Progression of FERA to FEMA
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Transcript of Progression of FERA to FEMA
PROGRESSION
OF
FERATOFEMA
Presented By:
Imran Patel 46Miraz Shaikh 56Ibrahim Shaikh 59MohsinMukaddam 62Nahida Qureshi 69Prasad Pame 76PushkarChitre 78SabaKadiri 81ShadabPathan 89ShavanaAnsari 95Toms Ambi 117
SR NO INDEX PAGE
NO
1 Introduction 3
2 FERA 4
3 FEMA 7
4 Change in economic environment 12
5 Provisions related to export & import
of goods
16
6 Current account convertibility 19
7 Capital account convertibility 21
8 External commercial borrowing 24
9 Provisions related to FDI 29
10 Impact of FEMA on forex 31
11 Conclusion 36
12 Case study 38
Page 2
INTRODUCTION
This topic helped us to understand provision laid down by FERA and the difficulty
or problems faced by the individuals in abiding the provision. Problems faced by thegovernm
ent to raise foreign investment in the country.It was due to the stringent and aggressive
provisions of FERA, that the need for introduction of FEMA was felt. After liberalization
when the global markets were opened for trading and investing provision of FERA was
acting like obstacles in raising foreign currency. FEMAwas introduced with the view to
simplify provisions and encourage foreign investment in the country. In this project we have
covered how the introduction of FEMA had a positive impact on the Indian economy after
the 1991 crisis by making investments like FDIpossible.
Page 3
FERA
FERA was legislation passed by Indian parliament in September 1973by government
of Indira Gandhi and it came in force from January 1, 1974. It was amended by the Foreign
Exchange Regulation (Amendment) Act 1993 and later in 2000, was replaced by FEMA.
FERA applied to all citizens of India, all over India. The idea was to regulate the foreign
payments, regulate the dealings in Foreign Exchange & securities and conservation of
Foreign exchange for the nation.
FERA was enacted at the time when there was scarcity of FX. It imposed stringent
regulations on certain kind of payments which had an indirect impact on the foreign exchange
and import and export of currency.
Coca – cola, the world’s largest selling soft drink company had established its strong
presence in the world since 1886. Coca-Cola is the first international soft drink brand to enter
the Indian market in the early 1970’s. Till 1977 Coca-Cola was the leading brand in India;
later, due to FERA (Foreign Exchange Regulation Act), they left India and didn’t return till
1993. In simple words, FERA
Regulated in India by foreign regulation act 1973
Consisted of 81 sections
Emphasized strict exchange control
Law violators were treated as criminal offenders
Aimed at minimizing dealing in foreign exchange and foreign securities.
NEED TO INTRODUCE FERA
1. FERA was introduced at a time when foreign exchange (Forex) reserves of the
country were low, Forex being a scarce commodity.
2. FERA therefore proceeded on the presumption that all foreign exchange earned by
Indian residents rightfully belonged to the Government of India and had to be
collected and surrendered to the Reserve bank of India (RBI).
OBJECTIVES OF FERA:
The main objective of FERA 1973 was to consolidate and amend the law regulating:
Page 4
Certain payments
Dealings in foreign exchange and securities
Transactions indirectly affecting foreign exchange
Import and export of currency for the conservation of foreign exchange
resources of the country
Proper utilization of this foreign exchange so as to promote the economic
development of the country.
However, violation of FERA was a criminal offence. One has heard so many
stories of people being imprisoned for trivial offences.
The case of the eminent industrialist, S.L.Kirloskar, being proceeded against
under FERA for having the princely amount of $82 in his possession is well known.
If you had ever visited a relative abroad, or had non-resident relatives visiting you, the
chances are high that you had also violated FERA. In such cases, it is highly likely
that your relatives may have given you or you’re visiting family members some small
gift inforex, which you spent on buying some small article which you wanted to bring
back. Or you may have spent some money on hospitality towards your non-resident
relatives visiting you. Strictly, speaking, till the 1990's, these were FERA violations.
Fortunately, with the winds of liberalization blowing in the early 1990's, the
Government relaxed many of the rigours of FERA by issuing notifications. Forex
reserves swelled, the rupee was made convertible on current account. In this liberal
atmosphere, the government realized that possession of forex could no longer be
regarded as crime but was an economic offense for which a more appropriate
punishment was a penalty. Thus the need of FEMA was felt.
Important features of FERA are as follows:
1. RBI can authorize a person / company to deal in foreign exchange.
2. RBI can authorize the dealers to do transact the Foreign Currencies, subject to review
and RBI was given power to revoke the authorization in case of non-compliancy RBI
would authorize the persons as Money Changers who will convert the currency of one
nation to currency of their nation at rates "Determined by RBI"
3. NO person, other than "authorized dealer" would enter in any transaction of the
foreign currency. For whatever purpose Foreign exchange was required, it was to be
Page 5
used only for that purpose. If he feels that he cannot use the currency of that particular
purpose, he would sell it to an authorized dealer within 30 days.
4. No person in India, without "permission from RBI" shall make payments to a person
resident outside India and receive any payment from a person from outside India.
5. No person shall draw issue or negotiate any bill of exchange in which a right to
receive payment outside India is created. No person shall make any credit in an
account of a person resident out of India.
6. No person except authorized by RBI shall send foreign currency out of India.
7. A person who has right to receive the foreign exchange would have not to delay the
receipt of the foreign exchange.
To sum up, in FERA "anything and everything" that has to do something with Foreign
Exchange was regulated. The Experts called it a "Draconian Act" which hindered the growth
and modernization of Indian Industries.
Page 6
FEMA
The Foreign Exchange Management Act (1999) or in short FEMA has been
introduced as are placement for earlier Foreign Exchange Regulation Act (FERA). FEMA
became an act on the 1st day of June, 2000. FEMA was introduced because the FERA didn’t
fit in with post-liberalisation policies. A significant change that the FEMA brought with it,
was that it made all offenses regarding foreign exchange as “civil offenses”, as opposed to
“criminal offenses” as dictated by FERA. The main objective behind the Foreign Exchange
Management Act (1999) is to consolidate and amend the law relating to foreign exchange
with the objective of facilitating external trade and payments. It was also formulated to
promote the orderly development and maintenance of foreign exchange market in India.
FEMA is applicable to all parts of India. It enabled a new foreign exchange management
regime consistent with the emerging framework of the World Trade Organisation (WTO). It
is another matter that the enactment of FEMA also brought with it the Prevention of Money
Laundering Act of 2002, which came into effect from 1 July 2005.
FEATURES OF FEMA
Main Features of the Act are as follows
The most important feature of the Act is that the definition of a resident and non-
resident are almost in line with income tax Law. Therefore there is uniformity in
defining the residential status of persons who are liable for income tax and who are
entitled for foreign exchange related exemptions, relaxations and amenities.
A "Person" defined includes persons like Firm, Company, HUF etc., which are
coherent with income tax laws. Previously the RBI had powers to determine the
residential status of artificial Persons.
Under FEMA residents who were earlier non-residents may hold, own, transfer or
invest in property abroad, provided such foreign exchange or property, and was
acquired by them while they were non-residents.
The Citizens of Countries like Pakistan, Afghanistan, Bangladesh, Nepal, Bhutan and
Sri Lanka are not allowed by the RBI to freely hold and transfer property in India.
Page 7
However, movables may be held subject to RBI guidelines, by Citizens of Countries
other than Pakistan and Bangladesh.
The obligations of Indian exporters of goods and services would be required to
repatriate the foreign exchange earnings into India without delay and expeditiously
i.e., normally within six months, as per current regulations.
Under FEMA, permission has been given to non-residents to acquire, hold, own,
transfer or dispose property in India, held by them when they were resident or which
they have inherited from residents.
The Act empowers RBI to authorize any person to deal in Foreign exchange or in
foreign securities. The RBI may specify the conditions in the authorisation and may
also revoke the same in public interest in the cases of:
1. Contravention of provisions of the Act
2. Failure to comply with the conditions in the authorisation.
No person in India, without permission from RBI shall make payment to a person
resident outside India and receive any payment from a person from outside India.
RBI can authorize a person / company to deal in foreign exchange.
RBI would authorize the person as Money Changers who will convert the currency of
one nation to currency of other nation at rates determined by RBI.
