CONVERTIBILITY MAHESH.docx

7/27/2019 CONVERTIBILITY MAHESH.docx

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CONVERTIBILITY

Convertibility is the quality that allows money or other financial instruments to be converted

into otherliquid stores of value. Convertibility is an important factor in international trade, where

instruments valued in different currencies must be exchanged

Convertibility first became an issue of significance during the time banknotesbegan to

replace commodity money in the money supply. Under the gold and silver standards, notes were

redeemable forcoin at face value, though often failing banks and governments would overextend

their reserves.

Historically, the banknote has followed a common or very similar pattern in the western nations.

Originally decentralized and issued from various independent banks, it was gradually brought

under state control and became a monopoly privilege of the central banks. In the process, the fact

that the banknote was merely a substitute for the real commodity money (gold and silver) was

gradually lost sight of.

Under the gold exchange standard, for example the Bretton Woods Institutions, banks of issue

were obliged to redeem their currencies in gold bullion, or in United States Dollars- which in

turn were redeemable in gold bullion at an official rate of $35/troy ounce. Due to limited growth

in the supply of gold reserves, during a time of great inflation of the dollar supply, the United

States eventually abandoned the gold exchange standard and thus bullion convertibility in 1974.

Under the contemporary international currency regimes, all currencies' inherent value derives

from fiat, thus there is no longer any thing(gold or other tangible store of value) for which paper

notes can be redeemed.
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Officially, the Indian rupee has a market-determined 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 the US dollaris a de facto controlled

exchange rate. This is sometimes called a "managed float". Other rates (such as the EUR/INR

and INR/JPY) have the volatility typical offloating exchange rates, and often create

persistant arbitrage opportunities against the RBI. Unlike China,

successive administrations(through RBI, the central bank) have not followed a policy of pegging

the INR to a specific foreign currency at a particular exchange rate. RBI intervention in currency

markets is solely to ensure low volatility in exchange rates, and not to influence the rate (or

direction) of the Indian rupee in relation to other currencies.

Also affecting convertibility is a series ofcustoms regulations restricting the import and export

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

nationals can import and export only up to 7,500 rupees at a time, and the possession of 500- and

1,000-rupee notes in Nepal is prohibited.

RBI also exercises a system ofcapital controls in addition to intervention (through active

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

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

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

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

capital out of the country in order to expand globally. However, local households are restricted in

their ability to diversify globally. Because of the expansion of the current and capital accounts,

India is increasingly moving towards full de facto convertibility.
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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 under any circumstances due to gold's

lack of liquidity therefore, money cannot be changed into gold by the RBI. India follows the

same principle as Great Britain and the U.S.

CURRENCY TRADING

Freely convertible currencies have immediate value on the foreign exchange market, and few

restrictions on the manner and amount that can be traded for another currency. Free

convertibility is a major feature of a hard currency.

Some countries pass laws restricting the legal exchange rates of their currencies, or requiring

permits to exchange more than a certain amount. Some currencies, such as theNorth Korean

won, the Transnistrian ruble and the Cuban national peso, are officially nonconvertible and can

only be exchanged on the black market. If an official exchange rate is set, its value on the black

market is often lower.

Convertibility controls may be introduced as part of an overall monetary policy. For example,

restrictions on the Argentine peso were introduced during an economic crisis in the 1990s, and

scrapped in 2002 during a subsequent crisis.
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Definition of 'Currency Convertibility'

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.

The ability to exchange money forgold or othercurrencies. Some governments which do not

have large reserves ofhard 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.

Investopedia explains 'Currency Convertibility'

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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TYPES

CAPITAL ACCOUNT CONVERTIBILITY

Capital Account Convertibility is a monetary policy that centers around the ability to conduct

transactions of local financial assets into foreign financial assets freely and at market determined

exchange rates. It is sometimes referred to as Capital Asset Liberation.

It is basically a policy that allows the easy exchange of local currency (cash) for foreign currency

at low rates. This is so local merchants can easily conduct transnational business without needing

foreign currency exchanges to handle small transactions. Capital Account Convertibility is

mostly a guideline to changes of ownership in foreign or domestic financial assets and liabilities.

