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Summary

Economics Class 45

## CONVERTIBILITY OF INDIAN RUPEE (05:02 PM)

- Convertibility means that the currency of a country can be freely converted into foreign exchange at a market-determined exchange rate.
- Convertibility is of two types:
- 1. On the Current Account
- 2. On the Capital Account
- **Current account** convertibility means the ability to convert rupees into any foreign currency and vice versa w.r.t. current account transactions.
- **Capital account** convertibility implies the freedom to convert local financial assets into foreign financial assets and vice-versa at market-determined rates of exchange.
- The rupee has been made fully convertible w.r.t. current account since 1994.
- Hereafter, to suggest a roadmap for capital account convertibility RBI constituted Taraore Committee 1 and Tarapore Committee II.
- However, the recommendations of these committees are yet to be adopted.
- Even today, Rupee is partially convertible w.r.t. Capital Account.
- Prior approval from RBI or the Government is still required.

## BENEFITS AND LIMITATIONS OF FULL CONVERTIBILITY (05:18 PM)

- **Benefits:**
- Convertibility helps in attracting foreign investments thereby enabling faster economic growth.
- Convertibility can lead to progress in multiple industries.
- Convertibility can improve employment opportunities and business opportunities.
- Convertibility can help in the Internationalisation of the Rupee.
- **Limitations:**
- Issue of flight of capital.
- Indian economy will become more vulnerable to external shocks.
- Lack of sealing on external debt may be disastrous.
- Risk of speculation.

## FULL CONVERTIBILITY

- As per the Tarapore Committee, some pre-conditions need to be fulfilled before going for full convertibility.
- 1. Reduce fiscal deficit to 3.5% of GDP.
- 2. Inflation target between 3 to 5 percent.
- 3. Strengthening the Indian financial sector.
- 4. Reduce public debt.
- 5. Adequate forex reserves.
- Thus going for complete convertibility is helpful for the Indian Economy.
- The decision should be based on macroeconomic benefits and a gradual approach to strengthening the financial sector.

## INTERNATIONALISATION OF RUPEE

- The Indian rupee is termed as Internationalised if it is accepted in International Transactions and non-residents are interested in investing in rupee-denominated assets.
- Banks and firms from other countries should hold Indian Rupees for financial security.
- **Requirements:**
- Stability of Currency
- Liquidity of Currency
- Easy availability of Currency
- Convertibility on Capital Accounts is gradually being relaxed which is also required for Internationalisation
- Presently, US Dollars, Euros, British Pound Sterling, Japanese Yen, and Chinese Renminbi may be termed as International Currency.
- The share of India in global trade is less and the Indian government is taking adequate measures in the direction of Internationalisation of the Rupee.

## INDIA'S EXTERNAL DEBT (05:32 PM)

- It refers to the total debt that India owes to foreign creditors (It can be govt of India, the state government, or corporations).
- The debt includes the money owed to foreign governments, private commercial banks, or even the IMF and World Bank.
- The various components of external debt include multi-lateral debt, bilateral debt, trade credit borrowings from IMF and World Bank, NRI Deposits, etc.
- Commercial borrowing remains the largest component followed by NRI Deposits.
- In terms of currency and composition, US dollar-denominated debt remains the largest component of India's external debt with a share of around 51 percent.
- Non-govt. debt is generally much higher.

## BRIEF DISCUSSION ON ECONOMICS PREPARATION (05:42 PM)

- Make combined short notes for Prelims and Mains from class notes.
- The short notes should be around 15-20 pages only.
- Additional Sources: Current Affairs and Newspaper.
- You can refer to additional books like Sanjeev Verma if time allows.
- Revision is the key.

