Currency Convertibility and

its Impact on B.O.P

Convertibility

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.

Classification
Rupee
Convertibility

Current
Account
Convertibility

Capital
Account
Convertibility

Current Account
It refers to currency convertibility required in the
case of transactions relating to exchange of goods
and services, money transfers and all those
transactions that are classified in the current
account.

In Short, Current account includes all

transactions, which give rise to or use of
our National income

Current Account Transactions

1. All imports and exports of merchandise
2. Invisible Exports and Imports
(sale/purchase of services
3. Inward private remittances (to & fro)
4. Pension payments (to & fro)
5. Government Grants (both ways)

Convertibility on Current Account

India is fully convertible on the current account
A full convertibility means movement of funds in
& out of India without any restrictions &
permissions.
Provides full freedom to both residents and nonresidents to trade in goods/services.
RBI has placed a cap in creation of a capital asset
In India, most current account transactions have
been freed from controls over the years.

Contd
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.

Rangarajan Committee
Recommendations
1. Liberalization of current account transactions leading to
current account convertibility
2. a compositional shift in capital flows away from debt- to
non-debt-creating flows
3. strict regulation of external commercial borrowings,
especially short-term debt
4. discouraging volatile elements of flows from nonresident
Indians
5. gradual liberalization of outflows
6. disintermediation of the government in the flow of
external assistance
7. Introducing a market-determined exchange rate regime

Rangarajan CommitteeImplementations
Step-1:Dual exchange rate system
Liberalised Exchange Rate Management System involving dual
exchange rate system was instituted in March 1992
The dual exchange rate system was essentially a transitional stage
leading to the ultimate convergence of the dual rates made effective
from March 1, 1993
Two rates of exchange: Official rate of exchange & Market rate of
exchange
60% of the export earnings could be converted at the free market
determined rate. (which was around Rs.28)
The balance 40% of the earnings should be sold to RBI through
authorised dealers at the official rate of exchange. (generally higher at
Rs.32)

 Step-2:Full convertibility of the current account

This unification of exchange rates brought about the
era of market determined exchange rate regime of
rupee, based on demand and supply in the forex
market.
Liberalize the access to foreign exchange for all
current business transactions including travel,
education, medical expenses, etc.
Under Article VIII of the IMFs Articles of
Agreement in August 1994.

Path that lead to Current Account

Convertibility
After 2000

From 1992 to
2000

Liberalization
began in 1991

Till 1990

Current Situation on Current Account

India is fully convertible on the current
account
Provides full freedom to both residents and
non-residents to trade in goods/services.
RBI has placed a cap in creation of a capital
asset

Capital Account
Capital Account consist of short term and long
term capital transactions
As per FEMA "capital account transaction"
means a transaction which alters the assets or
liabilities, including contingent liabilities,
outside India of persons resident in India or
assets or liabilities in India of persons resident
outside India

Capital Account Transactions

1. Direct Foreign Investments (both inward &
outward)
2. Investment in securities (both inward &
outward)
3. Other Investments (both inward & outward)
4. Government Loans (both inward & outward)
5. Short-term investments (both inward &
outward)

Capital Account Transaction

Capital Account transactions are classified as :1. Portfolio investment involves trade in
securities like stocks, bonds, bank loans,
derivatives, etc.
2. Direct investment involves purchase of real
estate, production facilities, or equity
investment.
3. Other investment involves holdings in loans,
bank accounts and currencies

Capital Account Convertibility

The freedom to convert local financial assets into
foreign financial assets and vice versa at market
determined rates of exchange.
In other words, it means allowing Indians to
purchase both the physical and financial assets
abroad and vice-versa.
In simple language, CAC allows anyone to freely
move from local currency into foreign currency
and back.
It is associated with changes of ownership in
foreign/domestic financial assets and liabilities.

Currently Restriction on Capital

Account are
1.
2.
3.
4.

There are limit to company borrowing abroad

Restriction on foreigner investing in India.
Restriction on amount that FII can hold.
Purchasing a company is allowed but limit
exit on the amount that can be send.
5. Global Diversification of household portfolio
is practically nonexistent.

