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POSITIVE SIGNALS

The Reserve Bank of India has liberalized exchange controls further. A new scheme called the Resident Foreign Currency (Domestic) Account has started, with current accounts permitted for foreign exchange earned legitimately through payment for services rendered abroad by residents, receipts from non-residents through contractual obligations, gifts or unspent foreign exchange from travels. This foreign exchange can be used for approved purposes. This was already permissible, but with a ceiling of $ 2,000. The difference with the earlier deposit scheme lies in removal of the threshold. The media have incorrectly described this as transition to capital account convertibility. The popular impression is that there is a neat and overnight transition from trade account convertibility to current account convertibility, and from current account convertibility to capital account convertibility.

Instead of such overnight transitions, there is gradual liberalization. The rupee is not quite completely convertible on the current account. With complete convertibility on the current account, there will be no thresholds ($ 5,000 or otherwise) for current account transactions. Since banks (authorized dealers) have such thresholds, the rupee is not completely convertible on the current account yet, and the new scheme only throws the lid open for recipients of foreign exchange, not everyone. Nor do approved purposes include capital account transactions like buying real estate abroad. Approved transactions include those for which global credit cards can already be used, with two differences. First, there is no threshold. Second, this scheme is for recipients of foreign exchange. So far as the capital account is concerned, the rupee is already convertible for capital inflows. The constraint arises for capital outflows. Since capital account transactions can be disguised as current account ones, no distinction between the two should be drawn, and approvals should only be needed beyond a threshold of something like $ 10,000 regardless of the nature of the transaction. But, as the Tarapore committee pointed out, complete convertibility requires impossible pre-requisites like reducing fiscal deficits and interest rates. Pending that, only gradual liberalization is possible.

Thanks to the misinterpretation of the east Asian currency crisis, movements towards capital account convertibility were on hold and the enforcement directorate has complained that some draconian provisions of the former Foreign Exchange Regulation Act are missing in the Foreign Exchange Management Act. That such pressures are resisted is welcome, and independent of the new scheme, the capital account has gradually been liberalized for both individual and the corporate sectors. The RBI also has an indirect objective of allowing the rupee to depreciate, since there is a limit to buying up dollars, with foreign exchange reserves fetching an exceedingly low rate of return and proving to be excessive. Apart from the positive signal, the new scheme is not quantitatively significant in attaining this objective.

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