foreign exchange management act
TRANSCRIPT
ACKNOWLEDGEMENT
First of all we would like to take this opportunity to thank our College for having projects
as a part of the Foreign Trade Practices and Management (COP) curriculum.
We wish to express our heartfelt gratitude to the following individuals who have played a
crucial role in the research for this project. Without their active cooperation the
preparation of this project could not have been completed within the specified time limit.
The first person we would like to acknowledge is our teacher Professor. Dyuti
Chatterjee, who guided us with this project with utmost cooperation and patience. We
are very much thankful to you mam, for sparing your precious and valuable time for us
and for helping us in doing this project. We are also thankful to Professor. Ashish
Mitra, who gave us an opportunity to make this project in our curriculum.
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INDEX
Chapter no.
Topic Page Number
1Introduction: Foreign Exchange Regulation Act 1973 & 1999
3
2Foreign Exchange Management Policy in India
4-6
3 India’s Foreign Trade 7-8
4 Foreign Trade Scenario in India 9-14
5 Foreign Exchange Rates & Risk 15-17
6 Bibliography 18
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Introduction
Foreign Exchange Regulation Act, 1973
The Foreign Exchange Regulation Act (FERA) was legislation passed by the Indian Parliament in 1973 by the government of Indira Gandhi. FERA imposed stringent regulations on certain kinds of payments, the dealings in foreign exchange and securities and the transactions which had an indirect impact on the foreign exchange and the import and export of currency.
FERA was repealed in 2000 by the government of Atal Bihari Vajpayee and replaced by the Foreign Exchange Management Act, which liberalised foreign exchange controls and restrictions on foreign investment.
Foreign Exchange Management Act, 1999
The Foreign Exchange Regulation Act of 1973 (FERA) in India was repealed on 1 June, 2000. It was replaced by the Foreign Exchange Management Act (FEMA), which was passed in the winter session of Parliament in 1999. Enacted in 1973, in the backdrop of acute shortage of Foreign Exchange in the country, FERA had a controversial 27 year stint during which many bosses of the Indian Corporate world found themselves at the mercy of the Enforcement Directorate (E.D.). Any offense under FERA was a criminal offense liable to imprisonment, whereas FEMA seeks to make offenses relating to foreign exchange civil offenses.
FEMA, which has replaced FERA, had become the need of the hour since FERA had become incompatible with the pro-liberalisation policies of the Government of India. FEMA has brought a new management regime of Foreign Exchange consistent with the emerging frame work of the World Trade Organisation (WTO). It is another matter that enactment of FEMA also brought with it Prevention of Money Laundering Act, 2002 which came into effect recently from 1 July, 2005 and the heat of which is yet to be felt as “Enforcement Directorate” would be investigating the cases under PMLA too.
Unlike other laws where everything is permitted unless specifically prohibited, under FERA nothing was permitted unless specifically permitted . Hence the tenor and tone of the Act was very drastic. It provided for imprisonment of even a very minor offence. Under FERA, a person was presumed guilty unless he proved himself innocent whereas under other laws, a person is presumed innocent unless he is proven guilty .
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Foreign Exchange Management Policy in India
OVERVIEW OF FOREX POLICY OVER THE YEARS
Independence ushered in a complex web of controls for all external transactions through a legislation i.e., Foreign Exchange Regulation Act (FERA), 1947. There were further amendments made to the FERA in 1973 where the regulation was intensified. The policy was designed around the need to conserve Foreign Exchange Reserves for essential imports such as Petroleum goods and food grains.
The year 1991 was an important milestone for the Economy. There was a paradigm shift in the Foreign Exchange Policy. It moved from an Import Substitution strategy to Export Promotion with sufficient Foreign Exchange Reserves. The adequacy of the Reserves was determined by the Guidotti (1) Rule, though the actual implementation of the rule was modified to meet our requirements.
As a result of measures initiated to liberalize capital inflows, India’s Foreign ExchangeReserves (mainly foreign currency assets) have increased from US$6 billion at end-March 1991 to US$270 billion (2) as on 9th November 2007. It would be useful to note that the Reserves accretion can be attributed to large Foreign Capital Inflow that could not be absorbed in the economy. This has been as a result of shift of funds from developed economies to emerging markets like India, China and Russia.
