Currency convertibility


Published on

  • Be the first to comment

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Currency convertibility

  1. 1. CURRENCY CONVERTIBILITY 1) INTRODUCTIONIndia‟s development strategy was based on protection, self-reliance & importsubstitution before the liberalization policy was accepted & initiated. Foreign capitalflows were not looked upon favorably & therefore not encouraged. If there is adeficit in the current account it was financed mainly through deft flows & officialdevelopment assistance. The policy followed was one which discouraged foreigninvestment. However, the adverse balance of payment & the economic crisis facedby 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 oftenrestrict currency convertibility because the government would not be in a position tointervene in the foreign exchange market (i.e. revalue, devalue) to support their owncurrency if and when necessary.Convertibility is the quality that allows money or other financial instruments to beconverted into other liquid stores of value. Convertibility is an important factor ininternational trade, where instruments valued in different currencies must beexchanged.Currency Convertibility means the ability to freely exchange the currency of oneMember State into the currency of another Member State.For example, a Barbadian should be able to easily purchase goods in a store in Portof Spain with his Barbadian dollars and receive his change in Trinidad and Tobagodollars. Page 1
  2. 2. CURRENCY CONVERTIBILITYHowever, this does not always happen because of the existence of two differentexchange systems in CARICOM – Fixed and Floating. Currency convertibilityimplies the absence of exchange controls or restrictions on foreign exchangetransactions.The ease with which a countrys currency can be converted into gold or anothercurrency. Convertibility is extremely important for international commerce. When acurrency in inconvertible, it poses a risk and barrier to trade with foreigners whohave 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 oftenrestrict currency convertibility because the government would not be in a position tointervene in the foreign exchange market (i.e. revalue, devalue) to support their owncurrency if and when necessary.An international monetary system has been in existence since monies have beentraded, its analyses have been traditionally started from the late 19th century whenthe gold standard beganConvertibility essentially means the ability of residents and non-residents toexchange domestic currency for foreign currency, without limit, whatever be thepurpose of the transactions.The Movement of Capital for the full functioning of the CSME depends to a largedegree on two conditions already pointed out in the Revised Treaty provisions – Abolishing exchange controls and The free convertibility of currency within the CSME. Page 2
  3. 3. CURRENCY CONVERTIBILITY 2) MEANING & DEFINITIONThe ease with which a countrys currency can be converted into gold or anothercurrency. Convertibility is extremely important for international commerce. When acurrency is inconvertible, it poses a risk and barrier to trade with foreigners whohave no need for the domestic currency.The ability to exchange money for gold or other currencies. Some governmentswhich do not have large reserves of hard currency foreign reserves try to restrictcurrency convertibility, since they are not in a position to handle large currencymarket operations to support their currency when necessary.The state of or the ease with which a currency may be exchanged for a foreigncurrency. Currency convertibility is vitally important in the foreign exchangemarket; higher convertibility means that a currency is more liquid and, therefore,less difficult to trade.Factors affecting convertibility include the availability of foreign currency reservesin a given country and domestic regulations seeking to protect local investors frombad investment decisions in, say, a currency undergoing a period of hyperinflation.Currency convertibility refers to the freedom to convert the domestic currency intoother internationally accepted currencies and vice versa at market determined ratesof exchange.A few socialist governments even issue inconvertible currencies, such as the Cubanpeso, in order to protect their citizens from perceived capitalist infiltration.Currency Convertibility refers to the degree to which one currency can be exchangedfor another. Some currencies trade less freely on the open market and exchanges, inthese cases, can be more difficult to process. Page 3
  4. 4. CURRENCY CONVERTIBILITYCurrency Convertibility is the ease with which a countrys currency can be convertedinto gold or another currency. Convertibility is extremely important for internationalcommerce. When a currency in inconvertible, it poses a risk and barrier to trade withforeigners who have no need for the domestic currency.Currency convertibility implies the absence of exchange controls or restrictions onforeign exchange transactions.Currency convertibility means “the freedom to convert one currency into otherinternationally accepted currencies”. There are two popular categories of currencyconvertibility, 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. Page 4
