CONVERTIBILITY OF RUPEES

Prepared by Ashutosh Singh Rakesh Singh Saurabh Singh Rajesh Kamuni Nanda Kumar

DEFINITION

Convertibility essentially means the ability of residents and nonresidents to exchange domestic currency for foreign currency, what ever be the purpose of the transaction. Free convertibility refers to officially sanctioned market mechanism for currency conversion.

BALANCE OF PAYMENTS(BOP)
Balance of Payment refers to the statement of accounts recording, all economic transactions of a country with rest of the world. Also, BoP is known as Statements of Accounts of these receipts. Economic Transactions in BoP: 1) Visible Items (Eg. Goods) 2) Invisible Items (Eg. Services) 3) Capital Transfers (Eg. Transfer of Assets)
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CATEGORIES

Convertibility of Rupees

Current Account

Capital Account

CURRENT ACCOUNT
Current Account is that account which records imports and exports of goods, services and unilateral transfers.
Components of Current Account: 1) Exports and Imports of goods. 2) Exports and Imports of services. 3) Unilateral transfers from one country to the other.
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COMPONENTS OF CURRENT ACCOUNT

Goods: It includes General merchandise, Repairs on goods and services like transportation, communication services, Construction services, Insurance and Financial services. Services: It covers the provision of insurance to non residents by resident insurance enterprises and vice versa. This item comprises services provided for freight insurance (on goods exported and imported), services provided for other types of direct insurance (including life and non-life), and services provided for reinsurance.

COMPONENTS OF CURRENT ACCOUNT

Unilateral Transfers: Compensation of employees covers wages, salaries, and other benefits, in cash or in kind, and includes those of border, seasonal, and other nonresident workers.

GOVERNMENT INITIATIONS

After Liberalization, in the year 1992, Indian Finance Minister Dr.Manmohan Singh allowed current account convertibility of rupees. The exporters and importers were allowed free conversion of rupees.

PARTIAL RUPEE CONVERTIBILITY

The government introduced a system of Partial Rupee Convertibility (PCR) (i.e. convertibility only in Current Account Convertibility not in capital) 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.

PARTIAL RUPEE CONVERTIBILITY

Government liberalized the flow of foreign exchange to include items like amount of foreign currency that can be procured for purpose like travel abroad, studying abroad, engaging the service of foreign consultants, etc. Because of this PCR we have imported cars, consumer goods, like Ferrari, Porsche cars, etc.

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CURRENT ACCOUNT- PRESENT SCENARIO

Indian scenario - fully convertible. Full freedom to both residents and nonresidents. Freedom in respect of payments and transfers for current international transactions.

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CAPITAL ACCOUNT
Capital Accounts is that account which records all such transactions between residents of a country and rest of the world which cause a change in asset or liabilities status of the residents of a country or its government. Components of Capital Account: 1) Foreign Investments 2) Loans

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COMPONENTS OF CAPITAL ACCOUNT

Foreign Investments: FDI: Purchase of assets in rest of world which allows control over the assets. Portfolio Investments: Purchase of assets in rest of world without any control over the assets. Loans: Commercial Borrowings: It refers to borrowings by a country from the international money market.

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COMPONENTS OF CAPITAL ACCOUNT

Borrowing from external Assistance: Borrowing by a country with consideration of assistance Banking Capital Transactions: Transactions of external financial assets and liability of commercial banks and co-operative banks operating as authorized dealers in foreign exchange

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CAPITAL ACCOUNT CONVERTIBILITY

Capital account convertibility is a feature of a nation's financial regime that centers on the ability to conduct transactions of local financial assets into foreign financial assets freely and at country determined exchange rates If Currency is fully capital account convertible, then anybody from anywhere in the world can invest in any asset in that currency. Then local merchants can easily conduct transnational business freely without any regulation.
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CAPITAL ACCOUNT CONVERTIBILITY

Thus, Indians could convert their rupees into dollars and use it in the US if there was capital account convertibility here. However full CAC is not allowed in India and the government has its own rules and policies to regulate foreign investments.

This would lead to an irrational demand for dollar and would cause a free fall in the value of the Indian Rupee, thereby detrimentally affecting the economy.

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TARAPORE COMMITTEE
In 1997 the government had set up a committee (Tarapore committee) to spell out a road map for the full convertibility of the rupee. Under the Tarapore Committee recommendations, this was possible only when the following conditions were satisfied:

The average rate of inflation should vary between 3% to 5% during the debt-servicing time. Decreasing the gross fiscal deficit to the GDP ratio by 3.5% in 1999-2000. Non-performing assets (NPAs) need to be brought down to 5% Cash Reserve Ratio (CRR) needs to be reduced to 3% A monetary exchange rate band of plus minus 5% should be instituted

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DISADVANTAGES OF FULL CAC

Frequent inflow and outflow of capital resulting into destabilizing of the economy if it is not robust to withstand such fluctuations. Example: East Asian financial crisis of late 1990s. o An open capital account can lead to the export of domestic savings o Under the threat of a crisis, the domestic savings too might leave the country along with the foreign investments, thereby rendering the government helpless to counter the threat.

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