Currency Convertibility

CURRENCY CONVERTIBILITY• What it is ? 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.

• Types Of Currency Convertibility. Fully convertible currency.

Partially convertible currency. Non-convertible currency.

RupeeConvertibility

CURRENT ACCOUNT• Transactions relating to: - Exchange of goods and services - Money transfers - Transactions that are classified in the Current

Accounts.• In Short, Current account includes all transactions,

which give rise to or use of our National Income.

CURRENT ACCOUNT TRANSACTIONS

• All imports and exports of merchandise.

• Invisible Exports and Imports (sale/purchase of services)

• Inward private remittances (to & fro)

• Pension payments (to & fro)

• Government Grants (both ways)

CURRENT ACCOUNT CONVERTIBILITY

• Indian scenario - fully convertible.

• Full freedom to both residents and non-residents.

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

• Freedom in respect of payments and transfers for current international transactions.

CAPITAL ACCOUNT

• Inflows and Outflows of capital.

• Borrowing from or Lending to aboard.

• Sales and Purchase of securities aboard.

CAPITAL ACCOUNT TRANSACTIONS

• Capital Direct Foreign Investments.

• Investment in securities.

• Other Investments.

• Government Loans.

• Short-term investments.

Portfolio Investment .

Stocks, Bonds, Bank Loans, Derivatives.

DirectInvestment.

Real estateProduction facilitiesEquity investment.

Other investment.

Holdings in loans Bank accounts Currencies

Capital Account Transaction’s Classification

CAPITAL ACCOUNT CONVERTIBILITY

• Floating Exchange Rate.

• What is means? – Freedom of Conversion• CAC allows anyone to freely move from local currency into

foreign currency and back. • Changes of ownership in foreign/domestic financial assets

and liabilities.

• Advantages !

CURRENTLY RESTRICTIONS : CAPITAL ACCOUNT

• Limits to companies borrowing abroad.• Restriction on foreigner investing in India.• Restriction on amount that FII can hold.• Purchasing a company is allowed but limit exit on

the amount that can be send.• Global Diversification of household portfolio is

practically non-existent.

LIMITS TO PARTIAL CAC Limits specified by the RBI:-

• Private visit

• Business travel

• Gift or donation

• Employment /For studies abroad

• Investment : Foreign stock markets

• Borrowings

REASONS FAVORING FINANCIAL OPENNESS & CAC

• Diversification

• NRI Remittances

• Foreign Investment in

• Catalyst for financial market, institutional development, competition, new technologies & discipline macro-economic policies.

• Reduction in the size of Black money.

• Induces competition against Indian finance.

REASONS FAVORING RESTRICTIONS

• Good times- More inflow; Bad times- More outflow.• Misallocation of Capital inflows.• Export of domestic Savings.• Entry of Foreign banks can create Unequal

playing field.• Highly volatile international finance (hot money)-

Higher speculation.

TARAPORE COMMITTEE

• Pre-Conditions

Gross fiscal deficit to GDP ratio to come down from a 4.5 %n 1997-98 to 3.5% in 1999-00.

A consolidated sinking fund has to be set up to meet government's debt repayment needs; financed by RBI.

Inflation rate to be at 3-5 per cent for the 3-year period 1997-2000 .

Gross NPAs of the public sector banking system needs to be brought down.

Average effective CRR needs to be brought down from the current 9.3% to 3% .

RBI should have a Monitoring Exchange Rate Band of plus minus 5% around a neutral .

Real Effective Exchange Rate RBI should be transparent about the changes in REER .

External sector policies should be designed to increase current receipts to GDP ratio .

Four indicators should be used for evaluating adequacy of foreign exchange reserves to safeguard against any contingency.

Contd...

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