On Currency Convertibility 3v4av

PPT ON CURRENCY CONVERTIBILITY

PRESENTED BY: SHREYA BANSAL; 43

MEANING OF CURRENCY CONVERTIBILTY 

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Currency convertibility refers to the freedom to convert the domestic currency into other internationally accepted currencies and vice versa. The report on Fuller Capital Convertibility (FCAC) defines convertibility as, the freedom to convert local financial assets into foreign financial assets and vice versa.

TYPES OF CONVERTIBLE CURRENCIES

types

Fully convertible currency

Partially convertible currency

Nonconvertible currency

CONVERTIBILITY OF RUPEE 

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1.

2.

Rupee convertibility means the system where any amount of rupee can be converted into any other currency without any question asked about the purpose for which the foreign exchange is to be used. The need to convert domestic currency into foreign currency or to convert foreign currency into domestic currency arises for two reasons: For transaction arising due to exports, imports, tourism, medical expenses, education, currency gifted overseas. These transaction are called current transactions. For transaction arising due to foreign direct investment (FDI) into a country or outside the country, to borrow overseas, and to lend overseas. These transactions are called capital transactions.

CURRENT CONVERTIBILITY 

Current 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 assets abroad, it is only current convertibility. As of now, convertibility of the rupee into foreign currencies is almost wholly free for current i.e. in case of transactions such as trade, travel and tourism, education abroad etc.

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The Government of India introduced a system of Partial Rupee Convertibility (PCR) (Current Convertibility) on February 29,1992. PCR is designed to provide a powerful boost to export as well as to achieve as efficient import substitution. It is designed to reduce the scope for bureaucratic controls, which contribute to delays and inefficiency. Government liberalized the flow of foreign exchange to include items like amount of foreign currency that can be procured for purpose like travel abroad, studying abroad etc. What it means that people are allowed to have access to foreign currency for buying a whole range of consumables products and services.

COMPONENTS OF CURRENT CONVERTIBILITY 1.

Goods and services

2.

Income

3.

unilateral transfers

RANGARAJAN COMMITTEE REPORT The chief recommendations as explained by Gopinath are: 1.

Introduction of a market determined exchange rate regime.

2.

Liberalization of current transactions and introduction of current convertibility.

3.

Shifting of capital flows away from debt creating to non-debt creating flows.

4.

Strict regulation of external commercial borrowing especially short-term debt.

5.

Giving full freedom to outflows associated inflows, such as repayment of principal taken in foreign currency , payment of interest, dividend to overseas investors , and sale proceeds from sale of assets held in India.

In august 1994,India accepted article VIII of the articles of agreement of the IMF. This required a country to introduce convertibility on the current . In June 2000, a new act called Foreign exchange management act (FEMA) was implemented and the existing act called foreign exchange regulation act (1973) ceased. FEMA was implement to ensure current convertibility.

CAPITAL CONVERTIBILITY (CAC) 

The concept of Capital Convertibility was coined by RBI and CAC is now almost synonymous with the SS Tarapore Committee.

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capital is made up of both the short-term and long-term capital transactions. The Capital Transaction may be Capital outflow or capital inflow.

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Capital convertibility (CAC) or a floating exchange rate 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 convertibility allows anyone to freely move from local currency into foreign currency and back.

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convertibility on the capital is usually introduced after a certain period of introducing the Current convertibility. The most important effect of introducing the capital convertibility is that it encourages the inflow of the foreign capital, because under certain conditions, the foreign investors are enabled to repatriate their investments, wherever they want.

BASIC STATEMENTS OF CAPITAL CONVERTIBILITY 

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All types of liquid capital assets must be able to be exchanged freely between any two nations with standardized exchange rates. The amounts must be significant amount( in excess of $5,00,000) Capital inflows should be invested in semi-liquid assets to prevent excessive outflow. Institutional investors should not use capital convertibility to manipulate exchange rates. Excessive inflows and outflows should be buffered by national banks to provide collateral.

IMPACT OF CAC 

After fully convertibility is adopted by India , it will lead to acceptance of Indian rupee currency all over the world.

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In case of two convertible currencies, forward exchange rates reflect interest rate differentials between these two currencies.

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Thus, it can be said that the forward exchange rate for the higher interest rate currency would depreciate so as to neutralize the interest rate difference.

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However, sometimes there can be opportunities when forward rates do not fully neutralize interest rate differentials.

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In such situations, arbitrageurs get into the act and forward exchange rates quickly adjust to eliminate the possibility of risk-less profits.

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Capital convertibility is likely to bring depth & large volumes in long-term INR currency swap markets.

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Thus for better market determination of INR exchange rates, the INR convertible.

should be

TARAPORE COMMITTEE ON CAPITAL CONVERTIBILITY 

The Committee on Capital Convertibility (CAC) or Tarapore Committee was constituted by the Reserve Bank of India for suggesting a roap on full convertibility of Rupee on Capital . The committee submitted its report in May 1997.

