The US and European Union are the major export destinations for India, and the others would be oil-exporting nations. Removal of restrictions on buying and selling of domestic currency in both the spot and forward markets. Foreign firms, financial institutions, government institutions, and individuals can hold the country’s currency and financial convertibility of rupee implies instruments. A currency with current account convertibility can be converted to any foreign currency at existing market rates for trade purposes for any amount. This allows for easy financial transactions for the export and import of goods and services.

Currencies that aren’t fully convertible are generally difficult to convert into other currencies. These currencies are usually more tightly controlled by a government’s regulatory authority or central bank. Current Account Convertibility refers to the degree of freedom to convert your rupees into other internationally accepted currencies and vice versa without any restrictions whenever payments are made. (b) The size of the current account deficit should be within manageable limits and the debt service ratio should be gradually reduced from the present 25 per cent to 20 per cent of the export earnings. In a move to counter Russia’s war over Ukraine, the US and the European Commission issued a joint statement to exclude seven Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) messaging system, which was the trigger point for all countries.

Current Account Convertibility in India

As economies slump into recession investors will often seek investment offshore or convert their money into one of the safe-haven currencies. To combat this and ensure money doesn’t flood out of the country, some governments put controls in place to reduce capital flight during trying economic times. A convertible currency is any nation’s legal tender that can be easily bought or sold on the foreign exchange market with little to no restrictions. A convertible currency is a highly liquid instrument as compared with currencies that are tightly controlled by a government’s central bank or other regulating authority. Any individual involved in trade can get foreign currency converted at designated banks or dealers.

Creating an offshore market for its domestic currency that allows foreign entities to sell renminbi for dollars However, it must not be forgotten that China also has a trade surplus with most of the other countries. There tends to be a correlation between a country’s economy and the convertibility of its currency. The stronger an economy is on the global scale, the more likely its currency will be easily converted into other major currencies. Nearly all countries have currencies that are at some level at least partially convertible. However, currencies such as the Brazilian real, Argentinian peso, and Chilean peso are considered non-convertible because it is virtually impossible to convert them into another legal tender, except in limited amounts on the black market. A fully convertible rupee would improve employment and consumer opportunities, help Indian businesses raise foreign capital, and allow India to become a global economic player.

1. 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.
2. 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.
3. Market forces may decide the rate of exchange between the currencies of the two trade partners.
4. 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.
5. When a currency is internationalised, both residents and non-residents can buy and sell domestic currency-denominated financial instruments such as stocks, bonds, and other securities.
6. The stronger an economy is on the global scale, the more likely its currency will be easily converted into other major currencies.

International Trade Settlement in Indian Rupees (INR)

India has made a modest attempt at facilitating rupee trade; the idea will take time to gain acceptance. When currency reforms were enacted at the end of the 20th century, the rupee was made partially convertible for goods, services, and merchandise only. During the mid-1990s, the rupee was fully made current account convertible for all trading activities, remittances, and indivisibles. In 1992, liberal economic reforms were introduced that impacted the way forex transactions were conducted. Exporters and importers could exchange foreign currencies for the trade of unbanned goods and services.

Poor currency convertibility can contribute to slower economic growth as global trade opportunities are missed. It is still possible to bring in foreign capital or take out local money for these purposes. However, there are ceilings imposed by the government, and transactions beyond those thresholds require approval. (d) All-India financial institutions which fulfill certain regulatory and prudential requirements would be allowed to participate in foreign exchange market along with authorised dealers (ADs) who are, at present, banks.

When Will the Indian Rupee Become Convertible?

Additionally, the advent of digital currencies has created a new category, virtual convertibility. A fully-convertible currency is highly liquid, and very desirable to other countries. Having this kind of currency promotes trading with the country in question and also serves to promote the country’s exports. However, Indians still require regulatory approval if they want to invest an amount above a pre-determined threshold in overseas assets. Similarly, incoming foreign investments in certain sectors like insurance or retail are capped at a specific percentage and require regulatory approvals for higher limits.

The authorised dealer banks (DB) have been allowed to open rupee Vostro accounts (an account that a correspondent bank holds on behalf of another bank). The rupee payment system also allows Indian exporters to collect advance payments in Indian rupees from foreign importers against shipments. The surplus rupee balance in the Vostro accounts may be used for advanced flow management of export-import transactions, investments in government securities, and payments for projects and investments. Good currency convertibility requires a readily available supply of physical currency which is why some countries impose capital controls on money leaving its country.

The rupee is not fully convertible; India’s share of global exports of goods is just about 2%, and these factors reduce the necessity for other countries to hold rupees. India accounts for less than 4% of global services trade, 2.5% of global merchandise trade, and an even lower percentage of global financial activities. In December 2022, India did its first settlement of foreign trade in rupees with Russia as part of the ‘International Settlement of Trade in Indian Rupee’ mechanism initiated by the RBI. As per the Bureau for International (BIS) Settlements “Triennial Central Bank Survey 2022”, as of April 2022, USD accounts for about 88% of global foreign exchange market turnover, followed by the Euro, Japanese Yen, and Pound Sterling. Countries with a currency that has poor convertibility are at a global trade disadvantage because transactions don’t run as smoothly as those with good convertibility.

1. The opposite happens when balance of payments is in surplus due to the under-valued exchange rate.
2. This mechanism plays a crucial role in international trade, investment, and economic stability.
3. Article VIII of the IMF’s Articles of Agreement is agreed by most economists to have been the basis for CAC, although it notably failed to anticipate problems with the concept in regard to outflows of currency.
4. By carefully managing these components, countries can optimise their economic interactions on the international stage, fostering growth, competitiveness, and resilience in an interconnected world.

This mechanism plays a crucial role in international trade, investment, and economic stability. This article aims to study in detail the concept of Currency Convertibility, including its components – Current Account Convertibility and Capital Account Convertibility, and other related concepts such as Internationalisation of Rupee. In this way, deficit in balance of payments get automatically corrected without intervention by the Government or its Central bank. The opposite happens when balance of payments is in surplus due to the under-valued exchange rate. 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.