Thus, partial convertibility of rupee on current account meant a dual exchange rate system. Further, full convertibility of rupees at that stage was considered to be risky in view of large deficit in balance of payments on current account. Referred to as ‘Capital Asset Liberation’ in foreign countries, it implies free exchangeability of currency at lower rates and an unrestricted mobility of capital. Capital account convertibility allows freedom to convert local financial assets into foreign financial assets and vice-versa. As of today, one can still bring in foreign capital or take out local money for these purposes, but there are ceilings imposed by the government that need approvals.
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.
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.
Convertibility of Indian Rupee
The growing international interest in the Indian rupee is evident from the development of offshore rupee markets in locations like Dubai, London, New York, and Singapore. Trading of the INR is still far lower than other currencies such as the euro. As of September 2024, INR contracts traded against the dollar an average of 11,825 times per day in 2024, compared to 198,027 contracts converted from Euro to USD. (a) Capital account convertibility exists for foreign investors and Non-Resident Indians (NRIs) for undertaking direct and portfolio investment in India.
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 was controlled by RBI for conversion of Indian currency into foreign exchange.
Indian Geography
Four indicators should be used for evaluating adequacy of foreign exchange reserves to safeguard against any contingency. Plus, a minimum net foreign asset to currency ratio of 40 per cent should be prescribed by law in the RBI Act. The correct answer is Freely permitting the conversion of rupee to other currencies and vice versa. Making the INR into a fully convertible currency comes with both advantages and disadvantages. The correct answer is Freely permitting the conversion of the rupee to other major currencies and vice versa. For this, interest rates should be folly deregulated, gross non-paying assets (NPAs) should be reduced to 5 per cent, the average effective CRR should be reduced to 3 per cent and weak banks should either be liquidated or be merged with other strong banks.
International Relations
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.
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.
Is the Indian Rupee Fully Convertible?
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.
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.
- Capital account convertibility refers to a liberalization of a country’s capital transactions such as loans and investment, both short term and long term as well as speculative capital flows.
- Having a convertible currency allows a government to pay for goods and services in a currency other than its own.
- The main purpose behind this was to utilize the foreign exchange earned by the residents as per the priorities fixed by the government.
Convertibility of Currency in India
(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.
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.
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.
- 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.
- 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.
- As even after partial convertibility of rupee foreign exchange value of rupee remained stable, this laid down a base for the full convertibility on current account.
- 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.
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.
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.
It allows the foreign investors to easily move in and move out from an economy. But now India is convertibility of rupee implies a fast developing country and one of the most preferred countries for investment by foreigners. So government has allowed convertibility of rupee in phased manner on current account transactions.
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