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DECLARATION BY THE STUDENT

I, _____________________________________________________student of M Com Part-I
Roll Number __________hereby declare that the project for the Paper _________________.
_________________________________________________________________________
submitted by me for Semester I during the academic year 2012-13, is based on actual work
carried out by me under the guidance and supervision of _______________________. I further
state that this work is original and not submitted anywhere else for any examination.

Signature of Student

EVALUATION CERTIFICATE
This is to certify that the undersigned have assessed and evaluated the project on
_________________________________________________________________________
submitted by ___________________________________________Student of M Com Part-I.
This project is original to the best of our knowledge and has been accepted for Internal
Assessment.

Internal Examiner

External Examiner

Principal

L. S. RAHEJA COLLEGE OF ARTS & COMMERCE

Internal Assessment: Project 40 Marks
Name of the Student
First name

Class

Division

Roll
Number.

Fathers Name:

M COM
PART I

Surname

Subject: Economics of Global Trade & Finance

Topic for the Project:

Marks Awarded Signature

DOCUMENTATION
Internal Examiner
(Out of 10 Marks)
External Examiner
(Out of 10 Marks)
Presentation
(Out of 10 Marks)
Viva and Interaction
(Out of 10 Marks)

TOTAL MARKS (Out of 40)

2

CONTENTS
Sr. No.

PARTICULARS

Page No.

CHAPTER I INTRODUCTION
1.1

INTRODUCTION

1.2

TYPES OF CURRENCY CONVERTIBILITY

1.3

RUPEE CONVERTIBILITY

CHAPTER II CURRENT ACCOUNT CONVERTIBILITY

2.1

COMPONENTS-GOODS

14

2.2

SERVICES

15

2.3

INCOME

18

CHAPTER III CAPITAL ACCOUNT CONVERTIBILITY

3.1

BASICS & APPLICATION

20

3.2

DIFFERENCE BETWEEN CAPITAL & CURRENT ACCOUNT

CONVERTIBILITY

21

3.3

PRINCIPLES GOVERNING CAPITAL ACCOUNT

CONVERTIBILITY

23

3.4

RESTRICTIONS ON CAPITAL ACCOUNT

CONVERTIBILITY

25

CHAPTER IV BURNING ISSUE

4.1

WHY IS FCAC IMPORTANT & WHAT ARE THE REASONS

FAVOURING SUCH A CONCEPT?

26

4.2

TARAPORE COMMITTEE APPOINTMENT

27

4.3

HOW DOES CAPITAL A/C CONVERTIBILITY AFFECT US?

32

CHAPTER V CONCLUSION
CHAPTER VI - REFERNECE ( BIBLIOGRAPHY )
3

INTRODUCTION
Each country has its own currency through which both national and
international transactions are performed. All the international business transactions
involve an exchange of one currency for another. For example, if any Indian firm
borrows funds from international financial market in US dollars for short or long
term then at maturity the same would be refunded in particular agreed currency
along with accrued interest on borrowed money. It means that the borrowed foreign
currency brought in the country will be converted into Indian currency, and when
borrowed fund are paid to the lender then the home currency will be converted into
foreign lenders currency. Thus, the currency units of a country involve an
exchange of one currency for another. The price of one currency in terms of other
currency is known as exchange rate.
The foreign exchange markets of a country provide the mechanism of exchanging
different currencies with one and another, and thus, facilitating transfer of
purchasing power from one country to another. With the multiple growths of
international trade and finance all over the world, trading in foreign currencies has
grown tremendously over the past several decades. Since the exchange rates are
continuously changing, so the firms are exposed to the risk of exchange rate
movements. As a result the assets or liability or cash flows of a firm which are

denominated in foreign currencies undergo a change in value over a period of time

due to variation in exchange rates. This variability in the value of assets or
liabilities or cash flows is referred to exchange rate risk. Since the fixed exchange
rate system has been fallen in the early 1970s, specifically in developed countries,
the currency risk has become substantial for many business firms. As a result, these
firms are increasingly turning to various risk hedging products like foreign
currency futures, foreign currency forwards, foreign currency options, and foreign
currency swaps. Convertibility essentially means the ability of residents and nonresidents to exchange domestic currency for foreign currency, without limit,
whatever is the purpose of the transactions.

Convertibility: why?

Externally inconvertible currencies may be of rather limited value to their holder.

An exported item from a developing country to the USSR, for example, may be
paid for in rubles or the currency of a country that has ratified Article VIII. The
proceeds

may

be

used

to

purchase

goods

anywhere.

