INTERNATIONAL FINANCE - INTERNATIONAL FINANCIAL MANAGEMENT

1. Dr. Mohamed Kutty Kakkakunnan
Associate Professor
P G Dept. of Commerce
N A M College Kallikkandy
Kannur –Kerala - India

2. INTRODUCTION
 For the rapid growth of world trade and capital
flows between countries convertibility of currency
is desirable.
 Without free and unrestricted convertibility of
currencies foreign exchange trade and capital flows
between countries cannot take place smoothly
 To achieve higher rate of economic growth and
thereby to improve living standards through greater
trade and capital flows, the need for convertibility
of currencies of different nations has been greatly
felt.

3.  The concept of convertibility formerly referred (in
the era of the gold standard and some time
thereafter) to the right to convert a currency into
Gold at a given rate of exchange
 Nowadays it means the ability of residents and non-
residents to exchange freely domestic currency for
foreign currency without limit, whatever is the
purpose of the transactions
 Convertibility can apply to currencies of countries
that have fixed or flexible rate regimes

4.  It is the ease with which a country's currency can be
converted into gold or another currency
 The quality that allows money or other financial
instruments to be converted into other liquid stores
of value
 It is the ability of citizens to exchange a currency
without restrictions or controls
 It also refers to the extent to which a foreign
financial security such as a foreign currency or
convertible loan can be exchanged for some other
currency or financial asset

5. • The currency of a country can be freely converted
into foreign exchange at market determined rate of
exchange or the rate is determined by market
forces (demand & supply)
• Convertibility of rupee means that those who have
foreign exchange can get them converted into
rupees and vice-versa at the market determined
rate of exchange.
• Under convertibility of a currency there are
authorized dealers of foreign exchange which
constitute foreign exchange market.
• Those who have foreign currency may sell it and
those who need may buy at market rates.

6. Currencies that can be freely converted and globally
traded are known as HARD or SAFE –HEAVEN or
STRONG CURRENCY
Serve as reliable and stable store of value. Long-term
stability of purchasing power, associated country’s
fiscal and political conditions and outlook and
policy of the central bank issuing the currency
Currencies whose value fluctuate widely and
depreciate often, are known as soft currencies
Associated country’s political and fiscal conditions and
outlook, the central banks policy make a country's
currency soft /hard

7. Fiat money A currency established as money by
government regulation or law. Latin word
‘fiat’ means “let it be done” or “it shall be”. It
is used in the sense of an order or decree.
First used in China around 1000 AD
Commodity money crated from a good, often a
precious metal- gold or sliver, having uses
other than as a medium of exchange
Representative Money represents a claim on
such a good (gold, silver)

8. SOFT AND HARD CONVERTIBILITY
Soft convertibility entails the ability to freely
exchange currencies at market determined
exchange rate while the hard convertibility
entails the right to freely exchange currencies at
a given exchange rate
The key distinction is here who bears the exchange
risk: under soft convertibility the holders of
currency do, while under the hard convertibility
the country issuing the currency does

9. CAPITAL ACCOUNT CONVERTIBILITY AND CURRENT
ACCOUNT CONVERTIBILITY
CAC refers to the freedom to convert local financial
assets into foreign financial assets and vice-versa, at
market determined rates of exchange (Tarapore
Committee, 1997)
It is the freedom to convert Rupee into foreign
currency and back for capital transactions
It is associated with changes of ownership in foreign
domestic financial assets and liabilities and
embodies the creation and liquidation of claims on
or by the rest of the world
It is an inevitable step in development and thus
cannot be avoided

10. Capital Account Convertibility in India
• Capital account is made up of both the short-
term and long-term capital transactions such as
investments in financial and non-financial assets
• The Capital Transaction may be Capital outflow or
capital inflow
• Capital account convertibility (CAC) or a floating
exchange rate means the freedom to convert
local financial assets into foreign financial assets
and vice versa at market determined rates of
exchange
• Capital account convertibility allows anyone to
freely move from local currency into foreign
currency and back

11. • Capital Account Convertibility (CAC) is the freedom
to convert local financial assets into foreign financial
assets at market determined exchange rates.
• Referred to as ‘Capital Asset Liberation’ in foreign
countries, it implies free exchangeability of currency
at lower rates and an unrestricted mobility of capital
• India, at present has partial capital account
convertibility with certain limits and caps on FDI
• In India there are conflicting views regarding whether
to move towards full convertibility of capital account
or not
• CAC and SS Tarapore Committee

12. • CAC is related with flows of portfolio capital, FDI
flows, flows of borrowed funds and dividends
and interest payable on them.
• Under CAC, a currency is freely convertible into
foreign currency and vice-versa at market
determined exchange rate
• Convertibility of rupee on capital account means
those who bring in foreign exchange for
purchasing stocks, bonds in Indian stock markets
or for direct investment can get them freely
converted into rupees without taking any
permission from the government

13. • Dividends, interest, capital gains earned on direct
investment can be converted into foreign currencies
at market determined exchange rate between these
currencies and repatriate them
• Capital convertibility is risky, makes foreign
exchange rate more volatile. It is introduced only
some time after the introduction of convertibility
on current account when exchange rate is relatively
stable, deficit in balance of payments is well under
control and enough foreign exchange reserves are
available with the Central Bank

