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. Capital account convertibility represents a crucial aspect of economic liberalization, facilitating increased participation in the global financial landscape and supporting both inward and outward capital flows. The careful sequencing and management of this process are vital for its successful implementation and impact on the economy. Full convertibility would mean the rupee exchange rate would be left to market factors without any regulatory intervention. There would be no limit on inflow or outflow of capital for various purposes including investments, remittances, or asset purchases/sales.
The full convertibility means no RBI dictated rates and there is a unified market determined exchange rate regime. Encouraged with the success of the LERMS, the government introduced the full convertibility of Rupee in Trade account(means only merchandise trade no service trade)from March 1993 onwards. With this the dual exchange rate system got automatically abolished and LERMS was now based upon the open market exchange. The full convertibility of Rupee was followed by stability in the Rupee Rate in the next many months coming up.
Reforming the International Monetary Fund (IMF) – UPSC Economy Notes
The exchange control consisted of restrictions on the purchase and sale of foreign exchange by general public and payments to and from non-residents. There were also restrictions on the import and export of Indian currency, foreign currency and bullion. A fully convertible rupee would improve employment and consumer opportunities, help Indian businesses raise foreign capital, and allow India to become a global economic player. However, this would also come with increased volatility, the risk of businesses becoming burdened by foreign debt, and reduced competitiveness in the global export market. 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.
Financial Transaction Plan (FTP) – UPSC Economy Notes
Availability of large funds to supplement domestic resources and thereby promote economic growth. The Indian rupee (INR) is a separate currency from the Nepalese rupee or the Pakistani rupee. However, some partial convertibility of Rupee on Capital Account was introduced later. We see that the Tarapore committee came up with some not from this world recommendations.
Though the Indian government has given indications that it is moving toward a fully convertible rupee, the timeline for that change is currently unknown. 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. After liberal economic reforms were introduced in 1991, many significant developments occurred that impacted the way forex transactions and businesses were conducted. 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.
Capital Account Convertibility Relaxations:
It was not a good idea to ignore the prerequisites so CAC was not translated into reality. (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.
Millennium Development Goals (MDGs) – UPSC Economy Notes
The convertibility of a currency such as Rupee has different meanings in different times. In existing standards, it means that the country’s currency becomes convertible in foreign exchange and vice versa in the market. The definition should be seen in historical aspect of foreign currency regulation in India.
- In the case of extreme volatility in rupee exchange rates, the RBI swings into action by purchasing/selling U.S. dollars (kept as a foreign reserve currency) to stabilize the rupee.
- The Capital Inflows would include the foreign borrowings by Indian corporates and businesses, NRI deposits and portfolio flows from institutional investors into the stock markets, Loans to government and short-term trade credit.
- Trading of the INR is still far lower than other currencies such as the euro.
- Recently RBIs governor Raguram Rajan, in an interview has suggested moving towards full capital account convertibility in short numbers of years.
Achieving full convertibility represents a progressive step toward creating a more open and globally integrated financial system. While challenges and considerations exist, the pursuit of fuller convertibility aligns with the broader goals of economic liberalization and globalization. The correct answer is Freely permitting the conversion of rupee to other currencies and vice versa. India is expected to become a truly global economy in the near future, and it will need a fuller integration into the world economic system. Improved access to international financial markets and reduction in cost of capital. The correct answer is Freely permitting the conversion of the rupee to other major currencies and vice versa.
- 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.
- The rupee is partially convertible because it is current account convertible but not capital account convertible.
- 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 focus of this act was on dealings in Foreign exchange and payments which directly affect foreign exchange resources.
Another important merit of currency convertibility lies in its self-balancing mechanism. When balance of payments is in deficit due to over-valued exchange rate, under currency convertibility, the currency of the country depreciates which gives boost to exports by lowering their prices on the one hand and discourages imports by raising their prices on the other. 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).
Gross Domestic Product and National Domestic Product – UPSC Economy…
People wanting to engage in foreign travel, foreign studies, the purchase of imported goods or to get cash for foreign currencies received (like with exports) were all required to go through RBI. All such forex exchanges occurred at pre-determined forex rates finalized by the RBI. 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. The recommendations and subsequent developments highlighted the importance of careful and phased measures to ensure a smooth transition towards fuller capital account convertibility in India. Understanding the process of rupee convertibility and the transition towards greater convertibility plays a crucial role in assessing India’s economic policies and their impact on international trade and capital flows.
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. The Tarapore Committee’s recommendations (in 1997 and 2006), including reducing fiscal deficits, inflation rates, and banking non-performing assets, should be pursued as a primary step towards internationalisation of rupee. Also, advocating for the rupee to become an official currency in international organizations would raise its profile and acceptance. 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.
In the beginning of reforms, the rupee was made partially convertible for goods, services and merchandise only. During mid-1990s, the rupee was made fully convertible for current account for all trading activities, remittances and indivisibles. 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. Hence, from March 1993, rupee was made convertible for all trade in merchandise. In March’ 1994, even indivisibles and remittances from abroad were allowed to be freely convertible into rupees at market determined exchange rate. 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.
Currency convertibility is an important part of global commerce because it opens up trade with other countries. Having a convertible currency allows a government to pay for goods and services in a currency other than its own. Having a nonconvertible currency makes it harder for a government to participate in the international market because these transactions generally take longer to execute. Until the early 1990s (pre-reform period), anyone willing to transact in a foreign currency would need permission from the Reserve Bank of India (RBI), regardless of the purpose.
The Government of India has taken the following steps towards capital account convertibility. Current Account Convertibility refers to the degree of freedom to convert your rupees into other internationally accepted currencies and vice versa without any restrictions whenever payments are made. However, Indians still require regulatory approval if they want to invest an amount above convertibility of rupee implies a pre-determined threshold in overseas assets. Similarly, incoming foreign investments in certain sectors like insurance or retail are capped at a specific percentage and require regulatory approvals for higher limits. Stronger currencies tend to be converted more easily than others, while growth may be stagnant for currencies with poor convertibility because these countries may miss trade opportunities.
Because when huge dollars flow, they would need to be bought by Central bank and in turn Central bank would pumps local currency. If there is an abrupt reverse flow of capital, it would put the country into vulnerable condition. In those times, the exchange rates used to be different than what they are today. Today we have a market determined exchange rate system, but during those times, RBI used to dictate its Official Exchange Rate on which Indian currency could be converted into foreign currency and vice versa. All transactions in foreign exchange were governed by this official rate of exchange.
So in India, there is free regime for current account transactions but still partial convertibility for capital account transactions. Many economics experts are of view that we need full capital account convertibility of currency. Recently RBIs governor Raguram Rajan, in an interview has suggested moving towards full capital account convertibility in short numbers of years.
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. (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. Making the INR into a fully convertible currency comes with both advantages and disadvantages.