At the same time, average effective CRR needs to be brought down from the current 9.3% to 3%. The Indian rupee is a different currency from the Pakistani rupee (used in the Republic of Pakistan) and the Nepalese rupee (used in the Federal Democratic Republic of Nepal). (ii) The Governments should fix the annual inflation target below 4 per cent. This was called mandated inflation target — and give foil freedom to RBI to use monetary weapons to achieve the inflation target. The Government should also set up a Consolidated Sinking Fund (CSF) to reduce Government debt.
In a way, capital account convertibility removes all the restrains on international flows on India’s capital account. There is a basic difference between current account convertibility and capital account convertibility. In the case of current account convertibility, it is important to have a transaction – importing and exporting of goods, buying and selling of services, inward or outward remittances, etc. involving payment or receipt of one currency against another currency. In the case of capital account convertibility, a currency can be converted into any other currency without any transaction. Convertibility of currency means when currency of a country can be freely converted into foreign exchange at market determined rate of exchange that is, exchange rate as determined by demand for and supply of a currency. For example, convertibility of rupee means that those who have foreign exchange (e.g. US dollars, Pound Sterlings etc.) can get them converted into rupees and vice-versa at the market determined rate of exchange.
Convertible bonds: pros and cons for companies and investors
Also, advocating for the rupee to become an official currency in international organizations would raise its profile and acceptance. However, Indians still require regulatory approvals if they want to invest an amount above a pre-determined threshold level for the purpose of investments or purchasing assets overseas. Similarly, incoming foreign investments in certain sectors (like insurance or retail) are capped at a specific percentage and require regulatory approvals for higher limits.
But full convertibility of currency for capital account transactions is still a distant dream. Rupee convertibility refers to the ability to freely exchange the Indian rupee for other foreign currencies or assets without significant restrictions or controls imposed by the Reserve Bank of India (RBI) or the government. It allows for the conversion of rupees into other currencies at market rates, enhancing international trade and investment.
At present, there are limits on investment by foreign financial investors and also caps on FDI ceiling in most sectors, for example, 74% in banking and communication, 49% in insurance, 0% in retail, etc. In the seventies and eighties many countries switched over to the free convertibility of their currencies into foreign exchange. By 1990, 70 countries of the world had introduced currency convertibility on current account and another 10 countries joined them in 1991. Current account convertibility means when foreign exchange (e.g. Pound Sterling, U.S.Dollar etc) received for export of merchandise and services can be freely converted into Indian rupees and vice-versa in case of imports. In India, some decades back, the exchange rate convertibility of rupee implies was controlled by RBI for conversion of Indian currency into foreign exchange.
Any currency may be current account convertible, capital account convertible, or both. The rupee is partially convertible because it is current account convertible but not capital account convertible. This means that although there is a lot of freedom to exchange local and foreign currency at market rates, a few important restrictions remain for higher amounts, and these still need approval. It is still possible to bring in foreign capital or take out local money for these purposes. However, there are ceilings imposed by the government, and transactions beyond those thresholds require approval.
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By virtue of this control all the foreign exchange earned was to be sold to authorized dealer and if we want to purchase foreign exchange we have to seek permission of central bank. The main purpose behind this was to utilize the foreign exchange earned by the residents as per the priorities fixed by the government. These controls were necessary at that time as India was underdeveloped country and its exports were limited to agricultural product and raw material and it used to import only consumable goods.
Currency Convertibility is the ease with which a country’s currency can be converted into gold or another currency. After the collapse of Breton Woods’s system in 1971, the various countries switched over to the floating foreign exchange rate system. Under the floating or flexible exchange rate system, exchange rates between different national currencies are allowed to be determined through market demand for and supply of the same. (c) Capital account convertibility means free conversion of cross-border capital flows. Any entity can convert domestic currency into hard currency at the prevailing market rate and take hard currency out of the country without the need of offering any explanation. In India there are conflicting views regarding whether to move towards full convertibility of capital account or not.
There would be no limit on inflow or outflow of capital for various purposes including investments, remittances, or asset purchases/sales. During the times when the financial markets of an economy are doing good , a country may receive huge foreign investment. For example when the federal reserve Bank of America gave a sign that they are going increase the interest rates the foreign Institutional investors who invested their dollars in Indian stock market had withdrawn their investment from India which adversely impacted the rupee value. When currency reforms were enacted at the end of the 20th century, the rupee was made partially convertible for goods, services, and merchandise only. During the mid-1990s, the rupee was fully made current account convertible for all trading activities, remittances, and indivisibles.
