Currency

Convertibility and it’s

Impact on B.O.P
 Convertibility

• 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.
 Classification
Rupee
Convertibility

Current Capital
Account Account
Convertibi Convertibi
lity lity
 Current Account
• It refers to currency convertibility required
in the case of transactions relating to
exchange of goods and services, money
transfers and all those transactions that
are classified in the current account.

• In Short, Current account includes all

transactions, which give rise to or
use of our National income
 Current Account
Transactions
1. All imports and exports of merchandise
2. Invisible Exports and Imports
(sale/purchase of services
3. Inward private remittances (to & fro)
4. Pension payments (to & fro)
5. Government Grants (both ways)
 Convertibility on Current
Account
India is fully convertible on the current account
A full convertibility means movement of funds in & out of India
without any restrictions & permissions.
Provides full freedom to both residents and non-residents to
trade in goods/services.
RBI has placed a cap in creation of a capital asset
In India, most current account transactions have been freed
from controls over the years.
 Contd…
• Current account 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 account
convertibility.
 Rangarajan Committee
Recommendations
1. Liberalization of current account transactions leading to
current account convertibility
2. a compositional shift in capital flows away from debt- to non-
debt-creating flows
3. strict regulation of external commercial borrowings, especially
short-term debt
4. discouraging volatile elements of flows from nonresident
Indians
5. gradual liberalization of outflows
6. disintermediation of the government in the flow of external
assistance
7. Introducing a market-determined exchange rate regime
 Rangarajan Committee-
Implementations
Step-1:Dual exchange rate system
Liberalised Exchange Rate Management System
involving dual exchange rate system was instituted in
March 1992
The dual exchange rate system was essentially a
transitional stage leading to the ultimate convergence
of the dual rates made effective from March 1, 1993
 Two rates of exchange: Official rate of exchange & Market
rate of exchange
 60% of the export earnings could be converted at the free
market determined rate. (which was around Rs.28)
 The balance 40% of the earnings should be sold to RBI
through authorised dealers at the official rate of
exchange. (generally higher at Rs.32)
• Step-2:Full convertibility of the current account
• This unification of exchange rates brought about the
era of market determined exchange rate regime of
rupee, based on demand and supply in the forex
market.
 Liberalize the access to foreign exchange for all
current business transactions including travel,
education, medical expenses, etc.
 Under Article VIII of the IMF’s Articles of Agreement
in August 1994.
Path that lead to Current
Account Convertibility
After 2000

From 1992
to 2000

Liberalizati
on began
in 1991

Till 1990
 Current Situation on Current
Account
• India is fully convertible on the current
account
• Provides full freedom to both residents
and non-residents to trade in
goods/services.
• RBI has placed a cap in creation of a
capital asset
 Capital Account
• Capital Account consist of short term
and long term capital transactions
• As per FEMA "capital account
transaction" means a transaction
which alters the assets or liabilities,
including contingent liabilities,
outside India of persons resident in
India or assets or liabilities in India of
persons resident outside India
 Capital Account
Transactions
1. Direct Foreign Investments (both inward &
outward)
2. Investment in securities (both inward & outward)
3. Other Investments (both inward & outward)
4. Government Loans (both inward & outward)
5. Short-term investments (both inward & outward)
 Capital Account
Transaction
Capital Account transactions are classified
as :-

1.Portfolio investment involves trade in

securities like stocks, bonds, bank loans,
derivatives, etc.
2.Direct investment involves purchase
of real estate, production facilities, or
equity investment.
3.Other investment involves holdings in
loans, bank accounts and currencies
 Capital Account
Convertibility
• The freedom to convert local financial assets into
foreign financial assets and vice versa at market
determined rates of exchange.
• In other words, it means allowing Indians to
purchase both the physical and financial assets
abroad and vice-versa.
• In simple language, CAC allows anyone to freely
move from local currency into foreign currency
and back.
• It is associated with changes of ownership in
foreign/domestic financial assets and liabilities.
 Currently Restriction on
Capital Account are
1. There are limit to company borrowing
abroad
2. Restriction on foreigner investing in India.
3. Restriction on amount that FII can hold.
4. Purchasing a company is allowed but limit
exit on the amount that can be send.
5. Global Diversification of household
portfolio is practically nonexistent.
 Limits to Partial CAC
• Limits specified by the Reserve Bank of
India:-
1.Private visit abroad is $10,000: of which only
$5,000 can be in cash
2.Business travel, the yearly limit is $25,000
3.Gift or donate up to $5,000 in a year.
4.Going abroad for employment, or are going for
studies abroad: the limit in both these cases is
$100,000
5.Investment into foreign stock markets up to the
extent of $25,000 in a year.
TARAPORE COMMITTEE-I
 Members of the Committee