Tangentially, it covers and extends the framework of the creation and liquidation of claims on, or

by the rest of the world, on local asset and currency markets.

Capital Account Convertibility is a monetary policy that centers around the ability to conduct

transactions of local financial assets into foreign financial assets freely and at market determined

exchange rates. It is sometimes referred to as Capital Asset Liberation.



foreign currency exchanges to handle small transactions. Capital Account Convertibility is

mostly a guideline to changes of ownership in foreign or domestic financial assets and liabilities.

Tangentially, it covers and extends the framework of the creation and liquidation of claims on, or

by the rest of the world, on local asset and currency markets.


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foreign currency exchanges to handle small transactions. CAC is mostly a guideline to changes

of ownership in foreign or domestic financial assets and liabilities. Tangentially, it covers and

extends the framework of the creation and liquidation of claims on, or by the rest of the world,

on local asset and currency markets.

Capital Account Convertibility has 5 basic statements designed as points of action:

1. All types of liquid capital assets must be able to be exchanged freely, between any two

nations, with standardized exchange rates.

2. The amounts must be a significant amount (in excess of $500,000).

3. Capital inflows should be invested in semi-liquid assets, to prevent churning and excessive

outflow.

4. Institutional investors should not use Capital Account Convertibility to manipulate fiscal

policy or exchange rates.

5. Excessive inflows and outflows should be buffered by national banks to provide collateral.

The status of capital account convertibility in India for various non-residents is as follows: for

foreign corporates, and foreign institutions, there is a reasonable amount of convertibility; for

non-resident Indians (NRIs) there is approximately an equal amount of convertibility, but one

accompanied by severe procedural and regulatory impediments. For non-resident individuals

other than NRIs, there is near-zero convertibility. Movement towards an Fuller Capital Account

Convertibility implies that all non-residents (corporates and individuals) should be treated

equally. This would mean the removal of the tax benefits presently accorded to NRIs via special

bank deposit schemes for NRIs, viz., Non-Resident External Rupee Account [NR(E)RA] and


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Foreign Currency Non-Resident (Banks) Scheme [FCNR(B)]. Non-residents, other than NRIs,

should be allowed to open FCNR(B) and NR(E)RA accounts without tax benefits, subject to

Know Your Customer (KYC) and Financial Action Task Force (FATF) norms. In the case of the

present NRI schemes for various types of investments, other than deposits, there are a number of

procedural impediments and these should be examined by the Government and the RBI.

A person resident in India is permitted to open, hold and maintain with an Authorized Dealer in

India a Foreign Currency Account known as Exchange Earners Foreign Currency (EEFC)

Account subject to the terms and conditions of the Exchange Earners Foreign Currency Account

Scheme specified. Further, all categories of foreign exchange earners are allowed to credit up to

100 per cent of their foreign exchange earnings, as specified in the paragraph 1 (A) of the

Schedule, to their EEFC Account.

All categories of foreign exchange earners are allowed to credit up to 100 per cent of their

foreign exchange earnings, as specified in the paragraph 1 (A) of the Schedule, to their EEFC

Account. As such, it will be in order for the Authorised Dealers to allow

SEZ developers to open, hold and maintain EEFC Account and to credit up to 100 per cent of

their foreign exchange earnings, as specified in the paragraph 1 (A) of the Schedule.

Any person resident in India,

i) may take outside India (other than to Nepal and Bhutan) currency notes of Government of

India and Reserve Bank of India notes up to an amount not exceeding Rs.7,500 (Rupees seven

thousand five hundred only) per person; and


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ii) who had gone out of India on a temporary visit, may bring into India at the time of his return

from any place outside India (other than from Nepal and Bhutan), currency notes of Government

of India and Reserve Bank of India notes up to an amount not exceeding Rs.7,500 (Rupees seven

thousand five hundred only) per person.

According to Regulation 7 of the Foreign Exchange Management (Foreign Currency Accounts

by a Person Resident in India) Regulations, 2000,

(i) A citizen of a foreign State, resident in India, being an employee of a foreign company or a

citizen of India, employed by a foreign company outside India and in either case on deputation to

the office /branch /subsidiary /joint venture in India of such foreign company may open, hold and

maintain a foreign currency account with a bank outside India and receive the whole salary

payable to him for the services rendered to the office/branch/subsidiary/joint venture in India of

such foreign company, by credit to such account, provided that income-tax chargeable under the

Income-tax Act,1961 is paid on the entire salary as accrued in India.

