Issue 47 Vol II, September 15, 2007

F E A T U R E S

Full Floating Indian Currency
Vinod Anand

THE Government of India has long been seriously considering for a full floating Indian currency. The rationale for this move as mentioned by the Prime Minister is that ‘India’s position, internally an externally, has become far more comfortable in the last two decades.’ Ever since there was a paradigm shift towards the reforms process in the year 1991, the rupee has become fully convertible on current account (just for trade purposes), but the Reserve Bank of India (RBI) has been following a cautious approach towards full float of the Indian currency, especially in the light of the South East Asian currency crisis in the nineties, that eventually led to the flight of capital from these countries. In the light of this experience of many emerging economies, the RBI had constituted the Tarapore Committee to look into the prospects of making Rupee fully convertible in all respects. This committee had submitted its report in 1997, emphasizing a three-year timeframe for complete convertibility by 1999-2000 subject to certain conditions like, bringing down Gross Fiscal Deficit (GFD)-Gross Domestic Ratio (GDP) to 3.5%, keeping the rate of inflation to an average of 3.5 for the three-year period, and managing the external sector to increase current receipts to GDP ratio and bringing down the debt servicing ratio from 25% to 20%. A few years back on the basis of the available data set, it was maintained by the government that all these conditions were fulfilled, and, hence, the country was capable of moving to full convertibility of the Indian Rupee (both in terms of current account and otherwise). It is quite often indicated, especially prior to every budget that that the fiscal deficit will come down to the required level during the given fiscal year, inflation (based on wholesale prices) will also get reduced, current account deficit will be below 3% or so, and foreign debt will be lower than the country’s foreign exchange reserves. This is a normal practice every time. This overshadows the reality and perhaps is a part of the political gimmick in the country. In the present times, although the external profile of the country has tremendously improved, yet the internal scenario remains to be bleak. According to what we see in the country in terms of many relevant parameters, full convertibility is not yet possible. Let us see how long it takes to achieve this objective effectively?

In fact, the capital account convertibility was introduced by The Foreign Exchange Management Act (FEMA) in 1999, which was enacted to deal both with the regulation and management of foreign exchange. It was a major departure from The Foreign Exchange Regulation Act (FERA) of 1973, which was restricted only to exchange regulation. In the context of capital account convertibility, FEMA very clearly states that ‘Reserve Bank shall not impose any restriction on the withdrawal of foreign exchange for payments due on account of amortization of loans or for depreciation of direct investments in the ordinary course of business.’ This provided immense assurance to the international investors for the protection of their interest on investments.

The move towards full convertibility will surely be a positive catalyst to pull Foreign Direct Investment (FDI) and Foreign Institutional Investors (FII), and push Business Process Outsourcing (BPO), and Resource Process Outsourcing (RPO), but, looking at the functioning of the government at all levels (especially in terms of governance), the vested political motives, political infighting and turmoil, and severe lack of effective strategies essentially in terms of implementation, it is rather difficult to assure and predict that the introduction of full convertibility of the Indian currency ( both in terms of current account and other wise) will, on the one hand, lead to higher rates of growth, effective percolation of the benefits of economic growth to the masses and better equity indices.

And, on the other, will not lead to

•        high liquidity, and, therefore, to high rate of inflation, low household savings, low gross domestic savings, and then to low rate of economic growth;

•        the tightening of the control of the Multi National Corporations (MNCs) over the economy by acquiring huge capital assets, banks and insurance companies through mergers and acquisitions;

•        massive repatriation of profits by the MNCs;

•        frequent changes in Rupee-Dollar exchange rates determined by the market pressures, and not by the RBI;

•        reduced value of Rupee, and hence reduced value of our exports, and reduced foreign exchange earnings;

•        adversely affect the current account deficit [sum of the difference between investment and saving in the private sector and the difference between expenditure and income in the government sector], thus creating all kinds of difficulties for the whole economy. and

•        to disastrous impact on the over-all economy as was witnessed in the South East Asian economies in the nineties.

One could conclude that full convertibility of the Indian currency is not a way out at the present moment. We have to make sure that the conditions as laid down by the Tarapore Committee are fully met not only within the three-year timeframe, but also within a much larger time span. Let us not put our country to stake purely on the basis of political motivations. Instead of making Rupee fully convertible, our Government should get it fully converted to loyalty rather than vested interests. The RBI has to be very  cautious now.

[The author is presently placed at the National University of Lesotho in Southern Africa as a Professor of Economics.]

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