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. Almost at the same when India got independence, the Foreign Exchange Regulation Act 1947 was enacted with the object of regulating certain dealings in foreign exchange and the import and export of currency and bullion. The focus of this act was on dealings in Foreign exchange and payments which directly affect foreign exchange resources. This act was later replaced by the Foreign Exchange Regulation, Act, 1973, which we call FERA. During the times when the financial markets of an economy are doing good , a country may receive huge foreign investment.
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). This means that only part of the current account receipts were made convertible at market rates and that is why it was called Partial Convertibility of Rupee on Current Account. The imports of materials other than petroleum, oil products, fertilizers, defence and life-saving drugs and equipment always had to be effected against market determined rates.
Fiscal Consolidation – UPSC Economy Notes
This allows for easy financial transactions for the export and import of goods and services. 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.
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 a vital aspect of a nation’s economic framework, determining the ease with which its currency can be exchanged for foreign currencies. This mechanism plays a crucial role in international trade, investment, and economic stability. This article aims to study in detail the concept of Currency Convertibility, including its components – Current Account Convertibility and Capital Account Convertibility, and other related concepts such as Internationalisation of Rupee. 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.
Capital account convertibility allows free mobility of Capital into a country from the foreign investors. It allows converting the foreign exchange brought into as Capital to convert into rupees at market determined rates, which makes the investors encouraging. It allows the foreign investors to easily move in and move out from an economy. RBI is very active in currency market and is capable to impact effective exchange rates effectively by its volume of lifting and releasing the foreign currency from and to the market. The impact of RBI on trade is so much that currency regime in India is de facto controlled.
Capital Account Convertibility Relaxations:
The correct answer is Freely permitting the conversion of the rupee to other major currencies and vice versa. Capital Account Convertibility allows FDI & FPI, enabling foreign investment in India, a significant structural reform to boost the economy. (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. The correct answer is Freely permitting the conversion of rupee to other currencies and vice versa.
- (ii) The Governments should fix the annual inflation target below 4 per cent.
- Almost at the same when India got independence, the Foreign Exchange Regulation Act 1947 was enacted with the object of regulating certain dealings in foreign exchange and the import and export of currency and bullion.
- Four indicators should be used for evaluating adequacy of foreign exchange reserves to safeguard against any contingency.
- However, there are ceilings imposed by the government, and transactions beyond those thresholds require approval.
- 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.
Remittances to India: Key Points – UPSC Economy Notes
However, there are still barriers to full convertibility in India, such as developing a more comprehensive infrastructure for regulating financial markets. Though the Indian government has given indications that it is moving toward a fully convertible rupee, the timeline for that change is currently unknown. In 1992, liberal economic reforms were introduced that convertibility of rupee implies impacted the way forex transactions were conducted.
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. Government of India (GOI) has revised rules pertaining to FEMA and capital account transactions during different periods of time. In context of large capital flows and the upshots of previous modifications during the last few years, GOI and RBI have recently done some additional amendments. 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.
Currency Convertibility and the State of Indian Currency
Through Capital controls, the RBI controls the foreign capital inflows in the form of loans and equity in India. The current account flows arise out of transactions in goods& services are permanent in nature whereas capital account flows are dynamic in nature and are can be reversed at any time. 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. The foreign Capital inflows bring cheaper resources to finance the economy but the dark side is that they pose risks to value of the country’s currency. 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 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. But now India is 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. But full convertibility of currency for capital account transactions is still a distant dream. Smaller amounts can be freely exchanged or converted, which is useful for smaller transactions like foreign travel or buying goods from other countries.
More RBI Questions
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. 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.
Gross NPAs of the public sector banking system needs to be brought down from the present 13.7% to 5% by 2000. 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).
- This is why; it is generally introduced after experimenting with the convertibility on current account.
- But full convertibility of currency for capital account transactions is still a distant dream.
- While challenges and considerations exist, the pursuit of fuller convertibility aligns with the broader goals of economic liberalization and globalization.
Plus, a minimum net foreign asset to currency ratio of 40 per cent should be prescribed by law in the RBI Act. As India continues to expand its role in the global economy, the rupee will likely become fully convertible. However, due to regulatory and financial challenges, this process may take several more years.
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. When currency reforms were enacted at the end of the 20th century, the rupee was made partially convertible for goods, services, and merchandise only.