  5. 5. CURRENCY CONVERTIBILITY 3) ADVANTAGESEncourages export: - Exporters are motivated to increase their exports sincethere is possibility of making more profits under currency convertibilityconditions. As a result of convertibility on current account, higher profits willbe earned since market exchange rate will give higher returns as compared tothe officially fixed exchange rate. From the given exports, they earn moreforeign exchange.Encourage Import Substitution: - since the market determined exchange rate ishigher than the officially fixed exchange rate, imports become moreexpensive. This makes countries to go in for import substitution.Incentives to Send Remittances from Abroad:- Indian workers employedabroad & NRIs find it convenient to send remittances of foreign exchangewithout hassle. This also encouraged illegal remittances like „hawala money‟& smuggling.Self-adjusting Process in the Correction of Surplus or Deficits in Balance ofPayments:- In case, a country faces a deficit due to overvalued exchange rate,the currency of the country will depreciate. This will encourage exports bylowering the prices & discourages imports by raising their prices. In thismanner the deficit or surplus in the BoP gets corrected without theintervention of the government. Page 5
  6. 6. CURRENCY CONVERTIBILITYCountries are Enabled to specialize in the Production of Goods for whichthey have a Comparative Advantage:- each country will be able to engage inthe production of goods in accordance with their comparative advantage &resource endowments. When there is currency convertibility, market exchangerate truly reflects the purchasing power of their currencies which is based onthe prices & costs of goods in different countries. In a competitiveenvironment, lower prices of goods which reflect the comparative advantagewill enable countries to increase exports. Thus currency convertibility willlead to specialization & international trade on the basis of comparativeadvantage. This will be beneficial for all countries in trade.Integration of World Economy:- currency convertibility enables betterintegration of the world economy. The easy availability of foreign exchangehelps in the growth of trade & increased capital flows between countries. Thiswill enables the growth of all countries which is important in the context ofglobalization.It forces the financial sector to be become more efficient, more disciplined,and much strongerIt paves the way for companies to access funds from outside withouthindrance. It makes it far easier for foreign companies to invest in India. Page 6
  7. 7. CURRENCY CONVERTIBILITYSince it exposes makes India more exposed to the vagaries of the internationalfinancial sector, it forces the government to become more disciplined on thefiscal side of things.It sends a signal to international investors as well as the financial world thatIndia is confident of itself herself in the economic and financial arena and hasthe capability to withstand anything that is thrown at it her.Since it exposes makes India more exposed to the vagaries of the internationalfinancial sector, it forces the government to become more disciplined on thefiscal side of things. Page 7
  8. 8. CURRENCY CONVERTIBILITY 4) DISADVANTAGESCurrency convertibility can give rise to problems of inflation in domestic economy.The market determined exchange rate is generally higher than the officially fixedexchange rate. This leads to a rise in prices of essential imports which can results ina situation of cost push inflation in an economy.If the people monitoring is not done, convertibility can results in the depreciation ofthe domestic currency. Undue depreciation of a currency can make people looseconfidence in the currency itself. This can adversely affect the trade & capital flowsof a country.Under capital account convertibility, a country is given the freedom to transact infinancial assets with foreign countries without restrictions. Such an arrangement is toenable increased investment activities. But there are risks attached to it. A verylikely possibility is that of capital flight at the first sign of an internal economicproblem.The short-term capital flights termed as “hot money” transfers can destabilize aneconomy unless precautionary or counter measures are taken to achieve stability.Speculative activities may increase under free convertibility, making the exchangerates highly volatile. Speculation can lead to depreciation of currencies & flight ofcapital. This is proved by the experience of the South East Asian countries likeThailand, Malaysia, in the year 1997-199, which experienced severe depreciation ofcurrency & capital flight. Page 8
  9. 9. CURRENCY CONVERTIBILITYIndia is moving very cautiously towards capital account convertibility due to variousrisks which can create macroeconomic imbalance in the in the economy. Though therupee is not freely convertible on the capital account, in certain transactions fullconvertibility prevails.For example, foreigners, non-resident Indians engaged in investing on portfolio ordirect investments are given freedom to bring in & repatriate their funds. It is feltthat a strengthening of the reserve position & structural strengthening will makeIndia ready to adopt full convertibility on the capital account.It exposes the country India to the volatility of the world financial system. The rupeecan possibly become more volatile.That said, there are infinitely more merits than demerits to going becomingconvertible on the capital account. The As far as the demerits are concerned, they areonly demerits so only as long as the financial system and government accounts areshoddy. If they it become world class financial system, the it can easily managevolatility can be managed without any problem. Page 9
