There are no prizes for guessing that surviving the gale forces of the Asiancurrency crisis then was a priority rather than attempting a calibrated movetowards convertibility. Nine years later, the country’s external profile ismuch more robust. A profound transformation has taken place in recent years asforeign exchange is hardly a constraint anymore for the Indian economy. Till the1990s, this was a major constraint and India had to look abroad for aid, for IMFsupport and high cost commercial borrowings to get the necessary foreignexchange. But now the economy’s reserves are plentiful at $144 billion –which are $20 billion higher than India’s stock of external debt – thanks tomassive net capital inflows and are enough to cover 13 months of imports.
With the Indian economy no longer facing an external constraint, itspolicymakers now feel emboldened enough to contemplate fuller convertibility.What indeed is convertibility? Shorn of jargon, a regime of full convertibilityobtains when any one of us Indian residents can go to a foreign exchange dealeror bank and freely convert our rupees into dollars, pounds or euros to acquireassets abroad. Such a regime was out of the question before the 1990s. Butwith the steady improvement in our reserves due to reforms, the regime hasbecome more liberal but stops short of full convertibility.
Indian businessmen thus are in a better position to make investments abroad oracquire potential overseas companies today than earlier. They can access cheaperexternal commercial borrowings and retire their costlier domestic debt. Thanksto the easing of the external constraint, very few businessmen now have tolocate abroad like Lakshmi Niwas Mittal and many others did during the 1970s and1980s or salt their savings in Swiss banks. No doubt, the environment isn’tfully businessman-friendly. But with a more liberal regime, he can expand hisdomestic business and go global much like Mittal can.
While Indian residents thus have experienced gradual liberalisation, foreignersincluding non-resident Indians (NRIs), by contrast, virtually enjoyed capitalaccount convertibility. They were, of course, sectoral caps for foreign directinvestments but such investors could repatriate their profits freely. Portfolioinvestments too have surged with reforms and such investors can freely movetheir money in and out of our stock markets at will. Similarly with the NRIs.Fuller capital account convertibility naturally entails removing the remainingrestrictions on capital inflows and outflows in a calibrated manner.
With a roadmap to head in that direction, the ongoing surge in foreign directand portfolio investments will only gather further momentum. The former iscurrently in the range of $3-5 billion and the numbers are looking up. Portfolioinvestments have surged to $3.2 billion so far this year alone and areresponsible for lifting stock market indices through the roof. Such investmentshit a record level of $10.7 billion in 2005. Overall, the prospect indeed is forgreater net capital inflows that currently amount to a whopping $32 billion ayear, adding to our reserve stockpile.
Is the economy not ready for full convertibility? The big fear is that withcapital inflows surging in and out of the economy, there is a prospect of therupee appreciating in value that can, in turn, adversely impact our boomingexport growth of 20 per cent in US dollar terms. True, net capital inflowsexerted upward pressure on the real effective exchange rate of the rupee by 5per cent last year but didn’t affect India’s export competitiveness.Similarly, inflows have made the rupee appreciate by 1.4 per cent since thestart of this year and this hasn’t affected the ongoing export boom either.
A far bigger concern is of an abrupt change in investor sentiment, leading intoa replay of the Asian currency crisis of 1997 when Tarapore submitted his firstreport. That is indeed a risk that bedevils any emerging economy that isattempting capital account convertibility. But suppose that eventuality comes topass and foreign investors and NRIs head for the exits. Thanks to the easing ofthe external constraint, however, our reserves today are plentiful enough totake care of this prospect as they exceed the stock of portfolio investments,NRI deposits and short-term residual maturity debt by $50 billion.
This is margin enough to revisit convertibility. The merit for proceeding on acarefully drawn up roadmap in this direction is also dictated by the fact thatmuch of money that was salted away abroad is now returning to India. Economistslike Professor Indira Rajaraman feel that there is a return flight of capitalthat is possibly augmenting the booming portfolio capital inflows into theeconomy. This is, of course, in the realm of conjecture so far, but there areenough people who think that this may be possible, which is only bound to sendthe rupee higher and higher. A convertible rupee clearly is another big-ticketreform whose time has come.