CONVERTIBILITY OF RUPEE HISTORICAL OVERVIEW

AND CURRENT SCENARIO

INTRODUCTION:

Indias development strategy was based on protection, self-reliance & import substitution before
the liberalization policy was accepted & initiated. Foreign capital flows were not looked upon
favorably & therefore not encouraged. If there is a deficit in the current account it was financed
mainly through deft flows & official development assistance. The policy followed was one
which discouraged foreign investment. However, the adverse balance of payment & the
economic crisis faced by India forced India to adopt economic reforms.
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.
Convertibility is the quality that allows money or other financial instruments to be converted into
other liquid stores of value. Convertibility is an important factor in international trade, where
instruments valued in different currencies must be exchanged.
Currency Convertibility means the ability to freely exchange the currency of one Member State
into the currency of another Member State.

For example, a Barbadian should be able to easily purchase goods in a store in Port of Spain with
his Barbadian dollars and receive his change in Trinidad and Tobago dollars.
However, this does not always happen because of the existence of two different exchange
systems in CARICOM Fixed and Floating. Currency convertibility implies the absence of
exchange controls or restrictions on foreign exchange transactions.
The ease with which a countrys 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.
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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.
An international monetary system has been in existence since monies have been traded, its
analyses have been traditionally started from the late 19th century when the gold standard began
Convertibility essentially means the ability of residents and non-residents to exchange domestic
currency for foreign currency, without limit, whatever is the purpose of the transactions.
The Movement of Capital for the full functioning of the CSME depends to a large degree on two
conditions already pointed out in the Revised Treaty provisions
Abolishing exchange controls and
The free convertibility of currency within the CSME.

MEANING & DEFINITION:

The ease with which a countrys currency can be converted into gold or another currency.
Convertibility is extremely important for international commerce. When a currency is
inconvertible, it poses a risk and barrier to trade with foreigners who have no need for the
domestic currency.
The ability to exchange money for gold or other currencies. Some governments which do not
have large reserves of hard 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. The state of or the ease with which a currency may be exchanged for a foreign
currency. Currency convertibility is vitally important in the foreign exchange market; higher
convertibility means that a currency is more liquid and, therefore, less difficult to trade.
Factors affecting convertibility include the availability of foreign currency reserves in a given
country and domestic regulations seeking to protect local investors from bad investment
decisions in, say, a currency undergoing a period of hyperinflation.
Currency convertibility refers to the freedom to convert the domestic currency into other
internationally accepted currencies and vice versa at market determined rates of exchange. A few
socialist governments even issue inconvertible currencies, such as the Cubanpeso, in order to
protect their citizens from perceived capitalist infiltration.
Currency Convertibility refers to the degree to which one currency can be exchanged for another.
Some currencies trade less freely on the open market and exchanges, in these cases, can be more
difficult to process.
Convertibility is the ease with which a countrys 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.
Currency convertibility implies the absence of exchange controls or restrictions on foreign
exchange transactions.
Currency convertibility means the freedom to convert one currency into other internationally
accepted currencies. There are two popular categories of currency convertibility, namely:
Convertibility for current international transactions; and
Convertibility for international capital movements.
Currency convertibility implies the absence of exchange controls or restrictions on foreign
exchange transactions.

CONVERIBILITY
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 dollar is 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 of floating exchange rates, and often create persistent
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 of customs 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 INR7, 500 at a time, and the possession of INR500
and INR1, 000 rupee notes in Nepal is prohibited. In 2014 India allowed to take INR500 and
INR1000 rupee notes to be taken to Nepal
RBI also exercises a system of capital 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.
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;[citation needed] therefore, money cannot be changed into gold by the RBI.
India follows the same principle as Great Britain and the US.
Reserve Bank of India clarifies its position regarding the promissory clause printed on each
banknote:
"As per Section 26 of Reserve Bank of India Act, 1934, the Bank is liable to pay the value of
banknote. This is payable on demand by RBI, being the issuer. The Bank's obligation to pay the
value of banknote does not arise out of a contract but out of statutory provisions. The promissory
clause printed on the banknotes i.e., "I promise to pay the bearer an amount of X" is a statement
which means that the banknote is a legal tender for X amount. The obligation on the part of the
Bank is to exchange a banknote for coins of an equivalent amount."
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ADVANTAGES