No person, other than authorized dealer would enter in any transaction of the foreign
currency.
For whatever purpose foreign exchange was required, it should be used for that
purpose only. If not used for that purpose then that person will have to sell that
currency to the authorized dealer within 30 days.
If a company is 100 % export-oriented, a foreign shareholding exceeding 74 per cent
may be allowed.
Except the "Current Account" transactions, other foreign exchange dealings and
payments are still controlled. All Capital Account related transactions are not freely
permitted unless specifically allowed under the Law.
FEMA has permitted all current Account transactions unless otherwise specifically
prohibited by the RBI. The following are some of the Current Account transactions.
i. Any payment in connection with foreign trade, other current business, services
and short term Banking and credit facilities in the ordinary course of business.
ii. Any payment due as interest on loans and as net income from investments.
Page 8
iii. Any remittances for living expenses of parents, spouse and children residing
abroad.
iv. Any expenditure incurred in connection with foreign travel, education and
medical care of parents, spouse and children.
The RBI has prohibited, restricted and regulated the following Capital Account
transactions.
a) Transfer or Issue of any foreign Security by a person resident in India.
b) Transfer or Issue of any security by a person resident outside India.
c) Transfer or Issue of any security or foreign security by any branch office or
agency in India, of a person resident outside India.
d) Any borrowing or lending in Foreign Exchange in whatever form or by whatever
name.
e) Any Borrowing or Lending in rupees, in whatever form or by whatever name
between a person resident in India and a person resident outside India.
f) Deposits between people are resident in India and person’s resident outside India.
g) Export, Import or holding of currency notes.
h) Transfer of immovable property outside India, other than a lease not exceeding
five years, by a person resident in India.
i) Acquisition or transfer of immovable property in India, other than a lease not
exceeding five years, by a person resident outside India.
HAS FEMA MET THE DEMANDS?
As far as transactions on account of trade in goods and services are concerned, FEMA
has by and large removed the restrictions except for the enabling provision for the Central
Government to impose reasonable restrictions in public interest. The capital account
transactions will be regulated by RBI / Central Govt. for which necessary circulars /
notifications will have to be issued under FEMA.
Page 9
DIFFERENCES BETWEEN FERA AND FEMA
SSr. No
DIFFERENCES FERA FEMA
11.
PROVISIONSFERA consisted of 81 sections, and was more complex
FEMA is much simple, and consist of only 49 sections.
22.
FEATURES
Presumption of negative intention (Mens Rea ) and joining hands in offence (abatement) existed in FEMA
These presumptions of Mens Rea and abatement have been excluded in FEMA
33.
NEW TERMS IN FEMA
Terms like Capital Account Transaction, current Account Transaction, person, service etc. were not defined in FERA.
Terms like Capital Account Transaction, current account Transaction person, service etc., have been defined in detail in FEMA
44.
DEFINITION OF AUTHORIZED PERSON
Definition of "Authorized Person" in FERA was a narrow one ( 2(b)
The definition of Authorized person has been widened to include banks, money changes, off shore banking Units etc. (2 ( c )
55.
MEANING OF "RESIDENT" AS COMPARED WITH INCOME TAX ACT.
There was a big difference in the definition of "Resident", under FERA, and Income Tax Act
The provision of FEMA, are in consistent with income Tax Act, in respect to the definition of term" Resident". Now the criteria of "In India for 182 days" to make a person resident has been brought under FEMA. Therefore a person who qualifies to be a non-resident under the income Tax Act, 1961 will also be considered a non-resident for the purposes of application of FEMA, but a person who is considered to be non-resident under FEMA may not necessarily be a non-resident under the Income Tax Act, for instance a business man going abroad and staying therefore a period of 182 days or more in a financial year will become a non-resident under FEMA.
Page 10
66.
PUNISHMENT
Any offence under FERA, was a criminal offence , punishable with imprisonment as per code of criminal procedure, 1973
Here, the offence is considered to be a civil offence only punishable with some amount of money as a penalty. Imprisonment is prescribed only when one fails to pay the penalty.
7.QUANTUM
OF PENALTY.
The monetary penalty payable underFERA, was nearly the five times the amount involved.
Under FEMA the quantum of penalty has been considerably decreased to three times the amount involved.
8. APPEAL
An appeal against the order of "Adjudicating office", before " Foreign Exchange Regulation Appellate Board went before High Court
The appellate authority under FEMA is the special Director ( Appeals) Appeal against the order of Adjudicating Authorities and special Director (appeals) lies before "Appellate Tribunal for Foreign Exchange." An appeal from an order of Appellate Tribunal would lie to the High Court. (sec 17,18,35)
99.
RIGHT OFASSISTANCE DURING LEGAL PROCEEDINGS.
FERA did not contain any express provision on the right of on impleadedperson to take legal assistance
FEMA expressly recognizes the right of appellant to take assistance of legal practitioner or chartered accountant (32)
110.
POWER OF SEARCH AND SEIZE
FERA conferred wide powers on a police officer not below the rank of a Deputy Superintendent of Police to make a search
The scope and power of search and seizure has been curtailed to a great extent
Page 11
ANALYSIS OF THE CHANGE IN THE ECONOMIC
ENVIRONMENT IN INDIA IN THE 1990’s (LPG)
The 1991 crisis had manifold roots central among which is the growing recourse to
various forms of external borrowing to finance a series of large trade and current account
deficits in the latter half of the eighties. The foreign exchange reserves were also run down to
finance the unsustainable external deficit and in mid-1991 foreign exchange reserves were
barely sufficient to meet two weeks import bill.
Although an active policy of real exchange rate depreciation in the second half of the
1980s induced good export growth in late eighties, it was a case of too little too late. The
value of imports increased at a faster pace (than what could be financed by the exports)
because of the gradual easing of import and industrial licensing requirements after the 1980s.
The growing recourse to external borrowing in the second half of the 1980s had led to
a substantial deterioration in India’s external debt indicators. As a ratio to foreign currency
reserves, short-term debt soared to a dangerous 382 per cent, signalling the heightened
fragility of India’s external finances.
The crisis was waiting to happen and the trigger came in the form of the Gulf War of
1991 and the associated oil price hike tipped India’s fragile external finances into a full-
blown balance of payments crisis.
Reasons for the crisis can be summed up in the following four points
i. A series of high fiscal deficits throughout the 1980s,
ii. An overvalued exchange rate (aggravated by real appreciation of the rupee in the
first half of the 1980s)
iii. Foreign trade and payments policies biased against exports
iv. Growing recourse to various forms of external borrowing to finance a series of
large trade and current account deficits in the latter half of the eighties.
What changed after 1991?
On July 24, 1991, India instituted a series of ongoing economic reforms, which is now
known as theEconomic Liberalization of 1991 or Liberalization, Privatization and
Globalization (LPG).
Page 12
Economic liberalization, in general, refers to a government applying a series of
deregulation measures, reducing the amount of government control, allowing foreign capital
in, allowing greater privatization, lowering taxes (and other economic barriers), etc to allow
room for private players to enter its market. In this way we entered in to "liberalization".
In countries like India and China, the term is used mainly in context of opening up the
economy to foreign investments, capital, service providers, etc and allow room for
international players to enter its economy.
After the assassination of Rajeev Gandhi in 1991, India (still persisting with a Fixed
Exchange rate) delved deeper into the crisis, when massive investor confidence decline
caused India to be on the verge of economic bankruptcy.
With just three weeks left to completely depleting the last loan from IMF, P V
Narasimha Rao took over as India's Prime Minister and announced India's liberalization. The
goal of his visionary policy was to remove unnecessary bureaucratic controls, take careful
measures to integrate India with the world's economy, remove restrictions on foreign
investments and crack down on public sector enterprises that yielded very low returns.
Rao's ability to steer tough reform measures through the Parliament enabled India to
move quickly through the financial crisis. Although people give credit to Manmohan Singh
for India's economic reforms, it is actually Rao's political statesmanship that helped bring
about massive reform.
