Currency convertibility means the free flow conversion of domestic currency into a foreign currency at prevailing market exchange rates.
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- As we know that there are two types of accounts in Balance of Payment: Current Account; Capital Account.
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- Thus, Currency convertibility is of two types:
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- Current Account Convertibility
- Capital Account Convertibility
- It is based on the transactions under various heads of balance of payment account.
- India follows a full current account convertibility which means that for most of the items of current account, the parties under transaction are free to convert their respective currencies to facilitate any volume of transactions.
- But there is a partial capital account convertibility in India as prior approval of Government of India, or the Reserve Bank of India is sought.
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Full Capital Account Convertibility
Merits
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- It is most likely usher in more foreign fund inflows which will lead to more economic activities and employment.
- It may assist in internationalisation of financial market which will lead to more stability and increased liquidity
- It may help in getting access to foreign capital in terms of offshore loans at attractive interest rates.
Concerns
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- It may trigger exposure to global vulnerability since there will be frequent movement of capital by foreign investors which may not be good for the economy.
- It may lead to very high external debt which may lead to default. This is because there could be higher external commercial borrowing which my risk the likelihood of default.
- It can likely lead to higher speculative trading which may increase volatility.
- There is a risk of capital flight from India since India’s macroeconomic fundamentals are still evolving.
Tarapore Committee on full rupee convertibility
The Tarapore Committee Reports were brought out in two different years namely, 1997 and 2006. It laid out a path to full convertibility. Some of the recommendations of the Committee were:
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- Reduce fiscal deficit to below 3.5 percent.
- Inflation should be brought down within a manageable band.
- Strengthening the banking and financial sector with a special focus on reduction of non-performing assets.
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