1. Encourages export: Exporters are motivated to increase their exports since there is possibility
of making more profits under currency convertibility conditions. As a result of convertibility
on current account, higher profits will be earned since market exchange rate will give higher
returns as compared to the officially fixed exchange rate. From the given exports, they earn
more foreign exchange.
2. Encourage Import Substitution: since the market determined exchange rate is higher than the
officially fixed exchange rate, imports become more expensive. This makes countries to go in
for import substitution.
3. Incentives to Send Remittances from Abroad: Indian workers employed abroad & NRIs find
it convenient to send remittances of foreign exchange without hassle. This also encouraged
illegal remittances like hawala money& smuggling.
4. Self-adjusting Process in the Correction of Surplus or Deficits in Balance of Payments: In
case, a country faces a deficit due to overvalued exchange rate, the currency of the country
will depreciate. This will encourage exports by lowering the prices & discourages imports by
raising their prices. In this manner the deficit or surplus in the BOP gets corrected without the
intervention of the government.
5. Countries are enabled to specialize in the Production of Goods for which they have a
Comparative Advantage: each country will be able to engage in the production of goods in
accordance with their comparative advantage &resource endowments. When there is
currency convertibility, market exchange rate truly reflects the purchasing power of their
currencies which is based on the prices & costs of goods in different countries. In a
competitive environment, lower prices of goods which reflect the comparative advantage will
enable countries to increase exports. Thus currency convertibility will lead to specialization
& international trade on the basis of comparative advantage. This will be beneficial for all
countries in trade.
6. Integration of World Economy: currency convertibility enables better integration of the world
economy. The easy availability of foreign exchange helps in the growth of trade & increased
capital flows between countries. This will enables the growth of all countries which is
important in the context of globalization.

It forces the financial sector to be become more efficient, more disciplined, and much
stronger
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It paves the way for companies to access funds from outside without hindrance. It makes it
far easier for foreign companies to invest in India.

Since it exposes makes India more exposed to the vagaries of the international financial
sector, it forces the government to become more disciplined on the fiscal side of things.

It sends a signal to international investors as well as the financial world that India is
confident of itself herself in the economic and financial arena and has the capability to
withstand anything that is thrown at it her.

Since it exposes makes India more exposed to the vagaries of the international financial
sector, it forces the government to become more disciplined on the fiscal side of things.

DISADVANTAGES

Currency convertibility can give rise to problems of inflation in domestic economy. The market
determined exchange rate is generally higher than the officially fixed exchange rate. This leads to
a rise in prices of essential imports which can results in a situation of cost push inflation in an
economy.
If the people monitoring is not done, convertibility can results in the depreciation of the
domestic currency. Undue depreciation of a currency can make people lose confidence in the
currency itself. This can adversely affect the trade & capital flows of a country.
Under capital account convertibility, a country is given the freedom to transact in financial assets
with foreign countries without restrictions. Such an arrangement is to enable increased
investment activities. But there are risks attached to it. A very likely possibility is that of capital
flight at the first sign of an internal economic problem.
The short-term capital flights termed as hot money transfers can destabilize an economy unless
precautionary or counter measures are taken to achieve stability.
Speculative activities may increase under free convertibility, making the exchange rates highly
volatile. Speculation can lead to depreciation of currencies & flight of capital. This is proved by
the experience of the South East Asian countries like Thailand, Malaysia, in the year 1997-199,
which experienced severe depreciation of currency & capital flight.
India is moving very cautiously towards capital account convertibility due to various risks which
can create macroeconomic imbalance in the in the economy. Though the rupee is not freely
convertible on the capital account, in certain transactions full convertibility prevails.
For example, foreigners, non-resident Indians engaged in investing on portfolio or direct
investments are given freedom to bring in & repatriate their funds. It is felt that a strengthening
of the reserve position & structural strengthening will make India ready to adopt full
convertibility on the capital account.
It exposes the country India to the volatility of the world financial system. The rupee can
possibly become more volatile.
That said, there are infinitely more merits than demerits to going becoming convertible on the
capital account. The as far as the demerits are concerned, they are only demerits so only as long
as the financial system and government accounts are shoddy. If they it becomes world class
financial system, it can easily manage volatility can be managed without any problem.