(ii) A citizen of a foreign State resident in India being in employment with a company

incorporated in India may open, hold and maintain a foreign currency account with a bank

outside India and remit the whole salary received in India in Indian Rupees, to such account, for

the services rendered to such an Indian company, provided that income-tax chargeable under the

Income-tax Act, 1961 is paid on the entire salary accrued in India.

It would be desirable to consider a gradual liberalisation for resident corporates/business entities,

banks, non-banks and individuals. The issue of liberalisation of capital outflows for individuals

is a strong confidence building measure, but such opening up has to be well calibrated as there

are fears of waves of outflows. The general experience is that as the capital account is liberalised


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for resident outflows, the net inflows do not decrease, provided the macroeconomic framework is

stable.

As India progressively moves on the path of convertibility, the issue of investments being

channeled through a particular country so as to obtain tax benefits would come to the fore as

investments through other channels get discriminated against. Such discriminatory tax treaties

are not consistent with an increasing liberalisation of the capital account as distortions inevitably

emerge, possibly raising the cost of capital to the host country. With global integration of capital

markets, tax policies should be harmonised. It would, therefore, be desirable that the

Government undertakes a review of tax policies and tax treaties.

A hierarchy of preferences may need to be set out on capital inflows. In terms of type of flows,

allowing greater flexibility for rupee denominated debt which would be preferable to foreign

currency debt, medium and long term debt in preference to short-term debt, and direct

investment to portfolio flows. There are reports of large flows of private equity capital, all of

which may not be captured in the data (this issue needs to be reviewed by the RBI). There is a

need to monitor the amount of short-term borrowings and banking capital, both of which have

been shown to be problematic during the crisis in East Asia and in other EMEs.

Greater focus may be needed on regulatory and supervisory issues in banking to strengthen the

entire risk management framework. Preference should be given to control volatility in cross-

border capital flows in prudential policy measures. Given the importance that the commercial

banks occupy in the Indian financial system, the banking system should be the focal point for

appropriate prudential policy measures


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Advantages of Capital Account Convertibility:

1. It encourages short term investments from foreigners

2. It makes it easier for a countrys citizens to invest in companies or properties abroad

Disadvantages of Capital Account Convertibility:

1. It makes it difficult for Indias producers as they now need to compete with international

producers who may be subsidized by their home countrys currency which have a low rate of

exchange. Example: China

2. It takes away investments from Indian companies


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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 paymentsreceive 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,

engaging the service of foreign consultants etc.


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Current account convertibility" is a term that is used to describe the flow of funds into and out of an

account that are not connected with some type of capital income or expense. Typically,

transactions that would be considered part of a current account convertibility would have to do

with trade-related issues such as the purchase of goods or services like the purchase of a new

kitchen appliance or paying for air fare as part of a travel package. This is different from capital

account convertibility, which would involve transactions such as making payments on loans or

using funds to purchase investments that constitute capital assets orliabilities.

Typically, current account convertibility takes place when the transactions involved require some

type of currency conversion in order to be completed. For example, if a consumer in the United

States wished to purchase a CD directly from a customer based in the United Kingdom using

funds in his or herchecking account, the transaction would involve converting the currency from

US dollars to the British pound. In like manner, if a customer wished to purchase and import

goods from a foreign supplier, there is a good chance that a currency conversion would be

involved that would make it necessary to be aware of the current rate of exchange and apply that

rate to the transaction.

The determination of whether or not a transaction involves current account convertibility or

capital account convertibility often depends on specific financial and trade regulations that apply.

