The continued stability of the rupee in the international market has created an environment where full convertibility of the rupee can now be introduced.
In the present context, convertibility of a currency refers to its convertibility into a foreign currency as desired by its holder. The currency is fully convertible if the holder can convert it into any other currency at rates determined by the forces of demand and supply and without any interference from the government. The convertibility therefore involves two aspects:
(i) The rate of exchange should be determined by the market and not by the regulatory authority and thus the holder does not incur any loss on conversion; and
(ii) There should not be any quantitative restrictions on the repatriation of the currency.
Earlier the exchange rate of the rupee was subject to the condition that the rate quoted by a bank to its customer should not be worse than the rate based on RBI rate. Rupee was made partially convertible when dual exchange rate was introduced and 60% of the remittance into India was converted at the market determined rates. Now the value of rupee is fully determined by the market forces.
Thus rupee now fulfils the first condition of convertibility, viz., the exchange rate should be determined by market forces. A currency is converted to effect remittances, either from the country or into the country from abroad. Remittances are broadly classified into two categories: (i) those on current account and (ii) those on capital account. This classification is based on the current and capital accounts in the balance of payments. Remittances on current account represent transactions relating to trade in goods and services. For such remittances no reverse flow of funds in the future is anticipated. Remit-tances on capital account relate to investments, loans etc. These represent the ex-ternal debt of the country and reverse flow in the form of interest/dividend and repatriation of capital is expected.
Rupee is now fully convertible on current account fulfilling the second condition for convertibility, viz., no quantitative ceiling on remittances abroad, though subject to certain regulations. As a part of liberalisation of foreign exchange transactions, the Reserve Bank has enhanced the discretionary powers for authorised dealers for making various remittances abroad. The limits on remittances for various purposes like travel, studies, medical treatments, gifts, services, etc., have become indicative. In certain cases authorised dealers themselves can permit remittance beyond the indicated limits. In certain other cases, the requests for remittances over the limits shall be referred to Reserve Bank, who will favourably consider the request.
As an affirmation of the convertibility of the rupee on current account, with effect from August 20, 1994, India moved over to Article VIII status in the IMF. IMF members accepting the obligations of Article VIII undertake to refrain from imposing restrictions on the making of payments and transfers for current international transactions or from engaging in discriminatory currency arrangements or multiple currency practices without IMF approval.
As yet, rupee is not fully convertible on capital account, although it is moving towards that goal. If rupee is made convertible on capital account, the investments into India and withdrawal of it should be without any restrictions. Apart from the consideration of risk factors involved (assessment of country risk), interest rate will play a major role in determining the foreign exchange position of the country.
A higher interest rate as compared to the international rates will attract capital into the country, while a slightly lower rate may imply massive capital outflow. The economy should first gain in strength to sustain such vagaries.