The following steps were taken:
a) In a brilliant political move, he instituted Dr Manmohan Singh (an economist rather
than a politician) as Finance Minister, and began India's Economic Reform (New
India) by first devaluing the Rupee.
b) Industrial de-licensing followed shortly afterward. Industrialists could finally breathe
free of the License Raj. Narasimha Rao announced the de-licensing on the same day
that Manmohan Singh presented his budget. Before anyone knew it, industrial
licensing was abolished.
c) The MRTP Act (that protected businesses from monopolies) was reformed and India
could finally be on the path to producing competitive and productive industries.
d) Gradual reduction of import duties followed, allowing foreign investments to slowly
start flowing in. More clearance was given to capital goods.
Page 13
e) Slowly, taxes were lowered (income and corporate taxes) and Foreign Technology
Agreements started getting signed.
f) In cities where the population was less than a million, they didn't even need
Government permits for industries.
g) The threats of massive layoffs were avoided by legislating judiciously and exercising
regulations carefully.
The result of all this was that Licensing slowly became the exception rather than the
rule. Every industry (except two) was opened to private sectors. Foreign technology was
accepted liberally and foreign investment was allowed in a large number of industries. The
monopoly laws were revised and there were no more restrictions on companies wanting to
grow big.
Narasimha Rao and Manmohan Singh basically braked with careful deregulation and
accelerated by reducing bottlenecks. They had to continually assure every worker striking
(from the banking sector to farmers, from opposition Yatras led by the BJP to the trade
unions) that there wouldn't be layoffs and that workers would be protected. These reforms
were both revolutionary and incremental.
The result of this was that the Indian economy grew to 7.5% of GDP (from USD 130
million in 1992, to USD 5 billion, in 1996).
Cities started to grow and became centres of post-liberalization industrialization.
AtalBihari Vajpayee continued with Manmohan Singh's economic reforms and India
welcomed IT and BPOs. Manmohan Singh's government in 2004 again continued with
market liberalization and larger role for enterprises.
India's capital markets found exponential growth. The number of listed companies
grew and resulted in a healthy trend of development in India. Even though there are serious
environmental impacts to India's growth story, India found a unique brand of capitalism (a
form of laissez-faire capitalism very different from the free-form capitalism in USA or
China).
Page 14
IMPORTANT TERMINOLOGIES IN FERA AND FEMA
Authorized dealer means a person for the time being authorized by the Reserve Bank
of India (RBI) under section 6 to deal in foreign exchange.
Bearer certificate means a certificate of title to securities, whose ownership can be
transferred by mere delivery, whether with endorsement or not. In this sense, it is similar to a
bearer cheque ie whoever has such a certificate can easily encash it without any other
person’s endorsement.
Certificate of title to a security means any document used in the ordinary course of
business as a proof of the possession or control of the security or authorizing or purporting to
authorize, either by endorsement or by delivery the possessor of the document to transfer or
receive the security thereby represented.
Page 15
PROVISIONS RELATED TO EXPORT AND IMPORT OF
GOODS
Export trade is regulated by the Directorate General of Foreign Trade (DGFT) and its
regional offices, functioning under the Ministry of Commerce and Industry, Department of
Commerce, Government of India. Policies and procedures required to be followed for exports
from India are announced by the DGFT, from time to time.
Banks may conduct export transactions in conformity with the Foreign Trade Policy
in vogue and the Rules framed by the Government of India and the Directions issued by
Reserve Bank from time to time.
General guidelines for Exports
The prerequisite of declaration of export of goods and software will not apply to the
cases indicated in Notification No. FEMA 23/2000-RB dated May 3, 2000 which mentions
that
Every exporter of goods or software in physical form or through any other form,
either directly or indirectly, to any place outside India, other than Nepal and Bhutan, shall
furnish to the specified authority
The declaration consists of true and correct material particulars including the amount
indicating:
1. The full export value of the goods or software; or
2. If the full export value is not ascertainable at the time of export, the value which the
exporter, expects should be specified.
However there are few exceptions in which export of goods can be made without
declaration in the following cases:
1. Trade samples of goods and publicity material supplied free of payment.
2. Personal effects of travellers, whether accompanied or unaccompanied.
3. Ship’s stores, trans-shipment cargo and goods supplied under the orders of Central
Government or of such officers as may be appointed by the Central Government in
Page 16
this behalf or of the military, naval or air force authorities in India for military, naval
or air force requirements.
4. Goods or software accompanied by a declaration by the exporter that they are not
more than twenty five thousand rupees in value.
5. By way of gift of goods accompanied by a declaration by the exporter that they are
not more than one lakh rupees in value.
6. Aircrafts or aircraft engines and spare parts for overhauling and/or repairs abroad
subject to their re-import into India after overhauling /repairs, within a period of six
months from the date of their export.
7. Goods imported free of cost on re-export basis.
8. Goods not exceeding U.S. $ 1000 or its equivalent in value per transaction exported to
Myanmar under the Barter Trade Agreement between the Central Government and the
Government of Myanmar.
9. The following goods which are permitted by the Development Commissioner of the
Export Processing Zones or Free Trade Zones to be re-exported, namely:
Imported goods found defective, for the purpose of their replacement by the
foreign suppliers/collaborators.
Goods imported from foreign suppliers/collaborators on loan basis.
Goods imported from foreign suppliers/collaborators free of cost, found
surplus after production operations.
10. Replacement goods exported free of charge in accordance with the provisions of Exim
Policy in force, for the time being.
Indication of importer-exporter code number
The importer-exporter code number allotted by the Director General of Foreign Trade
under Section 7 of the Foreign Trade (Development & Regulation) Act, 1992 (22 of 1992)
shall be indicated on all copies of the declaration forms submitted by the exporter to the
specified authority and in all correspondence of the exporter with the authorised dealer or the
Reserve Bank, whichever may be the case.
Accordingly, the Reserve Bank has in terms of the above referred regulations
prescribed the following forms for declaration of goods/software as specified in the schedule
annexed to the Regulations: -
Page 17
i) Form GR
ii) Form SDF
iii) Form PP
iv) Form SOFTEX
These forms are almost similar to the existing form GR, SDF, PP and SOFTEX
except that the declaration/undertaking to be furnished by the exporter has been suitably
modified.
Exemptions however has been granted under following cases:
a) Export of goods/software not exceeding Rs.25, 000 in values.
b) Export by way of gift not exceeding Rs one lakh in value.
c) Export of goods not exceeding US$ 1000 or its equivalent per transaction to
Myanmar under Barter Trade agreement.
Period within which export value of goods/software to be realised
Export proceeds are required to be realised within a period of 6 months from the date
of shipment. In the case of exports to a warehouse established abroad with the approval of
Reserve Bank, the proceeds have to be realised within 15 months from the date of shipment.
The requirement of repatriation of proceeds on due date has been dispensed with. An
enabling provision has been made in this regulation to delegate powers to authorised dealers
to allow extension of time. Export of goods on elongated credit terms beyond six months
requires prior approval of Reserve Bank.
Page 18
CURRENT ACCOUNT CONVERTIBILITY:
Current account convertibility refers to freedom in respect of Payments and transfers
for current international transactions. Current account convertibility allows free inflows and
outflows for all purposes other than for capital purposes such as investments and loans.
Any person may sell or draw foreign exchange to or from an authorised dealer if such
sale or withdrawal is a current account transaction except for following transactions where
Withdrawal of exchange is prohibited –
i. Travel to Nepal or Bhutan
ii. Transactions with a person resident in Nepal or Bhutan (unless specifically
exempted by Reserve Bank by general or special order)
iii. Remittance out of lottery winnings.
iv. Remittance of income from racing/riding etc. or any other hobby.
v. Remittance for purchase of lottery tickets, banned/proscribed magazines, football
pools, sweepstakes, etc.
vi. Payment of commission on exports made towards equity investment in Joint
Ventures/Wholly Owned Subsidiaries abroad of Indian companies.
vii. Remittance of dividend by any company to which the requirement of dividend
balancing is applicable.
viii. Payment of commission on exports under Rupee State Credit Route.
ix. Payment related to "Call Back Services" of telephones.
x. Remittance of interest income on funds held in Non-Resident Special Rupee
(NRSR) account scheme.
Besides these specific cases, there are certain other transactions, for which specific
RBI approval will be required. Reserve Bank approval would still be required for importers
availing ofSupplier's Credit beyond 180 days and Buyer's Credit irrespective of the period of
credit Authorised dealers may now permit remittance of surplus freight/passage collections
by shipping/airline companies or their agents, multimodal transport operators, operating
expenses of Indian airline/shipping companies and other such remittances after verification of
documentary evidence in support of the remittance.
