Currency Convertibility (1)

7/29/2019 Currency Convertibility (1)

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CHAPTER 1 : INTRODUCTION

Indias 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 debt 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.


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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 Tobagodollars.

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.


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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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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 Cubanpe so, 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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Convertibility is the ease with which a countrys currency can be converted into gold or another

currency. Convertibility is extremely important for international commerce. When a currency is

inconvertible, it possesses 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 of current international transaction ; and

Convertibility for international capital movement.

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

exchange transactions.


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ADVANTAGES

1. 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.

2. 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.

3. 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.

4. 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.

5. Countries are Enabled to specialize in the Production of Goods for whichthey have a

Comparative Advantage:- Each country will be able to engage in the production of

goods in accordance with their comparative advantage &resource endowments.


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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.

6. 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.

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

stronger.

8. 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.

9. Since it exposes India more exposed to various international financial sector, it forces the

government to become more disciplined on the fiscal side of things.

10.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.


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DI SADVANTAGES

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 lose 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.

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.


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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. Thus, as far as the demerits are concerned, they are only demerits as long as the

financial system and government accounts are shoddy. If they manage to have world class

financial system, then it can easily manage volatility without any problem.


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CHAPTER 2: EXTERNAL AND INTERNAL CONVERTIBILITYWhen 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

countrys 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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TYPES OF CURRENCY CONVERTI BI L I TY

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 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.

Currency

Convertibility

CurrentAccount

Convertibility

Capital

AccountConvertibility


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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 level.

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,


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engaging the service of 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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CHAPTER 3 NON CONVERTIBLE CURRENCY

Also known as a "blocked currency".

Any currency that is used primarily for domestic transactions and is not being traded openly in 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 nations currency is

nonconvertible it tends to limit the countrys participation in international trade as well as distort

its balance of trade.

A barrier to economic development arising from a nations 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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HOW IT WORKS IN INDI A ?

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.

Ensure that guidelines and regulations are consistent with regulatory intent.

Review the delegation of powers on foreign exchange regulations betweenCentral

Office and Regional offices of the RBI and examine, selectively, theefficiency in

the functioning of the delegation of powers by RBI to AuthorizedDealers (banks).


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CHAPTER 4 : 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 countrys 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.


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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.

Fully 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 euros) 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 Indians to

invest abroad.

After the economic liberalization process started in India in 1991, a Liberalized 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 early1990s 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.


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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%.Thecommittee was reappointed almost a decade later and

submitted almost the same recommendations with some modifications.

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.

Convertibility of Rupee will give pleasure to the 10 percent of Indian people who are either rich

or upper middle class, traders in the stock market, speculators, bankers, and accountants. The

rest 90 percent of the people will be adversely affected with loss of employments in the

manufacturing sector and bankruptcy in the agricultural sector and total economic uncertainly.

In any democratic country for any serious matter like turning the Rupee into a convertible

currency there must be referendums. There were referendums in each and every European

country when they wanted to create the European monetary system whereby each European

currency would be aligned to each other to create a common currency Euro. Although India

claims to be a democracy, Indian policy makers try their best to avoid the public opinion, even

the parliament. Major issues like Indias membership of the World Trade Organization, abolition

of the planned economy and privatization of public assets, free trade, and now the convertibility


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of Rupee should be debated in the parliament and people of India should be allowed to give

their verdict in referendums if India wants to be a true democracy.

Reduced interest rate for a convertible Rupee will reduce the exchange rate of the Rupee. The

currency speculators will start selling Rupee and short-term investments will fly out of the

country. There would be a free fall of the Rupee in the international currency market. As a result

the economy may go bankrupt without any foreign exchange. The result can be collapse of the

private companies leaving millions of people unemployed.


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HISTORY OF RUPEE CONVERTIBI L I TY

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.

a) First Phase in 200607

b) Second Phase in 200709

c) Third Phase in 2009 - 2011


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ADVANTAGES OF RUPEE CONVERTIBI L I TY

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.150,000Cores of uncollected taxes and Rs.120,000 Cores

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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DI SADVANTAGES OF RUPEE CONVERTIBI LI TY

Full convertibility also has adverse consequences for the Indias 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 Indias own agriculture.

There are many such historical examples in India. Within 20 years between 1860and 1880,

Indias 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

Indias foreign currency reserve created by the sweat and blood of the Indias poor in those days.

Full convertibility of Rupee and free trade may bring back those dark days.

The freedom for Indias 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.


