Re convertibility: Tread cautiously

The call for full convertibility of the rupee has recently come from both Reserve Bank of India (RBI) Governor Raghuram Rajan and Minister of State for Finance Jayant Sinha. At present, the rupee is fully convertible on the current account to meet export-import related expenses. But it is only partially convertible on the capital account to buy assets abroad, a situation known as managed float since the RBI intervenes to contain volatility. The benefits of full convertibility have been variously listed as bringing in efficiency in the financial sector, creating broader and deeper capital markets, and increasing India’s stature on the global stage. With limits gone from the liberalised remittances scheme (LRS) which caps investments in overseas assets at $250,000 annually, individuals can shop for the best returns and asset classes in capital, real estate, and commodity markets abroad, and diversify holdings across currencies. For corporates, convertibility could mean removal of the RBI annual cap of $750 million to raise overseas finances. This could be timely given that mounting bad loans in their portfolio have made Indian banks careful lenders. And of course, full convertibility could make the rupee aspire to the status of a global reserve currency, along with the dollar, the euro, the pound, and the yen.

Despite these advantages, those who advocate caution cite the 1997 East Asian crisis, which forced several countries to clamp down on largescale capital outflows. Also, as recently as 2013, the RBI had to impose capital controls after foreign investors pulled out $13 billion within six months. The fact remains that India’s financial markets and banking system are still vulnerable to external shocks. Unrestricted foreign capital movement may adversely affect the health of the rupee. Governor Rajan’s ambitious goal of full convertibility may best be realised by taking baby steps rather than rushing towards it headlong.

The RBI’s recent decision to allow companies to raise rupee debt abroad could be seen as one such step since it improves the currency’s visibility. It also bears repeating that like the rupee, China’s renminbi is convertible only on the current account. In global trade finance, however, the renminbi is transacted more than all other reserve currencies, save for the dollar. The International Monetary Fund is currently considering China’s demand to include the renminbi in its special drawing rights (SDR) basket, effectively conferring it reserve currency status. This is despite full convertibility being a requirement for the world’s reserve currencies. All this goes to show that there could be many paths towards India’s goal of raising the stature of the rupee, and not one standard prescription.