21814664 Currency Convertibility and Its Impact on BOP

8/9/2019 21814664 Currency Convertibility and Its Impact on BOP

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Currency Convertibility and

its Impact on B.O.P


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Convertibility

Convertibility essentially means the ability of residents and non-residents to exchange domestic

currency for foreign currency, without limit,

whatever be the purpose of the transactions.


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Current

Account

Convertibili

ty

Rupee

Convertibility

Capital

Account

Convertibil

ity

Classification


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Current Account

It refers to currency convertibility required in the

case of transactions relating to exchange of goods

and services, money transfers and all those

transactions that are classified in the currentaccount.

In Short, Current account includes alltransactions, which give rise to or use of

our National income


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Current Account Transactions

1. All imports and exports of merchandise

2. Invisible Exports and Imports(sale/purchase of services

3. Inward private remittances (to & fro)

4. Pension payments (to & fro)

5. Government Grants (both ways)


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Convertibility on Current Account

y India is fully convertible on the current account

yA full convertibility means movement of funds in

& out of India without any restrictions &

permissions.

y Provides full freedom to both residents and non-

residents to trade in goods/services.

y RBI has placed a cap in creation of a capital asset

y In India, most current account transactions have

been freed from controls over the years.


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Contd

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 assetsabroad, it is only current account

convertibility.


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Rangarajan Committee

Recommendations1. Liberalization of current account transactions leading to

current account convertibility

2. a compositional shift in capital flows away from debt- tonon-debt-creating flows

3. strict regulation of external commercial borrowings,especially short-term debt

4. discouraging volatile elements of flows from nonresidentIndians

5. gradual liberalization of outflows

6. disintermediation of the government in the flow ofexternal assistance

7. Introducing a market-determined exchange rate regime


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Rangarajan Committee-

Implementationsy Step-1:Dual exchange rate systemy Liberalised Exchange Rate Management System involving dual

exchange rate system was instituted in March 1992

y The dual exchange rate system was essentially a transitional stageleading to the ultimate convergence of the dual rates made effectivefrom March 1, 1993

Two rates of exchange: Official rate of exchange & Market rate ofexchange

60% of the export earnings could be converted at the free marketdetermined rate. (which was around Rs.28)

The balance 40% of the earnings should be sold to RBI throughauthorised dealers at the official rate of exchange. (generally higher atRs.32)


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Step-2:Full convertibility of the current account

This unification of exchange rates brought about the

era of market determined exchange rate regime of

rupee, based on demand and supply in the forex

market.

Liberalize the access to foreign exchange for allcurrent business transactions including travel,

education, medical expenses, etc.

Under Article VIII of the IMFs Articles of

Agreement in August 1994.


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Path that lead to Current Account

Convertibility

Till 1990

Liberalization

began in 1991

From 1992 to2000

After 2000


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Current Situation on Current Account

India is fully convertible on the current

account

Provides full freedom to both residents and

non-residents to trade in goods/services.

RBI has placed a cap in creation of a capital

asset


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Capital Account

Capital Account consist of short term and long

term capital transactions

As per FEMA "capital account transaction"means a transaction which alters the assets or

liabilities, including contingent liabilities,

outside India of persons resident in India or

assets or liabilities in India of persons residentoutside India


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Capital Account Transactions

1. Direct Foreign Investments (both inward &

outward)

2. Investment in securities (both inward &outward)

3. Other Investments (both inward & outward)

4. Government Loans (both inward & outward)5. Short-term investments (both inward &

outward)


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Capital Account Transaction

Capital Account transactions are classified as :-

1. Portfolio investment involves trade in

securities like stocks, bonds, bank loans,

derivatives, etc.

2. Direct investment involves purchase of real

estate, production facilities, or equityinvestment.

3. Other investment involves holdings in loans,

bank accounts and currencies


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Capital Account Convertibility

The freedom to convert local financial assets intoforeign financial assets and vice versa at marketdetermined rates of exchange.

In other words, it means allowing Indians topurchase both the physical and financial assetsabroad and vice-versa.

In simple language, CAC allows anyone to freelymove from local currency into foreign currencyand back.

It is associated with changes of ownership inforeign/domestic financial assets and liabilities.


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Limits to Partial CAC

Limits specified by the Reserve Bank of India:-

1. Private visit abroad is $10,000: of which only $5,000

can be in cash

2. Business travel, the yearly limit is $25,000

3. Gift or donate up to $5,000 in a year.

4. Going abroad for employment, or are going for

studies abroad: the limit in both these cases is$100,000

5. Investment into foreign stock markets up to the

extent of $25,000 in a year.