## BRETTON WOODS INSTITUTION (05:57 PM)

- Brettonwoods institutions were established after the Brettonwoods Conference in 1944.
- The conference was attended by 44 nations with the purpose of establishing the International Monetary and Financial Order after WWII.
- The conference is also known as the United Nations Monetary and Financial Conference and in this conference, agreements were signed to establish the IBRD (International Bank for Reconstruction and Development).
- It was established for the speedy reconstruction of war-affected countries during post WW-II.
- It also focussed on economic development along with investments to build infrastructure.
- The aim was to promote the stability of exchange rates along with financial stability.
- At the same conference, there was also a proposal to establish ITO, but it was not accepted

## INTERNATIONAL MONETARY FUND (06:32 PM)

- India is a founding member of the IMF.
- IMF provides loans only to member countries.
- IMF is financed by its member countries with each country's contribution being fixed in terms of quota.
- IMF can also borrow from other institutions during its inception IMF had $ 8.8 billion.
- With a quota of US around 31 percent.
- India's quota at that time was 0.5 percent.
- Presently, the USA has a quota of around 17.44 percent and India's quota is around 2.76 percent.
- **Objectives of IMF:**
- Handling the BoP crisis of member countries.
- Reduction of exchange rate control and to promote a stable exchange rate regime.
- To facilitate balanced growth of International trade and to promote International Monetary Cooperation
- **Functions of IMF:**
- **Lending:** It provides loans to member countries facing short-term BoP crises.
- It provides financial stability both at the domestic and the global level.
- Surveillance: IMF checks the international monetary system monitors economic and financial policies and advises the member countries about the possible risks.
- IMF also publishes two periodic reports in this regard: **World Economic Outlook, and Global Financial Stability Report.**
- World Economic Outlook: It is usually published twice a year.
- It publishes the forecast of the economic development and policies in the member countries during the short and medium term.
- The report also integrates the risk and uncertainty that may threaten the growth of member countries.
- **Global Financial Stability Report:**Like the world economic outlook, it is also published twice a year.
- It provides an assessment of the stability of the global financial market and emerging markets based on current market conditions.
- It tries to figure out financial and structural imbalances in a country.
- Technical Assistance:
- IMF provides guidance to member countries for strengthening their fiscal conditions.

## SPECIAL DRAWING RIGHTS (07:31 PM)

- SDRs are foreign exchange reserve assets, under the IMF.
- SDR is not intrinsically a currency nor a claim on IMF.
- Its value is based on the basket of five major currencies.
- USD 41.73 percent; Euro 30.93 percent; Chinese Renminbi 10.92 percent; Japanese yen 8.33 percent; British pound 8.09 percent.
- The basket is revised every five years and the value of SDR keeps changing due to continuous fluctuation in the exchange rate.
- Unlike other currencies, SDR is not traded in the forex market, a currency is included in the SDR market based on factors like export criteria and freely usable criteria.
- A member country can park up to 25 percent of the quota in foreign currencies represented in SDR.
- Currently, the formula to derive quota, is the weighted average of member countries' GDP with an assigned weight of 50 percent (Here the GDP is measured through a blend of market exchange rates (60 percent) and PPP exchange rates (40 percent)).
- Openness to the global economy (30 percent),
- Economic variability (15 percent),
- International reserves (5 percent).
- The quota determines member countries' level of subscription to the IMF.
- It indicates the maximum amount of financial resources a member has to deposit with the IMF.
- The quota also decides the voting power of a member country along with access to IMF financing.

## TYPES OF FINANCING BY IMF (07:42 PM)

- **A. Concessional Lendings:**
- It is mainly done in low-income countries with a main focus on poverty reduction.
- There are three concessional lending facilities under the IMF:
- 1. Extended Credit Facility
- It is a sustained medium to long-term loan for prolonged BoP problems of low-income countries.
- 2. Standby credit facilities:
- These are loans to low-income countries to meet the short-term BoP crisis.
- 3. Rapid credit facility for urgent BoP needs of low-income countries.
- **B. Non-concessional lending:**
- Extended fund facility at market-determined interest rates to address medium and long-term BoP problems of member countries.
- 2. Standby arrangements: Nonconcessional loans to address short-term BoP problems.
- Rapid financing facility: Urgent BoP crisis
- Flexible credit line: Under this funds are provided to member countries with very strong fundamentals/policies and track records of policy implementation the purpose is to boost market confidence and the duration of the loan is one to two years.

## The topic for the next class: International Institutions (Continued)