International Finance

Currency and Convertibility

The FOREX MarketThe FOREX Market The FOREX market is where currencies are traded The market incorporates all arrangements used to buy and sell foreign

exchange (not a physical place but a network of telephones, emails and faxes connecting all the large banks in the world).

Volumes traded daily are huge: $3 trillion per day Most transactions involve exchange of $US for other currencies. In

large transactions, traders exchange one currency for $US and then buy another currency with the dollar. The $US is thus called a vehicle currency.

Currency ConvertibilityCurrency ConvertibilityWhat it is ?

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.

Types Of Currency Convertibility.

1.Fully convertible currency.

2.Partially convertible currency.

3.Non-convertible currency.

Non convertible CurrencyNon convertible 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

Types of convertibilityTypes of convertibility

1. Current Account

2. Capital Account

Current AccountCurrent AccountTransactions relating to:

- Exchange of goods and services

- Money transfers

- Transactions that are classified in the Current Accounts.

In Short, Current account includes all transactions, which give rise to or use of our National Income.

Current Account TransactionsCurrent Account Transactions

• All imports and exports of merchandise.

• Invisible Exports and Imports (sale/purchase of services)

• Inward private remittances (to & fro)

• Pension payments (to & fro)

• Government Grants (both ways)

Current Account ConvertibilityCurrent Account Convertibility

Indian scenario - fully convertible.

Full freedom to both residents and non-residents.

RBI has placed a cap in creation of a capital asset Freedom in respect of payments and transfers for current

international transactions.

Capital accountCapital account

• Inflows and Outflows of capital.

• Borrowing from or Lending to aboard.

• Sales and Purchase of securities aboard.

Capital Account TransactionsCapital Account Transactions

Capital Direct Foreign Investments.

Investment in securities.

Other Investments.

Government Loans.

Short-term investments.

Capital Account Transaction’s Classification

Portfolio Investment .

Stocks, Bonds, Bank Loans, Derivatives.

DirectInvestment.

Real estateProduction facilitiesEquity investment.

Other investment.

Holdings in loans Bank accounts Currencies

Capital Account ConvertibilityCapital Account Convertibility

Capital account convertibility (CAC) refers to the freedom of converting local financial assets into foreign financial assets and vice versa at market determined rates of exchange. It refers to the elimination of restraints on international flows on a country’s capital account, facilitating full currency convertibility and opening of the financial system.

Benefits of capital account convertibility Benefits of capital account convertibility to India:to India:

The Tarapore Committee mentioned the following benefits of capital account convertibility to India:1. Availability of large funds to supplement domestic resources and thereby promote economic growth.2. Improved access to international financial markets and reduction in cost of capital.3. Incentive for Indians to acquire and hold international securities and assets, and4. Improvement of the financial system in the context of global competition.5. Freedom to convert local financial assets into foreign ones at market-determined exchange rates6. Leads to free exchange of currency at lower rates and an unrestricted mobility of capital

Currently Restrictions : Capital AccountCurrently Restrictions : Capital Account

Limits to companies borrowing abroad. Restriction on foreigner investing in India. Restriction on amount that FII can hold. Purchasing a company is allowed but limit exit on the

amount that can be send. Global Diversification of household portfolio is practically

non-existent.

RUPEE CONVERTIBILITYRUPEE CONVERTIBILITY

IntroductionIntroduction

• The Indian rupee(Devanagari: रुपया)) is the official currency of “The republic of India”.

• Today, the currency is available in the form of “Bank notes” and “coins of the rupee”.

Convertibility of RupeeConvertibility of RupeeConvertibility 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.

Convertibility of rupees is known as freedom of exchange of rupee with other all international currency

History of Rupee ConvertibilityHistory of Rupee Convertibility Upto 1991, there was rigid control on both Capital and Current

account. After start of liberalization in1991, India had accepted the IMF

rules for currency reforms. Capital account convertibility was introduced in India in August

1994. In 1997 the government had set up a committee (Tarapore

committee) to spell out a road map for the full convertibility of the rupee.

Tarapore CommitteeTarapore Committee

Tarapore CommitteeTarapore Committee Committee on capital account credibility, set up by

RBI(Reserve Bank of India) under the chairmanship of former RBI deputy governor S.S. Tarapore.

The report submitted by this Committee in the year 1997 proposed a three-year time period (1999-2000) for total conversion of Rupee

The committee was formed on 28 February 1997. The members were:

S. S. Tarapore, Chairman

Surjit S. Bhalla

M. G. Bhide

Kirit Parikh

A. V. Rajwade

Tarapore CommitteeTarapore CommitteeReasons for the introduction of CAC in India: It was meant to ensure total financial mobility in the country

It also aimed in the efficient appropriation or distribution of international capital in India

Pre - conditions:The fiscal deficit needs to be reduced to 3.5% of the GDP

Inflation rates need to be controlled between 3-5%

Non-performing assets (NPAs) need to be brought down to 5%

Cash Reserve Ratio (CRR) needs to be reduced to 3%

A monetary exchange rate band of plus minus 5% should be instituted

The Second Tarapore Committee on Capital The Second Tarapore Committee on Capital Account ConvertibilityAccount Convertibility

Reserve Bank of India appointed the second Tarapore committee to set out the framework for fuller Capital Account Convertibility.