In considering possible import suppliers, therefore, a developing country will have

some interest in directing its importers to those countries that will have some
interest in directing its importers to those countries whose inconvertible currencies
are in large supply. This is, of course, a case of trade discrimination that is
condemned by traditional theory. This means that goods are not being purchased
from the cheapest source. Recent economic writing has, however, reopened the
question in view of the continued existence of inconvertible currencies. Where it is
profitable on the export side to trade with countries maintaining inconvertible
currencies, and the government wishes to encourage imports from those countries
to offset its credit balances, it will utilize its exchange distribution mechanism to
limit the availability of convertible exchange where there are alternative suppliers
of the same type of goods in inconvertible currency countries.

TYPES OF CURRENCY CONVERTIBILITY:

1: Fully convertible currency.
2: Partially convertible currency.
3: Non convertible currency.
Convertibility of a currency determines the ability of an individual, corporate or
government to convert its local currency to another currency or vice versa with or
without central bank/government intervention. Based on the above restrictions or
free and readily conversion features currencies are classified as:
Fully Convertible - When there are no restrictions or limitations on the
amount of currency that can be traded on the international market and the
government does not artificially impose a fixed value or minimum value on
the currency in international trade. The US dollar is an example of a fully
convertible currency and for this reason, US dollars are one of the major
currencies traded in the FOREX market.
Partially Convertible - Central Banks control international investments
flowing in and out of the country, while most domestic trade transactions are
handled without any special requirements, there are significant restrictions
on international investing and special approval is often required in order to
7

convert into other currencies. The Indian Rupee is an example of a partially

convertible currency.
Nonconvertible - Neither participate in the international FOREX market nor
allow conversion of these currencies by individuals or companies. As a
result, these currencies are known as blocked currencies. e.g.: North Korean
Won and the Cuban Peso

RUPEE CONVERTIBILITY

Classification

Current Account Convertibility

Current account is defined as including the value of trade in merchandise, services,
investment, income and unilateral transfers. Current account convertibility, being
essential to the development of multilateral trade, three approaches to current
account convertibility has been adapted by developing countries. These are the preannouncement, by-product, and front-loading approaches. Each approach is
distinguished by the importance it attaches to convertibility relative to other
economic objectives.
Capital Account Convertibility
Capital account includes transactions of financial assets. Its convertibility refers to
the freedom to convert local financial assets into foreign assets in any form and
vice versa at market-determined rates of exchange. Capital controls normally
restrict or prohibit cross-border movement of capital. Thus, controls on capital
movements include prohibitions: need for prior approval; authorization and
notification; multiple currency practices; discriminatory taxes; and reserve
requirements or interest penalties imposed by the authorities that regulate the
conclusion or execution of transactions. The coverage of the regulations would
apply to receipts as well as payments and to actions initiated by non-residents and
residents.
10

To begin with lets understand the concept of currency convertibility. Currency

convertibility may be defined as the freedom to convert one currency into other
internationally accepted currencies. Thus in a CAG regime the country places no
exchange controls or restrictions on foreign exchange transactions. There are two
forms of convertibility convertibility for current international transactions and
the convertibility for international capital movements. While India is still to opt for
full Capital Account Convertibility, the government has made the rupee convertible
on the current account. This implies that companies and resident
Indians can make and receive payments for import/export of goods and services
and be able to access foreign currency for travel, education, medical or other
designated purposes. Though there is no formal definition of CAC, the Tarapore
Committee provides some clarity in this regard as it defines the same as - the
freedom to convert local financial assets into foreign financial assets and vice versa
at market determined rates of exchange. In other words, Capital account
convertibility means that the home currency can be freely converted into foreign
currencies for acquisition of capital assets abroad. Thus, implementation of the
capital account convertibility regime will allow Indian residents to invest, disinvest
or transact in any property or assets/liability of any country, convert one currency
to another or move funds anywhere in the world, solely guided by discretion of the
concern individual or company & not restricted by law.
11

India`s Situation
India has full current account convertibility.
Unfortunately, there are a few restrictions on capital account convertibility,
hence, India has partial capital account convertibility.

12

CURRENT ACCOUNT CONVERTIBILITY

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. As of now,
convertibility of the rupee into foreign currencies is almost wholly free for current
account i.e. in case of transactions such as trade, travel and tourism, education
abroad etc.
Components of Current Account
Covered in the current account are all transactions (other than those in financial
items) that involve economic values and occur between resident non-resident
entities. Also covered are offsets to current economic values provided or acquired
without a quid pro quo. Specifically, the major classifications are goods and
services, income, and current transfers.

