, however, underdeveloped. The term money market is limited
and although there is a domestic yield curve for government securities with
maturities up to 30 years, its depth and liquidity are limited.

The Govt. had however stated that if the value of the rupee depreciates to an
unreasonable level in the free market operations, the R.B.I. will intervene and
control it. This assurances certainly gives credence to the earnestness and sincerity
with which the full convertibility has been announced.

Page 34

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