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Since 1991 Manmohan Singh has formulated economic policy for India under the instructions of the IMF (International Monetary Fund), World Bank and later WTO (World Trade Organization), disregarding the interest of the 90 percent of the population of India who are either of lower middle class or poor. The recent decision of the government to have full convertibility of Rupee which will affect everyone in the country but remotely understandable by a few, is one such important decision, which is designed to please the international financial institutions and the 10 percent of the population of India who are either rich or of upper middle class.

It is essential to judge a policy by examining the costs and benefits of it. The government is talking about the illusory benefits of this convertibility, which will basically remove all obstacle to the free flow of money and as a result goods and services also can move freely. The government, in a fully convertible regime, will not be able to control these flows directly. Indirectly controls will be implemented by changing interest rates and taxes but the effectiveness of this control according to the international experiences are uncertain.

The benefits of free flows of money in a fully convertible regime means foreigners would be able to invest in the Indian stock markets, buy up companies and property including land (unless there are restrictions). Indian people and companies can import anything they would like, buy shares of foreign companies and property in foreign lands and can transfer money as they please without going through the Hawala business. Indians those who have not paid their taxes or repaid their loans taken from the Indian banks will be free to transfer their money to foreign countries outside the jurisdiction of the Indian authority. Implications are very serious indeed.

The expected benefits for India would depend on the attractiveness of the country as a safe destination for short-term investments. Long-term investments do not depend on convertibility. China has no convertibility, instead a fixed exchange rate for the last 12 years. Yet, China is the most important destination for long-term foreign investments. Thus, discussions about the full convertibility should be about the desirability of short-term investments and their implications.

Short term investments i.e., foreign investments in shares and bonds of the Indian companies and India government depend on the demonstration of profit of the Indian companies and the continuous good health of the Indian economy in terms of low budget deficits, low balance of payments deficits, low level of government borrowings, low level of non-performing loan in the Indian banking system. From these points of view India cannot be a very attractive destination as the health of the economy despite of the propaganda of the Indian government is very weak with huge government debt, revenue deficits, Rs.150,000 Crores of uncollected taxes and Rs.120,000 Crores of unpaid loans in the banks. Increasing price of petroleum also increasing the balance of payments deficits of the country. With 80 percent of people live on less than 2 dollars a day, and 70 percent of the people live on less than 1 dollar a day, profitable market in India is also very small. If the Indian companies working under these constraints cannot demonstrate good and continuous profit, short-term investments will fly out very easily if there is any sign of economic downturn when there is a fully convertible Rupee. The results will be further increase in the balance of payments deficits and fall of the exchange rate of Rupee, which will provoke Indians to take their money out of India.

Another advantage of full convertibility of Rupee for the Indian rich is that they can import as they like and buy properties abroad as they were allowed to do so during the days of British Raj. It has certain advantages for the Indian companies who will be able to import both raw materials and machineries or set up foreign establishments at will. This also has the adverse consequences for the India’s domestic producers of these raw materials and machineries, as they have to compete against foreign suppliers who like Chinese may have deliberate low rate of exchange for their currencies thus making their goods low in price. Foreign suppliers also can be supported by all kinds of subsidies by their government so as to make their prices very low. Agricultural exports from Europe, USA, Thailand, and Australia can ruin India’s own agriculture.

There are many such historical examples in India. Within 20 years between 1860 and 1880, India’s domestic manufacturing industries were wiped out by free trade and convertible Rupee during the days of British Raj. Indian farmers during those days could not cultivate their lands, as the imported food products were cheaper than whatever they could produce. Demonstration of wealth by the Nawabs and Maharajas of India in Paris and London during the days of British Raj has not done any good for starving millions of India but was responsible for massive misuse of India’s foreign currency reserve created by the sweat and blood of the India’s poor in those days. Full convertibility of Rupee and free trade may bring back those dark days.