13

1. Goods and services

Goods

General merchandise covers most movable goods that residents export to or

import from non residents.

Goods for processing covers exports (or, in the compiling economy, imports)
of goods crossing the frontier for processing abroad and subsequent re-import (or,
in the compiling economy, export) of the goods, which are valued on a gross basis
before and after processing. The treatment of this item in the goods account is an
exception to the change of ownership principle.

Repairs on goods covers repair activity on goods provided to or received

from non residents on ships, aircraft, etc. repairs are valued at the prices (fees paid
or received) of the repairs and not at the gross values of the goods before and after
repairs are made.

Goods procured in ports by carriers covers all goods (such as fuels,

provisions, stores, and supplies) that resident/nonresident carriers (air, shipping,
etc.) procure abroad or in the compiling economy. The classification does not cover

14

auxiliary services (towing, maintenance, etc.), which are covered under

transportation.

Nonmonetary gold covers exports and imports of all gold not held as reserve
assets (monetary gold) by the authorities. Nonmonetary gold is treated the same as
any other commodity and, when feasible, is subdivided into gold held as a store of
value and other (industrial) gold.
Services

Transportation covers most of the services that are performed by residents

for nonresidents (and vice versa) and that were included in shipment and other
transportation in the fourth edition of the Manual.

Travel covers goods and servicesincluding those related to health and

educationacquired from an economy by non resident travelers (including
excursionists) for business and personal purposes during their visits (of less than
one year) in that economy. Travel excludes international passenger services, which
are included in transportation. Students and medical patients are treated as
travelers, regardless of the length of stay. Certain othersmilitary and embassy
personnel and non resident workersare not regarded as travelers. However,

15

expenditures by non resident workers are included in travel, while those of military
and embassy personnel are included in government services.

Communications services cover communications transactions between

residents and nonresidents. Such services comprise postal, courier, and
telecommunications services .

Construction services covers construction and installation project work that

is, on a temporary basis, performed abroad/ or in Extra territorial enclaves by
resident/non resident enterprises and associated personnel. Such work does not
include that undertaken by a foreign affiliate of a resident enterprise or by an
unincorporated site office that, if it meets certain criteria, is equivalent to a foreign
affiliate.

Insurance services covers the provision of insurance to non residents by

resident insurance enterprises and vice versa. This item comprises services
provided for freight insurance (on goods exported and imported), services provided
for other types of direct insurance (including life and non-life), and services
provided for reinsurance.

16

Financial services (other than those related to insurance enterprises and

pension funds) covers financial intermediation services and auxiliary services
conducted between residents and nonresidents. Included are commissions and fees
for letters of credit, lines of credit, financial leasing services, foreign exchange
transactions, consumer and business credit services, brokerage services,
underwriting services, arrangements for various forms of hedging instruments, etc.
Auxiliary services include financial market operational and regulatory services,
security custody services, etc.

Computer and information services covers resident/non-resident transactions

related to hardware consultancy, software implementation, information services
(data processing, data base, news agency), and maintenance and repair of
computers and related equipment.

Royalties and license fees covers receipts (exports) and payments (imports)
of residents and non-residents for (i) the authorized use of intangible non produced,
nonfinancial assets and proprietary rightssuch as trademarks, copyrights, patents,
processes, techniques, designs, manufacturing rights, franchises, etc. and (ii) the
use, through licensing agreements, of produced originals or prototypessuch as
manuscripts, films, etc.
17

Other business services provided by residents to nonresidents and vice versa

covers merchandising and other trade-related services; operational leasing services;
and miscellaneous business, professional, and technical services.

Personal, cultural, and recreational services covers (i) audiovisual and

related services and (ii) other cultural services provided by residents to nonresidents and vice versa. Included under (i) are services associated with the
production of motion pictures on films or video tape, radio and television
programs, and musical recordings. (Examples of these services are rentals and fees
received by actors, producers, etc. for productions and for distribution rights sold
to the media.) Included under (ii) are other personal, cultural, and recreational
servicessuch as those associated with libraries, museumsand other cultural
and sporting activities.

Government services i.e. covers all services (such as expenditures of

embassies and consulates) associated with government sectors or international and
regional organizations and not classified under other items.