FROM CONTROL TO MANAGEMENTIn the 1990s, consistent with the general philosophy of economic reforms a sea change relating to the broad approach to reform in the external sector took place. The Report of the High Level Committee on Balance of Payments (Chairman: Dr. C. Rangarajan, 1993) set the broad agenda in this regard. The Committee recommended the following:
The introduction of a market-determined exchange rate regime within limits; Liberalization of current account transactions leading to current account
convertibility; Compositional shift in capital flows away from debt to non debt creating flows; Strict regulation of external commercial borrowings, especially short-term debt;
(1) The Guidotti Rule says that Usable foreign exchange reserves should exceed the scheduled amortization of foreign currency debts during the following 12 months. However this was amended to meet the Indian requirement
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(2) Source: Reserve Bank of India Weekly Statistics Publication (16th Nov 2007)
Discouraging volatile elements of flows from non-resident Indians; full freedom for outflows associated with inflows (i.e., principal, interest, dividend, profit and sale proceeds) and gradual liberalization of other outflows;
Dissociation of Government in the intermediation of flow of external assistance, as in the 1980s, receipts on capital account and external financing were confined to external assistance through multilateral and bilateral sources.
The sequence of events in the subsequent years generally followed these recommendations. In 1993, exchange rate of rupee was made market determined; close on the heels of this important step, India accepted Article VIII of the Articles ofAgreement of the International Monetary Fund in August 1994 and adopted the current account convertibility. In June 2000 a legal framework, with implementation of FEMA, was put into effect to ensure convertibility on the current account.
CAPITAL ACCOUNT LIBERALIZATION APPROACH
Globalization of the world economy is a reality that makes opening up of the capital account and integration with global economy an unavoidable process. Today capital account liberalization is not a choice. The capital account liberalization primarily aims at liberalizing controls that hinder the international integration and diversification of domestic savings in a portfolio of home assets and foreign assets and allows agents to reap the advantages of diversification of assets in the financial and real sector. However, the benefits of capital mobility come with certain risks which should be categorized and managed through a combination of administrative measures, gradual opening up of prudential restrictions and safeguards to contain these risks.
CURRENT SCENARIO
The main objectives in managing a stock of reserves for any developing country, including India, are preserving their long-term value in terms of purchasing power over goods and services, and minimizing risk and volatility in returns. After the East Asian crisis of 1997, India has followed a policy to build higher levels of Foreign Exchange Reserves that take into account not only anticipated current account deficits but also liquidity at risk arising from unanticipated capital movements. Accordingly, the primary objectives of maintaining Foreign Exchange Reserves in India are safety and liquidity; maximizing returns is considered secondary. In India, reserves are held for precautionary
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and transaction motives to provide confidence to the markets, both domestic and external, those foreign obligations can always be met.
The Reserve Bank of India (RBI), in consultation with the Government of India, currently manages Foreign Exchange Reserves. As the objectives of reserve management are liquidity and safety, attention is paid to the currency composition and duration of investment, so that a significant proportion can be converted into cash at short notice.
5327%
4724%
9246%
74%
Securities Deposits with foreign commerical banksDeposits with other central banks; BIS & IMFGold
Deployment of Foreign Exchange as on 31st July 2010
Source: The Reserve Bank of India
GROUP INSIGHTS & SUGGESTIONS
As part of the group suggestions and insights, we will touch upon how the foreign exchange reserves can be deployed in a manner that will fetch higher returns without compromising on the goals that are currently set for these investments. This is an addition to Capital Account Convertibility Issues.
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INDIA’S FOREIGN TRADE: August 2010.
EXPORTS (including re-exports)
Exports during August, 2010 were valued at US $ 16644 million (Rs. 77509 crore) which was 22.5 per cent higher in Dollar terms (18.0 per cent higher in Rupee terms) than the level of US $ 13586 million (Rs.65670 crore) during August, 2009. Cumulative value of exports for the period April-August 2010 was US $ 85273 million (Rs 392811 crore) as against US $ 66326 million (Rs. 322424 crore) registering a growth of 28.6 per cent in Dollar terms and 21.8 per cent in Rupee terms over the same period last year.
IMPORTS Imports during August, 2010 were valued at US $ 29679 million (Rs.138211 crore) representing a growth of 32.2 per cent in Dollar terms (27.4 per cent in Rupee terms) over the level of imports valued at US $ 22449 million ( Rs. 108506 crore) in August, 2009. Cumulative value of imports for the period April-August, 2010 was US $ 141894 million (Rs. 653828 crore) as against US $ 106605 million (Rs. 518024 crore) registering a growth of 33.1 per cent in Dollar terms and 26.2 per cent in Rupee terms over the same period last year.
