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- 1.............The ease with which a country's currency can be converted into gold or another currency. Convertibility is extremely important for international commerce. When a currency insinconvertible, it poses a risk and barrier to trade with foreigners who have no need for the domestic currency. 2.................Right of the holder of a currency to exchange it for another currency at the current exchange rates . Currency convertibility is an essential element of free trade 3.................... Convertibility is extremely important for international commerce. When a currency in inconvertible, it poses a risk and barrier to trade with foreigners who have no need for the domestic currency. Government restrictions can often result in a currency with a low convertibility. For example,a government with low reserves of hard foreign currency often restrictcurrency convertibilitybecause the government would not be in a position to intervenein the foreign exchange market (i. revalue, devalue) to supporttheir own currency if and when necessary.
- 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. The government introduced a system of Partial Rupee Convertibility (PCR) (Current Account Convertibility) on February 29,1992 as part of the Fiscal Budget for 1992-93. 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, engaging the service of foreign consultants etc. What it means that people are allowed to have access to foreign currency for buying a whole range of consumables products and services
- Payments due in connection with Foreign trade, Other current business Services, and Short-term banking and credit facilities in the ordinary course of business; Payments due as Interest on loans and Net income from investments, Remittances for living expenses of parents, spouse and children residing abroad, and Expenses in connection with Foreign travel, Education and Medical care of parents, spouse and children
- It is also know as floating exchange rate. It means the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates. It refers to the removal of restraints on international flows on a country's capital account, enabling full currency convertibility and opening of the financial system. A capital account refers to capital transfers and acquisition or disposal of non-produced, non-financial assets, and is one of the two standard components of a nation's balance of payments. The other being the current account, which refers to goods and services, income, and current transfers. Advantages:- 1. it is a major feature of developed economy. 2. It offers foreign investors a lot of comfort as they can re-convert local currency into foreign currency anytime they want to and take their money away. 3.It makes easier for domestic companies to tap foreign markets At the moment, India has current account convertibility. This means one can import and export goods or receive or make payments for services rendered. However, investments and borrowings are restricted. 4. Fear of economic crisis jus like East Asian economic crisis is suggested by economicst if india embrace capital account convertibility without adequate preparation. Steps:- The Reserve Bank of India has appointed a committee to set out the framework for fuller Capital Account Convertibility.
- Reasons favoring Financial Openness and CAC Diversification: Unrestricted investment in foreign assets would result in the domestic households diversifying their income sources into foreign economies and industries. This would enhance the returns while reducing risk as a direct consequence of the diversification. The resultant overall economy will be more robust and stable. NRI Remittances: The NRI Diaspora will benefit tremendously if and when Capital Account Convertibility becomes a reality. The reason is on account 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 Account Convertibility is incorporated. 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. When steel imports are made easier, steel becomes cheaper in India. Similarly, when inflows of capital into India are made easier, capital becomes cheaper in India. The main benefits of financial globalization may not be through the direct channel of providing more financing. Rather, the main benefits may be in terms of catalyzing financial market and institutional development, stimulating gains in efficiency through competition and access to new technologies, and disciplining macroeconomic policies. [3] Controls on the capital account are rather easy to evade through unscrupulous means. 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. 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. No matter how inefficient Indian finance is, households and firms do not have an alternative, thanks to capital controls. Exactly as we saw with trade liberalization, which consequently led to lower prices and superior quality of goods produced in India, capital account liberalization will improve the quality and drop the price of financial intermediation in India. [4]
- Reasons favoring Restrictions During the good years of the economy, it might experience huge inflows of foreign capital, but during the bad times there will be an enormous outflow of capital under “herd behavior” (refers to a phenomenon where investors acts as “herds”, i.e. if one moves out, others follow immediately). For example, the South East Asian countries received US$ 94 billion in 1996 and another US$ 70 billion in the first half of 1997. However, under the threat of the crisis, US$ 102 billion flowed out from the region in the second half of 1997, thereby accentuating the crisis. This has serious impact on the economy as a whole, and can even lead to an economic crisis as in South-East Asia. There arises 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 desist from investing in building up industries and factories, which leads to more capacity creation and utilization, and increased level of employment. This also reduces the potential of the country to increase exports and thus creates external imbalances. An open capital account 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. Moreover, under the threat of a crisis, the domestic savings too might leave the country along with the foreign ‘investments’, thereby rendering the government helpless to counter the threat. Entry of foreign banks can create an unequal playing field, whereby foreign banks “cherry-pick” the most creditworthy borrowers and depositors. This aggravates the problem of the farmers and the small-scale industrialists, who are not considered to be credit-worthy by these banks. In order to remain competitive, the domestic banks too refuse to lend to these sectors, or demand to raise interest rates to more “competitive” levels from the ‘subsidized’ rates usually followed. International finance capital today is “highly volatile”, i.e. it shifts from country to country in search of higher speculative returns. In this process, it has led to economic crisis in numerous developing countries. Such finance capital is referred to as “hot money” in today’s context. Full capital account convertibility exposes an economy to extreme volatility on account of “hot money” flows.