India News and Features Alliance (INFA) - Open New Vistas:Make Rupee Fully Convertible, by Dr. Vinod Mehta, 30 March 2006

A few days ago the Prime Minister asked the Reserve Bank of India (RBI) to prepare a roadmap for making rupee convertible on capital account. Considering the fact that India’s foreign exchange reserves are comfortable, manufacturing sector is looking up and the rate of inflation is under control, there is no reason for us to keep rupee away from full convertibility. In fact, the Tarapore Panel set up by the RBI had recommended, in 1997, full convertibility of rupee by the year 2001. Now we are in 2006 and full convertibility is still not in sight.

It is in this context that the Prime Minister’s suggestion for preparing a road map for full convertibility assumes importance. S.S. Tarapore, former Deputy Governor of the RBI, will again head the Committee to suggest the roadmap and submit its report by July 2006. However, the way foreign exchange regulations on current account convertibility have been relaxed over the past few years it appears that we have already been inching towards full convertibility of the rupee. It is easier to get foreign exchange today than it was a few years ago. It is not mandatory now to enter the purchase of foreign exchange in one’s passport. Banks purchasing foreign currency now rarely ask for passport details. People have started using their credit cards outside India. Some of the countries in Asia including Russia buy and sell Indian rupee.

At the moment bulk of India’s foreign exchange earnings go to meet the import bill of oil and petroleum followed by capital goods, precious metals and edible oil. These four items alone take more than 60% of India’s foreign exchange earnings; of this oil takes around 31.52%, capital goods 17.69% and edible oil 2.61%. As far as pearls and precious stones it spends 9.68% on their imports, but most of these precious stones are exported back after value addition.

The current discovery of gas and other expected discoveries coupled with burgeoning foreign exchange reserves have greatly bolstered the chances of making rupee fully convertible. This is an encouraging sign.The time is now appropriate to make the rupee fully convertible. In the liberal economic atmosphere the country cannot escape making the rupee convertible on both current and capital account. However, we will have to muster enough of political and economic courage to realize this.

Indeed there will be pitfalls if the rupee is made fully convertible over-night, but if we move slowly and surely in stages we can avoid the pitfalls associated with convertibility. It is in this context that the roadmap becomes essential which can make the move-over to convertibility as smooth as possible. Making any currency convertible overnight is fraught with danger as the experience of Russia has amply shown. The Russian ruble was a protected currency for over 70 years.

The rate of exchange was fixed at one ruble to one and a half US dollar; however, the exchange rate in the black market was around five to six ruble to a dollar during the Soviet regime. Once the ruble was made fully convertible over night the value of ruble started falling first every month then every week and every day and then by the hour. Within a time span of three to four years the value of ruble vis a vis dollar fell from six rubles to a dollar in 1991 to about 5,000 ruble to a dollar today.

Russia has been able to absorb the shock of convertibility for two reasons in spite of the fact that Russia's economy was in a very bad shape. The two factors which helped Russia to absorb the shock of convertibility are large reserves of gold raw materials and other mineral wealth. Today, the value of ruble vis-à-vis US $ and Euro is quite stable for the last four years. It has overcome all the crises.

India has none of these, but its economy is in a better shape today. However, before taking the plunge it needs to tone up its banking system and carry out the financial sector reforms. Once India switches over to full convertibility of the rupee it is going to bring immense benefits to the country as a whole and to do away with undesirable rules and regulations as well as undesirable practices like sale and purchase of foreign exchange through illegal channels and so on. Even though the country has switched over to partial convertibility of the rupee on current account still it has not been able to do away with illegal transactions through the hawala route.

As for the benefits accruing to the individuals are concerned after full convertibility any Indian citizens would be free to borrow funds from anywhere in the world and legally open bank accounts anywhere in the world, subscribe to foreign currency deposits, buy/sell shares or invest in foreign mutual or pension funds. This would also mean that those who can afford to pay for the education of their wards in a foreign university could do so without the permission of the RBI.

Similarly, anybody who wishes to have medical treatment abroad can do so without any limit on medical expenditure, anyone who wishes to import a book from abroad can do so easily. Again any person or family going abroad on a holiday can buy the required foreign exchange and that the credit or charge cards issued in India will be acceptable world-wide, i.e. to say, a person need not physically carry any foreign exchange with him but he could make the payments abroad through credit cards which will ultimately be debited to his rupee account in India.

The corporate sector will also gain immensely from the convertibility of the rupee. The sector will be able to raise additional equity abroad without any prior permission from RBI, would be able to issue dollar bonds or deposits, invest in bonds of foreign countries in foreign currency, and invest in dollars in overseas companies without any hinderance. For foreign institutional investors there will be no need to seek FERA approval from RBI every five years as is the practice now. Similarly, there will be no maturity restrictions for foreign institutional investment in the domestic debt market. The Indian Mutual Funds and Pension funds could also invest in profitable companies abroad. That is to say it will make life easier for the corporate sector to carry out its foreign exchange dealings in a transparent manner.

Full convertibility will also open up many new vistas of business for the domestic banks. The Indian banks' access to foreign currency loan of up to one year maturity will be made easier. The domestic banks will also be allowed to accept deposits in foreign currency as well as lend to Indian businessmen abroad. However, to realize the full benefit of convertible rupee, the Indian nationalized banks will have to spruce up their working and bring them at par with the level of foreign banks.

Most of these Indian banks would be in direct competition with the foreign banks for various kinds of services. Unless they adopt modern banking technologies and practices within the next two years most of them would be reduced to deposit mobilizing companies. With the exception of the State Bank of India and one or two other nationalized banks none of the nationalized banks are in a position to face the competition of foreign banks.

Again only some of the new banks which have come up in the private sector in the past eight years and have adopted the latest banking technology techniques will be able to survive the competition from foreign banks in foreign countries. It is, therefore, in the interest of the bank employees themselves to improve the functioning of the banks and to upgrade their technology in the next three years to survive in the coming years. Let us not dither on this issue any more and make rupee convertible at the earliest.---INFA