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TRADE BALANCE
The trade deficit for April - August, 2010 was estimated at US $ 56620 million which was higher than the deficit of US $ 40279 million during April -August, 2009.
DEPARTMENT OF COMMERCEECONOMIC DIVISION
EXPORTS & IMPORTS : (PROVISIONAL)
(Rs. Crores)
AUG APRIL-AUG
EXPORTS (including re-exports)
2009-2010 65670 322424
2010-2011 77509 392811
%Growth 2010-2011/2009-2010 18.0 21.8
IMPORTS
2009-2010 108506 518024
2010-2011 138211 653828
%Growth 2010-2011/2009-2010 27.4 26.2
TRADE BALANCE
2009-2010 -42836 -195600
2010-2011 -60702 -261017
FOREIGN TRADE SCENARIO In INDIA
Exports, Imports and Trade Balance ($ m) 1984-85 to 2008-09
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Year to Exports Imports Trade Balance
Rate of Change
Export Import
(percent)
1984-85 9878 14412 -4534 4.5 -5.9
1985-86 8904 16067 -7162 -9.9 11.5
1986-87 9745 15727 -5982 9.4 -2.1
1987-88 12089 17156 -5067 24.1 9.1
1988-89 13970 19497 -5526 15.6 13.6
1989-90 16612 21219 -4607 18.9 8.8
1990-91 18143 24075 -5932 9.2 13.5
1991-92 17865 19411 -1546 -1.5 -19.4
1992-93 18537 21882 -3345 3.8 12.7
1993-94 22238 23306 -1068 20.0 6.5
1994-95 26330 28654 -2324 18.4 22.9
1995-96 31797 36678 -4881 20.8 28.0
1996-97 33470 39133 -5663 5.3 6.7
1997-98 35006 41484 -6478 4.6 6.0
1998-99(P) 33218 42389 -9171 -5.1 2.2
1999-2000 36822 49671 -12849 10.8 17.2
2000-01 44560 50536 -5976 21.0 1.7
2001-02 43827 51413 -7586 -1.6 1.7
2002-03 52719 61412 -8693 20.3 19.4
2003-04 63843 78150 -14307 21.1 27.3
2004-05 83535 111516 -27982 30.8 42.7
2005-06 103092 149167 -46076 23.4 33.8
2006-07 126361 185749 -59388 22.6 24.5
2007-08 162904 251439 -88535 28.9 35.4
2008-09 168704 287759 -119055 3.6 14.4
Foreign exchange reserves (US $ m) 1995 to 2005
Reserves Transactions with IMF
Gold RTP SDRs Foreign
currency
Total
(2+3+4
Drawals Repurchase Outstanding
repurchase
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Assets ) s obligations
1995-96 4561 - 82 17044 21687 - 1710 2374
1996-97 4054 - 2 22367 26423 - 977 1313
1997-98 3391 - 1 25975 29367 - 615 664
1998-99 2960 - 8 29522 32490 - 102 287
1999-00 2974 - 4 35058 38036 - - -
2000-01 2725 - 2 39554 42281 - - -
2001-02 3047 - 10 51049 54106 - 26 -
2002-03 3534 672 4 71890 75428 - - -
2003-04 4198 1311 2 107448 112959 - - -
2004-05 4500 1438 5 135571 141514 - - -
2005-06 5755 756 3 145108 151622 - - -
2006-07 6784 469 2 191924 199179 - - -
2007-08 10039 436 18 299230 309723 - - -
2008-09
November 7861 854 3 238968 247686 - - -
December 8485 877 3 246603 255968 - - -
Jan,2009 8884 830 3 238894 248611 - - -
Feb,2009 9746 816 1 238715 249278 - - -
March,2009 9577 981 1 241426 251985 - - -
Balance of Payments ($ m)
Year to1995-
96
1996-
97
1997-
98
1998-
99
1999-
2000
2000-
01
1. Imports (CIF) 43670 48948 51187 47544 55383 59264
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2. Exports (FOB) 32311 34133 35680 34298 37542 44894
3. Trade balance (2-1) -11359 -14815 -15507 -13246 -17841 -14370
4. Invisibles
a) Receipts 17665 21405 23244 25770 30312 34447
b) Payments 12216 11209 13237 16562 17169 22656
of which: Interest & service payments
on loans and credits)(2312) (2201) (2912) (3045) (3186) (3542)
c) Net 5449 10196 10007 9208 13143 11791
5. Current account (net) -5910 -4619 -5500 -4038 -4698 -2579
6. Capital account (net)
I. Foreign Investments 4615 5963 5353 2312 5117 4588
a) Inflow 5643 7824 9266 5892 12240 14294
b) Outflow 1028 1861 3913 3580 7123 9706
c) Net 4615 5963 5353 2312 5117 4588
II. Loans (3) 2201 4795 4799 4418 1601 4531
i) External Assistance
a) Inflow 2933 3056 2885 2726 3074 2942
b) Outflow 2066 1955 2000 1927 2183 2532
c) Net 867 1101 885 799 891 410
ii) Commercial Borrowings
a) Inflow 8399 14664 14416 12045 9986 20134
b) Outflow 7065 10970 10502 8426 9276 16013
c) Net 1334 3694 3914 3619 710 4121
