The Indian rupee is fully convertible on the current account, but only partially convertible on the capital account. "We believe we must move towards capital account convertibility, along a road map -- the road map itself being recalibrated on a dynamic basis depending on both global and domestic developments," RBI Governor Duvvuri Subbarao told a meeting of central bankers and economists in Argentina on 3rd September, 2010. He said capital flows must always be managed and that India would have a widening current account deficit as its economy grows more quickly than others in the world. "Managing capital flows you never get capital flows of exactly the kind you want and exactly the quantity you want," he said. "This year, 2010/11, is quite important. We think current account deficit will widen because India is growing faster that the world which means our imports will grow faster than our exports," he added.
India has been relentlessly moving on the path towards liberalization, opening up its markets and loosening its controls over many economic matters so as to integrate with the global economy. Despite the opposition to globalization from some quarters, India has been quite watchful in its approach to embracing global economy. The issue of capital account convertibility is one such where the nation has tread very cautiously.
Currency convertibility:
Currency convertibility means “the freedom to convert one currency into other internationally accepted currencies”. Currency convertibility implies the absence of exchange controls or restrictions on foreign exchange transactions. Foreign exchange transactions are broadly classified into two types: current account transactions and capital account transactions. In the early nineties, India’s foreign exchange reserves were so low that these were hardly enough to pay for a few weeks of imports. To overcome this crisis situation, Indian Government had to pledge a part of its gold reserves to the Bank of England to obtain foreign exchange. However, after reforms were initiated and there was some improvement on FOREX front in 1994, transactions on the current account were made fully convertible and foreign exchange was made freely available for such transactions. But capital account transactions were not fully convertible as India wanted to conserve precious foreign exchange and protect the rupee from volatile fluctuations.
By late nineties situation further improved, a committee on capital account convertibility was setup in February, 1997 by the Reserve Bank of India (RBI) under the chairmanship of former RBI deputy governor S.S. Tarapore to "lay the road map" to capital account convertibility. The committee recommended that full capital account convertibility be brought in only after certain preconditions were satisfied. These included low inflation, financial sector reforms, a flexible exchange rate policy and a stringent fiscal policy.
Current Account Convertibility:
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 trade-related 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.
Capital account convertibility:
Capital account convertibility means the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. This means that capital account convertibility allows anyone to freely move from local currency into foreign currency and back. It refers to the removal of restraints on international flows on a country's capital account, enabling full currency convertibility and opening of the financial system. It means that the home currency can be freely converted into foreign currencies for acquisition of capital assets abroad and vice versa.
Capital account convertibility is considered to be one of the major features of a developed economy. It helps attract foreign investment. It offers foreign investors a lot of comfort as they can re-convert local currency into foreign currency anytime they want to and take their money away.
At the same time, capital account convertibility makes it easier for domestic companies to tap foreign markets. At the moment, India has current account convertibility. This means one can import and export goods or receive or make payments for services rendered. However, investments and borrowings are restricted. But India is now on firm ground given its strong financial sector reform and fiscal consolidation, and can move towards capital account convertibility.
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