Limits to Partial CAC

Limits specified by the Reserve Bank of India:1. Private visit abroad is $10,000: of which only $5,000
can be in cash
2. Business travel, the yearly limit is $25,000
3. Gift or donate up to $5,000 in a year.
4. Going abroad for employment, or are going for
studies abroad: the limit in both these cases is
$100,000
5. Investment into foreign stock markets up to the
extent of $25,000 in a year.

TARAPORE COMMITTEE-I

Members of the Committee

Head of Committee: S. S. Tarapore
Surjit S. Bhalla

Ajit Ranade
A. V. Rajwade
R. H. Patil
M. G. Bhide

The Terms Of Reference Of The Committee

i.

To review the experience of various measures of capital account

liberalization in India,

ii. To examine implications of fuller capital account convertibility on

monetary and exchange rate management, financial markets and financial
system,
iii. To study the implications of dollarization in India of domestic assets and
liabilities and internationalization of the Indian rupee,
iv. To survey regulatory framework in countries which have advanced
towards fuller capital account convertibility,
v. To suggest appropriate policy measures and prudential safe- guards to
ensure monetary and financial stability, and
vi. To make such other recommendations as the Committee may deem
relevant to the subject.

Tarapore Committee-I
Recommendations
Direct Investment in Ventures abroad by Indian
Corporate
ECB (External Commercial Borrowing) Ceiling
Foreign Direct and Portfolio Investment and
Disinvestment
should be Governed by
Comprehensive and Transparent Guidelines
Banks may be allowed to Borrow from Overseas
Markets
SEBI Registered Indian Investors may be allowed to
set up Funds for Investment Overseas

Contd
Currency Futures may be Introduced
Participation in Money Markets may be
Widened
RBI should withdraw from Primary Market in
Government Securities
Banks and Financial Institutes should be
allowed to Participate in Gold Markets in India
and abroad and Deal in Gold Products

Preconditions Of The Tarapore

Committee-I Report
Major Pre-Conditions by
Tarapore Committee
1. Reduction in gross fiscal deficit
to 3.5% by 1999-2000
2. The inflation rate for 3 years
should be an average 3% to 5%
3. Forex reserves should at least be
enough to cover 6 months import
cover
4. Gross NPAs to be brought down
to 5% by 1999-2000
5. CRR to be reduced to 3% by
1999-2000
6. Interest Rate to be fully
deregulated

Status as on July 2009

The present fiscal deficit is at 6.8%
Inflation at present is around 4.00%.
The present forex reserves are enough to
cover more than one years imports.
Gross NPA for the banking sector is around
3%
CRR is at 5.00%
All interest rates, except Saving Fund
interest rates, have already been deregulated.

TARAPORE COMMITTEE-II

Tarapore Committee IIRevisiting The Subject Of CAC

Prime Minister Manmohan Singh
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.

Tarapore Committee IIRecommendations

Meeting Fiscal Responsibility and Budget Management
targets
Shifting from present measures of fiscal deficit to public
sector borrowing requirement.
Segregating government debt management and monetary
policy operations
Imparting greater autonomy and transparency in the conduct
of monetary policy
Reduction in the share of government / RBI in the capital of
public sector banks.

Capital Controls in India

India maintains an extensive capital control regime
Controls have been quantity-based rather than markets based
Oriented towards limiting the countrys external debt
Controls remain on the external exposure of pension
funds, insurance companies etc. The external assets of
banks are closely monitored

Stricter controls on short term rather than long term inflows

What Will Full Capital Account

Convertibility Do?

Reduction in Cost of Capital

Help in Diversifying Portfolio Internationally

Improve the efficiency of the financial sector through

greater competition

Reduce Size of Black Economy

Issues to FCAC
Capital Flight
Credit and liquidity risks
Risk of regulatory arbitrage include new dimensions

Increased cross-border transactions will augment the

dimensions of risks that Indian financial institutions
face in their domestic markets

Pre-Requisites
These include:
1. Comfortable Current Account Position.
2. Maintenance of Domestic Economic Stability.
3. Adequate Foreign Exchange Reserve.
4. Restriction on inessential Import.
5. An Appropriate Industrial Policy.

The Road Ahead

India proceeds gradually towards CAC
Reform of Indian financial system is a precondition
Banking sector reform is required on a grand scale

THANK YOU!