III. Banking
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a) Receipts 6453 8018 8910 8897 10659 12772
b) Payments 5691 5789 9803 8199 8532 11961
c) Net 762 2229 -893 698 2127 811
IV. Rupee Debt Service -952 -727 -767 -802 -711 -617
V. Other Capital (net)
a) Receipts 748 2629 3815 4610 4572 3992
b) Payments 3285 2883 2463 2801 2262 4282
c) Net -2537 -254 1352 1809 2310 -290
VI. Errors & omissions 600 -594 167 -175 656 -588
7. Total Capital (I..VI) 4689 11412 10011 8260 11100 8435
8. Overall Balance (5+7) -1221 6793 4511 4222 6402 5856
9. Monetary movement
a) IMF Transactions
i) Purchases - - - - - -
ii) Repurchases 1715 975 618 393 260 26
iii) Net -1715 -975 -618 -393 -260 -26
b) (Inc)/dec in reserves 2936 -5818 -3893 -3829 -6142 -5830
India's external debt (Rs bn) - 2006 to 2009
Year to 2006 2007R 2008PREnd-June
2009PR
End-Sep.
2009PR
End Dec.
2009QE
I. Multilateral 145,503 154,053 157,901 170,269 182,594 193,297
A. Government borrowing 133,800 141,746 144,627 155,456 165,771 175,057
(i) Concessional 105,852 108,448 107,395 114,576 120,061 123,852
(a) IDA 104,457 107,019 105,947 113,042 118,450 122,245
(b) Others 1,395 1,429 1,448 1,534 1,611 1,607
(ii) Non-concessional 27,948 33,298 37,232 40,880 45,710 51,205
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(a) IBRD 19,626 21,864 22,631 24,548 26,820 28,583
(b) Others 8,322 11,434 14,601 16,332 18,890 22,622
B. Non-Government Borrowing 11,703 12,307 13,274 14,813 16,823 18,240
(i) Concessional 0 0 0 0 0 0
(ii) Non-concessional 11,703 12,307 13,274 14,813 16,823 18,240
(a) Public Sector 8,510 9,315 10,352 11,449 12,693 13,855
(i) IBRD 4,594 4,550 4,690 5,390 5,993 6,773
(ii) Others 3,916 4,765 5,662 6,059 6,700 7,082
(b) Financial Institutions 2,628 2,414 2,350 2,781 3,130 3,335
(i) IBRD 630 655 593 647 700 728
(ii) Others 1,998 1,759 1,757 2,134 2,430 2,607
(c) Private Sector 565 578 572 583 1,000 1,050
(i) IBRD 0 0 0 0 0 0
(ii) Others 565 578 572 583 1,000 1,050
II. Bilateral 70,302 70,034 78,777 80,442 88,259 103,823
A. Government borrowing 54,593 53,810 59,391 59,413 64,903 75,687
(i) Concessional 54,468 53,810 59,391 59,413 64,903 75,687
(ii) Non-concessional 125 0 0 0 0 0
B. Non-government borrowing 15,709 16,224 19,386 21,029 23,356 28,136
(i) Concessional 6,949 1,727 1,736 1,852 1,897 1,951
(a) Public sector 5,285 1,241 1,225 1,262 1,293 1,289
(b) Financial institutions 1,664 486 511 590 604 662
(c) Private sector 0 0 0 0 0 0
(ii) Non-concessional 8,760 14,497 17,650 19,177 21,459 26,185
(a) Public Sector 3,628 7,420 10,097 11,135 12,285 14,561
b) Financial Institutions 2,386 3,828 3,735 3,820 3,930 4,238
(c) Private Sector 2,746 3,249 3,818 4,222 5,244 7,386
III. IMF 0 0 0 0 0 0
IV. Export credit 24,175 31,237 41,542 47,566 57,241 67,567
(a) Buyers' credit 16,088 23,617 33,321 39,241 48,270 57,543
(b) Suppliers' credit 3,351 2,941 3,057 3,159 3,327 3,442
(c) Export credit - bilateral
credit4,736 4,679 5,164 5,166 5,644 6,582
(d) Export credit - defence
purchase0 0 0 0 0 0
V. Commercial borrowing 117,991 180,669 249,920 262,987 285,822 320,567
(a) Commercial bank loansa 73,508 107,145 160,971 172,140 184,722 215,217
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(b) Securitized borrowingsb 41,112 68,020 82,914 84,555 94,468 98,524
Foreign Exchange Rates
Introduction:
Exchange Rate is the price of one country’s money in terms of other country’s money. When we say that exchange rate of Indian rupee is 48.40 per U.S dollar, we mean than 48.40 Indian rupees are required to purchase one U.S. dollar. When his exchange rate becomes 48.90 we say that the value of Indian rupee has against the U.S dollar on the
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other hand when the exchange rate becomes 48.10 we say that Indian rupee has appreciated against the U.S. dollar.