2. Income
18

Compensation of employees covers wages, salaries, and other benefits, in

cash or in kind, and includes those of border, seasonal, and other non-resident
workers (e.g., local staff of embassies).

Investment income covers receipts and payments of income associated,

respectively, with residents holdings of external financial assets and with
residents liabilities to nonresidents. Investment income consists of direct
investment income, portfolio investment income, and other investment income.
The direct investment component is divided into income on equity (dividends,
branch profits, and reinvested earnings) and income on debt (interest); portfolio
investment income is divided into income on equity (dividends) and income on
debt (interest); other investment income covers interest earned on other capital
(loans, etc.) and, in principle, imputed income to households from net equity in life
insurance reserves and in pension funds.

19

CAPITAL ACCOUNT CONVERTIBILITY

Inflows and outflows of capital

Borrowing from or lending abroad.
Sales and purchases of securities abroad.
Capital Foreign Direct Investments
Short term and Long term Investments
Government Loans

APPLICATION:
Ultimate aim for such a concept is foreign investors could invest in other
countries without barriers.
This has led to many factories going overseas thus creating innumerable job
opportunities.
CAC should be used with proper restraints.

How is CAC different from current account convertibility?

20

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.

Is India ready to switch to full convertibility of rupee on capital account?

Some steps have already been taken to facilitate the full capital account
convertibility in the country. Foreign exchange has been allowed to flow into
Indian stock markets through registered institutional investors. In addition, many
categories of the resident Indians have been allowed to open foreign currency
accounts abroad. Indian companies have also been making overseas acquisitions
for which they have been given access to foreign currency resources.

It would, however, be wrong to presume that full convertibility on the capital

account would result in lifting of all the restrictions. Even the developed countries
like the USA block foreign investment in some of the sectors. Despite the

21

government decision in this regard, it has not been easy for the non-resident
Indians to acquire property and real estate in the country. The government of India,
though has allowed Direct Foreign Investment (FDI) in most of the fields, yet
certain caps have been put by the government on the FDI in some of the sectors..
Benefits would be in terms of more flow of foreign capital into the economy,
resulting in higher investment and the resultant growth rate. Further, the financial
and capital markets would bring more profits to the domestic investors. The
economy must be nearer to the global standards in the matter of fiscal deficit,
inflation rate, interest rates, foreign exchange reserves, etc. It is said that the
economy can be said to be ripe for capital account convertibility only if interest
rates are low and de-regulated and the inflation rate in the three consecutive years
had been around three per cent. Considering the above prerequisites it appears
that the Indian economy is not yet prepared for switching over to the capital
account convertibility.

PRINCIPLES GOVERNING CAPITAL ACCOUNT

CONVERTIBILITY
22

CAC has 5 basic statements designed as points of action

All types of liquid capital assets must be able to be exchanged freely,

between any two nations in the world, with standardized exchange rates.

The amounts must be a significant amount (in excess of $500,000).

Capital inflows should be invested in semi-liquid assets, to prevent churning

and excessive outflow.

Institutional investors should not use CAC to manipulate fiscal policy or

exchange rates.

Excessive inflows and outflows should be buffered by national banks to

provide collateral.

Current Account
In short
Includes all imports-exports, pension payments-both ways, remittances-to &
fro
Indian scenario-fully convertible
Freedom in respect of current international transactions
23

Capital account convertibility

In short
Inflows outflows of capital, borrowing or lending from abroad, sale and
purchase of securities.
Indian scenario-partially convertible.

RESTRICTIONS ON CAPITAL ACCOUNT

24

 Limits to companies borrowing abroad. Restrictions exist on Indians sending

money abroad that does not have to do with importing goods and services.

Restriction on foreigners investing in India

Restriction on amount that FII can hold.
Purchasing a company is permissible but a limit exists on the amount that
can be sent.

WHY IS FCAC(FULL CONVERTIBILITY ON CAPITAL ACCOUNT)

IS IMPORTANT & WHAT ARE THE REASONS WHICH ARE IN
FAVOUR OF SUCH A CONCEPT?
Reduction of black money-

25

Such a concept helps an economy to open up and make it

transparent.

Induces domestic competitionSuch a concept would open the market to foreign investment as
restriction would be relaxed and domestic competitors would have to
be on their toes to keep up.
Increases job opportunitiesSuch a benefit goes hand in hand with increase in domestic
competition.
A catalyst for financial markets, institutional development, new
technologies.
Diversification

TARAPORE COMMITTEE APPOINTMENT

The RBI has appointed a committee to set out the framework for fuller
Capital Account Convertibility
To revisit the subject of FCAC in the context of progress in economic
reforms, the stability of the external and financial sectors, accelerated
growth and global integration.