These regulations are often set by the countries involved in the transaction. At times, the focus is

on the total amount of the transaction, with smaller figures considered a current account

transaction and any figures exceeding a certain threshold being considered a capital account

transaction. In some nations, transactions involving specific goods such as heavy equipment are

processed as a capital account convertibility regardless of the amount of funds involved.
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A current account convertibility does not necessary have to be involved in the purchase of goods

or services. Money transfers may also involve this type of conversion strategy. For example, if

one party chooses to wire funds to a recipient residing in a different country, the conversion is

conducted at the current rate of exchange that is applicable to the date of the transaction. Since

the rate of exchange between the two currencies involved can change quickly, it is important to

determine that current rate just before the transaction is initiated.

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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Fully convertible currency

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

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

market.

Partially convertible currency

The Indian rupee is only partially convertible due to the Indian Central Banks control over

international investments flowing in and out of the country. While most domestic trade

transactions are handled without any special requirements, there are still significant restrictions

on international investing and special approval is often required in order to convert rupees into

other currencies. Due to Indias strong financial position in the international community, there is

discussion of allowing the Indian rupee to float freely on the market, altering it from a partially

convertible currency to a fully convertible one.

Nonconvertible currency

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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Convertibility is the quality of paper money substitutes which entitles the holder to redeem them

on demand into money proper.

Nonconvertible currency Also known as a "blocked currency" Any currency that is used

primarily for domestic transactions and is not openly traded on 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 anations 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. 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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Currency Convertibility : Indian and Global Experiences

Currency convertibility, as an aspect of a country's exchange rate policy, refers to the ease with

which domestic currency can be traded for foreign currency, for a particular usage and at a given

exchange rate. Currency convertibility policy of a government has two aspects: (a) current

account convertibility and (b) capital 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. In other words, it permits free inflows and

outflows for all purposes other than for capital purposes. Capital account convertibility allows

freedom to make investment in foreign equity, extend loans to foreigners, buy real estate in

foreign lands and vice versa. Broadly speaking, it allows anyone to move freely from local

currency into foreign currency and back. Current account convertibility was introduced in India

in August 1994 with the acceptance of the obligations under Article VIII of the IMF's Articles of

Agreement. This drastic measure contributed significantly to boost India's exports. Presently,

there is almost full convertibility on the current account and partial convertibility on the capital

account. This book explains and examines various aspects of currency convertibility risks and

their management.

With focus on India, it discusses convertibility experiences of a number of Latin American

Countries (Argentina, Brazil, Mexico, Chile, Colombia, Peru, Paraguay, Venezuela, Bolivia, and

Ecuador) and selected countries of East and South-East Asia (Thailand, South Korea, Indonesia,

Malaysia, and Philippines). The experiences of these countries, in a comparative perspective,

will help to understand the requisites of a regime of sustainable convertibility.


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Freely convertible currency

Convertibility - quality which allows money or other financial instruments to be transformed to

other liquid funds of savings. Convertibility is the important factor in international trade where

the tools evaluated in various currencies, should be interchanged. It is hard currencies have

direct value in the currency market, and it is a little restrictions in order and the size which they

can be interchanged for other currency. Free convertibility - a hard currency key feature.

Some countries pass the laws limiting legal exchange rates of the currencies, or requiring

the permission to an exchange of more certain sum. Some currencies, such as North Korean

wons and Cuban peso, are officially unconvertible and can be interchanged only on a kerbs

market. If the exchange official rate, its cost on a kerbs market frequently is positioned more

low. Control facilities behind convertibility can be entered within the limits of the general

monetary policy. For example, restrictions on Argentinean peso have been entered into

economic crisis time in 1990th years and revised in 2002 during the subsequent crisis.

The Question on convertibility has risen for the first time during replacement in a monetary stock

of commodity money notes. At gold and silver standards, notes interchanged on coins face value

though often enough problem banks and the governments exhausted the reserves. Under a gold

standard reflected in the Bretton-Vudsky agreement, issuing houses have been obliged to redeem

the currencies in gold ingots or in US dollars which in turn, were subject to settlement in gold

ingots on an official rate of 35 US dollars for troy ounce. Because of the limited growth of

deliveries of gold, during the big inflation of dollar, the United States in long run have refused

the gold exchange standard and investment convertibility in 1974.


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INDIAN RUPEE


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INDIAN RUPEE

The Indian rupee ( ) is the official currency of the Republic of India. The issuance of the

currency is controlled by the Reserve Bank of India.