Page 19
In today's changed scenario, Indian rupee has become fully convertible so far as
current account transactions are concerned. This implies that foreign exchange is freely
available to the residents for remittance on account of current account transactions for the
various purposes like foreign travel, foreign education, and medical treatment abroad etc. The
non-residents are also freely allowed to remit outside India the income or capital gain
generated in India. But, even today, the Indian rupee, in respect of capital account
transactions, is not fully convertible.
Page 20
CAPITAL ACCOUNT CONVERTIBILITY
Capital account convertibility (CAC) refers to the freedom of converting local
financial assets into foreign financial assets and vice versa at market determined rates
of exchange. It refers to the elimination of restraints on international flows on a country’s
capital account, facilitating full currency convertibility and opening of the financial system.
Regulations relating to CapitalAccount Transactions
Foreigners are not allowed to invest in any company or partnership firm or proprietary
concern which is engaged in the business of Chit Fund or as a Nidhi Company or in
Agricultural or Plantation activities or in Real Estate business (other than development of
townships, construction of residential / commercial premises, roads or bridges) or
construction of farm houses or trading in Transferable Development Rights (TDRs). Listing
of permissible classes of Capital account transactions for a person resident in India and also
by a person resident outside India has been provided in the regulations.
The act also provides detailed rules and regulations on borrowing and lending in
Foreign Currency as well as Indian Rupee by a person resident in India from/to a person
resident outside India either on non-repatriation or repatriation basis and restrictions on
borrowed funds.
Authorised dealers are now permitted to grant rupee loans to NRIs against security of
shares or immovable property in India, subject to certain terms and conditions. Authorised
dealers or housing finance institutions approved by National Housing Bank can also grant
rupee loans to NRIs for acquisition of residential accommodations subject to certain terms
and conditions.
Generally, there is no change in the existing Non Resident External (NRE) and
Foreign Currency Non Resident, FCNR (B) and Non Resident Ordinary (NRO) account
scheme except that the limit for permitting overdraft in NRE account has been raised from
Rs.20, 000 to Rs.50, 000 and ceiling on permitting overdraft in NRO accounts has been
dispensed with.
General permission has been granted to Indian company (including Non-Banking
Finance Company) registered with Reserve Bank to accept deposits from NRIs on
Page 21
repatriation basis subject to the terms and conditions specified in thisschedule. Indian
proprietorship concern/firm or a company (including Non-Banking Finance Company)
registered with Reserve Bank can also accept deposits from NRIs on non-repatriation basis
subject to the terms and conditions specified in this schedule.
General permission has been granted to Indian companies to accept deposits from
NRIs/OCBs by issue of a commercial paper subject to certain terms and conditions.
General permission has also been granted for retention of funds raised through
external commercial borrowings or raising of resources through ADRs/GDRs in deposit with
a bank outside India pending their utilisation or repatriation in India.
General permission has been granted to residents for purchase/acquisition of foreign
securities i.e. investment by a person resident in India in shares and securities issued outside
India.
a) Out of funds held in RFC account.
b) Issued as bonus shares on existing holding of foreign currency shares; and
c) Sale of shares/securities so acquired. For the purpose of regulating the investment in
India by person resident outside India, such investments have been divided in
following five categories and the regulations applicable have been specified
Schedule 1 - Investment under Foreign Direct Investment Scheme.
Schedule2 - Investment by Foreign Institutional Investors under Portfolio InvestmentScheme
Schedule 3 - Investment by NRIs/OCBs under Portfolio Investment Scheme
Schedule 4 - Purchase and sale of shares by NRIs/OCBs on Non-repatriation basis
Schedule 5 - Purchase and sale of securities other than shares or Convertible debentures of an
Indian company by Persons resident outside India
For transfer of existing shares/convertible debentures of anIndian company by a
resident to a non-resident by way of sale, the transferor should obtain an approval of the
Central Government and thereafter apply to Reserve Bank. In such cases the Reserve Bank
may permit the transfer subject to such terms and conditions including the price at which sale
may be made.
Page 22
Reserve Bank has granted general permission for remittance of net sale proceeds (net
of applicable taxes) of a security sold by a person resident outside India provided –
a) The security is held on repatriation basis;
b) Security is sold on recognised stock exchange or the Reserve Bank's permission for
sale of security and remittance of sale proceeds has been obtained and;
c) NOC/Tax Clearance Certificate from Income Tax authorities or an
undertaking/declaration as per the provisions of paragraph 3B.10 of ECM has been
produced.
Page 23
EXTERNAL COMMERCIAL BORROWINGS:
At present, Indian companies are allowed to access funds from abroad in the
following methods:
ECB policy focuses on three aspects:
Eligibility criteria for accessing external markets
Total amount of borrowings to be raised and their maturity structure
End use of the funds raised.
ELIGIBLE BORROWERS
AUTOMATIC ROUTE
1. Companies except financial intermediaries
2. Units in Special Economic Zones( SEZ)
3. NGOs engaged in micro finance activities
APPROVAL ROUTE
1. Infrastructure or export finance companies such as IDFC, IL&FS, Power
Finance Corporation, IRCON, Power trading corporation and EXIM bank
2. Banks and financial institutions which participated in the textile or steel
restructuring package
3. NBFCs to finance import of infrastructure equipment for leasing
4. Multistate Co-operative society engaged in manufacturing activities. A
research report on External Commercial Borrowing by Indian Companies
RECOGNIZED LENDERS
1. Internationally recognized sources such as international banks, international capital
markets, and multilateral financial institutions such as IFC, ADB and CDC, export credit
agencies, suppliers of equipment, foreign collaborators and foreign equity holders.
2. Overseas organizations and individuals with a certificate of due diligence from
overseas bank adhering to host country regulations (applicable only under the automatic
route).
Page 24
In case of foreign equity holders,
AUTOMATIC ROUTE
For ECBs up to USD 5 million – at least 25 percent to be held directly by the
lender
For ECBs more than USD 5 million - at least 25 percent to be held directly by the
lender and proposed ECB should not exceed four times the direct foreign equity
holding
APPROVAL ROUTE
At least 25 percent to be held directly by the lender but proposed ECB exceeds
four times the direct foreign equity holding.
AMOUNT AND MATURITY
AUTOMATIC ROUTE
Maximum Amount of ECB in a financial year
Companies other than those in hotel, hospital and software sectors - $500 million
Companies in services sector viz. hotels, hospitals and software sector - $100 million
NGOs engaged in micro finance activities - $5 million
Minimum Maturity Period
ECBs up to $20 million – 3 years
ECBs between USD 20 million and USD 500 million –5 years
APPROVAL ROUTE
Corporate can avail an additional amount of USD 250 million with average
maturity of more than 10 years over and above the existing limit of USD 500 million
under the automatic route.
ALL-IN-COST CEILINGS
Page 25
All-in-cost includes rate of interest, other fees and expenses in foreign
currency except commitment fee, pre-payment fee, withholding tax payment and fees
payable in Indian Rupees.
Following are the all-in-cost ceilings:-
Average Maturity Period All-in-cost Ceilings over 6 month LIBOR
Three to five years 300 basis points
More than five years 500 basis points
END USE
Permitted for
1. Investment (such as import of capital goods, new projects, modernization/expansion
of existing production units) in industrial sector including SMEs and infrastructure
sector.
2. Overseas direct investment in Joint ventures and Wholly owned subsidiaries
3. First stage acquisition of shares in the disinvestment process and in the mandatory
second stage offer under the Government’s disinvestment programme of PSU shares.
4. NGOs engaged in micro finance activities can utilize the proceeds for
lending to self-help groups
micro credit
bonafide micro finance activity including capacity building
Not permitted for
1. On-lending or investment in capital market or acquiring a company
2. Investment in real estate
3. Working capital, general corporate purpose and repayment of existing rupee loan
PROCEDURE
AUTOMATIC ROUTE
Borrower enters into a loan agreement with the lender
Submits the agreement to RBI for registration
Page 26
APPROVAL ROUTE
Borrower submits the application through Authorized Dealer (AD) to RBI
GUARANTEES
Issuance of guarantee, standby letter of credit, letter of undertaking or letter of
comfort by banks, financial institutions and NBFCs relating to ECB is not permitted.
