I was born in the ‘80s in an African country that had a so-called “non-convertible” currency. I think that forever marked my way of thinking about “currency” and I felt that was an injustice. This also became more and more evident when I discovered Bitcoin and when I used it as a medium of exchange.
Here, I will try to explain what I mean.
A non-convertible currency is one that one cannot exchange that currency on the international foreign exchange market. Outside the country, this currency has no value — it may also be referred to as locked money. For example, the Indian rupee is a semi-non convertible currency outside of India while dollars can be exchanged in all countries around the world.
It may sound crazy, but most countries in the world have a non-convertible currency. In 2022, only 18 countries (or regions) have a convertible currency. As you can see, not many do.
Beyond the macro-economic dimension, the non-convertibility of currencies has concrete repercussions on people’s lives. Tourism, for example, becomes a complex business due to the need to exchange its currency (and incur the exchange fees and conversion rates).
WHY DO SOME COUNTRIES OPT FOR NON-CONVERTIBLE CURRENCIES?
If governments decide to opt for a non-convertible currency, it is mainly to prevent capital flight abroad. In effect, by preventing convertibility, residents are then “forced” to use the currency in the country. Although the currency cannot leave the territory, it is nevertheless possible via complex financial instruments such as non-deliverable forwards (NDFs).
Thus, in theory, it may seem appropriate for a country to prefer non-convertibility. However, there are some drawbacks to this process which some countries seem to be tied up against.
When a currency is not convertible, it limits trade with other countries. This adds administrative and financial complexities to these partners. Also, when you have a non-convertible currency, the demand for it is relatively low (unless you have a comparative advantage on exports or it’s a sought-after tourist destination). This weak demand inevitably translates into a depreciation of the currency.
Naturally, the countries that benefit the most from international trade are those that have convertible currencies. With each transaction, demand increases and strengthens its legitimacy.