The modern rupee is subdivided into 100paise(singularpaisa), though as of 2011 only 50-paise

coins are legal tender.[2][3]Banknotes are available in nominal values of 5, 10, 20, 50, 100, 500

and 1000 rupees. Rupee coins are available in denominations of 1, 2, 5, 10, 100 and 1000; of

these, the 100 and 1000 coins are for commemorative purposes only; the only other rupee

coin has a nominal value of 50 paise, since lower denominations have been officially withdrawn.

The Indian rupee symbol (officially adopted in 2010) is derived from

the Devanagari consonant "" (Ra) with an added horizontal bar. The symbol can also be derived

from the Latin consonant "R" by removing the vertical line, and adding two horizontal bars (like

the symbols for the Japanese yen and the euro). The first series of coins with the rupee symbol

was launched on 8 July 2011.

The Reserve Bank manages currency in India.The Reserve Bank derives its role in currency

management on the basis of the Reserve Bank of India Act, 1934. Recently RBI launched a

website Paisa-Bolta-Hai to raise awareness of counterfeit currency among users of the INR.
http://en.wikipedia.org/wiki/Currencyhttp://en.wikipedia.org/wiki/Republic_of_Indiahttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/Paisehttp://en.wikipedia.org/wiki/Paisehttp://en.wikipedia.org/wiki/Paisehttp://en.wikipedia.org/wiki/Legal_tenderhttp://en.wikipedia.org/wiki/Indian_rupee#cite_note-2http://en.wikipedia.org/wiki/Indian_rupee#cite_note-2http://en.wikipedia.org/wiki/Indian_rupee_signhttp://en.wikipedia.org/wiki/Devanagarihttp://en.wikipedia.org/wiki/Ra_(disambiguation)#Educationhttp://en.wikipedia.org/wiki/Japanese_yenhttp://en.wikipedia.org/wiki/Eurohttp://www.paisaboltahai.rbi.org.in/http://www.paisaboltahai.rbi.org.in/http://en.wikipedia.org/wiki/Eurohttp://en.wikipedia.org/wiki/Japanese_yenhttp://en.wikipedia.org/wiki/Ra_(disambiguation)#Educationhttp://en.wikipedia.org/wiki/Devanagarihttp://en.wikipedia.org/wiki/Indian_rupee_signhttp://en.wikipedia.org/wiki/Indian_rupee#cite_note-2http://en.wikipedia.org/wiki/Indian_rupee#cite_note-2http://en.wikipedia.org/wiki/Legal_tenderhttp://en.wikipedia.org/wiki/Paisehttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/Republic_of_Indiahttp://en.wikipedia.org/wiki/Currency


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RUPEE CONVERTIBILITY

Convertibility can be related as the extent to which a country's 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.

After liberalization began in 1991, the government eased the movement of foreign currency on

trade account. I.e. exporters and importers were allowed to buy and sell foreign currency, as long

as the items that they are exporting and importing were not in the banned list. They need not get

permission on a CASE TO CASE basis as was prevalent in the earlier regime. This was the first

concrete step the economy took towards making our currency convertible on trade account.

In the next two to three years, government liberalized the flow of foreign exchange to include

items like amount of foreign currency that can be procured for purposes like travel abroad,

studying abroad, engaging the services of foreign consultants etc. This set the first step towards

getting our currency convertible on the current account.


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What it means is that people are allowed to have access to foreign currency for buying a whole

range of consumable products and services. These relaxations coincided with the liberalization

on the industry and commerce front - which is why we have Honda City cars, Mars chocolate

bars and Bacardi in India.

There was also simultaneous relaxation on the restriction on the funds that foreign investors can

bring into India to invest in companies and the stock market in the country. This step led to

partial convertibility on the Capital Account.

In response to this the Reserve Bank of India set up the Tara pore Committee to work out another

roadmap for current account convertibility. Full 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.

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.


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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.

Advantages

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.


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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. 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.150,000 Crores of uncollected taxes

and Rs.120,000 Crores 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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Disadvantages

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 1860 and 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 and then they can suddenly sell all to

gain enormous profit. That will drive down Rupee to a very low depth suddenly. If the Reserve

Bank of India wants to protect Rupee in such a situation, within a few days India will have no

foreign exchange left in reserve and the country will go bankrupt.