EXTERNAL AND INTERNAL CONVERTIBILITY

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When all holdings of the currency by non-residents are freely exchangeable into any foreign
(non- resident) currency at exchange rates within the official margins, then that currency is said
to be externally convertible. All payments that residents of the country are authorized to make to
non-residents, may be made in any externally convertible currency that residents can buy in
foreign exchange markets. And if there are no restrictions on the ability of a country to use their
holdings of domestic currency to acquire any foreign currency and hold it, or transfer it to any
nonresident for any purpose, that country's currency is said to be internally convertible. Thus
external convertibility is the partial convertibility and total convertibility is the sum of external
and internal convertibility.

Externally inconvertible currencies may be of rather limited value to their holder. An exported
item from a developing country to the USSR, for example, may be paid for in rubles or the
currency of a country that has ratified Article VIII. The proceeds may be used to purchase goods
anywhere.
In considering possible import suppliers, a developing country will have some interest in
directing its importers to those countries, whose inconvertible currencies are in large supply.

This is, of course, a case of trade discrimination that is condemned by traditional theory. This
means that goods are not being purchased from the cheapest source. Recent economic writing
has, however, reopened the question in view of the continued existence of inconvertible
currencies. Where it is profitable on the export side to trade with countries maintaining
inconvertible currencies, as well as the government wishes to encourage imports from such
countries to offset its credit balances, it will utilize its exchange distribution mechanism to limit
the availability of convertible exchange, where there are alternative suppliers of the same type of
goods in inconvertible currency countries.

RUPEE CONVERTIBILITY - HISTORICAL OVERVIEW

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Convertibility of a currency implies that a currency can be transferred into another currency
without any limitations or any control. A currency is said to be fully convertible, if it can be
converted into some other currency at the market price of that currency. Convertibility can be
related as the extent to which countrys 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 that 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.
At present, Indian rupee is partly convertible on current Account. That is convertibility in the
case of transactions relating to exchange of goods and services, money transfer.
In 1997, the Tara pore committee on capital Account convertibility was constituted by the
Reserve Bank. This committee indicated three preconditions for capital Account convertibility;
they are Fiscal consolidation, a mandated inflation target, strengthening of the financial system.
During March 2006, Prime Minister said that India is moving towards fuller capital account
convertibility. 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.

After the economic liberalization process started in India in 1991, a Liberalized Exchange Rate
Mechanism was introduced in 1992.This allowed partial convertibility of Indian rupee, thus
introducing dual exchange rate. After that full convertibility on trade account started from
1993.It was followed by Full convertibility on current account from 1994.However after the
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Mexico crisis in early1990s or the mammoth East Asia Crisis where there was sudden flow of
capitalist rationally debilitating the economies of the involved nations, India was reluctant to
adopt capital account convertibility.
However the Tara pore committee, appointed in 1997, recommended phased implementation of
capital account convertibility with certain prerequisites like fiscal deficit to be 3.5% of GDP,
CRR to be brought down to 3%, gross NPA of public sector banks to be 5% of the total assets,
inflation rate to be around 3.5%.Thecommittee was reappointed almost a decade later and
submitted almost the same recommendations with some modifications.
It must be remembered that the movement towards fuller CAC should be a process and not an
event. Macroeconomic stability is a must before achieving full CAC. Any Adhoc arrangement
from the fixed regime maintained for a long period of time might disturb the foreign exchange
market and disrupt the economic progress.
At present, Indian rupee is partly convertible on current Account. That is convertibility in the
case of transactions relating to exchange of goods and services, money transfer.
Convertibility of rupees is known as freedom of exchange of rupee with other all international
currency. It means that rupee can covert in USA dollars more easily and USA dollars can convert
in Indian currency for buying and selling of goods and services. After study everything, I am
writing, "it is conspiracy to lower the value of Indian currency that in real sense. In 1996, there
was just Rs. 38 for every one dollar but after liberalized convertibility of rupee, one dollar
exchange rate has reached up to Rs. 45 in 17th Jan. 2011. When convertibility of Rupee was
started, it was claimed that our export will increase because our Indian companies will easy to
trade in foreign country due to easy exchange without any govt. restriction. But, it opens doors
for importing useless things and moreover it is very sad for India that gold is not making as
standard exchange currency. China is smart than India, under his new foreign exchange policy,
convert all his foreign exchange in gold. Now, his Chinese Yuan is equal to Indian Rs. 6.89.