SECURITY
Choice of security is left to the borrower but in case of creation of charges
over immovable assets and financial securities such as shares is subjected to FEMA
regulations.
PARKING OF ECB PROCEEDS OVERSEAS
ECB proceeds should be invested overseas until the actual requirement in
India. These investments should be liquid in nature so that they can be liquidated as
and when required by the borrower. These investments include:-
1. Deposits or Certificate of Deposit or other products offered by banks rated not less
thanAA(-) by Standard and Poor/Fitch IBCA or Aa3 by Moody’s
2. Deposits with overseas branch of an authorized dealer in India
3. Treasury bills and other monetary instruments of one year maturity having
minimumrating as indicated above
PREPAYMENT
Prepayment up to USD 200 million is allowed by ADs without prior approval
of RBI but minimum average maturity period needs to be maintained. For prepayment
more than USD 200 million, approval from RBI is required.
REFINANCE OF EXISTING ECBS
Refinancing of ECBs is allowed but outstanding maturity of the original loan
needs to be maintained.
Page 27
DEBT SERVICING
Designated Authorized Dealers (ADs) make remittances of instalments of
principal, interest and other charges.
Page 28
PROVISIONS RELATED TO FDI POLICY
Transfer of shares by a person resident in India to person resident outside India, as
well as the transfer of shares by a person resident outside India to a person resident in India is
a capital account transaction. In terms of Section 6(3) of the Foreign Exchange Management
Act, 1999, RBI has the power to make regulations to prohibit, restrict or regulate the transfer
of shares.
Reporting of FDI for fresh issuance of shares
An Indian company receiving investment from outside India for issuing shares /
convertible debentures / preference shares under the FDI Scheme, should report the
details of the amount of consideration to the Reserve Bank through its AD Category I
bank, not later than 30 days from the date of receipt in the Advance Reporting Form
enclosed in Annex - 6. Non-compliance with the above provision would be reckoned
as a contravention under FEMA, 1999 and could attract penal provisions.
The equity instruments should be issued within 180 days from the date of receipt of
the inward remittance or by debit to the NRE/FCNR (B) /Escrow account of the non-
resident investor. In case, the equity instruments are not issued within 180 days from
the date of receipt of the inward remittance or date of debit to the NRE/FCNR (B)
account, the 56
After issue of shares (including bonus and shares issued on rights basis and shares
issued on conversion of stock option under ESOP scheme)/ convertible debentures /
convertible preference shares, the Indian company has to file Form FC-GPR, enclosed
in Annex - 8, through its AD Category I bank, not later than 30 days from the date of
issue of shares.
Reporting of FDI for Transfer of shares route
The actual inflows and outflows on account of such transfer of shares shall be
reported by the AD branch in the R-returns in the normal course.
Reporting of transfer of shares between residents and non-residents and vice- versa is
to be made in Form FC-TRS (enclosed in Annex – 9-i).
Page 29
The Form FC-TRS should be submitted to the AD Category – I bank, within 60 days
from the date of receipt of the amount of consideration.
The sale consideration in respect of equity instruments purchased by a person resident
outside India, remitted into India through normal banking channels, shall be subjected
to a KYC check (Annex 9-ii) by the remittance receiving AD Category – I bank at the
time of receipt of funds.
Page 30
IMPACT OF FEMA ON FOREX
Early Years of Foreign Exchange Market
Until 1992, all Foreign Investments in India and the repatriation of Foreign Capital
required previous approval of the government. The Foreign Exchange Regulation Act rarely
allowed foreign majority holdings for Foreign Exchange in India. However, a new Foreign
Investment Policy announced in July 1991, declared automatic approval for Foreign
Exchange in India for thirty-four industries. These industries were designated with high
priority, up to an equivalent limit of 51%. The foreign exchange market in India is regulated
by the Reserve Bank of India through the Exchange Control Department.
Initially, the Government required that a company`s routine approval must rely on
identical exports and dividend repatriation, but in May 1992, this requirement of Foreign
Exchange in India was lifted, with an exception to low-priority sectors. In 1994, foreign
nationals and non-resident Indian investors were permitted to repatriate not only their profits
but also their capital for Foreign Exchange in India. Indian exporters enjoyed the freedom to
use their export earnings as they found it suitable. However, transfer of capital abroad by
Indian nationals is only allowed in particular circumstances, such as emigration. Foreign
Exchange in India is automatically made accessible for imports for which import licenses are
widely issued.
Foreign Exchange Rate Policy in India
Indian authorities are able to manage the Exchange Rate easily, only because Foreign
Exchange Transactions in India are so securely controlled. From 1975 to 1992 the Rupee was
coupled to a trade-weighted basket of currencies. In February 1992, the Indian Government
started to make the Rupee convertible, and in March 1993 a single floating Exchange Rate in
the market of Foreign Exchange in India was implemented. In July 1995, Rs 31.81 was worth
US$1, as compared to Rs 7.86 in 1980, Rs 12.37 in 1985, Rs 17.50 in 1990, Rs 44.942 in
2000 and Rs 44.195 in the year 2011.
Page 31
1980 1985 1990 1995 2000 2011 2012 20130.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
7.8612.37
17.50
31.81
44.94 44.20
55.6659.74
Exchange Rate - USD INR
Since the onset of liberalisation, Foreign Exchange Markets in India have witnessed
explosive growth in trading capacity. The importance of the Exchange Rate of Foreign
Exchange in India for the Indian Economy has also been far greater than ever before. While
the Indian Government has clearly adopted a flexible exchange rate regime, in practice the
Rupee is one of most resourceful trackers of the US dollar.
India’s Exports, Imports and Balance of Trade:
The global slowdown had its impact on the economy of almost all the countries,
including India. The trade deficit in 2008-09 was much more (49.72 %) compare to the
previous two years. As such India’s trade deficit stood at Rs. 533680 crores during 2008-09
with values of exports and imports at Rs. 840755 crores and Rs. 1374436 crores respectively.
However, as may be seen from below that the position was better in 2009-10 as the trade
deficit had decreased (2.90 %) compare to last year. This happened due to the negative
Page 32
growth of import during 2009-10 (– 0.78 %). The trade deficit in 2009-10 was Rs. 518202
crores with values of exports and imports as Rs. 845534 crores and Rs. 1363736 crores
respectively.
India's Exports, Imports, and Balance of Trade from 2000-01 to 2011-12value in Rs.crores percentage growth
Year Exports Imports Balance of Trade
Exports Imports Balance of Trade
2000-01 203571 230873 -27302 27.58 7.26 -50.96 2001-02 209018 245200 -36182 2.68 6.21 32.53 2002-03 255137 297206 -42069 22.06 21.21 16.27 2003-04 293367 359108 -65741 14.98 20.83 56.27 2004-05 375340 501065 -125725 27.94 39.53 91.24 2005-06 456418 660409 -203991 21.60 31.80 62.25 2006-07 571779 840506 -268727 25.28 27.27 31.73 2007-08 655864 1012312 -356448 14.71 20.44 32.64 2008-09 840755 1374436 -533680 28.19 35.77 49.72 2009-10 845534 1363736 -518202 0.57 -0.78 -2.90 2010-11 1142922 1683467 -540545 0.74 0.81 0.96 2011-12 1454066 2342217 -888151 0.79 0.72 0.61
India’s imports in 2009-10 was Rs. 1363736 crores compared to Rs. 1374436 crores
in 2008-09, resulting in a negative growth of import for the first time in about more than two
decades. Although there was negative growth of import in 2009-10, export growth was also
less (0.57 %). While negative growth implies importing less, (which may be good for
economy in terms of self-sufficiency and foreign exchange reserve, etc.) decrease in export at
the same time may not be desirable.