CONCLUSION

The rupee exchange rate is neither completely free-floating nor fixed, but is managed by the

Reserve Bank of India through buying and selling other currencies. Up until April, the Reserve

Bank was buying lots of U.S. dollarsperhaps as much as $24 billion in the previous six

monthsto keep the rupee at around 44 to the dollar. But with investor sentiment so hot on

India and money pouring in from abroadinternational investors have bought more than $7.5

billion worth of Indian stocks so far this year, compared to $8 billion in all of 2006the

Reserve Bank found itself having to spend more and more on foreign currencies just to keep the


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rupee stable. When inflation shot up to over 6% in April, Bank officials appeared to decide

they never comment explicitly on such mattersto stop buying dollars. The result was, over the

next couple of months, a strengthening of the rupee to close to 40 to $1.

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.

During the days of the British Raj, Rupee was convertible, India had very large surplus in the

balance of payments. Indias share in the world trade was much higher than what it is today.

However, millions of Indians used to starve to death from time to time; millions of acres of land

were left uncultivated by the bankrupt farmers; there were hardly any industry except for a few

textile mills, only 15 percent of the population had any education at all. Yet at the same time, one

could buy Rolls Royce and Scotch whisky in Bombay and Calcutta; Jinnah could buy his

apartment in Bond Street of London; Maharaja of Patiala could build palace in Paris. We are

returning back to those days through the acts of an un-elected (only selected for the upper hose

of the parliament) Prime Minister Man Mohan Singh whose loyalty is not to the people of India

but to the international financial institutions.

The strengthening rupee may also send an even more important signal: India is not China. It

helps of course that Indias trade surplus with the U.S. last year was just $11.7 billion compared

to Chinas whopping $232.5 billion. But by allowing the rupee to strengthen over the past few

months, India is showing its prepared to play much more fairly in the global market. India is

seen as a more or less unambiguous ally to the U.S.


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Of course, the Reserve Bank could still intervene to push Indias rupee lower again. But both the

anonymous government official warning of rupee-related job losses and investors see the rupee

continuing to rise in the coming months. If that happens expect to hear a lot more bleating from

Indias exporters and not a word of complaint from Indias trading partners around the world.

Capital account convertibility is considered to be one of the major features of a developed

economy. It helps attract foreign investment. It offers foreign investors a lot of comfort as they

can re-convert local currency into foreign currency anytime they want to and take their money

away.

At the same time, capital account convertibility makes it easier for domestic companies to tap

foreign markets. At the moment, India has current account convertibility. This means one can

import and export goods or receive or make payments for services rendered. However,

investments and borrowings are restricted.

But economists say that jumping into capital account convertibility game without considering the

downside of the step could harm the economy. The East Asian economic crisis is cited as an

example by those opposed to capital account convertibility.

Even the World Bank has said that embracing capital account convertibility without adequate

preparation could be catastrophic. But India is now on firm ground given its strong financial

sector reform and fiscal consolidation, and can now slowly but steadily move towards fuller

capital account convertibility.


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DANGER / RISK OF CONVERTIBILITY

INDIA should revisit the issue of "capital account convertibility" (CAC) of the rupee that first

surfaced in the mid-1990s, Prime Minister Manmohan Singh said in Mumbai in early March.

Immediately after it first surfaced in the form of the Tarapore Committee Report, the South-East

Asian crisis of 1997, which afflicted Asian countries with more open capital accounts but left

untouched countries like China and India with restrictions on cross-border capital account

transactions, had put paid to that idea. The situation has changed substantially since then,

according to the Prime Minister, with high growth, low inflation and large foreign exchange

reserves warranting a rethink on the issue.

Taking its cue from there, the Reserve Bank of India (RBI) has constituted a committee to draw

up a new road map to convertibility, with former RBI Deputy Governor S.S. Tarapore, a CAC

votary, at the helm, and a majority of members who favour such a transition. Moreover, Finance

Minister P. Chidambaram has decided to launch a campaign in support of the move to full

convertibility, even publicly admonishing unnamed RBI officers who have reservations on the

issue.

