Currency Convertibility: Advantage, Benefits and Preconditions for Capital Account Convertibility

However, this would also come with increased volatility, the risk of businesses becoming burdened by foreign debt, and reduced competitiveness in the global export market. The growing international interest in the Indian rupee is evident from the development of offshore rupee markets in locations like Dubai, London, New York, and Singapore. As of September 2024, INR contracts traded against the dollar an average of 11,825 times per day in 2024, compared to 198,027 contracts converted from Euro to USD. Stronger currencies tend to be converted more easily than others, while growth may be stagnant for currencies with poor convertibility because these countries may miss trade opportunities. The Government of India has taken the following steps towards capital account convertibility.

1. To encourage the use of theIndian currency in cross-border trade is one of the major goals of the Foreign Trade Policy (FTP) 2023 of India which comes into effect from April 1, 2023.
2. Similarly, incoming foreign investments in certain sectors like insurance or retail are capped at a specific percentage and require regulatory approvals for higher limits.
3. (b) The size of the current account deficit should be within manageable limits and the debt service ratio should be gradually reduced from the present 25 per cent to 20 per cent of the export earnings.
4. Further, full convertibility of rupees at that stage was considered to be risky in view of large deficit in balance of payments on current account.
5. In the case of capital account convertibility, a currency can be converted into any other currency without any transaction.
6. Currency convertibility is important for international commerce as globally sourced goods must be paid for in an agreed-upon currency that may not be the buyer’s domestic currency.
7. There would be no limit on inflow or outflow of capital for various purposes including investments, remittances, or asset purchases/sales.

As economies slump into recession investors will often seek investment offshore or convert their money into one of the safe-haven currencies. To combat this and ensure money doesn’t flood out of the country, some governments put controls in place to reduce capital flight during trying economic times. A convertible currency is any nation’s legal tender that can be easily bought or sold on the foreign exchange market with little to no restrictions. A convertible currency is a highly liquid instrument as compared with currencies that are tightly controlled by a government’s central bank or other regulating authority. Any individual involved in trade can get foreign currency converted at designated banks or dealers.

Currencies that aren’t fully convertible are generally difficult to convert into other currencies. These currencies are usually more tightly controlled by a government’s regulatory authority or central bank. Current Account Convertibility refers to the degree of freedom to convert your rupees into other internationally accepted currencies and vice versa without any restrictions whenever payments are made. (b) The size of the current account deficit should be within manageable limits and the debt service ratio should be gradually reduced from the present 25 per cent to 20 per cent of the export earnings. In a move to counter Russia’s war over Ukraine, the US and the European Commission issued a joint statement to exclude seven Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) messaging system, which was the trigger point for all countries.

What Measures Can Be Taken to Facilitate Rupee Internationalization?

The authorised dealer banks (DB) have been allowed to open rupee Vostro accounts (an account that a correspondent bank holds on behalf of another bank). The rupee payment system also allows Indian exporters to collect advance payments in Indian rupees from foreign importers against shipments. The surplus rupee balance in the Vostro accounts may be used for advanced flow management of export-import transactions, investments in government securities, and payments for projects and investments. Good currency convertibility requires a readily available supply of physical currency which is why some countries impose capital controls on money leaving its country.

b allowing the value of rupee to be fixed by market forces

India has made a modest attempt at facilitating rupee trade; the idea will take time to gain acceptance. 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. In 1992, liberal economic reforms were introduced that impacted the way forex transactions were conducted. Exporters and importers could exchange foreign currencies for the trade of unbanned goods and services.

The rupee is not fully convertible; India’s share of global exports of goods is just about 2%, and these factors reduce the necessity for other countries to hold rupees. India accounts for less than 4% of global services trade, 2.5% of global merchandise trade, and an even lower percentage of global financial activities. In December 2022, India did its first settlement of foreign trade in rupees with Russia as part of the ‘International Settlement of Trade in Indian Rupee’ mechanism initiated by the RBI. As per the Bureau for International (BIS) Settlements “Triennial Central Bank Survey 2022”, as of April 2022, USD accounts for about 88% of global foreign exchange market turnover, followed by the Euro, Japanese Yen, and Pound Sterling. Countries with a currency that has poor convertibility are at a global trade disadvantage because transactions don’t run as smoothly as those with good convertibility.

Creating an offshore market for its domestic currency that allows foreign entities to sell renminbi for dollars However, it must not be forgotten that China also has a trade surplus with most of the other countries. There tends to be a correlation between a country’s economy and the convertibility of its currency. The stronger an economy is on the global scale, the more likely its currency will be easily converted into other major currencies. Nearly all countries have currencies that are at some level at least partially convertible. However, currencies such as the Brazilian real, Argentinian peso, and Chilean peso are considered non-convertible because it is virtually impossible to convert them into another legal tender, except in limited amounts on the black market. A fully convertible rupee would improve employment and consumer opportunities, help Indian businesses raise foreign capital, and allow India to become a global economic player.

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There was easy access to forex for studying or traveling abroad, and, depending on the industry, there were fewer restrictions on foreign business and investments. (c) Indian banks would be allowed to borrow from overseas markets for short-term and long-term upto certain limits, to invest in overseas money markets, to accept deposits and extend loans denominated in foreign currency. Such facilities would be available to financial institutions and financial intermediaries also. 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.

Additionally, the advent of digital currencies has created a new category, virtual convertibility. convertibility of rupee implies A fully-convertible currency is highly liquid, and very desirable to other countries. Having this kind of currency promotes trading with the country in question and also serves to promote the country’s exports. However, Indians still require regulatory approval if they want to invest an amount above a pre-determined threshold in overseas assets. Similarly, incoming foreign investments in certain sectors like insurance or retail are capped at a specific percentage and require regulatory approvals for higher limits.

1. (c) Indian banks would be allowed to borrow from overseas markets for short-term and long-term upto certain limits, to invest in overseas money markets, to accept deposits and extend loans denominated in foreign currency.
2. On the other hand, a country will tend to import those goods in the produc­tion of which it has a comparative disadvantage.
3. Russia’s exports to India in 2021 stood at $6.9 billion, mainly consisting of mineral oils, fertilisers, and rough diamonds, while India exported goods worth $3.33 billion to Russia in 2021, mainly comprising pharmaceutical products, tea, and coffee.
4. In the seventies and eighties many countries switched over to the free convertibility of their currencies into foreign exchange.
5. Exporters and importers could exchange foreign currencies for the trade of unbanned goods and services.
6. The most important advantage of internationalising the rupee is to reduce dependency on the USD for foreign trade.
7. The rupee payment system also allows Indian exporters to collect advance payments in Indian rupees from foreign importers against shipments.

Poor currency convertibility can contribute to slower economic growth as global trade opportunities are missed. It is still possible to bring in foreign capital or take out local money for these purposes. However, there are ceilings imposed by the government, and transactions beyond those thresholds require approval. (d) All-India financial institutions which fulfill certain regulatory and prudential requirements would be allowed to participate in foreign exchange market along with authorised dealers (ADs) who are, at present, banks.

The US and European Union are the major export destinations for India, and the others would be oil-exporting nations. Removal of restrictions on buying and selling of domestic currency in both the spot and forward markets. Foreign firms, financial institutions, government institutions, and individuals can hold the country’s currency and financial instruments. A currency with current account convertibility can be converted to any foreign currency at existing market rates for trade purposes for any amount. This allows for easy financial transactions for the export and import of goods and services.