21814664 currency convertibility and its impact on bop
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Currency Convertibility and
its Impact on B.O.P
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Convertibility
Convertibility essentially means the ability of residents and non-residents to exchange domestic
currency for foreign currency, without limit,
whatever be the purpose of the transactions.
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Current
Account
Convertibili
ty
Rupee
Convertibility
Capital
Account
Convertibil
ity
Classification
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Current Account
It refers to currency convertibility required in the
case of transactions relating to exchange of goods
and services, money transfers and all those
transactions that are classified in the currentaccount.
In Short, Current account includes alltransactions, which give rise to or use of
our National income
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Current Account Transactions
1. All imports and exports of merchandise
2. Invisible Exports and Imports(sale/purchase of services
3. Inward private remittances (to & fro)
4. Pension payments (to & fro)
5. Government Grants (both ways)
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Convertibility on Current Account
y India is fully convertible on the current account
yA full convertibility means movement of funds in
& out of India without any restrictions &
permissions.
y Provides full freedom to both residents and non-
residents to trade in goods/services.
y RBI has placed a cap in creation of a capital asset
y In India, most current account transactions have
been freed from controls over the years.
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Contd
Current account convertibility refers to
freedom in respect of Payments and transfers
for current international transactions.
In other words, if Indians are allowed to buy
only foreign goods and services but
restrictions remain on the purchase of assetsabroad, it is only current account
convertibility.
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Rangarajan Committee
Recommendations1. Liberalization of current account transactions leading to
current account convertibility
2. a compositional shift in capital flows away from debt- tonon-debt-creating flows
3. strict regulation of external commercial borrowings,especially short-term debt
4. discouraging volatile elements of flows from nonresidentIndians
5. gradual liberalization of outflows
6. disintermediation of the government in the flow ofexternal assistance
7. Introducing a market-determined exchange rate regime
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Rangarajan Committee-
Implementationsy Step-1:Dual exchange rate systemy Liberalised Exchange Rate Management System involving dual
exchange rate system was instituted in March 1992
y The dual exchange rate system was essentially a transitional stageleading to the ultimate convergence of the dual rates made effectivefrom March 1, 1993
Two rates of exchange: Official rate of exchange & Market rate ofexchange
60% of the export earnings could be converted at the free marketdetermined rate. (which was around Rs.28)
The balance 40% of the earnings should be sold to RBI throughauthorised dealers at the official rate of exchange. (generally higher atRs.32)
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Step-2:Full convertibility of the current account
This unification of exchange rates brought about the
era of market determined exchange rate regime of
rupee, based on demand and supply in the forex
market.
Liberalize the access to foreign exchange for allcurrent business transactions including travel,
education, medical expenses, etc.
Under Article VIII of the IMFs Articles of
Agreement in August 1994.
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Path that lead to Current Account
Convertibility
Till 1990
Liberalization
began in 1991
From 1992 to2000
After 2000
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Current Situation on Current Account
India is fully convertible on the current
account
Provides full freedom to both residents and
non-residents to trade in goods/services.
RBI has placed a cap in creation of a capital
asset
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Capital Account
Capital Account consist of short term and long
term capital transactions
As per FEMA "capital account transaction"means a transaction which alters the assets or
liabilities, including contingent liabilities,
outside India of persons resident in India or
assets or liabilities in India of persons residentoutside India
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Capital Account Transactions
1. Direct Foreign Investments (both inward &
outward)
2. Investment in securities (both inward &outward)
3. Other Investments (both inward & outward)
4. Government Loans (both inward & outward)5. Short-term investments (both inward &
outward)
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Capital Account Transaction
Capital Account transactions are classified as :-
1. Portfolio investment involves trade in
securities like stocks, bonds, bank loans,
derivatives, etc.
2. Direct investment involves purchase of real
estate, production facilities, or equityinvestment.
3. Other investment involves holdings in loans,
bank accounts and currencies
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Capital Account Convertibility
The freedom to convert local financial assets intoforeign financial assets and vice versa at marketdetermined rates of exchange.
In other words, it means allowing Indians topurchase both the physical and financial assetsabroad and vice-versa.
In simple language, CAC allows anyone to freelymove from local currency into foreign currencyand back.
It is associated with changes of ownership inforeign/domestic financial assets and liabilities.