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RUPEE AS A CONVERTIBLE CURRENCY

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.
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.

HISTORY OF RUPEE CONVERTIBILITY

Up to 1991, when India faced a major foreign exchange crisis, there had been very rigid
controls on both the capital account as well as the current account.
Current account convertibility was introduced in India in August 1994.
After start of liberalization in 1991; India had accepted the IMF rules for currency reforms.
In 1997 the government had set up a committee (Tara pore committee) to spell out a road
map for the full convertibility of the rupee.
Committee suggested three phases of adopting full convertibility of rupee in capital account.
1. First phase in 2006 -2007
2. Second phase in 2007-2009
3. Third phase in 2009- 2011

TYPES OF CURRENCY CONVERTIBILITY:

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1. Capital Account Convertibility:

Currency convertibility refers to the freedom to convert the domestic currency into other
internationally accepted currencies and vice versa. Convertibility in that sense is the obverse of
controls or restrictions on currency transactions. While current account convertibility refers to
freedom in respect of payments and transfers for current international transaction, capital
account convertibility (CAC) would mean freedom of currency conversion in relation to capital
transactions in terms of inflows and outflows. Article VIII of the International Monetary Fund
(IMF) puts a 12. Obligation on a member to avoid imposing restrictions on the making of
payments and transfers for current international transactions. Members may cooperate for the
purpose of making the exchange control regulations of members more effective. Article VI (3),
however, allows members to exercise such controls as are necessary to regulate international
capital movements, but not so as to restrict payments for current transactions or which would
unduly delay transfers of funds in settlement of commitments.

Advantages of CAC

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More capital available to the country, and the cost of capital would decline.
The freedom to trade in financial assets.
Difficult for a country to follow unwise macroeconomic policies.
Tax levels would move closer to international levels.
It will grow competition among financial institutions.

Disadvantages of CAC

It could lead to the export of domestic savings.

Expose the economy to larger macroeconomic instability.
Premature liberalization could initially stimulate capital inflows that would lead to
appreciation of real exchange rate and thereby destabilize an economy undergoing the
fragile process of transition and structural reform.
It may bring low quality investment.
It may generate the financial bubble.

2. 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 traderelated payments receive 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
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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. 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.

HOW IT WORKS IN INDIA?

Capital and current account convertibility in pretext to Indian economy.

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The Committee, chaired by former RBI governor S Tara pore, was set up by the Reserve
Bank of India in consultation with the Government of India to revisit the subject of fuller
capital account convertibility in the context of the progress in economic reforms, the stability
of the external and financial sectors, accelerated growth and global integration. Reserve Bank
of India, and will have the following terms of reference:

Undertake a review of the extant regulations that straddle current and capital accounts,
especially items in one account that have implication for the other account, and iron out
inconsistencies in such regulations.

Examine existing repatriation/surrender requirements in the context of current account

convertibility and management of capital account.

Identify areas where streamlining and simplification of procedure is possible and remove the
operational impediments, especially in respect of the ease with which transactions at the level
of authorized entities are conducted, so as to make liberalization more meaningful.

Ensure that guidelines and regulations are consistent with regulatory intent.

Review the delegation of powers on foreign exchange regulations between Central Office
and Regional offices of the RBI and examine, selectively, the efficacy in the functioning of
the delegation of powers by RBI to Authorized Dealers (banks).

ADVANTAGES OF RUPEE CONVERTIBILITY

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).
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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.
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 Crore of uncollected taxes and Rs.120, 000 Crore
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.

DISADVANTAGES OF RUPEE CONVERTIBILITY

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
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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 1860and 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. 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.

NONCONVERTIBLE CURRENCY

Non Convertible Currency 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 nations currency is
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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.