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The report made 40 recommendations of which 19 recommendations were fully implemented by the RBI & 15 were partly implemented.

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The CAC Committee recommended the implementation of Capital Convertibility for a 3 year period viz. 1997-98, 1998-99 and 1999-2000

parameter

target

Gross fiscal deficit as a percentage of GDP

1997-98:4.5% 1998-99:4% 1999-00:3%

Gross NPAs of public sector banks

1997-98:12% 1998-99:9% 1999-00:5%

Inflation range during 1997-00

3 to 5%

CONT… But this committee had laid down some pre conditions as follows: 1. Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5 per cent in 1997-98 to 3% in 1999-2000. 2. A consolidated sinking fund has to be set up to meet government's debt repayment needs; to be financed by increased in RBI's profit transfer to the govt. 3. Inflation rate should remain between an average 3-5 per cent for the 3-year period 1997-2000. 4. Gross NPAs of the public sector banking system needs to be brought down from the present 13.7% to 5% by 2000. At the same time, average effective CRR needs to be brought down from the current 9.3% to 3% 5. 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

CONT… 6. External sector policies should be designed to increase current receipts to GDP ratio and bring down the debt servicing ratio from 25% to 20% 7. Four indicators should be used for evaluating adequacy of foreign exchange reserves to safeguard against any contingency. Plus, a minimum net foreign asset to currency ratio of 40 per cent should be prescribed by law in the RBI Act. Since, the RBI aceepted only 34 of the 40 recommendations made by the report; some restrictions on convertibility still remained. Even in the case of residents, the implementation of recommendations by the RBI lead to greater freedom to resident corporate, and less to resident individuals. These were addressed in the FCAC report ,2006.

THE SECOND TARAPORE COMMITTEE ON CAPITAL CONVERTIBILITY Reserve Bank of India appointed the second Tarapore committee to set out the framework for fuller Capital Convertibility. The committee was established by RBI in consultation with the Government to revisit the subject of fuller capital convertibility in the context of the progress in economic reforms, the stability of the external and financial sectors, accelerated growth.  The report of this committee was made by RBI on 1st September 2006. In this report, the committee suggested 3 phases of adopting the full convertibility of rupee in capital . First Phase in 2006-7 Second phase in 2007-09 Third Phase by 2011 

CONT… Following were some important recommendations of this committee: 1. The ceiling for External Commercial Borrowings (ECB) should be raised for automatic approval. 2. NRI should be allowed to invest in capital markets 3. NRI deposits should be given tax benefits. 4. Improvement of the Banking regulation. 5. FII (Foreign Institutional Investors) should be prohibited from investing fresh money raised to participatory notes. 6. Existing PN holders should be given an exit route to phase out completely the PN notes.

PROS OF CAC 

It allows domestic residents to invest abroad and have a globally diversified investment portfolio, this reduces risk and stabilizes the economy. A globally diversified equity portfolio has roughly half the risk of an Indian equity portfolio.

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Capital Convertibility becomes a reality. The reason is on of current restrictions imposed on movement of their funds. As the remittances made by NRI’s are subject to numerous restrictions which will be eased considerably once Capital Convertibility is incorporated.

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It also opens the gate for international savings to be invested in India. It is good for India if foreigners invest in Indian assets — this makes more capital available for India’s development. That is, it reduces the cost of capital

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Huge amounts of capital are moving across the border anyway. It is better for India if these transactions happen in white money. Convertibility would reduce the size of the black economy, and improve law and order, tax compliance and corporate governance.

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Most importantly convertibility induces competition against Indian finance. Currently, finance is a monopoly in mobilizing the savings of Indian households for the investment plans of Indian firms.

CONS OF CAC 

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The possibility of misallocation of capital inflows. Such capital inflows may fund low-quality domestic investments, like investments in the stock markets or real estates, and factories, which leads to more creation and utilization, and increased level of employment. This also reduces the potential of the country to increase exports and thus creates external imbalances. capital can lead to “the export of domestic savings” (the rich can convert their savings into dollars or pounds in foreign banks or even assets in foreign countries), which for capital scarce developing countries would curb domestic investment. No evidence linking improved growth to CAC.

DIFFERENCE BETWEEN CAPITAL CONVERTABILITY AND CRRENT CONVERTIBILITY BASIS

CURRENT CONVERTIBILITY

CAPITAL CONVERTIBILITY

MEANING

Current 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

the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange

CONVERTIBILITY

Partial convertible

Fully convertible

ESTABLISHED

established with the acceptance of the obligations under Article VIII of the IMF's Articles of Agreement in August 1994.

Coined by RBI of India in 1997 by the Tarapore committee.