The Reserve Bank of India after allowing International Trade Settlement in Indian Rupees (INR) has opened the way forward of Capital Account Convertibility: the currency of a country can be converted into foreign exchange without any controls or restrictions e.g. Indians can convert their INR into Dollars or Euros and Vice Versa without any restrictions placed on them. It is postulated by RBI that the new policy on International Trade Settlement in INR shall be operated through Authorised Dealers (AD) banks and they shall require prior approval from the Foreign Exchange Department of Reserve Bank of India, Central Office at Mumbai.
They said transactions shall be done in Rupee Vostro Accounts: A vostro account is an account a correspondent bank holds on behalf of another bank. Vostro accounts are maintained in the domestic currency. These accounts are an essential aspect of correspondent banking in which the bank holding the funds acts as custodian for or manages the account of a foreign counterpart. For example, if an Indian Exporter company approaches a U.S. bank to manage funds on the Indian Exporter’s behalf, the account is deemed by the holding bank as a vostro account of the Exporter company. Thus the current account convertibility is fully allowed i.e. INR can be converted to any foreign currency at existing market rates for trade purposes for any amount.
There has been a long standing demand for allowing capital account convertibility in India and the adoption of the symbol for INR (₹) was a step forward. Conventional wisdom maintained that trade flows were the key determinants of exchange rate movements which is not only half true but also erroneous. The importance of capital flows in determining the exchange rate movements has increased considerably, thereby narrowing the scope of the Central Bank to manage the exchange rates either through monetary policy or open market operations. It is a different fact that the Monetary Authority of Singapore keeps an eye on the international currency exchange rates and intervenes to steer it into the right direction when necessary. And thus we must not get confused.
Reserve Bank of India says, “On a day-to-day basis, it is capital flows rather than trade flows which influence the exchange rate and interest rate arithmetic of the financial markets. Thus, instead of the real factors underlying trade competitiveness, it is expectations and reactions to news which drive capital flows and exchange rates, often out of alignment with fundamentals. Unregulated capital flows in some instances have been subject to destabilising speculation, thereby imposing a burden on the real economy.”
On June 03, 1997, Shri S S Tarapore, Chairman to the Committee on Capital Account Convertibility (CAC) formally presented the Report of the Committee to Dr. C Rangarajan, Governor, Reserve Bank of India. The Committee has, in its report, noted that India had already adopted current account convertibility in August 1994 by formally accepting the obligations under Article VIII of the Articles of Agreement of the International Monetary Fund (IMF). Furthermore, CAC is already instituted for foreign investors, both direct and portfolio, non resident depositors and resident corporates contracting external commercial borrowings (ECB). Controls, however, continue to operate on the ability of resident individuals and corporates to send capital abroad as also on inflows and outflows of capital associated with banks and non bank financial entities. Due to the balance of payment crisis, the banking sector in India was fragile in the 1990s due to huge net foreign liabilities resulting in making capital Account liberalisation as a process rather than an event.
The students of the traditional school of thought are skeptical that INR is weak and allowing International Trade Settlement in INR will jeopardise the reputation is nothing but a kind of fussbudget. They are missing the forest for trees. So far as weak currency is concerned, 1 Japanese Yen is equivalent to $0.0088 (approx.) and is trading globally instead. So far as volatility is concerned the US Dollar is quite volatile but predominates the position of means of forex reserve and exchange. So far as Fiat currency is concerned, again US Dollar is such currency not backed by gold either. Again Norwegian Krone is not pegged to any other currency. It is obvious that after the collapse of the Bretton Woods System, the gold standard has been mostly abandoned as the basis for a monetary system within a country, yet still many people argue that this is an important factor in identifying the stability of a currency. So far as Debt is concerned again Japanese Yen comes into picture as Japan has the highest national debt in the world. It is, therefore, advised not to moron on INR as our regulations are quite enforceable.
What is more important that you need to have robust banking system with highly developed infrastructure, inflation must be under control, must have natural resources reserve, there must have a policy that is aimed at the fundamental preservation of the currency exchange rate, must have stable government, low unemployment, must have enforcement of laws without prejudice, peaceful and healthy relationships with the neighbouring countries etc. We all know that INR is a partially convertible currency which can be exchanged at market rates in certain cases and so is the case with new international trade settlement in INR and making it fully convertible currency would mean increased liquidity in financial markets, improved employment and business opportunities, and easy access to capital. Sounds good! Our minds promenade! But what about burden of foreign debt? How will you cope with volatility when the currency in circulation increases incessantly?
Before answering, we must have to learn that on the front of Capital Account Convertibility, an Indian can acquire financial assets worth up to $250,000/- (annual) overseas and we have reached the same amount over the gradual period of time. Despite the fact that fundamentals and decreasing democratic value in the nation are becoming obstacles in the path and allegations of corruption is such a roadblock in India that hinders the investors from being confident towards the Indian Market, we must believe the market and growing pattern of Export will curb the volatility in the long run. Once export increases, the foreign debt subsides. Pessimists argue that fully allowing Capital Account Convertibility will attract terror funding is just their procrastination as the greenbacks are their favourite and USA does not give damn care. It has been 25 years since Tarapore committee submits its recommendations and the capital account convertibility has not taken place, so, abiding by the dictum now or never, RBI must allow capital account convertibility so that the INR can secure a rank in the global market lest speculation be arrested. The economy shall prosper that I can guarantee.