Today with India getting entangled with world trade and expanding its external links, the government and monetary authorities have to carefully review the macro and micro policies before taking any decision on the Rupee moving onto capital account convertibility(CAC). It is only after satisfactory homework has been done and basic fundamentals like inflation, fiscal deficit, legal and export and import trade laws are in place that a beginning should be made. Only judging the Indian economy’s performance on a few selective indicators which are currently temporarily performing well will not help solve the problem. For, with the world economy moving out of recession and a more optimistic climate for foreign investment interests developing,

What India needs today is basically more realistic policies capturing the recent happenings in the economy and a change in the mindset and moving away from a conservative approach to a more modern way of thinking. Today, the Indian markets are very protected and RBI is playing with the forex reserves to protect the Rupee at all costs. But if there is a drain on the capital flows in the future and forex reserves are not able to grow at a set pace and the RBI is left with no other option but tighten the monetary policy could spell disaster for the economy. Any unjustifiable move at the sensitive moment could reduce the expectations of the exporters and importers and send wrong signals in the economy. India will have to take a cautious approach once INR becomes convertible on the capital account as it will become a target of speculative attack. India’s Rupee convertibility is again being discussed all over again. After being a hot topic in 1994- 95, the issue was dormant in the wake of the Asian crisis. Indiahas managed to keep tight control on the Rupee over the past two years, and it has remained extremely steady. The Rupee is near its fair value of around 45/ USD. In future, India will see high volatility of the Rupee if it decides on convertibility. India has not had to spend its high US$ reserves to defend its currency. But this mechanism will surely come into play in future.

Therefore, India would be well advised to boost its exports to ensure strong foreign currency reserves. The other issue is the government deficit. India is running a high deficit which is being reflected in relatively high interest rates. A crowding out effect of rates will keep rates high which may help the Rupee but hurt the economy. India will eventually see its fiscal mismanagement putting pressure on the Rupee. In order to have a successful float of the Rupee, India needs to come up with a clear policy on its targeted range for the currency. In addition, India needs to maintain strong forex reserves while cutting the government deficit and the trade deficit. RBI should take a broader role, but should de-link itself from the MoF. These measures will help India manage its currency, but only to a certain extent.

Once the Rupee floats it will become much more subject to the whims of speculators. Going forward, India should see an average yearly depreciation of 5-7 per cent in the Rupee. If this occurs in an orderly fashion then foreign investors will remain relaxed. However, if the currency becomes convertible before it is fully ready then the ensuing volatility is likely to spook investors. The ministry of finance has put together blueprints for convertibility in the past and this is likely to be studied again. This time around, however, India has the benefit of hindsight from the Asian crisis to get the details right.