Page 33
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-120
5000
10000
15000
20000
25000
-60
-40
-20
0
20
40
60
80
100
Chart Title
Exports Imports Balance of Trade
Page 34
TURNOVER IN FOREIGN EXCHANGE MARKET
(In US $ Million)
Above figures shows Turnover in Foreign Exchange Market has been increase after
introduction of FEMA. In 1999-2000 Turnover of Merchant Purchase transactions were
123,145.80 which increase to 601,626.80 in 2005-006 & further increase to 1,549,746.90
in2011-12. In the same way in 19999-2000 Turnover of Merchant Sales transaction was
127,679.70 further increased to 615,528.60 in 2005-06 & 1,604,496.60 in 2011-12
respectively.
Page 35
CONCLUSION:
To conclude rules regulations and procedures have been simplified and diluted after
introduction of FEMA 1999.
FEMA which replaced FERA became the need of the hour since FERA
becameincompatible with the pro-liberalisation policies of the Government of
India. FEMA brought a new management regime of Foreign Exchange consistent with the
emerging framework of the WorldTrade Organisation (WTO). It applies to all branches,
offices and agencies outsideIndia owned or controlled by a person who is a resident of India
and outside India. FEMA was better than FERA in the following ways:
FEMA FERA
Was to facilitate external trade,
maintain FOREX and payments.
Was to conserve FOREX and to prevent
its misuse.
Violation of FEMA is a civil
offenceViolation of FERA was a criminal offence
Offences under FEMA are
compoundable
Offences under FERA were not
compoundable
To determine the residential status
of a person 182 days of stay was the only
requirement
To determine the residential status of a
person, citizenship was the criteria
In short, FERA required stringent controls to conserve foreign exchange and to
utilize in the best interest of the country. However, very strict restrictions have outlived their
utility in thecurrent changed scenario. Secondly there was a need to remove the draconian
provisions of FERA and have a forward-looking legislation covering foreign exchange
matters. In addition to this, FEMA was introduced by the RBI with a vision to lay down the
regulations rather than granting permissions on case to case basis.
As a result of FEMA in Indian market, foreign direct Investment (FDI) inflows are a
definingfeature of free market, liberalization and globalization. The important aspect is that
how andthrough what channels of FDI inflows affect the performance of companies in
developingcountries. One major channel through which inflow of foreign capital of Foreign
Page 36
DirectInvestment (FDI) in particular affect labour market in developing countries is
economicgrowth. If capital inflows enable the receivingdeveloping countries to increase the
investment
rate beyond what they could sustain with their domestic saving they shouldachieveaccelerate
d economic growth with favourable consequences for employment, wages, and
labour productivity. Emerging market contains a lot of potential for foreign direct investment
(FDI).The importance of FDI extends beyond the financial capital that flows into the country.
In addition to this, FDI inflows can also be a tool for bringing knowledgemanagerial
tools and
capability product design quality characteristics brand names channelsfor international marke
ting of products etc and consequent integrations into global product chains
which are thefoundations of a successful export strategy. FDI could benefit both the domestic
industry aswell as the consumers,by providing opportunities for technological transfers and
upgradation access to global managerial skills and practices optimum utilizations of
humancapabilities and natural resources making industries internationally competitive
opening upexport markets providing backward and forward linkages and access to
international qualitygoods and services and augmenting employment opportunities. For all
the above mentioned reasons, FDI isregarded as an important vehicle for economic
development particularly for developingeconomies.With the introduction of FEMA 1999 in
India, an era of liberalized environment and aninvestor friendly foreign exchange market was
introduced and as a positive effect, the number of transactions relating to inward and outward
remittance by way of equity participation,import of goods and services, borrowings,
investment outside India has drastically increased.However one should not forget South East
Countries crisis, where excessive Foreign CapitalInflow had created economic instability. So
we need to take advantages of liberalized marketin effective & balanced way in order to
achieve sound economic growth.
Page 37
Case Study: South-East Asian Crisis (1997)
Until 1997, Asia attracted almost half of total capital inflow to developing countries.
The economies of Southeast Asia in particular maintained high interest rates attractive to
foreign investors looking for a high rate of return. As a result the region's economies received
a large inflow of hot money and experienced a dramatic run-up in asset prices.
At the same time, the regional economies of Thailand, Malaysia, Indonesia, the Philippines,
Singapore, and South Korea experienced high, 8-12 percent GDP growth rates in the late
1980sand early 1990s.
This achievement was broadly acclaimed by economic institutions including the IMF and
World Bank, and was known as part of the Asian economic miracle. Triggered by events in
Latin America, particularly after the Mexican peso crisis of 1994, Western investors lost
confidence in securities in East Asia and began to pull money out, creating a snowball effect.
At the time Thailand, Indonesia and South Korea had large private current account deficits
and the maintenance of pegged exchange rates encouraged external borrowing and led to
excessive exposure to foreign exchange risk in both the financial and corporate sectors.
As the U.S. economy recovered from a recession in the early 1990s, the U.S. Federal Reserve
Bank under Alan Greenspan began to raise U.S. interest rates to head off inflation. This made
the U.S. a more attractive investment destination relative to Southeast Asia, which had
attracted hot money flows through high short-term interest rates, and raised the value of the
U.S. dollar, to which many Southeast Asian nations' currencies were pegged, thus making
their exports less competitive.
The foreign ministers of the ASEAN countries believed that the well-co-ordinated
manipulation of currencies was a deliberate attempt to destabilize the ASEAN economies.
Malaysian Prime Minister Mahathir Mohamad accused currency speculator George Sorosof
ruining Malaysia's economy with massive currency speculation at the 30th ASEAN
Ministerial Meeting held in SubangJaya, Malaysiathey issued a joint declaration on 25 July
1997 expressing serious concern and called for further intensification of ASEAN's
cooperation to safeguard and promote ASEAN's interest in this regard. Coincidentally, the
Central Bankers of most of the affected countries were at the EMEAP (Executive Meeting of
Page 38
East Asia Pacific) meeting in Shanghai, and they failed to make the New Arrangement to
Borrow operational.
A year earlier, the finance ministers of these same countries had attended the 3rd APEC
finance ministers meeting in Kyoto, Japan on 17 March 1996, and according to that joint
declaration, they had been unable to double the amounts available under the General
Agreement to Borrow and the Emergency Finance Mechanism.
EFFECTS IN EACH COUNTRY
Thailand
Thailand's economy was growing at an average of 9% until the crisis happened to hit
and then on 14 May and 15 May 1997, the baht, the local currency, was hit by massive
speculative attacks. On 30 June, Prime Minister ChavalitYongchaiyudh said that he would
not devalue the baht, but Thailand's administration eventually floated the local currency, on 2
July. Some have claimed that future Thai Prime Minister ThaksinShinawatra was behind the
devaluation.
In 1996, an American hedge fund had already sold $400 million of the Thai currency. From
1985 until 2 July 1997, the baht was pegged at 25 to the dollar. The baht dropped very swiftly
and lost half of its value. The baht reached its lowest point of 56 to the dollar in January
1998. The Thai stock market dropped 75% in 1997. Finance One, the largest Thai finance
company collapsed. On 11 August, the IMF unveiled a rescue package for Thailand with
more than 16 billion dollars. The IMF approved on 20 August, another bailout package of 3.9
billion dollars.
Philippines
The Philippines central bank raised interest rates by 1.75 percentage points in May
1997 and again by 2 points on 19 June. Thailand triggered the crisis on 2 July. On 3 July, the
Philippines central bank was forced to intervene heavily to defend the peso, raising the
overnight rate from 15 %to 24 % The peso fell significantly, from 26 pesos per dollar at the
start of the crisis, to 38 pesos in 2000, to 40 pesos by the end of the crisis.
During the tenure of former President Joseph Estrada, the Philippine economy recovered
from a contraction of .6 %in GDP during the worst part of the crisis to GDP growth of some
Page 39
3 %by 2001. Unfortunately, scandals rocked his administration in 2001, most notably the
"jueteng" scandal, became a significant factor to calls for his ouster which caused significant
falls in the share prices of companies listed on the Philippine Stock Exchange. The PSE
Composite Index, the main index of the PSE, fell to some 1000 points from a high of some
3000 points in 1997. The peso fell even further, trading from levels of about 35 pesos to 50
pesos. Later that year, he was impeached but was not voted out of office. Massive protests
caused EDSA II, which led to his resignation and lifted Gloria Macapagal-Arroyo to the
Philippine presidency. Arroyo did manage to end the crisis in the Philippines, which led to
the recovery of the Philippine peso to about 45 pesos by the time Arroyo became as the
president
Hong Kong
The collapse of the Thai baht on July 2, 1997, came 24 hours after the United
Kingdom handed over sovereignty over Hong Kong to the People's Republic of China. In
October 1997, the HK dollar, which was pegged at 7.8 to the US dollar, came under
speculative pressure since Hong Kong's inflation rate was significantly higher than that of the
US for years. Monetary authorities spent more than US$1 billion to defend the local currency.
