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.
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Currency convertibility refers to the ease with which a currency can be exchanged for another currency or converted into other forms of assets without restrictions or limitations. In the context of India, rupee convertibility specifically refers to the ability to freely exchange the Indian rupee for other currencies on the global market. This concept holds significant importance in international trade, investment, and economic policy, as it affects the flow of capital in and out of a country.
According to him keeping any restriction for too long could prove self defying. Referred to as ‘Capital Asset Liberation’ in foreign countries, it implies free exchangeability of currency at lower rates and an unrestricted mobility of capital. As even after partial convertibility of rupee foreign exchange value of rupee remained stable, this laid down a base for the full convertibility on current account. Hence, from March 1993, rupee was made convertible for all trade in merchandise. In March’ 1994, even indivisibles and remittances from abroad were allowed to be freely convertible into rupees at market determined exchange rate.
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One can easily invest in the equity and debt markets of another economies alongside a reduction in the cost of capital In this way, deficit in balance of payments get automatically corrected without intervention by the Government convertibility of rupee implies or its Central bank. The opposite happens when balance of payments is in surplus due to the under-valued exchange rate. It means all exports and imports of merchandise and invisible (like services etc).
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- (i) If difficulty arises in keeping the current account balance under control, the free market exchange rate is likely to rise steeply.
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- On February 28, 1997, the RBI instituted the Committee on Capital Account Convertibility (CAC) under the chairmanship of S.S.
- As of 2024, the Indian rupee is a partially convertible currency.
It allows the foreign investors to easily move in and move out from an economy. This enables the domestic companies to raise funds from abroad. As a part of new economic reforms initiated in 1991, India also joined the regime and made rupee partly convertible from March 1992 under the “Liberalized Exchange Rate Management scheme”. These 40 per cent exchange receipts on current account was meant for meeting Government needs for foreign exchange and for financing imports of essential commodities.
Preconditions for CAC:
- As India continues to expand its role in the global economy, the rupee will likely become fully convertible.
- Currency convertibility is an important part of global commerce because it opens up trade with other countries.
- Any currency may be current account convertible, capital account convertible, or both.
- These 40 per cent exchange receipts on current account was meant for meeting Government needs for foreign exchange and for financing imports of essential commodities.
- In existing standards, it means that the country’s currency becomes convertible in foreign exchange and vice versa in the market.
So, the way via which RBI affects the exchange rates in India is “Trade”. 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. Here we should note that the objective of RBI to intervene in the currency markets is to ensure low volatility in exchange rates, and not to influence the direction of the Indian rupee in relation to other currencies. Further, RBI has one more arm in its arsenal called “capital controls” in addition to intervention through active trading in currency markets. In those times, the exchange rates used to be different than what they are today.
Prerequisites for Fuller Convertibility (Tarapore Committee, :
Such facilities would also be available to non- bank financial institutions and financial intermediaries like insurance companies, investment companies and mutual funds. (b) Indian residents would be permitted to have foreign currency denominated deposits with banks in India, to make transfers of financial capital to other countries within certain limits, and to take loans from non-relatives and others up to a ceiling of $1 million. The balance 40% of the earnings should be sold to RBI through authorised dealers at the official rate of exchange; this amount of foreign exchange would be made available by RBI for financing preferred imports, bulk imports, etc. 60% of the export earnings could be converted at the market determined rate; this amount could be used freely for current account transactions and payments (i.e., for import of goods, for travel and for remittances abroad).
There would be no limit on inflow or outflow of capital for various purposes including investments, remittances, or asset purchases/sales. Additionally, the INR is not a completely free-floating currency left to market dynamics. Regulators will occasionally act to keep the exchange rates within permissible limits.
There were also restrictions on the import and export of Indian currency, foreign currency and bullion. When currency reforms were enacted at the end of the 20th century, the rupee was made partially convertible for goods, services, and merchandise only. During the mid-1990s, the rupee was fully made current account convertible for all trading activities, remittances, and indivisibles. (c) Indian banks would be permitted to borrow from overseas markets for short-term and long-term up to certain limits, to invest in overseas money markets, to accept deposits and extend loans denominated in foreign currency.
So in India, there is free regime for current account transactions but still partial convertibility for capital account transactions. Many economics experts are of view that we need full capital account convertibility of currency. Recently RBIs governor Raguram Rajan, in an interview has suggested moving towards full capital account convertibility in short numbers of years. Mr. G Padmanabhan, Executive Director of the Reserve Bank of India (RBI), has suggested that India should move towards making the rupee more convertible for capital transactions by foreign investors.
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Under CAC any Indian or Indian company is free to convert Indian financial assets into foreign financial assets and reconvert foreign financial assets into rupees at the prevailing market rate of exchange. This means that CAC removes all the restrains on international flows on India’s capital account. As the next step, the GOI announced the convertibility of the rupee on the current account, that is, liberalise the access to foreign exchange for all current business transactions including travel, education, medical expenses, etc.