CONVERTIBILITY OF RUPEE IS DEFINED AS:

Partial Convertibility of Rupee
Full Convertibility of Rupee

PARTIAL CONVERTIBILITY OF RUPEE

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Partial convertibility of Rupee was started in 1992 for current account. In simple word, there is
no control of Indian currency official. Any foreign company can do business and can go to his
country with this profit after exchanging all Indian currency in their foreign currency. For
example, According to its Directors Report, a public document filed with Indias Registrar of
Companies, Google India Private Ltd reported revenues of Rs. 779.34 Crore (around $172.03
million at current rates),over the 15 month period from Jan 2009 to March 2010. For the same
period, it reported a profit after tax of 97.96 Crore ($21.62 million), and received foreign
exchange of Rs. 666.25 Crore, with a foreign exchange out go of Rs. 304.24 Crore. In this,
example, we see that there is no our control our one foreign currency. From economic point of
view, if any country has largest amount of other countries currency, that country will become
economically sound. Suppose, if India has not USA dollars for exchanging Rs. 304.24 Crore to
Google India Pvt. Ltd, at that time, India has to take loan of same USA Dollars from USA and
will pay interest on it. So, it will increase adverse balance of payment.
It is true, with partial convertibility of Rupees, investment in foreign country has become easy
but it is also harmful for India, because same investment should be in India instead any other
country. All companies think the benefit of their residential country from where they are
operating their business. So, for Indias interest, we have to make some strict rules for stopping
outflow of fund on the name of convertibility of rupee or liberalization.
The rupee has arrived. Long before the domestic currency gets the `convertible tag, its being
freely accepted and exchanged in Singapore, Malaysia, Indonesia, Hong Kong, Sri Lanka and
other countries. Till now, such transactions were confined to select departmental stores which are
favorite of Indian tourists; now more and more shops, hotels and even money changers are
willing to accept the local legal tender.
This means no double conversions, and therefore, extra cost while exchanging Indian rupees.
This may not be quite legal since in the international money market, the rupee is still not a
deliverable currency. Nonetheless, its acceptance is on the rise, thanks to growing trade with
India and a surge in tourist inflows.
It has certainly made things easier for the Indian tourists who can simply carry rupees, and do
away with travelers cheques. In most Asian countries, the nearest money exchange shop will
give them the local currency against rupees. Many feel the trend has picked with hints that
convertibility may be matter of time.

Travel agents, in India, say that since many Indians are travelling abroad, especially to Asian
countries, many banks and foreign exchange agents abroad have started accepting Indian rupees.
Tarmo Wong, a manager with `money exchange shop in one of the biggest hotels in Singapore,
said, We have orders to accept the Rs 500and Rs 1,000 bills. We have been doing this for almost
6-8 months now. Some of the `money changers in Singapore have a similar view.
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Interestingly, in the small, but growing parallel market, the conversion rates have become finer
for the Indian traveler or the business tourist. Earlier, a handful of outfits accepted the Indian
rupee and usually the buy/sell spread was high.
Most travelers (even today) convert their rupees in US dollars in India and then exchange them
again in local currencies of countries they visit. The cost of such double conversion could be as
high as 5%. Prakash Dagia, a regular business traveler to countries like Indonesia, Bangladesh
and Malaysia, said, In the past few months, the rupee has gained acceptance in almost all
countries in Asia. The best part is you can exchange it back to Indian rupees when youre flying
back to India.
Full currency convertibility of the Indian rupee means that you can travel abroad and buy dollars
you need over the counter. Partial currency convertibility already exists in the system. For
instance, you can spend through your credit card and pay the money spent in foreign currency
back in India in Indian rupees. Currency convertibility refers to the absence of any restriction on
the holding of foreign currencies by residents and of the national currency by foreigners, and on
free conversion between currencies. It does not preclude restrictions on the type and quantity of
non-currency assets that residents can hold abroad or foreigners can hold in the country.

