Friday, August 14, 2009

Convertibility refers to the
freedom to convert one currency to any other internationally accepted currencies.
It is of two types-
Current account Convertibility and Capital Account Convertibility


Capital Account Convertibility refers to the freedom in converting financial assets of one country to the financial assests of another and vice versa in the market determined rates.In other words it refers to the flexibility in converting currencies of one country to another one for acquisition of capital assets abroad and vice versa.On the other hand
current account convertibility refers to the flexibility in exchanging currencies of one nation to another for other purposes like trade,interest payment,amortization,family expenses etc.

After the economic liberalization process started in India in 1991, a Liberalised Exchange Rate Mechanism was introduced in 1992.This allowed partial convertibility of Indian rupee, thus introducing dual exchange rate.After that full convertibility on trade account started from 1993.It was followed by Full convertibility on current account from 1994.However after the Mexico crisis in early 1990s or the mammoth East Asia Crisis where there was sudden flow of capital internationally debilitating the economies of the involved nations,India was reluctant to adopt capital account convertibility.

However the Tarapore committee,appointed in 1997,recommended phased implementation of capital account convertibility with certain prerequisites like fiscal deficit to be 3.5% of GDP,CRR to be brought down to 3%, gross NPA of public sector banks to be 5% of the total assets,inflation rate to be around 3.5%.The committee was reappointed almost a decade later and submitted almost the same recommendations with some modifications.

It must be remembered that the movement towards fuller CAC should be aprocess and not an event.Macroeconomic stability is a must before achieving full CAC.Any adhoc arrangement from the fixed regime maintained for a long period of time might disturb the foreign exchange market and disrupt the economic progress.

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