Wait and watch

Mumbai: During the last six months, there has been a heavy inflow of foreign exchange (forex) into India that has led to forex reserves swelling to about $70 billion — equivalent to about 14 months of the country’s import requirements.

The rupee too, during this period, appreciated dramatically against the dollar — from about Rs 48.60 to Rs 47.90. This has reopened a debate on whether India should go in for capital account convertibility.

Foreign exchange transactions are broadly classified into two types: current account transactions and capital account transactions. If a citizen needs foreign exchange of smaller amounts, say $3,000, for travelling abroad or for educational purposes, s/he can obtain the same from a bank or a moneychanger. This is a current account transaction.

But if someone wants to import plant and machinery and needs a large amount of foreign exchange, say $1 million, the importer will have to first obtain the permission of the Reserve Bank of India (RBI). If approved, this becomes a transaction on the capital account.

What recent history teaches us In 1994, transactions on the current account were made fully convertible and foreign exchange was made freely available for such transactions. But capital account transactions are still not fully convertible. The rationale behind this is clear. India wants to conserve precious foreign exchange and protect the rupee from volatile fluctuations.

In the early nineties, India’s foreign exchange reserves had dipped to such abysmally low levels that there was just enough forex to pay for a few weeks of imports. To overcome the crisis the then government had to pledge a part of its gold reserves to the Bank of England to obtain foreign exchange.