By Dr Navin Chandra Joshi
The current strength of the rupee as against the dollar is sufficient evidence of the growing resistance of Indian economy. Macro economic indicators show a ´feel good´ factor and further consolidation of India´s economic development. No wonder India is shining.
The government has laid sufficient emphasis on financial-sector reforms in all areas as a pre-requisite to full convertibility of the Indian rupee. Indian financial system needs to be prepared to handle the structural changes that may emerge in the move to adopt capital account convertibility (CAC). Increased competition as a consequence of globalisation has reduced the spreads and margins available to banks and other financial institutions. Only efficient and viable banks and financial institutions can survive in the face of increased competition.
A currency can be convertible in two accounts-current and capital. The current account includes visible and invisible trade transactions. Repatriation of interest, dividend, royalty and knowhow fee come under invisible trade. So do expenses abroad for travel, education, medical treatment, gifts, services, etc. However, full convertibility of the rupee on current account is not a guarantee of a higher overall investment climate, including infrastructure facilities, work ethos and political stability in the country. Capital account involves transactions in areas such as purchase of real estates, shares abroad, investment in industry and so on.
In fact, convertibility is a much abused word in India. In 1992, a scheme of dual exchange rate was announced and the whole country started believing that it was partial convertibility of the rupee. It took nearly one year for the government to put the record straight and tell the public that it was not partial convertibility but only dual exchange rates. And when the exchange rates were unified in July 1993, the Indian rupee got floating against major currencies and it was called convertibility on trade account. Then in August 1994, the government announced certain steps to make the rupee almost totally convertible on current account. But some misundertood this to be the full float of the Indian rupee in the foreign exhange market. The leading currencies of Europe, Japan and the United States were convertible even during the Bretton Woods days, though the exchange rates remained fixed till the early 1970s.
After the full float of the rupee, coping with capital inflows will pose major problems as inflows with the intention of short-term profits will need to be discouraged or else, they should be subjected to a certain lock-in period while tax may be imposed on outflows. Our experts will need to be jacked up significantly and imports will have to be checked and curbed drastically.
Obviously, the path leading to capital account convertibility is full of caveats and cautions to be rigorously applied and effectively managed if the major milestone in the journey towards complete liberalisation is to be achieved. Blowing hot and cold for introducing CAC is doing no good for the country. It is time that the government policy for this measure is announced in unambiguous terms, sooner than later.
The recent vicissitudes of the Asian currencies have revived the premonition of chaotic forex market working havoc with countries that are still ascending the steps towards economic recognition. The Mexican folly of unbridled external borrowings (1994) could be taken as a freak aberration. Sandwiched between these conflicting viewpoints, the Indian government has rightly decided to proceed cautiously.
Capital account convertibility, in a strict sense, can take place only if the NRI can sell the capital asset here and repatriate the capital asset plus the appreciation. Moreover, there has to be some relaxation on their dealings in real estate by way of purchase of property, agricultural land and estates.
Also, the deposit schemes for NRIs will need to be done away with as they have become a running scam. Currently, anyone with an ´Indian-sounding´ name borrows at cheap rates from a local bank abroad and then parks the funds in the overseas branch of an Indian bank, thereby making a hefty killing. Experience from countries which introduced CAC has not been quite encouraging. It is said that the expected benefits from CAC in terms of improved efficiency and better integration with the world economy, especially as regards capital flows, do not always come about. Moreover, instead of generating stability, CAC can cause volatility of capital flows that may destabilise the domestic economy, while capital controls do not often work.
As a precaution, India should adopt full convertibility of rupee in a phased manner and learn from the experience gained thereby. Higher capital inflows may lead to appreciation of rupee as well as to domestic monetary expansion beyond the desired levels. These and other aspects in trade, etc., need to be gone through thoroughly.
(The writer is a former Colombo Plan professor and has retired from Delhi University.)