FULL CONVERTIBILITY OF RUPEE

The Prime Minister, Dr. Manmohan Singh in a speech at the Reserve Bank of India, Mumbai, on
March 18, 2006 referred to the need to revisit the subject of capital account convertibility. To
quote:
Given the changes that have taken place over the last two decades, there is merit in moving
towards fuller capital account convertibility within a transparent frameworkI will therefore
request the Finance Minister and the Reserve Bank to revisit the subject and come out with a
roadmap based on current realities.
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Convertible currencies are defined as currencies that are readily bought, sold, and converted
without the need for permission from a central bank or government entity. Most major currencies
are fully convertible; that is, they can be traded freely without restriction and with no permission
required. The easy convertibility of currency is are relatively recent development and is in part
attributable to the growth of the international trading markets and the Forex markets in particular.
Historically, movement away from the gold exchange standard once in common usage has led to
more and more convertible currencies becoming available on the market. Because the value of
currencies is established in comparison to each other, rather than measured against a real
commodity like gold or silver, the ready trade of currencies can offer investors and opportunity
for profit.
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.
Although the Minister of Finance had indicated during his presentation of the 1992-93 Budget
that full convertibility of the rupee would be introduced in a span of 3 or4 years, full
convertibility was announced much earlier and in fact it is the highlight of the 1993-94 Budget.
There is, however, a subtle difference in the full convertibility of the rupee introduced in India
and the concept of full convertibility prevailing in developed countries like the U.K., U.S.A. etc.
In developed countries, full convertibility means that their currency is freely convertible
anywhere in the world. Their home currency can be converted into foreign currency without any
restriction. One does not have to disclose even the purpose of such conversion. For instance, U.S.
Dollars can be changed into Sterling Pounds in New York, Japanese Yen could be exchanged to
Deutsche Marks in Frankfurt, Australian Dollars can be converted into Canadian Dollars in
Adelaide etc., and the exchange rate is controlled by the position of supply and demand in the
market.
The full convertibility announced in the Union Budget of 1993-94, however, allows
convertibility only in the current account, which means the amount received by way of sale
proceeds of exports, paid for imports and the remittance by NRIs etc., alone are convertible at
market determined rates.
In the last years Budget, a dual exchange rate was announced i.e., 60% at market rates and 40%
at the official rate. In the current Budget, the dual exchange rate has become a unified exchange
rate which is a 100% conversion of foreign exchange at market rate. This is described as Full
Convertibility. This does not mean that one can get any amount of foreign exchange at market
rate for meeting any of ones needs. The Reserve Bank of India will permit sale of foreign
exchange currency to any one only for those purposes which are stipulated by the Govt. of India.
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It does not permit conversion of ones savings in the country for investment in foreign countries,
as could be done by the citizens of developed countries like the U.K. or U.S.A. For instance, if a
citizen resident in India wishes to undertake a foreign travel, the exchange for such travel can be
had only as per the norms prescribed by the Govt. under the Foreign Travel Scheme. Full
convertibility of the Rupee we have adopted for our country is tied up with exchange controls
and restriction envisaged by the provisions of the F.E.R. Act 1973 as amended.
Full convertibility has been introduced only as a measure of reforms to revitalize the economy of
our country and to bring it on to the path of liberalization. The New Economic Policy ushered in
by out Govt. is with a view to take India forward from a control-ridden-inward-looking economy
into a market - friendly, forward looking progressive and dynamic economy. Full convertibility
of the rupee, lower Customs and Central Excise duties, relaxation of Import / Export restrictions,
streamlining of procedural rules governing taxations, streamlining of procedural rules governing
taxation laws etc., have opened out our economy with a view to expansion and globalization of
our trading activities. These are measures taken to move India forward in her march towards
economic freedom.

CURRENT SCENARIO
(A LOOK AT RECENT DEPRECIATION OF RUPEE)
India has recently gone through the crisis of sharp depreciation of rupee and depletion of foreign
exchange reserve resulting into inflation, demand recession and slow down of economic
activities. The paper examines issues related to management of both domestic and external
sectors of Indian Economy in a Globalized world. The paper first examines the operation of open
economy- the interconnectivity developed through exports and imports and capital flows. Then,
an analysis is carried out on long period movements of the exchange rate in the regime of full
Current Account and Partial Capital Account convertibility of rupee. The statistical analysis on
the association of exchange rate movements with various components of capital inflows and
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Current Account deficit has been done. The last section analyses, the crisis period until Sept.
2013, measures to manage the crisis and turnaround of the external environment of Indian
economy in the framework developed in the paper.