The committee was established 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.

The report of this committee was made public by RBI on 1st September 2006. In this report, the committee suggested 3 phases of adopting the full convertibility of rupee in capital account.

First Phase in 2006-7

Second phase in 2007-09

Third Phase by 2011.

RecommendationsRecommendationsFollowing were some important recommendations of this committee:

The ceiling for External Commercial Borrowings (ECB) should be raised for automatic approval.

NRI should be allowed to invest in capital markets and NRI deposits should be given tax benefits.

Improvement of the Banking regulation.

FII (Foreign Institutional Investors) should be prohibited from investing fresh money raised to participatory notes.

Existing PN holders should be given an exit route to phase out completely the PN notes.

At present the rupee is fully convertible on the current account, but only partially convertible on the capital account.

CAC Benefits to INDIA

PROGRESS AT COUNTRY LEVEL

1. End of Balance of Payment (BoP) crisis:

In 1991 India was struggling with the crisis in its balance of payments. Importing was essential for the country while the governments conservative approach towards exports pushed country into severe balance of payment deficit. Capital account liberalisation has been the strongest medium in curbing such crisis

(2) Plenty of Foreign Currency Reserves:

India has envisaged a plentiful surge in its reserves. The liberalisation of capital account has helped country in recovering from reserve shortage. The doting supply of dollars to Reserve Bank exchequer is a healthy sign for economy, as reserves can be utilised during the times of adversity.

(3) Efficiency in Financial System:Capital Account Convertibility is incomplete without fiscal consolidation, sound policies and financial prudence. RBI and Government of India have been very conservative and watchful during whole process of liberalisation. This has improved total financial performance of economy.

Banks today have greater access to additional capital (foreign borrowing), autonomy in operations (easening of control by RBI) and intensive competition (opening of private and foreign banks and Non Banking Finance Corporations).

(4) Development of Securities Market:

Gush of Foreign Institutional Investment (FII) has helped in multifold enlargement of security market. The market capitalisation of BSE and NSE has significantly risen. Derivates, bonds, commodities now constitute the major trading instruments besides equity shares. Sensex (above 24,000) and Nifty (above 7,000) touched new heights due to huge investment in the listed stocks.

(5) Worldwide Presence and Friendly Relations with Trading Counterparts

Flow of investment is a distinctive medium of developing global relationships. Indian MNCs and service organisations are conducting business operations in almost 140 countries across the globe.

India is 19th largest exporting country in the world according to 2011 estimates. Indian IT services, handicrafts, cuisine and jewellery are world famous and contribute to major chunk of revenue from international operations. It all has become reality with the financial liberalisation

PROGRESS AT CORPORATE LEVEL1) Indian corporate sector is inundated with broader access to low cost capital through

External Commercial Borrowings. In addition, companies have the prospect of expanding their capital base through issue of American Depository Receipts, Global Depository Receipts and corporate bonds.

2) Diversification of risk and economies of scale through business performance in different realms.

3) Increase in profit after tax through intercontinental operations (manufacturing, sales, services and Intellectual Property Rights).

4) Gains in technology through joint ventures, international license and import of technology from the specialised manufacturer.

5) Access to worldwide pool of intellectuals, managers, technical personnel etc and their specialised knowledge and skills

SECTORS WITH 74% FDI LIMITS ARE —1. Airports

2. Broadcasting

3. Coal and lignite

4. Credit information companies

5. Direct to home (dth)

6. Mining ( diamonds & precious stones)

7. Satellites

8. Private sector banking

sectors with 100% fdi limits are —

1. Advertising2. Agriculture3. Air transport services (domestic airlines)— 100 % for nris49% for others4. Courier services5. Drugs and pharmaceuticals6. Electricity7. Power8. Films and studios9. Hotel and tourism10. Housing and real estate

11. Construction12. Mass rapid transport system13. Minig(minig of gold and silver)14. Nbfc15. Oil exploration16. Petroleum product marketing17. Petroleum product pipelines18. Petroleum refining(private sector)19. Pollution control20. Road,highways,ports and harbours

21. Tourism

22. Tranportation infrastructure

23. Townships

24. Special economic zone(sez)

25. Railways

26. Single brand retail (upto 49% automatic 49-100% by fipb)

27. Telecommunications (upto 49% automatic 49-100% by fipb)

28. Asset reconstruction companies ( upto 49% automatic 49-100% by fipb)

sectors with 49% fdi limits are —

1. Airlines/aviation

2. Defence

3. Insurance

4. Pension

sectors with 26% fdi limits are —

1. Print media ( newspaper – 26%

scientific & periodicals – 100% )

2. Fm radio

sectors with 20% fdi limits is —

1. Public sector banks

““give a man a fish give a man a fish and you feed him for and you feed him for a day; teach a man to a day; teach a man to fish and you feed him fish and you feed him

for a lifetime”for a lifetime”