Since Hong Kong has more than US$80 billion of foreign reserves, which is equivalent to
700% of M1 money supply and 45% of M3 money supply of Hong Kong, Hong Kong
managed to keep the currency pegged to the US dollar despite the speculative attacks. Stock
markets become more and more volatile; between 20 October and 23 October the Hang Seng
Index dipped by 23%. Hong Kong Monetary Authority promised to protect the currency. On
15 August 1998, Hong Kong raised rates overnight from 8 %to 23 % and at one point, to
500%. While the Monetary Authority recognized that the speculative forces were taking
advantage of the unique currency board system, in which the overnight rates would
automatically increase proportionally when the currency is sold in the market heavily, which
would in turn increase the downward pressure of the stock market and thus allowing the
speculators to earn a large profit by short selling shares, the Monetary Authority started
buying component shares of the HengSeng Index in mid-August. The Monetary Authority
and Donald Tsang, then Financial Secretary, declared war withspeculators openly. The
Government ended up buying approximately HK$120 billion (about US$15 billion) of shares
of various companies, and becoming the largest shareholder of some of the companies (e.g.
Page 40
the government owned 10% of HSBC) at the end of August when hostilities ended with the
closing of the August contract of HengSeng Index Futures. The Government started to divest
itself from the position in 2001 and made a profit of about HK$30 billion (about US$4
billion) in the process.
Speculative actions against the Hong Kong Dollar and the stock market did not continue into
September largely due to extraordinary reaction to speculators by the Malaysian authorities
and the onset of the collapse of Russian bond and currency market, which caused massive
loss to the speculators. The currency peg between the Hong Kong Dollar and the US Dollar at
7.8:1 continued to exist undeterred.
South Korea
South Korea is the world's 11th largest economy. Macroeconomic fundamentals were
good but the banking sector was burdened with non-performing loans. Excess debt would
eventually lead to major failures and take-overs. For example, in July, South Korea's third
largest car maker, Kia Motors asked for emergency loans. In the wake of the Asian market
downturn, Moody's lowered the credit rating of South Korea from A1 to A3, on November
28, 1997, and downgraded again to Baa2 on December 11. That contributed to a further
decline in Korean shares since stock markets were already bearish in November.
The Seoul stock exchange fell by 4 %on 7 November 1997. On November 8, it plunged by 7
% the biggest one-day drop recorded there to date. And on November 24, stocks fell another
7.2 %on fears that the IMF would demand tough reforms. In 1998, Hyundai Motor took over
Kia Motors.
Malaysia
Pre-crisis, Malaysia had a large current account deficit of 5% of GDP. At the time,
Malaysia was a top investment destination, and this was reflected in KLSE activity which
was regularly the most active exchange in the world. (With turnover exceeding even markets
with far higher capitalisation like the NYSE). Expectations at the time were that the growth
rate would continue, propelling Malaysia into developed status by 2020, a government policy
articulated in Wawasan 2020. As at start of 1997, the KLSE Composite index was above
1,200, the ringgit was trading above 2.50 to the dollar, and the overnight rate was below 7%.
In July, within days of the Thai baht devaluation, the Malaysian ringgit was "attacked" by
speculators. The overnight rate jumped from under 8% to over 40%. This led to rating
Page 41
downgrades and a general sell off on the stock and currency markets. By end 1997, ratings
had fallen many notches from investment grade to junk, the KLSE had lost more than 50%
from above 1,200 to under 600, and the ringgit had lost 50% of its value, falling from above
2.50 to under 3.80 to the dollar.
In 1998, the output of the real economy declined plunging the country into its first
recession for many years. The construction sector contracted 23.5%, manufacturing shrunk
9% and the agriculture sector 5.9%. Overall, the country's gross domestic product plunged
6.2% in 1998. During the year, the ringgit plunged below 4.7 and the KLSE fell below 270.
In September that year, various defensive measures were announced to overcome the crisis.
The principal measure taken were to move the ringgit from a free float to a fixed
exchange rate regime. Bank Negara fixed the ringgit at 3.8 to the dollar. Capital controls were
imposed. Various agencies were formed. The CDRC (Corporate Debt Restructuring
Committee) dealt with corporate loans. Danaharta discounted and bought bad loans from
banks to facilitate orderly asset realization. Danamodal recapitalised banks.
Growth then settled at a slower but more sustainable pace. The massive current account
deficit became a fairly substantial surplus. Banks were better capitalised and NPLs were
realised in an orderly way. Small banks were bought out by strong ones. A large number of
PLCs were unable to regularise their financial affairs and were de listed.Asset values
however, have not returned to their pre-crisis highs.
In 2005 the last of the crisis measures was removed as the ringgit was taken off the
fixed exchange system. But unlike pre-crisis days, it does not appear to be a free float, but a
dirty managed float, like the Singapore dollar.
Indonesia
In June 1997, Indonesia seemed far from crisis. Unlike Thailand, Indonesia had low
inflation, a trade surplus of more than $900 million, huge foreign exchange reserves of more
than $20 billion, and a good banking sector. But a large number of Indonesian corporations
had been borrowing in U.S. dollars.
During preceding years, as the rupiah had strengthened respective to the dollar, this practice
had worked well for those corporations -- their effective levels of debt and financing costs
had decreased as the local currency's value rose.
In July, when Thailand floated the baht, Indonesia's monetary authorities widened the rupiah
Page 42
trading band from 8% to 12%. The rupiah came under severe attack in August. On 14 August
1997, the managed floating exchange regime was replaced by a free-floating exchange rate
arrangement. The rupiah dropped further. The IMF came forward with a rescue package of
$23 billion, but the rupiah was sinking further amid fears over corporate debts, massive
selling of rupiah, and strong demand for dollars. The rupiah and Jakarta Stock Exchange
touched a new historic low in September. Moody's eventually downgraded Indonesia's long-
term debt to junk bond.
Although the rupiah crisis began in July and August, it intensified in November when the
effects of that summer devaluation showed up on corporate balance sheets. Companies that
had borrowed in dollars had to face the higher costs imposed upon them by the rupiah's
decline, and many reacted by buying dollars, i.e. selling rupiah, undermining the value of the
latter further. The inflation of the rupiah and the resulting steep hikes in the prices of food
staples led to riots throughout the country in which more than 500 people died alone in
Jakarta. In February 1998, President Suharto sacked the governor of Bank Indonesia, but this
proved insufficient. Suharto was forced to resign in mid-1998 and B. J. Habibie became
President. Before the crisis, the exchange rate between the rupiah and the dollar was roughly
2000 rupiah to 1 USD. The rate had plunged to over 18000 rupiah to 1 USD at times during
the crisis. Indonesia lost 13.5% of its GDP that year.
Singapore
The Singaporean economy dipped into a short recession almost purely as a result of
contagion. The relatively short duration and milder effects can be credited to active
management by the government. For example, the Monetary Authority of Singapore allowed
for a gradual 20% depreciation of the Singapore dollar to cushion and guide the economy to a
soft landing. The timing of government programmes such as the Interim Upgrading Program
and other construction related projects were brought forward. Instead of allowing the labor
markets to work, the National Wage Council pre-emptively agreed to CPF cuts to lower labor
costs, with limited impact on disposable income and local demand. Unlike in Hong Kong, no
attempt was made to directly intervene in the capital markets, and the Straits Times index was
allowed to drop 60%. In less than a year, the Singapore economy recovered, and continued on
its growth trajectory.
Page 43
Needless to say, the economic effects, although collectively much milder than in other
economies, were, in absolute terms, still very devastating, to those badly affected.