(b) Indian investment abroad up to US $ 4 million is eligible for automatic approval by the RBI subject to certain conditions. (d) The Government should remove all restrictions on the movement of gold.
- Another important merit of currency convertibility lies in its self-balancing mechanism.
- Regulators will occasionally act to keep the exchange rates within permissible limits.
- There would be no limit on inflow or outflow of capital for various purposes including investments, remittances, or asset purchases/sales.
- Current account convertibility is the next phase for attaining full convertibility of rupee.
Convertibility establishes a system where the market place determines the rate of exchange through the free interplay of demand and supply forces. A currency with current account convertibility can be converted to any foreign currency at existing market rates for trade purposes for any amount. This allows for easy financial transactions for the export and import of goods and services. Reserve Bank of India appointed the second Tarapore committee to set out the framework for fuller Capital Account Convertibility.
- Any individual involved in trade can get foreign currency converted at designated banks or dealers.
- Thus, partial convertibility of rupee on current account meant a dual exchange rate system.
- Convertibility is the ease with which a country’s currency can be converted into gold or another currency in global exchanges.
- In essence, current account convertibility remains within the institutional trading realms.
- Recently RBIs governor Raguram Rajan, in an interview has suggested moving towards full capital account convertibility in short numbers of years.
The Pros and Cons of a Fully Convertible Rupee
Convertibility is the quality that allows money or other financial instruments to be converted into other liquid stores of value. 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. In 1992, liberal economic reforms were introduced that impacted the way forex transactions were conducted. Exporters and importers could exchange foreign currencies for the trade of unbanned goods and services. There was easy access to forex for studying or traveling abroad, and, depending on the industry, there were fewer restrictions on foreign business and investments. (c) Convertibility of rupee implies freely permitting the conversion of rupee to other currencies and vice versa.
As of today, the Indian rupee is partly convertible, which means that although there is a lot of freedom to exchange local and foreign currency at market rates, a few important restrictions remain for higher amounts and these still need approvals. The regulators also pitch in from time-to-time to keep the exchange rates within permissible limits, instead of keeping INR as a completely free-floating currency left to the market dynamics. In the case of extreme volatility in rupee exchange rates, the RBI swings into action by purchasing/selling U.S. dollars (kept as foreign reserve) to stabilize the rupee.
The State of the Indian Rupee
But this does not mean that one can get any amount of foreign exchange for meeting one’s needs e.g. one cannot convert his savings in the country for investment in foreign exchange as could be done by citizens of developed countries like U.K. As a part of new economic reforms initiated in 1991, India also joined the regime and made rupee partly convertible from March 1992 under the “Liberalized Exchange Rate Management scheme”. These 40 per cent exchange receipts on current account was meant for meeting Government needs for foreign exchange and for financing imports of essential commodities.
Capital account convertibility allows the individuals of a nation to invest in abroad by easily converting their rupees into foreign exchange at the rates determined by the Market. This enables those potential domestic investors to acquire & own the assets in abroad. Full convertibility would mean the rupee exchange rate would be left to market factors, without any regulatory intervention. There may be no limit on inflow or outflow of capital for various purposes (including investments, remittances or asset purchase/sale). Full convertibility would mean the rupee exchange rate would be left to market factors without any regulatory intervention.
UPSC Civil Services Examination, Previous Year Questions (PYQs)
Any currency may be current account or capital account convertible or both. Current account convertibility implies that the Indian rupee can be converted to any foreign currency at existing market rates for trade purposes for any amount. It allows easy financial transactions for the export and import of goods and services. Any individual involved in trade can get foreign currency converted at designated banks or dealers. In essence, current account convertibility remains within the institutional trading realms. In the beginning of reforms, the rupee was made partially convertible for goods, services and merchandise only.
It means all exports and imports of merchandise and invisible (like services etc). A Reserve Bank of India-appointed working group recommended inclusion of the rupee in the Special Drawing Rights (SDR) basket and recalibration of the foreign portfolio investor (FPI) regime to accelerate the pace of internationalisation of the rupee. (c) In September 1995, the RBI appointed a special committee to process all applications involving Indian direct foreign investment abroad beyond US $ 4 million or those not qualifying for fast track clearance. The Indian rupee (INR) is a separate currency from the Nepalese rupee or the Pakistani rupee. Availability of large funds to supplement domestic resources and thereby promote economic growth. Gross NPAs of the public sector banking system needs to be brought down from the present 13.7% to 5% by 2000.