This payment arrangement assumed greater importance in 2022–23 as India increased its dependence on discounted Russian oil, making it the second largest source of crude oil. Russia’s exports to India in 2021 stood at $6.9 billion, mainly consisting of mineral oils, fertilisers, and rough diamonds, while India exported goods worth $3.33 billion to Russia in 2021, mainly comprising pharmaceutical products, tea, and coffee. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

There would be no limit on inflow or outflow of capital for various purposes including investments, remittances, or asset purchases/sales. Additionally, the INR is not a completely free-floating currency left to market dynamics. Regulators will occasionally act to keep the exchange rates within permissible limits. In the case of extreme volatility in rupee exchange rates, the RBI swings into action by purchasing/selling U.S. dollars (kept as a foreign reserve currency) to stabilize the rupee. The major difficulty with the Tarapore Committee recommendation was that it would like the current account convertibility to be achieved in a 3 year period – 1998 to 2000.

Current Account Convertibility

A currency may be convertible on current account (that is, exports and imports of merchandise and invisibles) only. Among the emerging economies, China is the only country that has been able to steadily internationalise its currency while maintaining controls on its capital account. It has done so by finalising currency swap agreements between the central banks of China and 43 other countries, which assure the markets that there will not be an oversupply of the renminbi. The RBI has also updated from time to time about the broad framework for exporting goods and services from India according to the Master Direction of the Foreign Exchange Management Act, 1999 (FEMA). The approved dealer banks will need prior clearance from the RBI’s foreign currency department before implementing this method.

1. It is only when there is currency convertibility that market exchange rate truly reflects the purchasing powers of their currencies which is based on the prices and costs of goods found in different countries.
2. Dr. Nitish Kumar Arya is an Assistant Professor of Economics in the University Economics Department Bhupendra Narayan Mandal University, Madhepura, Bihar, India.
3. Additionally, the INR is not a completely free-floating currency left to market dynamics.
4. The correct answer is Freely permitting the conversion of the rupee to other major currencies and vice versa.

Current Account Convertibility in India

Having a nonconvertible currency makes it harder for a government to participate in the international market because these transactions generally take longer to execute. For the rapid growth of world trade and capital flows between countries convertibility of a currency is desirable. Without free and unrestricted convertibility of currencies into foreign ex­change trade and capital flows between countries cannot take place smoothly. It would require India to have considerable thinking and planning to make rupee-internationalization function in a manner that does not adversely affect the economy’s fundamentals. The government must carefully balance the benefits with the potential risks and respond appropriately to ensure the stability of the economy. It also requires India to have a large and deep domestic financial market to be better equipped to handle external shocks and make it easier for the RBI to manage its monetary policy.

However, larger transactions, such as buying property overseas, still need regulatory approval. This partial convertibility of rupee on current account was adopted so that essential imports could be made available at lower exchange rate to ensure that their prices do not rise much. 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. By convertibility of a currency we mean currency of a country can be freely converted into foreign exchange at market determined rate of exchange that is, exchange rate as determined by demand for and supply of a currency. Firstly, since market determined exchange rate is generally higher than the previous officially fixed exchange rate, prices of essential imports rise which may generate cost-push inflation in the economy. 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.

There was easy access to forex for studying or traveling abroad, and, depending on the industry, there were fewer restrictions on foreign business and investments. (c) Indian banks would be allowed to borrow from overseas markets for short-term and long-term upto certain limits, to invest in overseas money markets, to accept deposits and extend loans denominated in foreign currency. Such facilities would be available to financial institutions and financial intermediaries also. 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.

In essence, current account convertibility remains within the institutional trading realms. This means that although there is a lot of freedom to exchange local and foreign currency at market rates, a few important restrictions remain for higher amounts, and these still need approval. Likewise, the dividends, capital gains, interest received on purchased stock, equity etc. profits earned on direct investment get the rupees converted into US dollars, Pound Sterlings at market determined exchange rate between these currencies and repatriate them. When Bretton Woods system collapsed in 1971, the various countries switched over to the floating foreign exchange rate system. Under the floating or flexible exchange rate system, exchange rates between different national currencies are allowed to the determined through market demand for and supply of them.

This implies that from given exports, exporters can get more rupees convertibility of rupee implies against foreign exchange (e.g. US dollars) earned from exports. Currency convertibility especially encourages those exports which have low import-intensity. In simple language, capital account convertibility allows anyone to freely move from local currency into foreign currency and back. The purpose of capital convertibility is to give foreign investors an easy market to move in and move out and to send a strong message that Indian economy was strong enough and that India had sufficient forex reserves to meet any flight of capital from the country to any extent. 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 trade and capital flows between the countries.

What is Currency Convertibility?

1. For this, interest rates should be folly deregulated, gross non-paying assets (NPAs) should be reduced to 5 per cent, the average effective CRR should be reduced to 3 per cent and weak banks should either be liquidated or be merged with other strong banks.
2. This payment arrangement assumed greater importance in 2022–23 as India increased its dependence on discounted Russian oil, making it the second largest source of crude oil.
3. This means that although there is a lot of freedom to exchange local and foreign currency at market rates, a few important restrictions remain for higher amounts, and these still need approval.
4. Non-deliverable forward contracts (NDFs) can give a trader, for instance, indirect exposure to the Chinese renminbi, Indian rupee, South Korean won, new Taiwan dollar, and Brazilian real and other inconvertible currencies.
5. However, larger transactions, such as buying property overseas, still need regulatory approval.
6. Such facilities would be available to financial institutions and financial intermediaries also.

Currency convertibility is the ease with which a country’s currency can be converted into gold or another currency. Currency convertibility is important for international commerce as globally sourced goods must be paid for in an agreed-upon currency that may not be the buyer’s domestic currency. India’s currency, the rupee, is not yet a fully convertible currency, meaning there are still restrictions that make it difficult to buy or sell in the foreign exchange (forex) market. However, there have been talks of making the rupee (INR) fully convertible and setting up an onshore INR market. It was generally agreed that foil convertibility of the rupee, both on current account and capital account was a welcome measure and is necessary for closer integration of the Indian economy with the global economy.

However, this would also come with increased volatility, the risk of businesses becoming burdened by foreign debt, and reduced competitiveness in the global export market. The growing international interest in the Indian rupee is evident from the development of offshore rupee markets in locations like Dubai, London, New York, and Singapore. As of September 2024, INR contracts traded against the dollar an average of 11,825 times per day in 2024, compared to 198,027 contracts converted from Euro to USD. Stronger currencies tend to be converted more easily than others, while growth may be stagnant for currencies with poor convertibility because these countries may miss trade opportunities. The Government of India has taken the following steps towards capital account convertibility.

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; another 10 countries joined them in 1991. More recently, Greece imposed capital controls in June 2015 to slow the capital outflows during the Greek Debt Crisis and these stayed in place until 2018. The interesting thing about the Greek controls is that the country is an EU member and uses the euro, so the capital controls did not actually affect the currency convertibility as Greece is just one part of the economies underlying the euro.

In the context of heavy depreciation of the currency not only there is capital flight but inflow of capital in the economy is discouraged as due to depreciation of the currency profitability of investment in an economy is adversely affected. (e) Banks and financial institutions would be allowed to operate in domestic and international markets and they would also be allowed to buy and sell gold freely and offer gold denominated deposits and loans. 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.