The currency exchange and convertibility is necessitated and facilitated by the urge of global trade. So, the purpose of currency convertibility is to accelerate the pace of international trade among trading partners for healthy economic growth and development.
Meaning and Need of open economy
It is the system of economy in which government grants freedom of trade for others in the absence of barriers, license, and extra incentives.
Besides, it also includes the specific degree of currency convertibility to facilitate trade.
Here, nations trade with one another depending on theirs comparative advantages.
Purpose of Currency convertibility
Currency is the system of money with certain value which is subject to change according to state of economy of that nation. For clearity, currency convertibility means swapping values of one currency with another.
The concrete motive is to facilitate trade among nations. By doing so, without any obstructions exchange of things can be executed.
In simple words, it is the exchange of purchasing power of one currency for another to sell or buy in the global market.
Types of currency convertibility
There are two types of convertibility. One is current account convertibility, whereas other is capital account convertibility. Let’s see more detailed about both types
1. Current account currency convertibility
It is all about the convertibility of one’s domestic currency into foreign currency. In short, exchange of one currency for another without much restrictions. Its purpose is to ease trade in goods and services. In addition, it is more helpful in transferring remittance, tourism, study, etc.
2. Capital account currency convertibility
You may be aware about the terms capital inflow and outflow. Both terms are used to show the degree of currency convertibility by nationals.
Simply, it is all about the sell and purchase of financial asset at will in any nation provided that the there is no limitations. It may be bonds, shares, or other forms.
Potential impacts of currency convertibility
If we talk about the currency convertibility, its degree is directly proportional to the strength of economy. It means that stronger the economy, more the freedom that country offers to convert.
Here are some impacts:-
1. Positive impacts
It boosts trade, circulation of capital, and generate employment opportunities.
Currency convertibility is the sign of open market economy where barriers are hardly present.
So, the goods, services, and capital can be exchanged as per the law of demand and supply.
In this case, countries with greater advantage can export, whereas countries with higher opportunity costs can import required goods.
Capital convertibility allows firms to raise funds to power productive activities.
Subsequently, it accelerates the rate of employment generations and improves the standards of living.
Furthermore, it helps to utilize untapped resources in the backward regions.
Free exchange of capital automatically generates natural balancing mechanism of checks and balances.
2. Negative impacts
To be a fully convertibility on both accounts, a nation should have economically better resilient.
As we know that currency market is more volatile than anything else.
Trade imbalance could also be a potential fallout due to aggressive export policies of export-led growth strategy.
It may affect domestic firms, as well as balance of payment.
The voices for protectionist policies might not be ruled out.
The possibility of excessive debt burden due to easy availability might pave the way for bankruptcy or insolvency of leading firms.
Some argues that fully currency convertibility may compromise the national interests or sovereignty of that nation.
Now, after considering all aspects, you might be understood the importance and purpose of currency convertibility to power the pace of economic well-being across the world. At the same time, we should not forget the fundamental rule and words of wisdom. As per them, economy should be strong enough to expose it for the global volatility. Otherwise, partial convertibility is more better option.