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Limits to Partial CAC
Limits specified by the Reserve Bank of India:-
1. Private visit abroad is $10,000: of which only $5,000
can be in cash
2. Business travel, the yearly limit is $25,000
3. Gift or donate up to $5,000 in a year.
4. Going abroad for employment, or are going for
studies abroad: the limit in both these cases is$100,000
5. Investment into foreign stock markets up to the
extent of $25,000 in a year.
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TARAPORE COMMITTEE-I
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Members of the Committee
Head of Committee: S. S. Tarapore
Surjit S. BhallaAjit Ranade
A. V. Rajwade
R. H. Patil
M. G. Bhide
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The Terms Of Reference Of The Committee
i. To review the experience of various measures of capital account
liberalization in India,
ii. To examine implications of fuller capital account convertibility on
monetary and exchange rate management, financial markets and financial
system,
iii. To study the implications of dollarization in India of domestic assets and
liabilities and internationalization of the Indian rupee,
iv. To survey regulatory framework in countries which have advanced
towards fuller capital account convertibility,
v. To suggest appropriate policy measures and prudential safe- guards to
ensure monetary and financial stability, and
vi. To make such other recommendations as the Committee may deemrelevant to the subject.
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Tarapore Committee-I
Recommendations Direct Investment in Ventures abroad by Indian
Corporate
ECB (External Commercial Borrowing) Ceiling
Foreign Direct and Portfolio Investment and
Disinvestment should be Governed by
Comprehensive and Transparent Guidelines
Banks may be allowed to Borrow from OverseasMarkets
SEBI Registered Indian Investors may be allowed to
set up Funds for Investment Overseas
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Contd
Currency Futures may be Introduced
Participation in Money Markets may be
Widened RBI should withdraw from Primary Market in
Government Securities
Banks and Financial Institutes should beallowed to Participate in Gold Markets in India
and abroad and Deal in Gold Products
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Preconditions Of The Tarapore
Committee-I ReportMajor Pre-Conditions by
Tarapore Committee
Status as on July 2009
1. Reduction in gross fiscal deficit
to 3.5% by 1999-2000
The present fiscal deficit is at 6.8%
2. The inflation rate for 3 yearsshould be an average 3% to 5%
Inflation at present is around 4.00%.
3. Forex reserves should at least be
enough to cover 6 months import
cover
The present forex reserves are enough to
cover more than one years imports.
4. Gross NPAs to be brought down
to 5% by 1999-2000
Gross NPA for the banking sector is around
3%
5. CRR to be reduced to 3% by
1999-2000
CRR is at 5.00%
6. Interest Rate to be fully
deregulated
All interest rates, except Saving Fund
interest rates, have already been deregulated.
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TARAPORE COMMITTEE-II
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Tarapore Committee II-
Revisiting The Subject Of CACPrime Minister Manmohan Singh
Given the changes that have taken place over
the last two decades, there is merit in movingtowards fuller capital account convertibility
within a transparent frameworkI will
therefore request the Finance Minister andthe Reserve Bank to revisit the subject and
come out with a roadmap based on current
realities.
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Tarapore Committee II-
Recommendations Meeting Fiscal Responsibility and Budget Managementtargets
Shifting from present measures of fiscal deficit to public
sector borrowing requirement. Segregating government debt management and monetary
policy operations
Imparting greater autonomy and transparency in the conduct
of monetary policy
Reduction in the share of government / RBI in the capital of
public sector banks.
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Capital Controls in India
India maintains an extensive capital control regime
Controls have been quantity-based rather than markets based
Oriented towards limiting the countrys external debt
Controls remain on the external exposure of pension
funds, insurance companies etc. The external assets of
banks are closely monitored
Stricter controls on short term rather than long term inflows
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What Will Full Capital Account
Convertibility Do? Reduction in Cost of Capital
Help in Diversifying Portfolio Internationally
Improve the efficiency of the financial sector through
greater competition
Reduce Size of Black Economy
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Issues to FCAC
Capital Flight
Credit and liquidity risks
Risk of regulatory arbitrage include new dimensions
Increased cross-border transactions will augment the
dimensions of risks that Indian financial institutions
face in their domestic markets
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Pre-Requisites
These include:
1. Comfortable Current Account Position.
2. Maintenance of Domestic Economic Stability.
3. Adequate Foreign Exchange Reserve.
4. Restriction on inessential Import.
5. An Appropriate Industrial Policy.
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The Road Ahead
India proceeds gradually towards CAC
Reform of Indian financial system is a precondition
Banking sector reform is required on a grand scale
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THANK YOU!
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