Factors affecting Foreign Exchange Rates:
► Fundamental factors► Political and psychological factors► Technical factors - Capital movement - Relative inflation rates - Exchange rates policy and intervention - Interest rates► Speculation► Others
Determination of Exchange Rates:
►Balance of payments►Demand and supply►Purchasing power of party►Interest rate►Relative income levels►Market expectations
Types of Exchange Rates:
Spot Exchange Rates Forward Exchange Rates
Spot Exchange Rates
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A spot exchange rate is a rate at which currencies are being traded for delivery on the same day for e.g. an Indian importer may need U.S. $ to pay for the shipment that has just arrived. He will have to purchase the $ in the market to make payment for the import. The rate at which he will buy the $ in the market is known as spot exchange rate.
Forward Exchange Rates:
The forward rate is a price quotation to deliver the currency in future. The exchange rate is determined at the time of concluding the contract, but payment and delivery are not required till maturity. Foreign exchange dealers and Banks give the forward rate quotations for delivery in future according to the requirement of their clients.
Foreign Exchange Rate Risk
When you conduct business overseas, you will have to convert currencies involved at some prevailing exchange rate. The price of one country's currency in terms of another country is called the exchange rate. When the currency of one country depreciates (drops in value), there will be a corresponding appreciation of value in another country's currency. Depreciation occurs when it takes more currency to purchase the currency of another country. Appreciation is just the opposite; the currency is able to purchase more units of the other country's currency. Since most currencies are valued according to the marketplace, there are constant changes to exchange rates. This gives rise to exchange rate risk.
There are several ways to reduce exchange rate risk. Two popular approaches are hedging and netting. Hedging is where you buy or sell a forward exchange contract to cover liabilities or receivables that are denominated in a foreign currency. Forward exchange contracts offset the gains or losses associated with foreign receivables or payables.A very popular form of hedging is the Interest Rate Swap. Interest rate swaps are arrangements whereby two companies located in different countries agree to exchange or swap debt-servicing obligations. This swap helps each company avoid the risks of changes in the foreign currency exchange rates. Due to the popularity of interest rate swaps, most major international banks offer interest rate swaps for organizations concerned about foreign exchange rate risks when making interest payments. The costs charged by banks for interest rate swaps are relatively low.
Another solution to foreign exchange rate risk is the use of netting. Netting is the practice of maintaining an equal level of foreign receivables against foreign payables. The net position is zero and thus exchange rate risk is avoided. If you expect the currency to
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depreciate in value, than you should hold a net liability position since it will take fewer units of currency to pay the foreign currency debt. If you expect the currency to appreciate in value, then you would want to have a net receivable position to take advantage of the increased purchasing power of the foreign currency.
There are other vehicles for dealing with exchange rate risk, such as option hedges and other types of derivatives. However, the costs and risks associated with these types of arrangements can be much higher than a simple approach such as the interest rate swap.
If you have exchange rate exposure, then take a look at simple hedges and netting as ways of avoiding foreign exchange rate risk.
Bibliography
Websites: http://rbi.org.in http://mospi.gov.in http://imf.org http://treasury.worldbank.org
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Publications: Bank of International Settlement – 2005 Following the Singapore model - S. Venkataramanan The Hindu Business Line Stanford Institute for Economic Policy Research
Databases: CMIE RBI Database (link from http://rbi.org.in) CSO Database on Foreign Exchange Reserves
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