One’s support for full rupee convertibility is almost a measure of one’s faith in the Indian economy and New Delhi’s fiscal integrity. After the experience of the past decade, when the Manmohan Singh government, through a series of self-inflicted wounds, halved India’s economic growth, aggravated double-digit inflation and nearly sank New Delhi in red ink, this faith cannot be high. The Narendra Modi government is in the process of undoing much of this damage.
Recently, the minister of state for finance, Jayant Sinha, has come out in favour of full rupee convertibility. Given the country’s concerns about illicit capital flows, black economic activity and government profligacy the comment seems premature. The commonest critique of such a move is that convertibility would open the rupee to speculation. This is almost certainly the case, and in the midst of a financial crisis, there are few things as damaging to an economy than the feeding frenzy of currency speculators. The collapse of the European Rate Mechanism, the East Asian financial crisis and even the recent global banking meltdown were testament to this. But speculators do not go after currencies that are backed by strong economies and governments with sound finances. If a government has its books balanced and there is confidence in its financial institutions, then a currency will weather any storm. Economies that are also major trading and investment hubs also have a degree of immunity because demand for their currency is too high for speculation to have much impact.
One of the strongest arguments in favour of full convertibility is that the fear of speculators will keep New Delhi’s own profligate habits in check. This would be particularly useful, given the terrible record of most Indian governments when it comes to reckless spending. If India can develop a more competitive economy and its government can show a willingness to keep its books in shape over the next several years, the rupee deserves to be freed. The real question is New Delhi and its political will to carry out reforms. If it can, convertibility will be a natural outcome.