Full Capital Convertibility

FULL CONVERTIBILITYOF
INDIAN RUPEE
Balance Of Payment Account (BOP)
• BOP is a statistical measure that summarizes economic activity
between a resident and a non-resident during a defined time period.
CURRENT ACCOUNT CAPITAL ACCOUNT FINANCIAL ACCOUNT

It refers to the import and It refers to the record of trade It refers to the change in
export of goods and services to of assets and liabilities. international assets that a
and from the country. Thereby indicates the net country is associated with.
Thereby indicating the net change in ownership of Eg. Deposits in foreign bank,
income of a country by trade. national assets. stocks and bonds owned by
Eg. Importing to buy a car Eg. FDI, loans etc. foreigners.
Current Account Convertibility
• Convertibility means that anybody can freely convert one’s domestic
currency into a foreign currency at the existing market exchange rate.
When done for purchase of goods & services it is called current
account convertibility.
$ 1 million Rs. 7 crore

BOP CURRENT
ACCOUNT
$ 1 million
Current Account Convertibility
• There is full convertibility of current account
• Some restrictions under FEMA (Foreign Exchange Management ACT,
1999)
• Not on gambling, betting or prohibited items
• Travel : $ 25,000 ( $10,000 for Nepal and Bhutan ), beyond this RBI
permission req.
• Education, Medical, Employment: $ 1 Lakh
• Gift: worth Rs. 5 Lakh
Capital Account Convertibility
• Consider the case of Vijay Malya
Rs. 7000 crore $ 1 billion
INDIAN RUPEE IS NOT FULLY CONVERTIBLE ON CAPITAL ACCOUNT

Capital Account Convertibility
• External Commercial Borrowing rules by FEMA
• Particular to the aviation industry: $1billion for entire industry and $300
million for one company. And subjected to RBI approval.
• Restrictions on FDI, FII
• 100% for investment in Bhutan
• $75,000 for investing anywhere else
• No investment in countries blacklisted by FATF (Financial Action Task
Force) like in Iran and North Korea
• Further extensions were made under the liberalized remittance
scheme 2004
Benefits & Drawbacks Of Full Convertibility
Benefits Drawbacks
• Increase in the foreign direct Investment and • Possibility of outflow of funds.
portfolio Investment.
• Increase in business and job opportunities. • Risk of uncertainty.
• In case of India it discourages the import from • Effects on balance of trade and export.
foreign countries while simultaneously increasing
the exports from the country as the Indian Rupee is
valued lesser than US Dollar in the Market.
• Better access to foreign capital • Lack of effective regulation

Fuller Convertibility Of Currency
(Tarapore Committee)
Recommendation of
Position in
Items 1997 Committee for
2018
1999-2000
1 Gross Fiscal Deficit of the Centre as a 3.5 3.5
percentage of GDP
2 Inflation Rate 3.0 – 5.0 (average for 3 years) 4.2 (average for 3
years)
3 Financial Sector
(i) Gross NPAs as a percentage of total 5.0 11.8

advances
(ii) Average effective CRR for the banking 3.0 4.0
system
Preconditions suggested by SS Tarapore Committee for the implementation of Capital Account Convertibility
Importance And Need Of FDI
• For sustainable growth, an important parameter is capital.
• Sources of Capital :
Government Financial Institutions FDI / FII
Already fiscal deficit No bank will lend for Willing to invest if

Budget so, limited supply Infrastructure due to hospitable environment
of capital its long duration for business growth
FDI-led Growth
Reforms that made Mexico FDI-ready
+ + =
01 Privatization and Debt 02 Liberalisation of 03 FDI Legislation Changes Ready for FDI
Conversion Programs Tradeable Sectors
FDI-led Growth: Positive effects on Mexico
121,000 by US MNCs between

1999-2008
2,800 maquiladora plants employ over

11,00,000
FDI-led Growth: Positive effects on South Korea`
 Low interest rate policy loans, preferential tax treatments, specialized banks, the Foreign Capital Inducement
Act promoted FDI
 Double-digit growth post FDI influx
 Spillover effect of FDI increased the competitiveness and productivity of local resources
 The Republic of Korea ranks 20th in terms of FDI inflows among all the countries as per UNCTAD report, 2018
 From one of the poorest countries in 1960s to per capita income of 38,260 PPP dollars, one of the highest per
capita incomes in the world
Crisis due to FDI
FDI + FULL ACCOUNT CONVERTIBILITY