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TARAPORE COMMITTEE-I


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Members of the Committee

Head of Committee: S. S. Tarapore

Surjit S. BhallaAjit Ranade

A. V. Rajwade

R. H. Patil

M. G. Bhide


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The Terms Of Reference Of The Committee

i. To review the experience of various measures of capital account

liberalization in India,

ii. To examine implications of fuller capital account convertibility on

monetary and exchange rate management, financial markets and financial

system,

iii. To study the implications of dollarization in India of domestic assets and

liabilities and internationalization of the Indian rupee,

iv. To survey regulatory framework in countries which have advanced

towards fuller capital account convertibility,

v. To suggest appropriate policy measures and prudential safe- guards to

ensure monetary and financial stability, and

vi. To make such other recommendations as the Committee may deemrelevant to the subject.


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Tarapore Committee-I

Recommendations Direct Investment in Ventures abroad by Indian

Corporate

ECB (External Commercial Borrowing) Ceiling

Foreign Direct and Portfolio Investment and

Disinvestment should be Governed by

Comprehensive and Transparent Guidelines

Banks may be allowed to Borrow from OverseasMarkets

SEBI Registered Indian Investors may be allowed to

set up Funds for Investment Overseas


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Contd

Currency Futures may be Introduced

Participation in Money Markets may be

Widened RBI should withdraw from Primary Market in

Government Securities

Banks and Financial Institutes should beallowed to Participate in Gold Markets in India

and abroad and Deal in Gold Products


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Preconditions Of The Tarapore

Committee-I ReportMajor Pre-Conditions by

Tarapore Committee

Status as on July 2009

1. Reduction in gross fiscal deficit

to 3.5% by 1999-2000

The present fiscal deficit is at 6.8%

2. The inflation rate for 3 yearsshould be an average 3% to 5%

Inflation at present is around 4.00%.

3. Forex reserves should at least be

enough to cover 6 months import

cover

The present forex reserves are enough to

cover more than one years imports.

4. Gross NPAs to be brought down

to 5% by 1999-2000

Gross NPA for the banking sector is around

3%

5. CRR to be reduced to 3% by

1999-2000

CRR is at 5.00%

6. Interest Rate to be fully

deregulated

All interest rates, except Saving Fund

interest rates, have already been deregulated.


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TARAPORE COMMITTEE-II


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Tarapore Committee II-

Revisiting The Subject Of CACPrime Minister Manmohan Singh

Given the changes that have taken place over

the last two decades, there is merit in movingtowards fuller capital account convertibility

within a transparent frameworkI will

therefore request the Finance Minister andthe Reserve Bank to revisit the subject and

come out with a roadmap based on current

realities.


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Tarapore Committee II-

Recommendations Meeting Fiscal Responsibility and Budget Managementtargets

Shifting from present measures of fiscal deficit to public

sector borrowing requirement. Segregating government debt management and monetary

policy operations

Imparting greater autonomy and transparency in the conduct

of monetary policy

Reduction in the share of government / RBI in the capital of

public sector banks.


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Capital Controls in India

India maintains an extensive capital control regime

Controls have been quantity-based rather than markets based

Oriented towards limiting the countrys external debt

Controls remain on the external exposure of pension

funds, insurance companies etc. The external assets of

banks are closely monitored

Stricter controls on short term rather than long term inflows


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What Will Full Capital Account

Convertibility Do? Reduction in Cost of Capital

Help in Diversifying Portfolio Internationally

Improve the efficiency of the financial sector through

greater competition

Reduce Size of Black Economy


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Issues to FCAC

Capital Flight

Credit and liquidity risks

Risk of regulatory arbitrage include new dimensions

Increased cross-border transactions will augment the

dimensions of risks that Indian financial institutions

face in their domestic markets


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Pre-Requisites

These include:

1. Comfortable Current Account Position.

2. Maintenance of Domestic Economic Stability.

3. Adequate Foreign Exchange Reserve.

4. Restriction on inessential Import.

5. An Appropriate Industrial Policy.


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The Road Ahead

India proceeds gradually towards CAC

Reform of Indian financial system is a precondition

Banking sector reform is required on a grand scale


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THANK YOU!

21814664 Currency Convertibility and Its Impact on BOP

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