People's Republic of China (PRC)
The Chinese currency, renminbi (RMB), had been pegged to the US dollar at a ratio
of 8.3 RMB to the dollar, in 1994. Throughout 1998 there was heavy speculation in the
Western press that China would soon be forced to devalue its currency to protect the
competitiveness of Chinese exports vis-a-vis those of ASEAN nations, whose exports became
cheaper relative to China's. However, the RMB's non-convertibility protected its value from
currency speculators, and the decision was made to maintain the peg of the currency,
improving the country's standing within Asia. The currency peg was partly scrapped in July
2005 rising (only) 2.3 % against the dollar, reflecting pressure from the United States. Unlike
investments of many of the Southeast Asian nations, almost all of its foreign investment took
the form of factories on the ground rather than securities, which insulated the country from
rapid capital flight. While the PRC was relatively unaffected by the crisis compared to
Southeast Asia and Korea, GDP growth slowed sharply in 1998 and 1999, calling attention to
structural problems with the PRC economy. In particular, the Asian financial crisis convinced
the Chinese government of the need to resolve the issue of non-performing loans within the
banking system.
Although most of the deposits in PRC banks are domestic and there was not a run on the
banks, there was a fear within the Chinese government that weak banks would cause a future
crisis lead to a scenario similar to the fall of Suharto in which the Communist Party of China
would be overthrown. This led to measures to fix the banks and the industrial enterprises,
which were largely complete by 2005.
The United States and Japan
The "Asian flu" also put pressure on the United States and Japan. Their economies did
not collapse, but they were severely hit. On 27 October 1997, the Dow Jones industrial
plunged 554-points, or 7.2%, amid ongoing worries about the Asian economies. The New
York Stock Exchange briefly suspended trading. The crisis led to a drop in consumer and
spending confidence.
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Japan was affected because its economy is prominent in the region. Asian countries
usually run a trade deficit with Japan because the latter's economy was more than twice the
size of the rest of Asia together. About 40% of Japan's exports go to Asia. GDP real growth
rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998. The
Asian financial crisis also led to more bankruptcies in Japan.
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Case Analysis
An Analysis of the Merits And Demerits of Capital Account Convertibility
From An Indian Perspective
Consequences of the Crisis:
The crisis had significant macro-level effects, including sharp reductions in values of
currencies, stock markets, and other asset prices of several Asian countries. Many businesses
collapsed, and as a consequence, millions of people fell below the poverty line in 1997-1998.
Indonesia, South Korea and Thailand were the countries most affected by the crisis.
The economic crisis also led to political upheaval, most notably culminating in the
resignations of Suharto in Indonesia and ChavalitYongchaiyudh in Thailand. There was a
general rise in anti-Western sentiment, with George Soros and the International Monetary
Fund in particular singled out as targets of criticisms.
Culturally, the Asian financial crisis dealt a setback to the idea that there is a
distinctive set of Asian values, i.e. that East Asia had found a political and economic structure
that was superior to the West. More long-term consequences include reversal of the relative
gains made in the boom years just preceding the crisis. For example, the CIA World Fact
book reports that the per capita income (measured by purchasing power parity) in Thailand
declined from $8,800 to $8,300 between 1997 and 2005; in Indonesia it declined from $4,600
to $3,700; in Malaysia it declined from $11,100 to $10,400. Over the same period, world per
capita income rose from $6,500 to $9,300. Indeed, the CIA's analysis suggests the economy
of Indonesia was still smaller in 2005 than it had been in 1997 despite a population increase
of 30 million, suggesting an impact on that country similar to the Great Depression. Within
East Asia, the bulk of investment and a significant amount of economic weight shifted from
Japan and ASEAN to China.
The crisis has been intensively analyzed by economists for its breadth, speed, and
dynamism; it affected dozens of countries, had a direct impact on the livelihood of millions,
happened within the course of a mere few months, and at each stage of the crisis leading
economists, in particular the international institutions, seemed a step behind. Perhaps more
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interesting to economists is the speed with which it ended, leaving most of the developed
economies unharmed. These curiosities have prompted an explosion of literature about
financial economics and a litany of explanations why the crisis occurred. A number of
critiques have been levelled against the conduct of the International Monetary Fund in the
crisis, including one by former World Bank economist Joseph Stiglitz.
Lessons for India
The campaign for full Capital Account Convertibility [CAC] of the Indian currency
began in 1997 with the then and present Finance Minister Mr. P Chidambaram saying that it
is not a long term idea but a near term one. Chidambaram was very keen to make the Indian
currency fully convertible within a period of three years from 1996 when he first became the
finance minister. He set up the First Tarapore Committee then to lay the road map for full
convertibility. At that time full convertibility of the currency was regarded as the ultimate
fashion statement in macroeconomics. That was also regarded as the best and the most
market-friendly way of accessing foreign direct investment. In fact, the Asian and East Asian
countries became the prime examples of countries got on to the escalator of prosperity by
floating their currencies and making them fully convertible.
CAC is a concept which cannot be understood without the historic background and
therefore the group felt the need to include the detailed case study.
Capital Account Convertibility (CAC) has been regarded by modern economists as
one of the hallmarks of a developed country, the enduring endgame in globalisation. One of
the most persuasive arguments for capital account liberalization is that globalization has
come to stay and that; developing countries need to be part of the global financial integration
of countries. It is argued that the need for increasing financial integration of the developing
countries with financial markets of the industrialized world is completed through CAC. It is
also reasoned by some that if countries allow convertibility on the current account, it should
as a natural sequel allow convertibility on the capital account. And India having introduced
convertibility on the current account, India should follow suit by introducing CAC.
According to those who favour CAC, argue that full CAC will allow Indians to hold
an internationally diversified portfolio that provides them with the added opportunity of
diverse choices in wealth maximisation. Further, with full CAC it is necessary that we could
move towards unrestricted flow of FDI in all sectors, i.e. without any limit.
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The upsides of CAC are summarized as hereunder:
CAC could facilitate the Indian need to attract global capital as we need to augment
our domestic savings with external savings to boost out investment rates.
Ordinary Indian residents would get an increased choice of investment, which could
enhance their welfare. Further, by offering a diverse global market for investment
purposes, an open capital account permits domestic investors to protect the real value
of their assets through risk reduction
Capital controls, it is often found, are not very effective, particularly when current
account is convertible, as current account transactions create channels for disguised
capital flows and thereby distorting trade.
An open capital account could bring with it greater financial efficiency, specialization
and innovation by exposing the financial sector to global competition.
The downsides of CAC are summarized as hereunder:
A free capital account could lead to the export of domestic savings, which for capital
scarce developing countries like India could be ruinous. Given the fact that one hand
we seem to invite FDI i.e. import foreign savings into India, any step that could lead
flight of domestic capital is highly contradictory to the national policy of attracting
higher savings through FDI route into India.
Capital convertibility could lead to exchange rate volatility of the Rupee resulting in
macroeconomic instability caused through the risk of rapid and large capital outflows
as well as inflows. Moreover, such speculative capital flows may make domestic
monetary policy virtually ineffective. Also one needs to understand that India imports
approximately 75% of her crude requirements. Given the fact that the oil prices have
been well above the USD 90 per barrel and extremely volatile, any volatility in the FE
position of India could result in soaring energy prices. This could upset the economy
and have a debilitating impact on inflation within India.
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The CAC would not suit an economy like India, undergoing the process of structural
reforms, which needs controls and regulations for some more foreseeable future.
In short, during the pre-crisis period, controls on the capital account were generally
viewed as primeval economics. In contrast to this developing countries in the post-crisis
period have undergone a tectonic shift in their approach on this subject, with several
developing countries finding confort in retaining controls on the capital account. This shift in
the perspective shift is the direct consequence of the fact that costs of a full CAC appear to
overwhelm its benefits.
The Southeast Asian financial crisis has demonstrated how a sudden withdrawal of
capital can seriously affect the exchange and interest rates, and thereby threaten
macroeconomic management and economic stability not only in one country but several
others, depending on the degree of economic integration. Thanks to controls on its capital
account, India was not as badly engulfed by the Asian currency crisis as other countries in the
region. Many experts have rightly pointed out that slower deregulation of the financial sector
in India has proved to be the saving factor. If India had adopted capital account liberalization;
it would have been difficult to protect its economy from getting severely affected by the
Asian turmoil. It is in this context that the impact of the Southeast Asian crisis on the Indian
markets has to be understood.
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