Free float and rupee volatility

Following a brief discussion on twitter with @deepakshenoy I’m wondering what’s preventing the RBI from making the rupee fully convertible. The usual argument for full convertibility is that it will make the exchange rates volatile. My argument is that exchange rates are already so volatile that the additional volatility that could stem out of a free float is marginal, and a small price to pay.

The wise men at RBI, though, might argue the precise opposite. They will claim that in terms of already high volatility they wouldn’t want to do anything that might add to volatility, however marginally. This is a constant battle I faced in my last job, of delta improvements. I would frequently argued that when something was already high, making it delta higher was not so bad. I would argue in terms of making systemic changes that would reduce drastically the already high number, rather than focusing on the deltas.

Coming back to the rupee, you can also imagine the wise men talking about some stuff about black money and hawala money and all that. The thing with making the rupee fully convertible would be that hawala would be fully legal now, and the illegal practice would cease to exist. And when something becomes legalized it comes back to the mainstream rather than remaining on the margins, and that is always a good thing.

Then you can expect some strategic affairs experts to bring some national sovereignty and national security argument there. There will be people who will talk about the increase in counterfeit money (since it’ll become easier to “smuggle” rupees into India then), and about how foreign governments might pose a threat to India’s security by manipulating the rupee (who says that threat doesn’t already exist?)!

I don’t know. I don’t find any of these anti-full-convertibility arguments compelling. If we do adopt full convertibility, though, we can at least pay Iran for the oil we get from them, and that might for all you know help tackle inflation. I don’t, however, expect the RBI to act on this.