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

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.

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:

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

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.

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.

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.

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.

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.

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

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).

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.

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).

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.

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

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: -

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.

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.

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.

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

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.

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.

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).

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

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

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.

DEBT SERVICING

Designated Authorized Dealers (ADs) make remittances of instalments of

principal, interest and other charges.

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).

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.

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.

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

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.

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

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.

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

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.

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

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

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.

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

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

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.

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.

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.

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

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.

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.

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.

progression of fera to fema

Documents

foreign exchange securities

foreign exchange import

foreign securities

foreign payments

foreign currency

foreign investment

foreign regulation act

provision of fera