Recent Crisis Scenario in India and Management of Exchange rate & Foreign
Exchange Reserves
Recent crisis in the external sector has been occurring for both domestic as well as international
demand recession induced by the declaration of Fed Chairman Ben Bernanke in May that the US
would be pulling back its bond-purchase programmed. This created exodus of FII from emerging
economy. During this time, Current Account Deficit (CAD) was increasing alarmingly and could
not be compensated with laggard inflows of capital. Since depreciation of rupee, costs of
importing oil which is an essential imports for India, has been increasing. Attempts have been
made by RBI through LAF schemes to attract inflows of foreign capital which led to increase in
the repo rate and hence discouraged both domestic consumption as well as investment demands.
As a result of increase in the prices of importable, the domestic economy has been experiencing
high inflation.
RBI intervened in the foreign exchange market by selling dollars which temporarily halted the
fall of rupee, but could not be sustained. Indias foreign exchange reserve fell to the critical level
and was unable to cover adequate risks of foreign exchange reserves as per IMF adequacy
norms. According to end March 2013 RBIs half yearly report on Management of Foreign
Exchange Reserves, the ratio of volatile capital inflows defined as cumulative portfolio inflows
and short term debt to reserves increased to 96.1 in March 2013 from 83.9 percent at end
September 2012.
Measures such as restriction on gold imports and capital outflows by Indian residents and the
corporate did not have any favorable impact on the exchange rate and foreign Exchange reserves.
Among other measures, the Govt. of India opened dialogue to have rupee payments with major
oil exporting countries.

Turn around in foreign Exchange rate and Foreign Exchange Reserve situation
Turn around in the exchange rate of rupee started only with the announcement by US Fed to put
off tapering "easy money" by selling Govt. bonds. Overseas investors started investing in India
thus Improving inflows of capital in India. Another measure that has improved Foreign Exchange
Reserves and rupee value is the Swap Arrangement announced by RBI allowing a US DollarRupee swap window for fresh FCNR (B) dollar funds for a minimum tenor of three years. Total
reserves, including gold and balances with IMF, are currently at $281 billion in Oct.2013 up
from $275 billion at the end of August. Recently as a result of optimistic outlook for easy money

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policy by US Govt., exports rose 11.2% in September while imports fell 18.1%, which
compressed trade deficit to $6.8 billion.

Conclusion

Though rupee at present is fully convertible only at Current Account and partially convertible at
Capital Account, Indian economy is still vulnerable to external economic environment.
Worldwide demand recession induced due to fear of tapering of US Feds bond purchase and
flight of capital through FII route caused serious depreciation of rupee and depletion of foreign
exchange reserves for Indian economy. This calls for new instruments to build up foreign
exchange reserves and strengthen rupee on long term basis. Recent measure of swap arrangement
for NRI deposits with banks is proving to be successful. The measure to control gold import has
also been useful to control import bills. The Govt.'s attempt to enter into the rupee payment
system with those countries exporting oil to India also will improve Indias reserve position.
Thus, RBI has an active role to find measures to be executed for management of the external
value of rupee and foreign exchange reserves with both short term and long term goals. Though
monetary policies have a significant role to play in the management of volatility of capital
inflows and foreign exchange reserves the long term stability for the economy calls for fiscal
policies

CONCLUSION

The volatile nature of capital inflow presents an alarming trend. Liberalizing capital control may
lead to huge dependence on foreign portfolio capital. Need is to channelize the capital flow.
As recognized in the recent Tara pore Committee Report, financial institutions ability to
identify, measure, and manage risk will also depend on the availability of instruments to manage
risk, the liquidity of financial markets and the quality of market infrastructure, and level of
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market discipline. Key segments of the Indian capital markets remain, however, underdeveloped.
The term money market is limited and although there is a domestic yield curve for government
securities with maturities up to 30 years, its depth and liquidity are limited.
The Govt. had however stated that if the value of the rupee depreciates to an unreasonable level
in the free market operations, the R.B.I. will intervene and control it. This assurance certainly
gives credence to the earnestness and sincerity with which the full convertibility has been
announced.

BIBLOGRAPHY

Business Line Research Bureau, (March22, 2006): Capital account convertibility, Dua, Pami
and Sen, Partha, (2006). Capital Flow Volatility and exchange rates in India.

RBI (2012-13). Handbook of Statistics on Indian Economy, Reserve Bank of India

Publication, http:/www.rbi.org.in

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 Gian Jyoti e-Journal, Volume 1, Issue 3 (ISSN 2250-348X), www.gjimt.com/GianJyotiEJournal.htm

http://www.econjournals.com

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