Capital account convertibility Wikipedia

Currency Convertibility, encompassing both current and capital account aspects, is crucial for integrating a country’s economy with the global financial system. While current account convertibility has been fully achieved in India, capital account convertibility remains a work in progress, balancing the benefits of increased financial access with the risks of economic instability. By carefully managing these components, countries can optimise their economic interactions on the international stage, fostering growth, competitiveness, and resilience in an interconnected world. Consequently, Russia wanted the trade to be done in Chinese Yuan, UAE Dirham, or other currencies.

Tarapore Committee defined capital account convertibility as the freedom to convert local financial assets with foreign financial assets and vice-versa at market determined rates of exchange. An important advantage of currency convertibility is that it encourages exports by increasing their profitability. With convertibility profitability of exports increases because market foreign exchange rate is higher than the previous officially fixed exchange rate.

In order to maintain the exchange rate of their currencies in terms of dollar or gold various countries imposed several controls over the use of foreign exchange. This required some restrictions on the use of foreign exchange and its allocation among different uses, the currency of a nation was converted into foreign exchange on the basis of officially fixed exchange rate. The most important advantage of internationalising the rupee is to reduce dependency on the USD for foreign trade.

b allowing the value of rupee to be fixed by market forces

India has a trade deficit with its major trading partners, including China, the UAE, Saudi Arabia, and Russia. In fact, India’s large trade deficit vis-à-vis Russia, which implies that the latter would be saddled with large rupee balances, is also why it has been reluctant to engage in rupee-rubble trade. Balancing exchange rate stability and domestic monetary policy is one of the major obstacles to the internationalization of the rupee. As the rupee becomes more internationalised, it is likely to become more vulnerable to external economic shocks, such as changes in global interest rates or fluctuations in commodity prices.

The State of the Indian Rupee

1. The expan­sion in trade and capital flows between countries will ensure rapid economic growth in the econo­mies of the world.
2. Thirdly, rupee convertibility provided greater incentives to send remittances of foreign exchange by Indian workers living abroad and by NRI.
3. The Reserve Bank of India appointed in 1997 the Committee on Capital Account Convertibility with Mr. S.S. Tarapore, former Deputy Governor of RBI as its chairman.
4. Creating an offshore market for its domestic currency that allows foreign entities to sell renminbi for dollars However, it must not be forgotten that China also has a trade surplus with most of the other countries.
5. It was generally agreed that foil convertibility of the rupee, both on current account and capital account was a welcome measure and is necessary for closer integration of the Indian economy with the global economy.

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). The Indian rupee (INR) is a separate currency from the Nepalese rupee or the Pakistani rupee.

However, various countries still imposed restrictions on the free convertibility of their currencies in view of their difficult balance of payment situation. Therefore, to achieve higher rate of economic growth and thereby to improve living standards through greater trade and capital flows, the need for convertibility of currencies of different nations has been greatly felt. Under Bretton Woods system fixed exchange rate system was adopted by various countries. As countries become larger players in the global economy, they generally move toward a fully convertible currency to facilitate global economic transactions.

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. 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. 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.

Create your account

The expan­sion in trade and capital flows between countries will ensure rapid economic growth in the econo­mies of the world. In fact, currency convertibility is said to be a prerequisite for the success of globalisation. The exporters and others who receive US dol­lars, Pound Sterlings etc. can go to these dealers which are generally banks and get their dollars exchanged for rupees at the market determined rates of exchange.

Currencies such as the South Korean won and the Chinese Yuan are known as partially convertible currencies. A partially convertible currency is the legal tender of a country that is traded in low volumes in the global foreign exchange market. The governments of these countries place capital controls that limit the amount of currency that can exit or enter the country. Secondly, if current account convertibility is not properly managed and monitored, market exchange rate may lead to the depreciation of domestic currency. If a currency depreciates heavily, the confidence in it is shaken and no one will accept it in its transactions. The Reserve Bank of India appointed in 1997 the Committee on Capital Account Convertibility with Mr. S.S. Tarapore, former Deputy Governor of RBI as its chairman.

1. Smaller amounts can be freely exchanged or converted, which is useful for smaller transactions like foreign travel or buying goods from other countries.
2. Convertibility is the ease with which a country’s currency can be converted into gold or another currency through global exchanges.
3. To become a truly global economic player, India will need fuller integration into the global economic system.
4. A convertible currency is any nation’s legal tender that can be easily bought or sold on the foreign exchange market with little to no restrictions.

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. In this way, deficit in balance of payments get automatically corrected without intervention by the Government or its Central bank. The opposite happens when balance of payments is in surplus due to the under-valued exchange rate. Thirdly, rupee convertibility provided greater incentives to send remittances of foreign exchange by Indian workers living abroad and by NRI. Further, it makes illegal remittance such ‘hawala money’ and smuggling of gold less attractive.

To become a truly global economic player, India will need fuller integration into the global economic system. Making the INR into a fully convertible currency comes with both advantages and disadvantages. All such forex exchanges occurred at pre-determined forex rates finalized by the RBI. Accordingly, the Tarapore Committee recommended the adoption of capital account convertibil­ity. Availability of large funds to supplement domestic resources and thereby promote economic convertibility of rupee implies growth.

A blocked currency is a currency that can’t freely be converted to other currencies on the forex markets as a result of exchange controls. Such money is mainly used for domestic transactions alone and does not freely exchange with other currencies, often due to government restrictions at home or abroad. 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. However, successive Indian governments have avoided full convertibility on the capital account to prevent the Indian economy from being exposed to the risks of external financial shocks. Rupee-trade arrangements are not easy to implement, which is why India and Russia have suspended efforts to settle bilateral trade in rupees after months of negotiations failed to convince the latter to keep rupees in their coffers.

Under convertibility of a currency there are authorised dealers of foreign exchange which constitute foreign exchange market. Internationalization of the rupee indicates that it may be freely exchanged between residents and non-residents and that it can be used as a reserve currency in international trade. It entails encouraging the use of the rupee for capital account transactions, other current account operations, and import and export trade.