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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)