16. • Investors can diversify their portfolio internationally
thereby decreasing their vulnerability to domestic
shocks
• Companies can go global by investing abroad. It
should encourage Indian entrepreneurs to seek a
global presence
• CAC would bring in its wake international
competition. This in turn would propel the economy
to a higher level of efficiency

17. The Benefits of Capital Account Convertibility
(Tarapore Committee)
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
4. Improvement of the financial system in the context of
global competition

18. Demerits
• Since market determined exchange rate is generally
higher than the previous officially fixed exchange rate,
prices of essential imports rise which may generate
cost-push inflation in the economy
• If not properly managed and monitored, market
exchange rate may lead to the depreciation of domestic
currency. If a currency depreciates heavily, the
confidence in it is shaken and no one will accept it in its
transactions. As a result, trade and capital flows in the
country are adversely affected.
• Convertibility of a currency sometimes makes it highly
volatile

19. Demerits contd…
• Operations by speculators make it more volatile and
unstable and adversely affect confidence in the
currency and capital flight
Eg:-South East Asian economies like Thailand,
Malaysia, Indonesia, Singapore and South Korea -
1997-98
• Capital flight adversely affect economic growth and
depreciation of currency discourage further inflow

21. ADVANTAGES OF CURRENCY CONVERTIBILITY
1.Encouragement to exports increasing
profitability.
2. Encouragement to import substitution
3. Incentive to send remittances from abroad:
4. A self – balancing mechanism to correct BOP
5. Specialization in accordance with comparative
advantage
6. Integration of World Economy

22. Convertibility of Indian Rupee
At the time of independence the Foreign Exchange
Regulation Act 1947 (FERA) was enacted with the
object of regulating certain dealings in foreign
exchange and the import and export of currency
and bullion
 The focus of this act was on dealings in Foreign
exchange and payments which directly affect
foreign exchange resources.
 This act was later replaced by the Foreign
Exchange Regulation, Act, 1973, which we
call FERA.
 Later FERA was laid to rest and its successor is now
FEMA

23.  Those were the days of restriction on foreign exchange
 No one could keep foreign exchange without the
knowledge and due permission of RBI
 The exchange control consisted of restrictions on the
purchase and sale of foreign exchange by general
public and payments to and from non-residents
 There were also restrictions on the import and export
of Indian currency, foreign currency and bullion
 In those times, the exchange rates used to be different
than what they are today.

24.  In the olden days, RBI used to dictate its Official
Exchange Rate on which Indian currency could be
converted into foreign currency and vice versa
 All transactions in foreign exchange were governed by
this official rate of exchange
 Means that Rupee was inconvertible at the market rate
 An importer who wanted to import from abroad was
supposed to buy dollars at the RBI dictated rates
 An exporter who got dollars was supposed to sell them
to RBI appointed Authorize agents at RBI decided rate
 This was the inconvertibility of Rupee

25. • MAJOR implications of these restrictions were:
– Exchange rate was controlled by RBI
– All foreign exchange received by any person in
India had to sell to RBI authorized dealers at
the rate fixed by RBI.
• The main purpose of the control was to utilize the
foreign exchange earned by the residents as per
the priorities fixed by the government
• Controls were necessary at that time as India was
underdeveloped country and its exports were
limited to agricultural product and raw material
and it used to import only consumable goods

26. Now India is a fast developing country and
one of the most preferred countries for
investment by foreigners
 India needs foreign exchange to grow further
 Government has allowed convertibility of
Rupee in phased manner on current account
transactions
 But full convertibility of currency for capital
account transactions is still a distant dream
At present, Rupee is both convertible on
capital account (partial) and current account

27. Full Convertibility of Rupee on Current Account
• In 1992, Government announced intention to introduce the
full convertibility on the current account in 3 to 5 years
• Full convertibility means no RBI dictated rates and a unified
market determined exchange rate regime
• Encouraged with the success of the LERMS, the
government introduced the full convertibility of Rupee in
Trade account (means only merchandise trade no service
trade) from March 1993 onwards
• With this the dual exchange rate system got automatically
abolished and LERMS was now based upon the open
market exchange
• The full convertibility of Rupee was followed by stability in
the Rupee Rate in the next many months coming up

28. • In August 1994, declared full convertibility of Rupee on
Current account with announcing some relaxations as per
requirements of the Article VIII of the IMF
These were:
• Repatriation of the income earned by the NRIs and overseas
corporate bodies of NRIs in a Phased manner in 3 years period
• Ceiling for providing foreign exchange for foreign tours,
education, medical treatment, gifts and services was made
just an indicative
• Above this ceiling, foreign exchange could be obtained for
payments, while making a reference to RBI
• Principal amount on the NRNR (Non Resident Non
Repatriable) Accounts was non repatriable, the interest was
made repatriable

29. ADVANTAGES OF CURRENCY CONVERTIBILITY
1. Encouragement to exports
2. Encourages import substitution
3. Incentive to remittances from abroad
4. Reduction in Malpractices
5. A self – balancing mechanism