The freedom for India’s rich to buy companies and property abroad may lead to massive diversion of funds from investments in the home economy of India to investments abroad. These amount to exports of jobs to foreign countries creating more and more unemployment at home. Japan in recent years suffers from this phenomenon, where increasingly Japanese companies are transferring funds to China for investments, taking advantage of the very low wage rate and low exchange rate of Yuan, thus creating unemployment at home. Although China has massive surplus in the balance of payments, huge reserve of dollars and gigantic flows of foreign investments, a non-convertible Yuan and controls on transfer of money have kept China’s exchange rate low enough so that Chinese goods can capture the markets of every important country of the world.

The most dangerous consequence of convertibility is that Rupee will be under the control of currency speculators. A fully convertible regime for the Rupee will certainly include participation of Rupee in the international currency market and in the ‘future market’ of Rupee, the playground for the international speculators. It is very much possible for the speculators to buy massive amount of Rupee to drive up its exchange rate and then they can suddenly sell all to gain enormous profit. That will drive down Rupee to a very low depth suddenly. If the Reserve Bank of India wants to protect Rupee in such a situation, within a few days India will have no foreign exchange left in reserve and the country will go bankrupt. Similar situation took place in 1998 for South Korea, Thailand, and Indonesia, all with then convertible currency. Malaysia has survived by imposing fixed exchange rate, exchange control, and making Malaysian dollar nonconvertible. Both India and China were unaffected because their economies at that time was closed and their currencies were non-convertible.

Similar situation took place for the British pound in 1992 when the British government lost its entire dollar holding to save pound, which was under attack from the speculators. However, Britain with 400 tons of gold in the Bank of England could not go bankrupt. There is no guarantee that a similar situation will not occur for India. India has no massive gold reserve; in 1991 it had to submit its gold reserve to the Bank of England to get loan from the I.M.F. Thus, it will certainly go bankrupt if there is any speculative attack on Rupee.

Convertibility also implies that the government of India will lose all controls over the economy. In a regime with convertible currency and as a result a flexible exchange rate, fiscal policy of the government, i.e., various taxes and public expenditure to stimulate the economy, will be neutralized by adverse monetary flows out of the country. Only monetary policy i.e., interest rate and money supply by the Reserve Bank of India, may work to some extent.

Money supply as experience suggests can work only on the negative direction; i.e., if the country reduces the money supply inflation can be controlled at the cost of reduced investments and increased unemployment. If the country, instead, increases the money supply to stimulate the economy it can cause inflation and eventually unemployment will go up as well because of possible bankruptcy of the private companies as a result of high inflation. The argument of Keynes that if there are underemployed resources in the economy increased money supply resultant from increased government spending cannot cause inflation is not valid for a dual economy like India where the 10 percent of the population live in a different planet from the other 90 percent of the population.

Interest rate is a dangerous instrument. If the government reduces it, there will be inflation, speculative movements in the market and disincentives for the savers, which would reduce future investments.

Reduced interest rate for a convertible Rupee will reduce the exchange rate of the Rupee. The currency speculators will start selling Rupee and short-term investments will fly out of the country. There would be a free fall of the Rupee in the international currency market. As a result the economy may go bankrupt without any foreign exchange. The result can be collapse of the private companies leaving millions of people unemployed.

If the government increases the interest rate exchange rate of Rupee will go up. Short-term investment will flood the market, speculators will buy more Rupee, but the exporters will be unable to sell their products abroad because of higher price of Indian exports as a result of higher exchange rate of Rupee. High exchange rate of Rupee also mean lower price of imported products. As a result both manufacturers and farmers will suffer from enhanced competitions from the manufactured products from the East and South East Asia and farm products from USA, Europe, Australia and Thailand.

Thus, interest rate is a dangerous weapon to depend upon. If a country wants to use it extensively the economy will go up and down creating havoc for the people. In 1988 Nigel Lawson, the then Chancellor of Exchequer of Britain used lower interest rate to stimulate the economy creating speculative bubble for a few years until 1991, then he had to increase the interest rate to a very high level to protect the British pound from the speculators causing serious depression of the economy and high unemployment. The policy of the Federal Reserve of the U.S during the presidency of Carter had the same experience. Recently Thailand, South Korea, Argentina, and Chile have suffered in the same way.