What does CAC in the current Indian context signify? The phrase, we must not forget, is largely

descriptive. Convertibility on the capital account does not exist if there is a ban either on

residents converting rupees into foreign exchange for investment in real or financial assets

(termed capital as opposed to current account transactions), or on foreigners converting foreign

exchange into rupees for similar purposes. A country is characterised as having partial

convertibility on the capital account if there are restrictions on either residents or foreigners


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converting currency for the above-mentioned transactions but no ban on at least one side

resorting to such conversion.

It needs to be noted that having the right to convert currency for acquisition of assets or

investment abroad does not imply that any and every kind of investment can actually be

undertaken. That depends on the foreign investment rules relating to the specific sector in the

country in which investment is being contemplated. Many countries with convertible currencies

have strong restrictions on foreigners acquiring real estate for personal use or investing in the

media, for example.

Seen in this light, the distinction between countries that have or do not have CAC is meaningless.

For example, there is virtually no country now where foreign investment, or the conversion of

foreign currency into domestic currency by foreigners for acquisition of assets, is not permitted.

In fact, in most not only are such acquisitions possible, but post-acquisition returns from those

assets earned in local currency can be "converted" and repatriated or those assets can be sold and

the proceeds repatriated abroad as foreign currency. This is possible in India too, though, as

elsewhere, there are some restrictions on the sectors in which this is possible and norms on the

maximum share of equity that can be acquired in single firms in individual sectors. But there are

no restrictions on the aggregate amount of foreign currency that can be brought into the country

by a single entity for investment purposes.


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The dangers of opening doors on this front are clear from the experience of a number of

developing countries, especially in Latin America. The exit of resident rather than foreign capital

was responsible for balance of payments and currency crises there. If any set of factors, domestic

or external, generates the expectation that the domestic currency (say, the rupee) might

depreciate, the exit from domestic assets would be far greater than in a situation where only

foreign investors have the right to opt out. This could happen, for example, if the trade and

current account deficits widen because of an increase in oil prices, as is happening now. The

resulting outflow could lead to expectations being realised, in the form of an actual depreciation

of the rupee, which can result in capital flight. This is only one of the many dangers, though an

important one, that full CAC would open the country too.

Advocates of CAC argue, of course, that there is no need for such lack of self-confidence given

India's recent economic performance. But the experience of the "miracle" countries of South-

East Asia during the late 1990s indicates that economic strength, economic performance and

even better macroeconomic indicators may not insulate countries against financial fragility. The

case for caution cannot, therefore, be dismissed as reflecting a lack of confidence.

Given this prospect, unless full CAC is going to deliver something that India currently lacks,

there is no need to even consider it. It is argued that the move to full CAC may increase the

confidence of foreign investors and result in more foreign capital inflow into the country. The

point is, India today is receiving more capital that it can absorb, forcing the RBI to purchase

foreign currency and invest it in liquid foreign assets that offer a far lower return than what is

garnered by the investors who brought that currency in. But this, CAC votaries argue, is foreign

portfolio investment and not foreign direct investment (FDI), which is what the country needs.


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The obvious response to this is that China, which receives the largest share of aggregate FDI

flows to developing countries, is no paragon of openness on the capital account.

In short, the call to revisit CAC at a time when the country's rich are sitting pretty, seems to be

driven by some other objective. It could, for example, be that domestic financial investors are

sensing that the ongoing unprecedented and irrational stock market boom is bound to go bust.

That would result in financial and real asset deflation that could make paupers out of princes.

But if wealth-holders have the option to sell out and leave, they may be able to escape that

outcome. The government may be giving in to pressure and paving the way for the very rich to

exit leaving the rest of us with bales of worthless paper.


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BIBLIOGRAPHY

http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/72250.pdf

http://www.mysmp.com/forex/convertible-currency.html

http://en.wikipedia.org/wiki/Convertibility

http://economics.about.com/od/foreigntrade/a/bretton_woods.htm

http://www1.uni-hamburg.de/RRZ/R.Tiwari/papers/exchange-rate.pdf

http://financial-dictionary.thefreedictionary.com/Fixed+currency

Documents

CONVERTIBILITY MAHESH.docx