  10. 10. CURRENCY CONVERTIBILITY 5) EXTERNAL AND INTERNAL CONVERTIBILITYWhen all holdings of the currency by non-residents are freely exchangeable into anyforeign (non- resident) currency at exchange rates within the official margins thanthat currency is said to be externally convertible.All payments that residents of the country are authorized to make to non-residentsmay be made in any externally convertible currency that residents can buy in foreignexchange markets.If there are no restrictions on the ability of a country to use their holdings ofdomestic currency to acquire any foreign currency and hold it, or transfer it to anynonresident for any purpose, that country‟s currency is said to be internallyconvertible.Thus external convertibility is the partial convertibility and total convertibilityis the sum of external and internal convertibility. Page 10
  11. 11. CURRENCY CONVERTIBILITY 6) TYPES OF CURRENCY CONVERTIBILITY1. Capital Account Convertibility :-Currency convertibility refers to the freedom to convert the domestic currency intoother internationally accepted currencies and vice versa. Convertibility in that senseis the obverse of controls or restrictions on currency transactions. While currentaccount convertibility refers to freedom in respect of „payments and transfers forcurrent international transactions‟, capital account convertibility (CAC) would meanfreedom of currency conversion in relation to capital transactions in terms of inflowsand outflows. Article VIII of the International Monetary Fund (IMF) puts an Page 11
  12. 12. CURRENCY CONVERTIBILITYobligation on a member to avoid imposing restrictions on the making of paymentsand transfers for current international transactions. Members may cooperate for thepurpose of making the exchange control regulations of members more effective.Article VI (3), however, allows members to exercise such controls as are necessaryto regulate international capital movements, but not so as to restrict payments forcurrent transactions or which would unduly delay transfers of funds in settlement ofcommitments.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. Page 12
  13. 13. CURRENCY CONVERTIBILITY2. Current Account Convertibility :-Current account convertibility allows residents to make and receive trade-relatedpayments, i.e. receive foreign currency for export of goods and services and payforeign currency for import of goods and services like travels, medical treatment andstudies abroad. Current account convertibility allows free inflows and outflows forall purposes other than for capital purposes such as investments and loans. In otherwords, it allows residents to make and receive trade-related payments -- receivedollars (or any other foreign currency) for export of goods and services and paydollars for import of goods and services, make sundry remittances, access foreigncurrency for travel, studies abroad, medical treatment and gifts, etc.Current account convertibility refers to freedom in respect of Payments and transfersfor current international transactions. In other words, if Indians are allowed to buyonly foreign goods and services but restrictions remain on the purchase of assetsabroad, it is only current account convertibility. As of now, convertibility of therupee into foreign currencies is almost wholly free for current account i.e. in case oftransactions such as trade, travel and tourism, education abroad etc.The government introduced a system of Partial Rupee Convertibility (PCR) (CurrentAccount 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 asefficient import substitution. It is designed to reduce the scope for bureaucraticcontrols, which contribute to delays and inefficiency. Government liberalized theflow of foreign exchange to include items like amount of foreign currency that canbe procured for purpose like travel abroad, studying abroad, engaging the service of Page 13
  14. 14. CURRENCY CONVERTIBILITYforeign consultants etc. What it means that people are allowed to have access toforeign currency for buying a whole range of consumables products and servicesCurrent account convertibility is popularly defined as the freedom to buy or sellforeign exchange for:-a. The international transactions consisting of payments due in connection withforeign trade, other current businesses including services and normal short-termbanking and credit facilitiesb. Payments due as interest on loans and as net income from other investmentsc. Payment of moderate amounts of amortization of loans for depreciation ofdirect investmentsd. Moderate remittances for family living expensese. Authorized Dealers may also provide exchange facilities to their customerswithout prior approval of the RBI beyond specified indicative limits, provided, theyare satisfied about the bonafides of the application such as, business travel,participation in overseas conferences/seminars, studies/ study tours abroad, medicaltreatment/check-up and specialized apprenticeship training. Page 14
