Convertibility: a global view

While most currencies across the world are convertible on the current account, many are still not convertible on the capital account. Given the risk with unrestricted capital movement, the International Monetary Fund, too, — which has been all for free capital mobility — agrees that some controls on international capital flows may be necessary.

It’s not without reason that China, which has for long let known its intention of making the renminbi convertible on the capital account, is yet to do so. The renminbi, which is the world’s second-most globally-traded currency, is today fully convertible only for current account transactions.

While a shift to full convertibility on the capital account may be a necessary step towards the possible emergence of the renminbi as a reserve currency, such as the US dollar, it would also expose China to the risk of large capital outflows.

Take the case of Russia which, backed by solid foreign exchange reserves, lifted all controls on the rouble and made it fully convertible in 2006.

But with oil prices crashing and foreign investors pulling money out of the country, the rouble has come under pressure over the last one year. While the oil-dependent Russia has resisted imposing capital controls so far, it has had to intervene in the foreign exchange market to prop up the currency.

One of the best known examples of a country’s vulnerability to unrestricted capital movements is the East Asian crisis of 1997.

Instigated by a speculative attack on the Thai baht, the crisis unfolded with large capital outflows from Thailand and other countries in the region.

Until then the East Asian region, which was experiencing rapid economic growth and rising stock and property prices, had been attracting large amounts of foreign capital. The worst hit by the crisis were Thailand, Indonesia and South Korea — countries with fully convertible currencies. With the local currency freely exchangeable for dollars, there was an unfettered outflow of foreign capital from these economies. Controls were imposed by these countries in the aftermath of the crisis and even afterwards to stem capital outflows. Singapore, though, despite a convertible currency, was affected to a much lesser extent. This was thanks to a strong economy supported by large foreign exchange reserves, surplus on the current account and strong foreign direct investment inflows.

Then, there are the reserve currencies — the US dollar, British pound, Japanese yen and the euro — which are all fully convertible. But given the trust these currencies and, particularly the dollar, command, their status is unlikely to change anytime soon with countries world over continuing to hold them as part of their foreign exchange reserves. In fact, post the 2008 financial crisis too, the US dollar continues to remain a safe haven despite suggestions on the need for an alternative currency to take its position.

The European Central Bank’s €1.1-trillion asset buying programme since March has, however, kept the euro weak.

Other developed countries such as Australia and New Zealand too have managed to have stable currencies so far despite full convertibility, given their stable economies.

In recent times, though, the Australian dollar has been hurt by the slowing economic growth. The mining-dependent Australian economy has been hurt by the fall in prices of metals as demand from China, the world’s largest consumer of industrial raw materials, has slowed.

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