Tuesday, 20 March 2012



What is full convertibility of rupee on capital account? Is the Indian economy ready to switch over to such full convertibility?

Convertibility of the domestic currency is one of the prerequisite for complete globalisation of any economy. Along with de-controls, freer movement of goods and services, removal of tariff and non-tariff restrictions and easier mobility of the workforce, convertibility is one of the important cornerstones of the process of globalisation and economic reforms.

Current account convertibility is already there and the stringent controls of pre-nineties over the foreign exchange have also been relaxed to a great extent. The stringent Foreign Exchange Regulation Act (FERA) was replaced by a relaxed Act called Foreign Exchange Management Act (FEMA), making the movement of foreign exchange easier. Resident Indians and companies now have access to foreign exchange for various purposes, including education and travel. They can also receive and make payments in foreign currencies on trade account.

Full convertibility implies that the existing restrictions on the capital account would also be withdrawn. Corollary of this step would be that the domestic assets, including the real estate and stocks, could be sold to the foreigners and the payments in foreign currency could be received in the country without prior regulatory clearances.

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 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. Most of these restrictions may continue even after the capital account convertibility is introduced. 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.

There are certain prerequisites for introduction of capital account full convertibility. 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.

In addition, fiscal deficit should be low at around 3 per cent and foreign exchange reserves should be reasonably high. Further, the economy has to be in good shape, as full convertibility would result in bringing in the instabilities and fluctuations of the outside world into the economy, as it gets more connected to the outside world. Further, imperfections in the economy, like the urban-rural dichotomy and difference in the growth rates in various sectors like agriculture and industries, as well as services, must be removed.

Considering the above prerequisites it appears that the Indian economy is not yet prepared for switching over to the capital account convertibility. The only requisites which have been met are reasonably high level of foreign exchange reserves, mostly deregulated interest rates and relatively good condition of the economy as a whole. In most of the other areas there is lot more to be done. Interest rates as well as the inflation rate are higher than the required levels. Further, the imperfections of the economy are glaring as the services and industrial sectors are booming, but the agricultural sector which employs over 65 per cent of the total work force, is growing at a much lower rate of 2 to 3 per cent per annum.

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