  15. 15. CURRENCY CONVERTIBILITY 7) NONCONVERTIBLE CURRENCYAlso known as a "blocked currency".Any currency that is used primarily for domestic transactions and is not openlytraded on a forex market. This usually is a result of government restrictions, whichprevent it from being exchanged for foreign currencies.As the name implies, it is virtually impossible to convert a nonconvertible currencyinto other legal tender, except in limited amounts on the black market. When anations currency is nonconvertible it tends to limit the countrys participation ininternational trade as well as distort its balance of trade.A barrier to economic development arising from a nation‟s inability to convert itscurrency on foreign exchange markets, thus its inability to acquire the foreign capitalit needs to achieve improvements in productivity, income and human welfare amongits people.Almost all nations allow for some method of currency conversion; Cuba and NorthKorea are the exceptions.They neither participate in the international FOREX market nor allow conversion oftheir currencies by individuals or companies. As a result, these currencies are knownas blocked currencies; the North Korean won and the Cuban national peso cannot beaccurately valued against other currencies and are only used for domestic purposesand debts. Page 15
  16. 16. CURRENCY CONVERTIBILITYSuch nonconvertible currencies present a major obstruction to international trade forcompanies who reside in these countries.Convertibility is the quality of paper money substitutes which entitles the holder toredeem them on demand into money proper. Page 16
  17. 17. CURRENCY CONVERTIBILITY 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. Page 17
  18. 18. CURRENCY CONVERTIBILITYEnsure 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, theefficacy in the functioning of the delegation of powers by RBI to AuthorizedDealers (banks). Page 18
  19. 19. CURRENCY CONVERTIBILITY 9) RUPEE CONVERTIBILITYConvertibility of a currency implies that a currency can be transferred into anothercurrency without any limitations or any control. A currency is said to be fullyconvertible, if it can be converted into some other currency at the market price ofthat currency. Convertibility can be related as the extent to which a countrysregulations 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 theGovernment 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 orpaying fees for a ward who pursues higher studies abroad. Similarly, any exporterwho exports goods or services and brings foreign currency into the country has tosurrender the foreign exchange to RBI and get it converted at a rate pre-determinedby RBI.At present, Indian rupee is partly convertible on current Account. That isconvertibility 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 constitutedby the Reserve Bank. This committee indicated three preconditions for capitalAccount 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 capitalaccount convertibility. In response to this the Reserve Bank of India set up the Tarapore Committee to work out another roadmap for current account convertibility. Page 19
  20. 20. CURRENCY CONVERTIBILITYFull currency convertibility of the Indian rupee means, can travel abroad and buydollars over the counters, currency convertibility refers to the absence of anyrestriction on the holding of foreign currency by residents and of the nationalcurrency by foreigners, and on free conversion between currencies. Can incurexpenses 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 attractsmany foreign tourists, which can be contributed to the GDP.Therefore, fuller convertibility of Indian rupee helps to attract FDI and also helpsIndians to invest abroad.After the economic liberalization process started in India in 1991, a LiberalisedExchange Rate Mechanism was introduced in 1992.This allowed partialconvertibility of Indian rupee, thus introducing dual exchange rate. After that fullconvertibility on trade account started from 1993.It was followed by Fullconvertibility on current account from 1994.However after the Mexico crisis in early1990s or the mammoth East Asia Crisis where there was sudden flow of capitalinternationally debilitating the economies of the involved nations, India wasreluctant to adopt capital account convertibility.However the Tara pore committee, appointed in 1997, recommended phasedimplementation of capital account convertibility with certain prerequisites like fiscaldeficit to be 3.5% of GDP,CRR to be brought down to 3%, gross NPA of publicsector 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 samerecommendations with some modifications. Page 20
  21. 21. CURRENCY CONVERTIBILITYIt must be remembered that the movement towards fuller CAC should be a processand not an event. Macroeconomic stability is a must before achieving full CAC. Anyadhoc arrangement from the fixed regime maintained for a long period of time mightdisturb the foreign exchange market and disrupt the economic progress.At present, Indian rupee is partly convertible on current Account. That isconvertibility 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 allinternational currency. It means that rupee can covert in USA dollars more easilyand USA dollars can convert in Indian currency for buying and selling of goods andservices. after study everything, I am writing, "it is conspiracy to lower the value ofIndian currency that in real sense. In 1996, there were just Rs. 38 for every onedollar but after liberalized convertibility of rupee, one dollar exchange rate hasreached up to Rs. 45 in 17th Jan. 2011. When convertibility of Rupee was started, itwas claimed that our export will increase because our Indian companies will easy totrade in foreign country due to easy exchange without any govt. restriction. But, itopens doors for importing useless things and moreover it is very sad for India thatgold is not make as standard exchange currency. China is smart than India, underhis new foreign exchange policy, convert all his foreign exchange in gold. Now, hisChinese yuan is equal to Indian Rs. 6.89. Page 21