26

 Suggestions of the committee:

1.
2.
3.
4.

Reduction in gross fiscal deficit as a percentage of GDP

A certain level of rate of inflation for a certain period
A fully de-regulated interest rate structure.
A reduction of non-performing assets as a percentage of total
advances.

Such factors were the pre-requisites towards attainment of FCAC.

Unfortunately the performance was below satisfactory as none of the conditions
could be met.

For Example:
Gross fiscal deficit did not show a reducing trend and it did not reduce as
expected.
Interest rates could not be completely deregulated.
Non-performing assets did not reduce as expected.

What are the dangers of CAC? Or points in favour of restrictions?

1. Huge Inflow & Enormous outflow-

27

Good years get good inflow of capital and vice versa as per herd
behavior by which the investors tend to follow the movement of other investors so
if one moves out the other also does the same.
Eg: South Asian Countries received more than 150US$ by the first half of 1997
starting from 1996,but in the second half due to the threat of a crisis lost 102US$.

2. Misallocation of capital inflowsSuch capital inflows may tend to use up the funds for low quality
domestic investments like investments in the stock markets real estates & prevent
from investing in building up industries & factories which gives better job
opportunities. Also exports suffer and thus create external imbalances.

3.Export of domestic savingsDomestic savings would be invested in foreign banks thus leading to
savings being dragged away from the country. And in times of crisis, domestic
savings and foreign investments would also move out thus making the country
helpless in trying times.
28

4.Creation of unequal playing fieldOnly the rich can borrow from foreign banks while the farmers face the
axe from such banks as well as domestic banks as domestic ones also tend to
increase their interest rates and reduce subsidies in order to keep up with the
foreign banks.

2012 FDI Reforms

FDI in insurance sector up now to 49% from 26%.

FDI in single retail sector available upto 100%
FDI in multi retail sector available upto 51%
FDI in housing sector available upto 51%

The basic point highlighted here is that restrictions are getting relaxed and the Govt
is showing some hope towards FCAC although there are many pre requisites left to
be accomplished.

29

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

30

HOW DOES CAPITAL A/C CONVERTIBILITY AFFECT US?

As most of us know, resident Indians cannot move their money abroad freely. That
is, one has to operate within the limits specified by the Reserve Bank of India and
obtain permission from RBI for anything concerning foreign currency.

For example, the annual limit for the amount you are allowed to carry on a private
visit abroad is $10,000: of which only $5,000 can be in cash. For business travel,
the yearly limit is $25,000. Similarly, you can gift or donate up to $5,000 in a year.

31

The RBI limit raises the limit if you are going abroad for employment, or are
emigrating to another country, or are going for studies abroad: the limit in both
these cases is $100,000.

You are also allowed to invest into foreign stock markets up to the extent of
$25,000 in a year.
For the average Indian, these 'limits' seem generous and might not affect him at all.
But for heavy spenders and those with visions of buying a house abroad or a Van
Gogh painting, it will mean a lot. . .

But with the markets opening up further with the advent of capital account
convertibility, one would be able to look forward to more and better goods and
services.

32

And how will it affect Non-Resident Indians?

Capital account convertibility may NRIs as it will help remove all shackles on
movement of their funds.

Currently, NRIs have to produce a whole lot of documents and certificates if they
want to buy a house in India (for which the lock-in period is 10 years, meaning
they can't take their money back overseas if they sell the house after having owned
it for less than 10 years), or send money to India from their overseas accounts.

33

CONCLUSION
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.

34

A high-level committee to look into this matter, appointed by the Reserve Bank of
India recommended that India move to fuller capital account convertibility over the
next five years and has laid down the roadmap for the move.

Various pre requisites need to be fulfilled:

Reduction in gross fiscal deficit as a percentage of GDP

A certain level of rate of inflation for a certain period
A fully de-regulated interest rate structure.
A reduction of non-performing assets as a percentage of total advances.

Such steps will help India match with the global standards and these steps
would also pave the way for Full Capital Convertibility.

35

BIBLIOGRAPHY

Recent Development in International Currency Market by: Lucjan T.

Orlowski
www.investopedia.com
www.hindubusinessline.com
www.ias.org
www.phindia.com
www.rbi.org

36