If the interest rate is determined by the market, as it should be in a convertible currency regime with unrestricted flows of money, India government will not have any control over the economy to give it a direction. The only instrument that may be available is the public expenditure policy. The government can stimulate the economy by increasing public expenditure, which may have uncertain consequences for the fate of Indian Rupee. Due to increased public expenditure, rate of growth of the economy and employment may go up, but at the same time there will be increased deficits in the balance of payments. Increased rate of growth may invite short-term investments and international speculators will buy more Rupee. However, increased budget deficit will cause increased deficits in the balance of payments, which will soon drive out short-term investments and speculators will start selling Rupee. The exact consequence will depend upon how fast the economy can grow and whether the reduced exchange rate will stimulate the export earnings strong enough to keep the growth growing. The experience of South Korea with a convertible currency from 1996 to 1998 showed that convertibility leads to bankruptcy due to speculative attacks against the currency in the international currency market. Argentina and Chile have similar experiences recently. USA during the days of Reagan and Clinton has avoided the consequences because USA is immune from effects of balance of payments deficits. Value of the U.S dollar does not depend on the balance of payments deficits of USA but on the value of international trade in petroleum, as dollar is the sole currency for petroleum trading in the world. Also, dollar is the currency in which other countries keep their reserve of foreign exchange. As India not USA, the experience of USA cannot give any guide for the Indian policy makers.

India should learn from China. China has no convertibility of Yuan, instead there are extensive controls on financial, and commodity flows in or out of the country. Foreign companies cannot have 100 percent ownership; they must have partnership with Chinese state owned companies. Foreign companies cannot repatriate profit, as they like; they must bring new technology, they must export most of their products. China imports what it needs, although theoretically it is a member of the World Trade Organization. China does not allow short-term investments, but it is the most attractive destination for the long-term foreign investments.

Chinese Yuan does not take part in the international foreign exchange market and thus, protected from the currency speculators. China has reduced the exchange rate of Yuan by 40 percent in 1984 and kept it fixed only to increase it by only 2 percent in 2005 when it has gigantic reserve of US dollars and massive trade surplus with the rest of the world. Very low exchange rate of Yuan is one of the most important reasons why China has managed to capture the markets of every important countries of the world.

Convertibility of Rupee will give pleasure to the 10 percent of Indian people who are either rich or upper middle class, traders in the stock market, speculators, bankers, and accountants. The rest 90 percent of the people will be adversely affected with loss of employments in the manufacturing sector and bankruptcy in the agricultural sector and total economic uncertainly.

During the days of the British Raj, Rupee was convertible, India had very large surplus in the balance of payments. India’s share in the world trade was much higher than what it is today. However, millions of Indians used to starve to death from time to time; millions of acres of land were left uncultivated by the bankrupt farmers; there were hardly any industry except for a few textile mills, only 15 percent of the population had any education at all. Yet at the same time, one could buy Rolls Royce and Scotch whisky in Bombay and Calcutta; Jinnah could buy his apartment in Bond Street of London; Maharaja of Patiala could build palace in Paris. We are returning back to those days through the acts of an un-elected (only selected for the upper hose of the parliament) Prime Minister Man Mohan Singh whose loyalty is not to the people of India but to the international financial institutions.

In any democratic country for any serious matter like turning the Rupee into a convertible currency there must be referendums. There were referendums in each and every European country when they wanted to create the European monetary system whereby each European currency would be aligned to each other to create a common currency Euro. Although India claims to be a democracy, Indian policy makers try their best to avoid the public opinion, even the parliament. Major issues like India’s membership of the World Trade Organization, abolition of the planned economy and privatization of public assets, free trade, and now the convertibility of Rupee should be debated in the parliament and people of India should be allowed to give their verdict in referendums if India wants to be a true democracy.

Dr.Dipak Basu

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