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Although China has massive 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 Chinas 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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PARTIAL CONVERTIBI LI TY 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 Indias 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 Indias interest, we have to make some strict rules for stopping

outflow of fund on the name of convertibility of rupee or liberalization.

The rupee has arrived. Long before the domestic currency gets the `convertible tag, its 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


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favorite 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 500and Rs 1,000 bills. We have been doing this for

almost 6-8 months now. Some ofthe `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.

Most travelers (even today) convert their rupees in US dollars in India and then exchange them

again in local currencies of countries they visit.


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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 youre 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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FUL L CONVERTIBI LI TY 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 frameworkI 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 tomore 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


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international trade. For this reason, dollars are one of the major currencies traded in the FOREX

market.

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 or4 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 years 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.


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This does not mean that one can get any amount of foreign exchange at market rate for meeting

any of ones 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

conversion of ones 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.

New Delhi, March 12 (IANS) Finance Minister Pranab Mukherjee Friday said the

government was taking necessary steps to gradually move towards full convertibility of

the Indian rupee.


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Full convertibility of rupee is our ultimate aim. We are gradually moving towards it. But it

is not the right time to implement it in one go now, Mukherjee said in a reply t o a question in

the Rajya Sabha.

The full convertibility of the Indian currency means that the rupee would be made freely

exchangeable into other currencies and vice versa. Also, this would mean that international

investors can buy and sell Indian assets at will.

Since 1994, the rupee has been partially convertible by which the currency is changed freely into

foreign currency for business and trade expenses. But it cannot be converted freely for activities

like acquiring overseas assets.

Full convertibility of the rupee was one of the bottlenecks telecom firm Bharti Airtel faced in its

bid to acquire South African firm MTN.

Mukherjee said the government was adopting a cautious approach, taking into consideration all

aspects and the risks involved in opening up the economy by allowing convertibility of the

currency.

Experts feel full convertibility of rupee would facilitate further growth and higher investments.


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CHAPTER 5 : CONCLUSIONOfficially, the Indian rupee has a market-set exchange rate. However, the RBI trades

actively in the USD/INR currency market to impact effective exchange rates. Thus, the

currency regime in place for the Indian rupee with respect to theUS dollaris ade

factocontrolled exchange rate. This is sometimes called a managedfloat. Other rates such as the

EUR/INR and INR/JPY have volatilities that are typical of floating exchange rates.It should be

noted, however, that unlikeChina, successiveadministrations (throughRBI, the central bank)

have not followed a policy ofpeggingthe INR to a specific foreign currency at a particular

exchange rate. RBI intervention in currency markets is solely to deliver low volatility in the

exchange rates, and not to take a view on the rate or direction of the Indian rupee in relation to

other currencies.

Also affecting convertibility is a series ofcustomsregulations restricting the import and

export of rupees. Legally, foreign nationals are forbidden from importing or exporting rupees,

while Indian nationals can import and export only up to 5000 rupees at a time, and the possession

of 500 and 1000 rupee notes inNepalis prohibited.

RBI also exercises a system ofcapital controlsin addition to the intervention (through

active trading) in the currency markets. On the current account, there are no currency conversion

restrictions hindering buying or selling foreign exchange (though trade barriers do exist). On the

capital account, foreign institutional investors have convertibility to bring money in and out of

the country and buy securities (subject to certain quantitative restrictions). Local firms are able to

take capital out of the country in order to expand globally. But local households are restricted in

their ability to do global diversification. However, owing to an enormous expansion of the
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current account and the capital account, India is increasingly moving towards de facto full

convertibility.

There is some confusion regarding the interchange of the currency with gold, but the

system that India follows is that money cannot be exchanged for gold, in any circumstances or

any situation. Money cannot be changed into gold by the RBI. This is because it will become

difficult to handle it. India follows the same gold-interchange principle as Great Britain and

America.

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 assurance certainly

gives credence to the earnestness and sincerity with which the full convertibility has been

announced.


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BIBLIOGRAPHY

1. www.rbi.org2. www.marketguru.com3. www.investopedia.com4. www.economictimes.com5. www.currencymarkets.com
http://www.rbi.org/http://www.rbi.org/http://www.marketguru.com/http://www.marketguru.com/http://www.investopedia.com/http://www.investopedia.com/http://www.economictimes.com/http://www.economictimes.com/http://www.currencymarkets.com/http://www.currencymarkets.com/http://www.currencymarkets.com/http://www.economictimes.com/http://www.investopedia.com/http://www.marketguru.com/http://www.rbi.org/

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