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6/23/2011 www.taxpertpro.com

Convertible currencies are defined as currencies that are readily bought, sold, and converted without the need for permission from a central bank or government entity. Most major currencies are fully convertible; that is, they can be traded freely without restriction and with no permission required. The easy convertibility of currency is a relatively recent development and is in part attributable to the growth of the international trading markets and the FOREX markets in particular. Historically, movement away from the gold exchange standard once in common usage has led to more and more convertible currencies becoming available on the market. Because the value of currencies is established in comparison to each other, rather than measured against a rea commodity like gold or silver, the ready trade of currencies can offer investors an opportunity for profit. In case of two convertible currencies, Forward Exchange Rates reflect interest rate differentials between these two currencies. Thus, we can say that the Forward Exchange Rate for the higher interest rate currency would depreciate so as to neutralize the interest rate difference. However, sometimes there can be opportunities when forward rates do not fully neutralize interest rate differentials. In such situations forward exchange rates quickly adjust to eliminate the possibility of risk-less profits.

Fully convertible currency The U.S.dollar is an example of a fully convertible currency. There are no restrictions or limitations on the amount of dollars that can be traded on the international market, and the U.S. Government does not artificially impose a fixed value or minimum value on the dollar in international trade. For this reason, dollars are one of the major currencies traded in the FOREX market. Partially convertible currency The Indian rupee is only partially convertible due to the Indian Central Banks control over international investments flowing in and out of the country. Foreign exchange transactions are broadly classified into two types: current account transactions and capital account transactions. Transactions on the current account are fully convertible and foreign exchange was made freely available for such transactions. But capital account transactions are not fully convertible. The rationale behind this is clear, that India wants to conserve precious foreign exchange and protect the rupee from volatile fluctuations.

Capital account convertibility is likely to bring depth and large volumes in long-term INR currency swap markets. Thus for a better market determination of INR exchange rates, the INR should be convertible.

For more insight in Fuller convertibility of Rupee follow the link: http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/72252.pdf

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