Head of Committee: S. S. Tarapore

Surjit S. Bhalla
Ajit Ranade
A. V. Rajwade
R. H. Patil
M. G. Bhide
 The Terms Of Reference Of The
Committee
i. To review the experience of various measures of capital
account liberalization in India,

ii. To examine implications of fuller capital account convertibility

on monetary and exchange rate management, financial
markets and financial system,

iii. To study the implications of dollarization in India of domestic

assets and liabilities and internationalization of the Indian
rupee,

iv. To survey regulatory framework in countries which have

advanced towards fuller capital account convertibility,

v. To suggest appropriate policy measures and prudential safe-

guards to ensure monetary and financial stability, and

vi. To make such other recommendations as the Committee may

deem relevant to the subject.
 Tarapore Committee-I
Recommendations
• Direct Investment in Ventures abroad by Indian Corporate
• ECB (External Commercial Borrowing) Ceiling
• Foreign Direct and Portfolio Investment and
Disinvestment should be Governed by Comprehensive
and Transparent Guidelines
• Banks may be allowed to Borrow from Overseas Markets
• SEBI Registered Indian Investors may be allowed to set
up Funds for Investment Overseas
 Contd…
• Currency Futures may be Introduced
• Participation in Money Markets may be
Widened
• RBI should withdraw from Primary
Market in Government Securities
• Banks and Financial Institutes should be
allowed to Participate in Gold Markets
in India and abroad and Deal in Gold
Products
 Preconditions Of The
Tarapore Committee-I
Major Pre-Conditions by Report
Status as on July 2009
Tarapore Committee
1. Reduction in gross fiscal deficit The present fiscal deficit is at 6.8%
to 3.5% by 1999-2000
2. The inflation rate for 3 years Inflation at present is around 4.00%.
should be an average 3% to 5%
3. Forex reserves should at least be The present forex reserves are enough to
enough to cover 6 months import cover more than one year’s imports.
cover
4. Gross NPAs to be brought down Gross NPA for the banking sector is around
to 5% by 1999-2000 3%
5. CRR to be reduced to 3% by CRR is at 5.00%
1999-2000
6. Interest Rate to be fully All interest rates, except Saving Fund interest
deregulated rates, have already been deregulated.
TARAPORE COMMITTEE-II
 Tarapore Committee II-
Revisiting The Subject Of
CAC
Prime Minister Manmohan Singh
“Given the changes that have taken place
over the last two decades, there is merit
in moving towards fuller capital account
convertibility within a transparent
framework…I will therefore request the
Finance Minister and the Reserve Bank to
revisit the subject and come out with a
roadmap based on current realities”.
 Tarapore Committee II-
Recommendations
• Meeting Fiscal Responsibility and Budget
Management targets
• Shifting from present measures of fiscal deficit to
public sector borrowing requirement.
• Segregating government debt management and
monetary policy operations
• Imparting greater autonomy and transparency in
the conduct of monetary policy
• Reduction in the share of government / RBI in the
capital of public sector banks.
 Capital Controls in
India
• India maintains an extensive capital control regime

• Controls have been quantity-based rather than markets

based
 Oriented towards limiting the country’s external debt
 Controls remain on the external exposure of pension
funds, insurance companies etc. The external assets of
banks are closely monitored

• Stricter controls on short term rather than long term inflows

 What Will Full Capital
Account Convertibility Do?
• Reduction in Cost of Capital

• Help in Diversifying Portfolio Internationally

• Improve the efficiency of the financial sector

through greater competition

• Reduce Size of Black Economy

 Issues to FCAC

• Capital Flight

• Credit and liquidity risks

• Risk of regulatory arbitrage include new dimensions

• Increased cross-border transactions will augment the

dimensions of risks that Indian financial institutions
face in their domestic markets
 Pre-Requisites
• These include:
1.Comfortable Current Account Position.
2.Maintenance of Domestic Economic
Stability.
3.Adequate Foreign Exchange Reserve.
4.Restriction on inessential Import.
5.An Appropriate Industrial Policy.
 The Road Ahead

• India proceeds gradually towards CAC

• Reform of Indian financial system is a

precondition

• Banking sector reform is required on a grand

scale
 THANK
YOU!