  22. 22. CURRENCY CONVERTIBILITYRUPEE AS A CONVERTIBLE CURRENCY:-The recent decision of the government to have full convertibility of the Indian Rupeewhich will affect everyone in the country but is remotely understandable by a few, isone such important decision, which is designed to please the international financialinstitutions and the 10 percent of the population of India who are either rich or ofupper middle class.It is essential to judge a policy by examining both the costs and benefits of it. Thegovernment is talking about the illusory benefits of this convertibility, which willbasically remove all obstacle to the free flow of money and as a result goods andservices also can move freely.The government, in a fully convertible regime, will not be able to control these flowsdirectly. Indirect controls will be implemented by changing interest rates and taxesbut the effectiveness of this control according to the international experiences isuncertain. Page 22
  23. 23. CURRENCY CONVERTIBILITY 9.1) HISTORY OF RUPEE CONVERTIBILITYUp to 1991, when India faced a major foreign exchange crisis, there had beenvery 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 forcurrency reforms.In 1997 the government had set up a committee (Tarapore committee) to spellout a road map for the full convertibility of the rupee.Committee suggested three phases of adopting full convertibility of rupee incapital account.  First phase in 2006 -2007  Second phase in 2007-2009  Third phase in 2009- 2011 Page 23
  24. 24. CURRENCY CONVERTIBILITY 9.2) ADVANTAGES OF RUPEE CONVERTIBILITYThe benefits of free flows of money in a fully convertible regime means foreignerswould be able to invest in the Indian stock markets, buy up companies and propertyincluding land (unless there are restrictions).Indian people and companies can import anything they would like, buy shares offoreign companies and property in foreign lands and can transfer money as theyplease without going through the Hawala business.Indians who have not paid their taxes or repaid their loans taken from the Indianbanks will be free to transfer their money to foreign countries outside the jurisdictionof the Indian authority.The expected benefits for India would depend on the attractiveness of the country asa safe destination for short-term investments. Long-term investments do not dependon 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 Indiancompanies and Indian government depend on the demonstration of profit of theIndian companies and the continuous good health of the Indian economy in terms oflow budget deficits, low balance of payments deficits, low level of governmentborrowings and low level of non-performing loan in the Indian banking system. Page 24
  25. 25. CURRENCY CONVERTIBILITYFrom these points of view India cannot be a very attractive destination as the healthof the economy despite of the propaganda of the Indian government is very weakwith huge government debt, revenue deficits, Rs.150,000 Crores of uncollected taxesand Rs.120,000 Crores of unpaid loans in the banks, increasing price of petroleumand increasing balance of payments deficits of the country. With 80 percent ofpeople live on less than 2 dollars a day, and 70 percent of the people live on lessthan 1 dollar a day, profitable market in India is also very small. If the Indiancompanies working under these constraints cannot demonstrate good and continuousprofit, short-term investments will fly out very easily if there is any sign ofeconomic downturn when there is a fully convertible Rupee. The result will befurther increase in the balance of payments deficits and fall of the exchange rate ofRupee, 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 canimport as they like and buy properties abroad as they were allowed to do so duringthe days of British Raj. It has certain advantages for the Indian companies who willbe able to import both raw materials and machineries or set up foreignestablishments at will. Page 25
  26. 26. CURRENCY CONVERTIBILITY 9.3) DISADVANTAGES OF RUPEE CONVERTIBILITYFull convertibility also has adverse consequences for the India‟s domestic producersof these raw materials and machineries, as they have to compete against foreignsuppliers who like Chinese may have deliberate low rate of exchange for theircurrencies thus making their goods low in price. Foreign suppliers also can besupported by all kinds of subsidies by their government so as to make their pricesvery low. Agricultural exports from Europe, USA, Thailand, and Australia can ruinIndia‟s own agriculture.There are many such historical examples in India. Within 20 years between 1860and 1880, India‟s domestic manufacturing industries were wiped out by free tradeand convertible Rupee during the days of British Raj. Indian farmers during thosedays could not cultivate their lands, as the