The price of one currency in terms of the other currency is called the exchange rate. For example $1 = ₹ 70. so it means that it costs ₹ 70 to buy one dollar (or $0.014 to buy ₹ 1). This is also called Nominal Exchange Rate because it does not take into consideration inflation or purchasing power in the respective countries. Generally, These dealers keep separate prices for buying and selling, to make a profit in between. while on the other hand Such currency transaction service is also subjected to GST, however, their rate depends on the quantum of currency exchanged. for example, up to ₹ 10 lakh exchanged in foreign currency then only ~₹ 3000 of that 10 lakh will be taxable in GST so it means that 18% of 3000 =₹ 540 GST Tax.) American Economist James Tobin had suggested 0.1% to 0.5% Tobin Tax on currency exchange transactions to discourage the speculative trading and volatility in the International Financial Market, but on that logic, if ₹ 10 lakhs exchanged then 0.1-0.5% = ₹1,000 to 5,000 should be levied as ‘tax’, but since GST amount is much lower, so in reality, it can’t be labelled as ‘Tobin Tax
In theory, there are two tax regime one is floating and the other is the fixed exchange rate system, India has adopted the path of the managed floating exchange rate. It is considered to be the middle path between the two extremes (floating and fixed). But there are certain challenges in the managed floating exchange rate system which includes the currency speculation and interest rates, here interest rates mean If US repo rate / Treasury Bonds are going @2% whereas in Greece’s bonds going@4% Then American investors will convert Dollars to invest in Greece. Later, when the US federal reserve increases its repo rate from 2% to 4% American investors might pull back from Greece. (Because American commercial bank loans will become more expensive ~5%, then there will be American companies willing to borrow by issuing Bond/debentures at 4.5%.)
Some times even the central bank keeps buying dollars to create an artificial scarcity of $ in the forex markets and this leads to the dollar becomes expensive and local currency becomes weak which ultimately proved to be a boost to exports. however, in this regard, the US Department of the Treasury publishes a semi-annual report to track such nations. In 2018: China, Germany, Japan, Switzerland, S.Korea and India have been kept in (‘Watch list’) citing the lack of transparency and consistency in their respective Central bank’s operations. The USA has not officially labelled anyone as a “Currency Manipulator”, since 1994.
Presently, India has managed a floating exchange rate system wherein, the currency exchange rate is determined by the market forces of supply and demand, however, during the high level of volatility RBI will intervene to buy/sell ₹ or $ to stabilize the exchange rate. But if people are allowed to convert the local and foreign currency in an unrestricted manner then this will lead to so much volatility that RBI will not be able to manage. So, RBI puts certain restrictions on the convertibility of the Indian rupee to foreign currency using the powers conferred under Foreign Exchange Management Act, 1999 (FEMA)
There are certain restriction on the convertibility of the rupee which includes a restriction on Convertibility on Capital Account Transactions and current account transaction
In the case of Capital Account Transactions RBI’s External commercial borrowing (ECB) ceiling is up to $750 million (or equivalent other currency) per year for Indian Companies. That means even if Bank of America was willing to lend $1500 million to Reliance ltd, Mukesh Ambani can’t bring all those dollars in India. If he tries through illegal methods like Hawala, then Enforcement Directorate will take action for FEMA violation.
While on the other hand, An FPI can’t invest in more than 5% of available government securities in the Indian market and more than 20% of the available corporate bonds in the Indian market. So, even if Morgan Stanley or Franklin Templeton investment fund has billions of dollars they can’t bring them all to India because of the above restrictions. Similar restrictions on FDI as well. As Government decides FDI policy and then RBI mandates the forex dealers accordingly to convert or not convert foreign currency into Indian currency. Thus, the Indian rupee is not fully convertible on capital account transactions.
While In the case of current Account Transactions there are also certain restrictions like From 2013 to 2014, RBI’s 80:20 norms mandated min.20% of the imported gold must be exported back. Until then Jeweller/bullion dealers will not get permission to import the next consignment of gold. However, if we disregard such a few rare examples/restriction, the Indian rupee is considered fully convertible on current account transactions (i.e. Import and export, remittance, income transfer gift and donations) since 1994.
Is it possible to have Full convertibility of Rupee?
There are two sides on this, according to one side India should permit unrestricted conversion of Indian ₹ to foreign currency for both current account and capital account transactions which leads to more FDI investment in India and then NPA problem will be solved, new factories, jobs, GDP growth, rivers of honey and milk will flow. But there is another side to which says Before 1997, East Asian “Tiger” economies: (South Korea, Indonesia, Malaysia, Thailand, Vietnam Philippines etc.) allowed full capital account convertibility to attract FDI. But in 1997 Their automobile & steel companies filed bankruptcy and then The foreign investors panicked, sold their shares and bonds and got local currency converted into $ and ran away. The flight of this ‘HOT MONEY’ resulted in extreme depreciation of local currency from $1 = 2000 Indonesian Rupiah to $1= 18,000 Indonesian Rupiah resulted in heavy inflation in petrol diesel, social unrest, riots and political instability. None of their central banks had enough forex reserve to combat this crisis. So, in 1998, their GDP growth rates fell in negative territory e.g. Indonesia (-13.7%) Because of their mistake of allowing full currency convertibility. Whereas India and China grew at 6-8% because we had not allowed it.
In this regard, there was a committee which was being set up in 1997 ( S.S tarapore committee)
The committee suggested India should allow full Capital Account Convertibility (CAC) only when the fundamentals of our economy become strong enough, such as RBI must have enough forex to sustain 6 months’ import, Fiscal deficit must not be more than 3.5% of GDP, Inflation must not be more than 3-5%, Banks’ NPA must not be more than 5% of their total assets and so forth. So, time is not yet ripe for allowing full CAC.
However, from 2016 onwards, RBI began relaxing the norms for External Commercial Borrowing (ECB: ), mainly to soften the NPA problem e.g. Software cos. can bring up to $200 million in ECB, Microfinance $500 million, Infrastructure companies $750 million etc. In 2018-19 When ₹ started to depreciate heavily against dollars ($1 → ₹ 63 → ₹ 74), RBI had to encourage the flow of dollars into the Indian economy. So, all eligible companies automatically allowed to borrow up to $750 million via the ECB route. (Although prohibited in certain categories e.g. purchase of farmhouse, tobacco, betting, gambling, lottery etc.) in 2019 RBI allowed ECB even for working capital & repayment of rupee loans. Thus, the Indian rupee is not fully convertible on capital account transactions, unlike the current account transactions.
Rahul Mishra ( Faculty of Social Sciences )