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The changes in exports and imports, capital outflows and capital inflows bring about a large fluctuations in foreign exchange rate of rupee. Capital account convertibility allows the individuals of a nation to invest in abroad by easily converting their rupees into foreign exchange at the rates determined by the Market. This enables those potential domestic investors to acquire & own the assets in abroad.

Government of India (GOI) has revised rules pertaining to FEMA and capital account transactions during different periods of time. In context of large capital flows and the upshots of previous modifications during the last few years, GOI and RBI have recently done some additional amendments. In this way, deficit in balance of payments get automatically corrected without intervention by the Government or its Central bank. Currency convertibility describes how easy it is to convert a specific currency into another currency or gold. Economics of a specific country can greatly impact, and be impacted by, currency convertibility. Additionally, the advent of digital currencies has created a new category, virtual convertibility.

1. (iii) In case the exportable products have high import-content, to that extent, a higher market-determined rate of exchange can reduce profitability of exports.
2. Any individual involved in trade can get foreign currency converted at designated banks or dealers.
3. Economics of a specific country can greatly impact, and be impacted by, currency convertibility.
4. All such forex exchanges occurred at pre-determined forex rates finalized by the RBI.
5. For example, convertibility of rupee means that those who have foreign exchange (e.g. US dollars, Pound Sterlings etc.) can get them converted into rupees and vice-versa at the market determined rate of exchange.

What is Currency Convertibility?

Each stage in this historical progression has brought about new challenges and opportunities, shaping the way nations and individuals interact economically. As we look to the future, it is clear that the concept of currency convertibility will continue to evolve, adapting to the ever-changing landscape of global commerce. From the perspective of a business owner, convertibility is crucial as it affects the ability to transact with overseas partners, hedge against currency risk, and repatriate profits.

While currency convertibility facilitates global trade, it also necessitates a sophisticated understanding of financial markets and the implementation of prudent risk management strategies. The interplay of market forces, regulatory frameworks, and economic policies creates a dynamic environment where the benefits of currency convertibility must be balanced against its inherent risks. Currency convertibility is a pivotal aspect of the global financial system, serving as a cornerstone for international trade and investment. It refers to the ease with which a country’s currency can be exchanged for another currency or for gold.

Since free or market determined exchange rate is higher than the previous officially fixed exchange rate, imports become more expensive after con­vertibility of a currency. In the seventies and eighties many countries switched over to the free convertibility of their currencies into foreign exchange. By 1990, 70 countries of the world had introduced currency convertibility on current account and another 10 countries joined them in 1991.

Steps taken for Capital Account Convertibility in India

Although the rupee is not fully convertible on capital account, yet in respect of some elements, it had convertibility on capital account even earlier. For instance, capital account convertibility existed before for foreign investors and Non-Resident Indians for undertaking direct and portfolio investment in India. During the times when the financial markets of an economy are doing good , a country may receive huge foreign investment.

Convertibility of rupee implies

The time frame for the movement towards fuller convertibility involved three phases- Phase I ( ), Phase II ( ) and Phase III ( ). (d) The Committee made several recommendations for preparing the financial system for CAC. (i) If difficulty arises in keeping the current account balance under control, the free market exchange rate is likely to rise steeply. Before moving on to capital account usage, it comprises promoting the use of the rupee in import and export trade as well as other current account operations. Thirdly, rupee convertibility provided greater incentives to send remittances of foreign exchange by Indian workers living abroad and by NRI. Further, it makes illegal remittance such ‘hawala money’ and smuggling of gold less attractive.

The Foreign Trade Policy (FTP) has recently undergone revisions by the Central government to enable rupee settlement of foreign trade for export development initiatives. A deputy governor of the Reserve Bank of India (RBI) recently emphasized the advantages and risks of the internationalization of the rupee. Accordingly, the Tarapore Committee recommended the adoption of capital account convert­ibility. Making the INR into a fully convertible currency comes with both advantages and disadvantages. Even if not for all the crisis, the US often weaponising the US Dollar against its adversaries by imposing sanctions on them (Iran, Russia etc.) has led to countries across the globe look for alternate means of trade and payment settlements.

What are the Various Advantages of Internationalisation of the Rupee?

As a part of new economic reforms initiated in 1991, India also joined the regime and made rupee partly convertible from March 1992 under the “Liberalized Exchange Rate Management scheme”. These 40 per cent exchange receipts on current account was meant for meeting Government needs for foreign exchange and for financing imports of essential commodities. Thus, partial convertibility of rupee on current account meant a dual exchange rate system. Further, full convertibility of rupees at that stage was considered to be risky in view of large deficit in balance of payments on current account. So in India, there is free regime for current account transactions but still partial convertibility for capital account transactions. Many economics experts are of view that we need full capital account convertibility of currency.

Finally, currency convertibility gives boost to the inte­gration of the world economy. As under currency convertibility there is easy access to foreign exchange, it greatly helps the growth of convertibility of rupee implies trade and capital flows between the countries. The expan­sion in trade and capital flows between countries will ensure rapid economic growth in the econo­mies of the world. In fact, currency convertibility is said to be a prerequisite for the success of globalization. Another important merit of currency convertibility lies in its self-balancing mechanism.