imported food products were cheaper thanwhatever they could produce. Demonstration of wealth by the Nawabs andMaharajas of India in Paris and London during the days of British Raj has not doneany good for starving millions of India but was responsible for massive misuse ofIndia‟s foreign currency reserve created by the sweat and blood of the India‟s poorin those days. Full convertibility of Rupee and free trade may bring back those darkdays.The freedom for India‟s rich to buy companies and property abroad may lead tomassive diversion of funds from investments in the home economy of India toinvestments abroad. This would amount to export of jobs to foreign countriescreating more and more unemployment at home. Japan in recent years suffers fromthis phenomenon, where increasingly Japanese companies are transferring funds toChina for investments, taking advantage of the very low wage rate and low exchangerate of Yuan, thus creating unemployment at home. Although China has massive Page 26
  27. 27. CURRENCY CONVERTIBILITYsurplus in the balance of payments, huge reserve of dollars and gigantic flows offoreign investments, a non-convertible Yuan and controls on transfer of money havekept China‟s exchange rate low enough so that Chinese goods can capture themarkets of every important country of the world.The most dangerous consequence of convertibility is that Rupee will be under thecontrol of currency speculators. A fully convertible regime for the Rupee willcertainly include participation of Rupee in the international currency market and inthe „future market‟ of Rupee, the playground for the international speculators. It isvery much possible for the speculators to buy massive amount of Rupee to drive upits exchange Rate. Page 27
  28. 28. CURRENCY CONVERTIBILITY 9.4) PARTIAL CONVERTIBILITY OF RUPEEPartial convertibility of Rupee was started in 1992 for current account. In simpleword, there is no control of Indian currency official. Any foreign company can dobusiness and can go to his country with this profit after exchanging all Indiancurrency in their foreign currency. For example, According to its Directors‟ Report,a public document filed with India‟s Registrar of Companies, “Google India PrivateLtd” 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, itreported a profit after tax of 97.96 crore ($21.62 million), and received foreignexchange of Rs. 666.25 crore, with a foreign exchange out go of Rs. 304.24 crore. Inthis, example, we see that there is no our control our one foreign currency. Fromeconomic point of view, if any country has largest amount of other countriescurrency, that country will become economically sound. Suppose, if India has notUSA 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 hasbecome easy but it is also harmful for India, because same investment should be inIndia instead any other country. All companies think the benefit of their residentialcountry from where they are operating their business. So, for Indias interest, wehave to make some strict rules for stopping outflow of fund on the name ofconvertibility of rupee or liberalization. Page 28
  29. 29. CURRENCY CONVERTIBILITYThe rupee has arrived. Long before the domestic currency gets the `convertible‟ tag,it‟s being freely accepted and exchanged in Singapore, Malaysia, Indonesia, HongKong, Sri Lanka and other countries. Till now, such transactions were confined toselect departmental stores which are favourite of Indian tourists; now more and moreshops, hotels and even money changers are willing to accept the local legal tender.This means no double conversions, and therefore, extra cost while exchangingIndian 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 carryrupees, and do away with travelers cheques. In most Asian countries, the nearest`money exchange‟ shop will give them the local currency against rupees. Many feelthe trend has picked with hints that convertibility may be matter of time.Travel agents, in India, say that since many Indians are travelling abroad, especiallyto Asian countries, many banks and foreign exchange agents abroad have startedaccepting Indian rupees. Tarmo Wong, a manager with `money exchange‟ shop inone 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 havebecome finer for the Indian traveler or the business tourist. Earlier, a handful ofoutfits accepted the Indian rupee and usually the buy/sell spread was high. Page 29
  30. 30. CURRENCY CONVERTIBILITYMost travelers (even today) convert their rupees in US dollars in India and thenexchange them again in local currencies of countries they visit. The cost of suchdouble conversion could be as high as 5%. Prakash Dagia, a regular businesstraveler to countries like Indonesia, Bangladesh and Malaysia, said, “In the past fewmonths, the rupee has gained acceptance in almost all countries in Asia. The bestpart 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 andbuy dollars you need over the counter. Partial currency convertibility already existsin the system. For instance, you can spend through your credit card and pay themoney spent in foreign currency back in India in Indian rupees. Currencyconvertibility refers to the absence of any restriction on the holding of foreigncurrencies by residents and of the national currency by foreigners, and on freeconversion between currencies. It does not preclude restrictions on the type andquantity of non-currency assets that residents can hold abroad or foreigners can holdin the country. Page 30
