Convertible currencies is one which can easily be bought, sold and converted without the need of obtaining a central bank or government agency. There are three types of currencies:-
Fully convertible: These can be freely traded without restriction and without required authorization. This helps in development and growth of international markets and also trading in the Foreign exchange markets. Since the currency value is fixed as compared with each other, trading in currencies is capable to offer the investors the profit opportunity. E.g. dollar which makes it one of the major currencies that are traded in FOREX markets.
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Partially Convertible: These can’t be freely traded. They have restrictions from the Central Bank e.g The Indian Rupee. There is a control of the Central Bank of India on the international trade. But there are discussions going on about permitting the Indian rupee to freely float just like the dollar.
Non-convertible: Countries like Cuba and North Korea are some which do not participate in the FOREX market. These results in blockage of their currency and these can’t be measured against any other currency.
The Tarapore Committee selected by RBI was intended for recommending ways of Rupee convertibility. The statement submitted by the Committee in 1997 projected a 3-year time period (1999-2000) for full conversion of Rupee. However, Committee highlighted that this was doable only when the following conditions are fulfilled:
The average inflation rate should fluctuate between 3% to 5% during the debt-servicing time
Diminishing the gross fiscal deficit to the GDP ratio by 3.5% in 1999-2000
According to Committee, the reason for the introducing capital account convertibility in India is to make sure full money mobility in the country. It also helps in the proficient distribution and allocation of worldwide funds in India. This helps in matching the capital return rates and increasing the production levels. Also, it brings about a reasonable allotment of the earnings in India as well.
Rupee convertibility is a very important decision taken by government. The government has decided to make rupee fully convertible but in a gradual manner so as to deal with complicated situations. This will have a big effect on everyone in the country. This is designed so as to delight the international institutions and 10 % of the Indian population who come under category of rich and upper middle class.
It is necessary to evaluate both the pros and cons of it. The government says that it will remove all the obstacles to money free flow and hence goods and services can also travel freely. The direct control for the government will not be possible. So, the indirect control(s) will have to be employed by varying the interest rates and taxes but the effectiveness of this control according to the international experiences is uncertain.
Short term reserves i.e., foreign funds in shares of Indian companies and government depend on the display of profit made by the Indian companies and also the constant good physical condition of the Indian economy in the form of short budget debits, low BOP (Balance Of Payments) deficits, lower level of government’s borrowings and of non-performing loans in the banking system.
The advantage of money free flow in fully convertible rule:
Foreigners could invest in Indian stock market. They could buy up the companies and properties such as land and buildings.
Indian natives and companies also can trade in anything, purchase shares of overseas companies including foreign property and also can transfer funds without indulging in any fraudulent act.
Indians who have not paid their taxes or repaid their loans taken from the Indian banks will be free to transfer their money to foreign countries outside the jurisdiction of the Indian authority.
Indian companies will be able to trade in both raw materials and machinery or they could set up foreign enterprises at will.
It will facilitate growth and high investments.
Apart from the advantages, it also has unpleasant consequences especially for the domestic manufacturers of the raw materials & machinery. This is because
They have to struggle against foreign sellers who may have low exchange rate for their currency therefore manufacture their goods at low price.
Foreign traders can also be maintained by subsidies of all kinds by their (foreign) government to make their costs exceptionally low. Exports of agricultural products from foreign countries can devastate India’s agriculture.
Healthcare and education can become very costly.
It can affect the country’s cultural heritage.
There are a lot of past examples here in India. From 1860 to 1880, the domestic industries especially manufacturing were washed out by this free trade and fully convertible Rupee rage when there was British Empire in the country. Indian farmers strived hard and even were not able to do cultivation, for the reason that the imported products were economical than produced by them. The Maharajas of India were obsessed with the demonstration of their wealth in London and Paris didn’t do well to the hungry millions of people of India but it was liable for huge misuse of country’s foreign reserves generated by the India’s poor work force.
It may lead to considerable diversion of finances from domestic investments to foreign investments.
This would result in jobs transportation in foreign countries which will result in more unemployment at home. Recently, Japan is suffering from this experience, in which Japanese companies are increasingly shifting funds to invest in China. Japan is taking advantage of the very low price of wages and small exchange price of Yuan, which is creating unemployment in the home country.
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The most hazardous effect of convertibility is that the Rupee will come under the power of money speculators. A fully convertible system for the Rupee will definitely take account of involvement of Rupee in international market. So it is possible for the speculators to purchase huge sum of Rupee to make up the exchange rate and after that they can abruptly trade all to get enormous profit. This will bring down the Rupee to a dreadfully low level. This may cause the country to go bankrupt.
After considering the advantages and disadvantages of capital convertibility it has been found that it is showing bad signs more than good ones. The problems that have been discussed in above points are very critical. It is acceptable that the country can have smooth flow of funds leading to better growth and development but the side effects are equally dangerous. The government is going with this regime but the progress should be such that the negative factors are properly taken care of. There can be allowance of free flow of currency but the limits need to be defined such that any other company from abroad cannot take the necessary fields under their command such as agriculture, education, healthcare, etc. This may prove to be a boon for the rich and upper middle class people but may or may not be beneficial for the middle class and people of below poverty line.
This regime does not provide the purposes of the genuine segments of Indian economy e.g. eradication of poverty, appreciation of the rate of employment and other disparities. Even when CAC is there in Indian economy, the financial crisis will exist any ways. Due to this, in spite of several advantages, CAC seems to be insufficient to crack the Indian financial crises. The comprehensive solution of this problem is to have a synchronized inflow of funds into the market.