An economy might allow its currency full or partial convertibility in thecurrent and the capital accounts. If domestic currency is allowed to convertinto foreign currency for all current account purposes, it is a case of fullcurrent account convertibility. Similarly, in cases of capital outflow, if thedomestic currency is allowed to convert into foreign currency, it is a case offull capital account convertibility. If the situation is of partial convertibility,then the portion allowed by the government can be converted into foreign currency for current and capital purposes. It should always be kept in mind downloaded that the issue of currency convertibility is concerned with foreign currencyoutflow only.

Convertibility in India

India’s foreign exchange earning capacity was always poor and hence it hadall possible provisions to check the foreign exchange outflow, be it forcurrent purposes or capital purposes (remember the draconian FERA). Butthe process of economic reforms has changed the situation to unidentifiablelevels.

Current Account

Capital Account

After the recommendations of the S.S. Tarapore Committee (1997) on CapitalAccount Convertibility, India has been moving in the direction of allowingfull convertibility in this account, but with required precautions. India is stilla country of partial convertibility (40:60) in the capital account, but insidethis overall policy, enough reforms have been made and to certain levels offoreign exchange requirements, it is an economy allowing full capital accountconvertibility —

(iii) Individuals are allowed to invest in foreignassets, shares, etc., upto the level of $ 2,50,000 per annum.

(iv) Unlimited amount of gold is allowed to be imported (this is equal toallowing full convertibility in capital account via current account route,but not feasible for everybody) which is not allowed now.

India announced the Liberalised Exchange Rate Mechanism System(LERMS) in the Union Budget 1992–93 and in March 1993 it wasoperationalized. India delinked its currency from the fixed currency systemand moved into the era of floating exchange-rate system under it.

Indian form of exchange rate is known as the ‘dual exchange rate’, oneexchange rate of rupee is official and the other is market-driven.Themarket-driven exchange rate shows the actual tendencies of the foreigncurrency demand and supply in the economy vis-á-vis the domestic currency.

It is the market-driven exchange rate which affects the official rate and notthe other way round.

The Nominal Effective Exchange Rate (NEER) of the rupee is a weightedaverage of exchange rates before the currencies of India’s major tradingpartners.

When the weight of inflation is adjusted with the NEER, we get the RealEffective Exchange Rate (REER) of the rupee. Since inflation has been onthe higher side in recent months, the REER of the rupee has been moreagainst it than the NEER.

The Extended fund Facility (EFF) is a service provided by the IMF to itsmember countries which authorises them to raise any amount of foreignexchange from it to fulfil their BoP crisis, but on the conditions of structuralreforms in the economy put by the body. It is the first agreement of its kind.

India had signed this agreement with the IMF in the financial year 1981–82.

IMF CONDITIONS ON INDIA

The BoP crisis of the early 1990s made India borrow from the IMF whichcame on some conditions. The medium-term loan to India was given for therestructuring of the economy on the following conditions:

(i) Devaluation of rupee by 22 per cent (done in two consecutive fortnights—rupee fell from ‘21 to ‘27 against every US Dollar).

(ii) Drastic custom cut to a peak duty of 30 per cent from the erstwhile levelof 130 per cent for all goods.

(iii) Excise duty to be increased by 20 per cent to neutralise the loss ofrevenue due to custom cut.

(iv) Government expenditure to be cut by 10 per cent per annum (the burdenof salaries, pensions, subsidies, etc.).

The above-given conditions to which India was obliged were vehementlyopposed by the Indian corporate sector, opposition in the Parliament andmajority of Indians. But by the end of 1999–2000, when India saw everylogic in strengthening its BoP position there was no ideological opposition tothe idea. It should always be kept in mind that the nature of structural reformsIndia went through were guided and decided by these pre-conditions of theIMF.

This is how the direction of structural reforms of an economy are regulatedby the IMF in the process of strengthening the BoP position of the crisis-driven economy. The purpose has been served in the Indian case. India hasnot only fulfilled these conditions but it has also moved ahead.

CONVERTIBILITY| GS ARTICLES

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