Convertibility of Indian rupee

Exchange Rate Policy during British Rule

Sterling 1927 R 13 33 Sterling Links in 1927: = Rs 13.33
Re Devaluation from = Rs 13.33 to Rs 21.0 on June 6 1966 on June 6, 1966
US Dollar fell too: $1 = Rs 4.76 to Rs. 7.50

INTRODUCTORY:
The Foreign Exchange Regulation Act 1947 was publicized in 1947 with object of regulating certain
dealings in foreign exchange and the import and export of currency and bullion. The basic control was
directed towards dealings in Foreign exchange and payments which directly affect foreign exchange
resources. The exchange control consisted of restricting purchase and sale of foreign exchange by general
public and payments involving nonresidents. Restrictions were also imposed on the import and export of
Indian currency, foreign currency and bullion. An official exchange rate was fixed by the Reserve Bank of
India for the conversion of Indian currency into foreign exchange. All transactions in foreign exchange
were governed by this official rate of exchange.
By virtue of these controls exercised by the Reserve Bank of India, all foreign exchange earned and
received by any person in India were required to be sold to authorized dealers so that all foreign exchange
earned or received can be converted and utilized only according to the priorities fixed by the Government.
These controls were necessary at a time when India was still an undeveloped country exporting only
agricultural products and raw materials like Iron ore, manganese ore, mica etc., and importing almost all
the required consumer goods. However, with four decades of such controlled and regimented system,
India has been able to reverse the pattern of trade to a considerable extent.
Instead of exporting merely agricultural products etc., and importing consumables, we are now in a
position to export sophisticated electronic gadgets and import mainly capital equipments and intermediate
products for our Industrial development. To move economy further in this direction some relaxation in the
controls exercised on foreign exchange was found imperative and this has been brought about by what is
termed as "Liberalized Exchange Rate Management System", (LERMS for short), introduced with effect
from 1.3.1992.
LERMS:
Under the LERMS, Exporters of goods and services and those who are recipients of remittances from
abroad could sell the bulk of their foreign exchange receipts at market determined rates. Similarly, those
who need to import goods and services or undertake travel abroad could buy foreign exchange to meet
such needs, at market determined rates from the authorized dealers, subject to their transactions being
eligible under the liberalized exchange control system. However, in respect of certain specified priority
imports and transactions, provisions were made in the scheme for making available foreign exchange at
the official rate by the Reserve Bank of India.

By this scheme, partial convertibility of the rupee was introduced. 40% of the foreign exchange received
on current account receipts, whether through export of goods or services alone needed to be converted at
the official rate, while take remaining 60% was convertible at market determined rates. The imports of
materials other than petroleum, oil products, fertilizers, defense and life saving drugs and equipment
always had to be effected against market determined rates. All receipts of foreign exchange were required
to be surrendered to authorized dealers as was the practice hitherto. The rate of exchange for the
transactions was to be the free market rate quoted by authorized dealers except for 40% of the proceeds
which would be based on the official rate fixed by the Reserve Bank of India. The authorized dealers were
required to surrender 40% of their purchases of foreign exchange to the RBI at official rate. The
remaining 60% could be retained by them for sale in free market for all permissible transactions. The
Exporters were also given a choice to retain a maximum of 15% of the export earnings in foreign
exchange itself, which could be utilized by them for their own personal needs.
FULL CONVERTIBILITY:
Although the Minister of Finance had indicated during his presentation of the 1992-93 Budget that full
convertibility of the rupee would be introduced in a span of 3 or 4 years, full convertibility was
announced much earlier and in fact it is the highlight of the 1993-94 Budget.
There is, however, a subtle difference in the full convertibility of the rupee introduced in India and the
concept of full convertibility prevailing in developed countries like the U.K., U.S.A. etc. In developed
countries, full convertibility means that their currency is freely convertible anywhere in the world. Their
home currency can be converted into foreign currency without any restriction. One does not have to
disclose even the purpose of such conversion. For instance, U.S. Dollars can be changed into Sterling
Pounds in New York, Japanese Yen could be exchanged to Deutsche Marks in Frankfurt, Australian
Dollars can be converted into Canadian Dollars in Adelaide etc., and the exchange rate is controlled by
the position of supply and demand in the market. The full convertibility announced in the Union Budget
of 1993-94, however, allows convertibility only in the current account, which means the amount received
by way of sale proceeds of exports, paid for imports and the remittance by NRIs etc., alone are
convertible at market determined rates.
In the last year's Budget, a dual exchange rate was announced i.e., 60% at market rates and 40% at the
official rate. In the current Budget, the dual exchange rate has become a unified exchange rate which is a
100% conversion of foreign exchange at market rate. This is described as Full Convertibility. This does
not mean that one can get any amount of foreign exchange at market rate for meeting any of one's needs.
The Reserve Bank of India will permit sale of foreign exchange currency to anyone only for those
purposes which are stipulated by the Govt. of India. It does not permit conversion of one's savings in the
country for investment in foreign countries, as could be done by the citizens of developed countries like
the U.K. or U.S.A. For instance, if a citizen resident in India wishes to undertake a foreign travel, the
exchange for such travel can be had only as per the norms prescribed by the Govt. under the Foreign
Travel Scheme. Full convertibility of the Rupee we have adopted for our country is tied up with exchange
controls and restriction envisaged by the provisions of the F.E.R. Act 1973as amended. Full convertibility
has been introduced only as a measure of reforms to revitalize the economy of our country and to bring it
onto the path of liberalization. The New Economic Policy ushered in by out Govt. is with a view to take

India forward from a control ridden-inward-looking economy into a market - friendly, forward-looking
progressive and dynamic economy. Full convertibility of the rupee, lower Customs and Central Excise
duties, relaxation of Import / Export restrictions, streamlining of procedural rules governing taxations,
streamlining of procedural rules governing taxation laws etc., have opened out our economy with a view
to expansion and globalization of our trading activities. These are measures taken to move India forward
in her March towards economic freedom.
ADVANTAGES:

Full convertibility will enable Exporters to get a higher price for the goods exported.
This is certainly a big incentive for increasing export.
Since the Importers have to pay more than the goods imported, there will be a natural
tendency to import less, confining the imports to absolutely necessary items although the
Export/Import Policy has been liberalized.
Malpractices like under-invoicing of exports may not arise as the rupee is fully
convertible and full value of exports is realized.
Indian rupee would become stable and the gap in the balance of trade reduced
considerably. A self balancing mechanism of import export trade will eventually get
established.
CONCLUSION:
The Govt. had however stated that if the value of the rupee depreciates to an unreasonable level in the
free market operations, the R.B.I. will intervene and control it. This assurance certainly gives credence to
the earnestness and sincerity with which the full convertibility has been announced. What is important is
that changes in the global markets will automatically get reflected in the Indian markets on account of the
full convertibility. This is certainly a move in the right direction. Instead of remaining as an insulated
economy, India will surge forward as a free economy, unfettered and opened out for the world markets.