  31. 31. CURRENCY CONVERTIBILITY 9.5) FULL CONVERTIBILITY OF RUPEEThe 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 capitalaccount convertibility. To quote:“Given the changes that have taken place over the last two decades, there is merit inmoving towards fuller capital account convertibility within a transparentframework…I will therefore request the Finance Minister and the Reserve Bank torevisit the subject and come out with a roadmap based on current realities”.Convertible currencies are defined as currencies that are readily bought, sold, andconverted 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 withoutrestriction and with no permission required. The easy convertibility of currency is arelatively recent development and is in part attributable to the growth of theinternational 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. Becausethe value of currencies is established in comparison to each other, rather thanmeasured against a real commodity like gold or silver, the ready trade of currenciescan offer investors an opportunity for profit.The U.S. dollar is an example of a fully convertible currency. There are norestrictions or limitations on the amount of dollars that can be traded on theinternational market, and the U.S. Government does not artificially impose a fixedvalue or minimum value on the dollar in international trade. For this reason, dollarsare one of the major currencies traded in the FOREX market. Page 31
  32. 32. CURRENCY CONVERTIBILITYAlthough 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 highlightof the 1993-94 Budget.There is, however, a subtle difference in the full convertibility of the rupeeintroduced in India and the concept of full convertibility prevailing in developedcountries like the U.K., U.S.A. etc. In developed countries, full convertibility meansthat their currency is freely convertible anywhere in the world. Their home currencycan be converted into foreign currency without any restriction. One does not have todisclose even the purpose of such conversion. For instance, U.S. Dollars can bechanged into Sterling Pounds in New York, Japanese Yen could be exchanged toDeutsche Marks in Frankfurt, Australian Dollars can be converted into CandianDollars in Adelaide etc., The exchange rate is controlled by the position of supplyand demand in the market.The full convertibility announced in the Union Budget of 1993-94, however, allowsconvertibility only in the current account, which means the amount received by wayof sale proceeds of exports, paid for imports and the remittance by NRIs etc., aloneare convertible at market determined rates.In the last years Budget, a dual exchange rate was announced i.e., 60% at marketrates and 40% at the official rate. In the current Budget, the dual exchange rate hasbecome a unified exchange rate which is a 100% conversion of foreign exchange atmarket rate. This is described as Full Convertibility. This does not mean that one canget 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 anyoneonly for those purposes which are stipulated by the Govt. of India. It does not permit Page 32
  33. 33. CURRENCY CONVERTIBILITYconversion of ones savings in the country for investment in foreign countries, ascould be done by the citizens of developed countries like the U.K. or U.S.A. Forinstance, if a citizen resident in India wishes to undertake a foreign travel, theexchange 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 adoptedfor our country is tied up with exchange controls and restriction envisaged by theprovisions of the F.E.R. Act 1973 as amended.Full convertibility has been introduced only as a measure of reforms to revitalize theeconomy of our country and to bring it on to the path of liberalization. The NewEconomic Policy ushered in by out Govt. is with a view to take India forward from acontrol-ridden-inward-looking economy into a market - friendly, forward lookingprogressive and dynamic economy. Full convertibility of the rupee, lower Customsand Central Excise duties, relaxation of Import / Export restrictions, streamlining ofprocedural rules governing taxations, streamlining of procedural rules governingtaxation laws etc.,. have opened out our economy with a view to expansion andglobalisation of our trading activities. These are measures taken to move Indiaforward in her march towards economic freedom. Page 33
  34. 34. CURRENCY CONVERTIBILITY 10) CONCLUSIONThe volatile nature of capital inflow presents an alarming trend. Liberalizing capitalcontrol may lead to huge dependence on foreign portfolio capital. Need is tochannelize 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 ofinstruments to manage risk, the liquidity of financial markets and the quality ofmarket infrastructure, and level of market discipline. Key segments of the Indiancapital markets remain, however, underdeveloped. The term money market is limitedand although there is a domestic yield curve for government securities withmaturities up to 30 years, its depth and liquidity are limited.The Govt. had however stated that if the value of the rupee depreciates to anunreasonable level in the free market operations, the R.B.I. will intervene andcontrol it. This assurances certainly gives credence to the earnestness and sinceritywith which the full convertibility has been announced. Page 34