01 In presence of full account convertibility, having huge FDI inflows can pose a great risk in case
of a negative event in the economy
FOREIGN INVESTORS WITHDRAW MONEY

02 When an event occurs that de-stabilizes the economy, the foreign investors are quick
enough to withdraw their investment as happened in 1997-98 South East crisis
REDUCTION IN FDI
03 In crisis hit countries - Thailand, Indonesia, Malaysia, Korea and Philippines, the total capital
inflows reduced from a net inflow of USD B 6.8 in 1996 to outflow of USD 25.5 B in 1997
IMPACT OF STATEMENTS FROM PROMINENT INVESTORS

04 George Soros in 1997, shorted huge amount of Thai baht in January 1997, sending a market signal
that something is wrong and that the baht can be over-valued. This led to negative market
speculation and the foreign investors withdrew their capital from the South East Asian countries
.
Convertibility Timeline In India
Full convertibility of RBI again appointed
Partial Indian rupee on Tarapore Committee
convertibility of current account to set out roadmap
Indian Rupee (included invisibles for Fuller Capital
on current like services) Account convertibility
1991 account 1993 1997
BoP Crisis Full RBI appointed a

leading to 1992 convertibility of 1994 Committee on 2006
liberalisation Indian rupee on Capital Account
trade account Convertibility
FDI ROUTES IN INDIA
Automatic Government
Route Route
FDI VS GDP
FDI GROWTH RATE
70000
GROWTH 12.00%
Growth over previous year
60000 140.0%
10.00%
120.0%
50000
8.00% 100.0%
40000
80.0%
6.00%
30000 60.0%
4.00%
40.0%
20000
20.0%
2.00%
10000
0.0%
0 0.00%
-20.0%
-40.0%
FDI (million) GDP -60.0%

FDI Trend In India
Double Taxation Avoidance Agreement (DTAA): Mauritius
Tax treaty signed so that taxpayers do not have to pay double taxes on their income
POSITIVES NEGATIVES
1. Attracts foreign investments. 1. Breaches the reciprocity of a
tax treaty
2. Creates inflow of technology
and capital from developed 2. Revenue gains for third
countries. countries
3. Tax Benefits and Exemption 3. Revenue loss

Recommendations
Proactive market
Fiscal discipline Tax harmonization Stable currency
regulation
A large fiscal deficit makes Investments routed from Stable currency decreases India being an emerging
India vulnerable. India is some countries like uncertainty in the minds of market, the government
likely to miss its fiscal deficit Mauritius are taxed the investors and therefore needs to regulate the Indian
target of 3.3% of GDP in FY- differently from even if there is no capital market proactively to create
2018 too, as it has investments from other convertibility, investors will a hospitable environment
exhausted nearly 95.3% in 6 countries. So the be willing to invest in India for investors to show them
months. Therefore, better investments channeled as it is a major emerging trust in the Indian economy
fiscal discipline is imperative through these routes need market
to be harmonized.

Full Capital Convertibility

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FULL CONVERTIBILITYOF

CURRENT ACCOUNT CAPITAL ACCOUNT FINANCIAL ACCOUNT

$ 1 million Rs. 7 crore

Rs. 7000 crore $ 1 billion

INDIAN RUPEE IS NOT FULLY CONVERTIBLE ON CAPITAL ACCOUNT

• Increase in business and job opportunities. • Risk of uncertainty.

• Better access to foreign capital • Lack of effective regulation

(i) Gross NPAs as a percentage of total 5.0 11.8

Already fiscal deficit No bank will lend for Willing to invest if

121,000 by US MNCs between

2,800 maquiladora plants employ over

FDI + FULL ACCOUNT CONVERTIBILITY

FOREIGN INVESTORS WITHDRAW MONEY

IMPACT OF STATEMENTS FROM PROMINENT INVESTORS

BoP Crisis Full RBI appointed a

FDI (million) GDP -60.0%

3. Tax Benefits and Exemption 3. Revenue loss

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