III. CONVERTIBILITY
3.1 Indian Rupee is now partly convertible. It is convertible on “current” account and non-convertible on “capital” account.
This partial convertibility was brought in August 1994 by RBI circulars. RBI informed the International Monetary Fund (IMF) that India has adopted article VIII. Status under the IMF regulations. This was followed up by circular No. 18 dated 19th August, 1994. Now the concept has been introduced in the Act itself by defining the terms “capital account transaction” and “current account transaction”, and by providing for convertibility in Section 5.
The concept of current vs. capital account is different under FEMA from the concept in accounts and income-tax. Under accounts a machine purchased by a factory would be considered a capital account transaction. It would be a fixed asset lasting for more than the year of purchase. If that machine were imported, under FEMA, it would become a current account transaction. Import of goods (any goods), and payment of the import price completes the transaction. There is no carry forward. If the machinery were imported on credit and liability were created, then it would be a capital account transaction under FEMA. For FX purposes the classification base is borrowed from IMF. The two classes are made for the purpose of reporting Balance of Payments to IMF. Now of course definitions are provided within FEMA.
3.2 In one sense, rupee is already almost fully convertible. (i) Rupee rates in the FX market are market determined and not RBI prescribed. (ii) Most of the transactions for inward foreign investment are liberalised. (iii) For outward investments, upto U.S. $ 15 million, automatic permission is available. Larger outward investments are also permissible if one can satisfy RBI about the project.
Now there are a few areas left because of which one has to use the word “almost” fully convertible.
(i) Speculation in FX is not free.
This is a blessing for India.
(ii) There are still some procedural issues which can be simplified.
Hopefully, the new ECM will take care of it.
(iii) There are still some “business decisions” which RBI monitors. Like valuation of shares in case of sale by collaborators.
World wide trend is that statutory authorities are leaving business decisions to businessmen.
(iv) Still, all FX dealing in India can be done only by “authorised persons” only. This may have to be continued for some more time.
3.3 South-East Asian crisis :
Many people had strongly recommended that the whole of FERA should be scrapped. Western nations were particularly strong in “persuading” the Indian Government in making rupee fully convertible. At least twice central government ministers on visit outside India had made announcements to the press that on their return to India, FERA would be scrapped. However, the conservative forces within India did not allow full convertibility.
The South-East Asian crisis destroyed the economies of - Thailand, Malaysia, Indonesia, Phillipines and South Korea. Even strong economies like Hongkong and Singapore met with powerful attacks by foreign exchange (FX) gamblers. They were followed by absolute collapse of Russian currency. Brazil was affected.
In all this crisis India and China were not seriously affected. There were attacks on Chinese currency. There were rumors about Indian rupee. However, both currencies survived the crisis.
Today, international financial circles at the highest level grudgingly admit that (i) IMF had failed. Its prescriptions to the South East Asian Countries only aggravated the crisis. (ii) it was because of the exchange controls that India and China were saved. Expert handling of the crisis by the Reserve Bank of India and the finance ministry was of great help. Post crisis analysis shows that most of the countries affected by the crisis did not have central banks and finance ministries as competent as in India.
There are some experts on international economics who are now considering the danger posed by FX gamblers as the biggest danger to world financial system. These gamblers can destroy a small currency within a few weeks. They would do it for their profits irrespective of the fundamentals of the currency. The sustained attacks on Hongkong gives ample evidence.
The only protection from these gamblers lies in reintroducing exchange controls.
While Malaysia has with tremendous moral courage reintroduced exchange controls, no other country has expressed similar courage.
In this situation to call for full convertibility of Indian rupee would be premature. It is probably in the light of this background that the finance minister Mr. Yashwant Sinha gave an assurance in the parliament while moving the FEMA bill (December, 99) that the government will not take risk by making the rupee convertible on capital account.
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