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What is current account convertibility and its Advantages
Currency convertibility :
Currency convertibility means currency of a country can be freely converted into foreign exchange at market determined rate of exchange ,i.e the rate determined by demand and supply of currency of different countries. In India there are some dealers whose job is facilitating the services of exchanging the currency of one country into another. Mostly these are commercial banks who act as dealers of exchange. Convertibility of currency allows you to go there and convert your Indian rupees into what ever currency you wanted.
Currency convertibility is of two types as follows :
(1)Current account convertibility
(2) Capital account convertibility
In this post I’m going to discuss about current account convertibility.
Current account convertibility :
Current account convertibility allows free inflows and outflows for all purposes other than for capital purposes.
Capital purpose means dealing the investments in foreign currency and obtaining loans in foreign currency, acquiring any plant and machinery from abroad by making payments in foreign exchange.
These are covered under capital account convertibility which I will discuss in my another post. Current account convertibility allows the exporter and importers to convert the currency into foreign exchange for all the trade related purposes. It allows to convert the currency for foreign studies, medical treatment, and buying any goods and services other than of capital nature.
Must Read – Devaluation of Currency
Current account convertibility in Indian economy :
As a part of the economic reforms introduced during and after 1991, Government of India has initiated steps to allow partial convertibility of rupee into foreign currency under liberalised exchange management scheme in which 60 per cent of all receipts on current account could be converted freely into rupees at market determined exchange rate quoted by authorised dealers, whereas the remaining 40% should be surrendered to the Reserve Bank of India at the rates determined by it. Here current account transactions include import and exports of all goods and services.
This 40% of foreign currency was meant for fulfilling the foreign exchange needs of government and to make payments for the Imports of essential commodities by the government. That’s why this was called as Dual exchange rate system.
Later in 1993 full current account-convertibility was allowed by the government to provide the full conversion of foreign receipts on current account in to Indian rupees.
Must Read – How the value of rupee is determined?
Advantages of Current account convertibility:
(1) Facility to send the foreign earnings to India freely :
Current account convertibility allows you to receive and convert the earnings sent by your family members working in abroad without going under a complex procedure as earlier.
(2) Flourish the international trade :
Current account convertibility leads to smoother exchange of foreign exchange into domestic currency and vice versa. This helps in integrating the trade activities among different countries of the world. It enhances the international trade relations between the countries by removing the exchange barriers.
(3) Imports and exports can be done at fair rates determined by the market :
Earlier when there was no free current account-convertibility one needs to surrender either some portion of their foreign exchange receipt or should convert it in to Indian rupees at the rates determined by RBI. Usually the rate determined used to be less than the rate determined by the market. Hence current account-convertibility allows you to convert your foreign exchange at the rates determined by the market which is more fair than pre determined rates.