Currency convertibility refers to the freedom to convert the domestic currency into other internationally accepted currencies and vice versa at the market-determined exchange rate.
Current account convertibility
Current account convertibility means freedom to convert domestic currency into foreign currency and vice versa to execute the trade in goods and Invisibles.
In India, there is full current account convertibility since August 20,1993. A series of measures were launched then to liberalise exchange controls and the exchange rate system was shifted to market- determined exchange rates since March 1993. After that, on August 20, 1993, the RBI announced that that the rupee became fully convertible on current account.
Capital account convertibility
On the other hand, capital account convertibility implies freedom of currency conversion related to capital inflows and outflows.
Compared to current account convertibility, capital account convertibility is a complex issue because of the peculiar feature of capital account transactions.
An important one is the high frequency and volume of international capital movements across borders which may produce many macroeconomic effects in host countries like India.
There is partial capital account convertibility in India.
Partial convertibility can be defined as converting Indian currency (up to a specific extent) into the currency of other countries. So that the flow of foreign investment in terms of Foreign Institutional Investment (FII) and Foreign Direct Investment (FDI). In 1991-92 the GOI adopted a dual exchange rate system under which the official rate of exchange was controlled and the market rate (or the black-market rate) of exchange was free to move or fluctuate according to forces of supply and demand. All of India's foreign exchange remittances—earned through export of goods or services or through inward remittances—were allowed to be converted in the following manner:
- 60% of the export earnings could be converted at the market-determined rate; this amount could be used freely for current account transactions and payments (i.e., for import of goods, for travel, and for remittances abroad).
- The balance of 40% of the earnings should be sold to RBI through authorized dealers at the official rate of exchange; this amount of foreign exchange would be made available by RBI for financing preferred imports, bulk imports, etc.
The system of the dual exchange rate of the rupee enabled the exporters to convert (at least) 60% of their export earnings at the market rate of exchange which was much higher than the official exchange rate.
The GOI expected that this would provide adequate incentives to exporters and increase foreign exchange earnings.
The Committee on Capital Account Convertibility (1997, Tarapore committee) in its report has given a working definition for the CAC which is: "CAC refers to the freedom to convert local financial assets into foreign financial assets and vice versa at market-determined rates of exchange. It is associated with changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by, the rest of the world."
Reference - Here