REGULATION OF INDIAN FOREIGN EXCHANGE MARKET UNDER FEMA

PREPARED BY ANKIT VARDHAN (10DF016)

Early Stages: 1947-1977

India followed the par value system of exchange rate. the rupees external par value was fixed at 4.15 grains of fine gold The Reserve Bank maintained the par value of the rupee within the permitted margin of 1 per cent using pound sterling as the intervention currency.

 The objective of exchange controls was primarily to regulate the demand for foreign exchange for various purposes, within the limit set by the available supply. The Foreign Exchange Regulation Act initially enacted in 1947 was placed on a permanent basis in 1957. In terms of the provisions of the Act, the Reserve Bank, and in certain cases, the Central Government controlled and regulated the dealings in foreign exchange payments outside India, export and import of currency notes and bullion, transfers of securities between residents and non-residents, acquisition of foreign securities, etc.

 With the breakdown of the Bretton Woods System in 1971 and the floatation of major currencies, the conduct of exchange rate policy posed a serious challenge to all central banks world wide. In December 1971, the rupee was linked with pound sterling. Since sterling was fixed in terms of US dollar under the Smithsonian Agreement of 1971, the rupee also remained stable against dollar. to overcome the weaknesses associated with a single currency peg and to ensure stability of the exchange rate, the rupee, with effect from September 1975, was pegged to a basket of currencies.

 The currency selection and weights assigned were left to the discretion of the Reserve Bank. The currencies included in the basket and their relative weights were kept confidential to discourage speculation. It was around this time that banks in India became interested in trading in foreign exchange.

Formative Period: 1978-1992

Banks in India were allowed by the Reserve Bank to undertake intra-day trading in foreign exchange in 1978 They were required to comply with the stipulation of maintaining square or near square position only at the close of business hours each day. The exchange rate of the rupee during this period was officially determined by the Reserve Bank in terms of a weighted basket of currencies of Indias major trading partners.

 major banks in India started quoting two-way prices against the rupee as well as in cross currencies and, gradually, trading volumes began to increase. This led to the adoption of widely different practices (some of them being irregular) and the need was felt for a comprehensive set of guidelines or operation of banks engaged in foreign exchange business. Guidelines for Internal Control over Foreign Exchange Business, were framed for adoption by the banks in 1981. The foreign exchange market in India till the early 1990s, however, remained highly regulated with restrictions on external transactions, barriers to entry, low liquidity and high transaction costs. The exchange rate during this period was managed mainly for facilitating Indias imports.

 By the late 1980s and the early 1990s, it was recognised that both macroeconomic policy and structural factors had contributed to balance of payments difficulties. Devaluations by Indias competitors had aggravated the situation. Although exports had recorded a higher growth during the second half of the 1980s (from about 4.3 per cent of GDP in 1987-88 to about 5.8 per cent of GDP in 1990-91), trade imbalances persisted at around 3 per cent of GDP.

 This combined with a precipitous fall in invisible receipts in the form of private remittances, travel and tourism earnings in the year 1990-91 led to further widening of current account deficit. The weaknesses in the external sector were accentuated by the Gulf crisis of 1990-91. As a result, the current account deficit widened to 3.2 per cent of GDP in 1990-91 and the capital flows also dried up necessitating the adoption of exceptional corrective steps.

Post-Reform Period: 1992 onwards

This phase was marked by wide ranging reform measures aimed at widening and deepening the foreign exchange market and liberalisation of exchange control regimes. The dual exchange rate system was replaced by a unified exchange rate system in March 1993, whereby all foreign exchange receipts could be converted at market determined exchange rates. The restrictions on a number of other current account transactions were relaxed.

 On unification of the exchange rates, the nominal exchange rate of the rupee against both the US dollar as also against a basket of currencies got adjusted lower, which almost nullified the impact of the previous inflation differential. With the rupee becoming fully convertible on all current account transactions, the risk-bearing capacity of banks increased and foreign exchange trading volumes started rising. The reform phase began with the Sodhani Committee (1994) which in its report submitted in 1995 made several recommendations to relax the regulations with a view to vitalising the foreign exchange market

Foreign Exchange Management Act

The bill passed in the winter session of Parliament in 1999 FEMA became an act on the 1st day of June, 2000 & It extends to the whole of India. FERA had become incompatible with the proliberalisation policies of the Government of India. FEMA has brought a new management regime of Foreign Exchange consistent with the emerging framework of the World Trade

Organisation (WTO).

Switch from FERA

The introduction of Foreign Exchange Regulation Act was done in 1974, a period when Indias foreign exchange reserve position wasnt at its best. A new control in place to improve this position was the need of the hour. FERA did not succeed in restricting activities, especially the expansion of TNCs (Transnational Corporations). The concessions made to FERA in 1991-1993 showed that FERA was on the verge of becoming ions involving current account for external trade no longer required RBIs permission. The deals in Foreign Exchange were to be managed instead of regulated. The switch to FEMA shows the change on the part of the government in terms of foreign capital

FERA 1973
Control & Regulation of Foreign Exchange Prohibited almost all foreign exchange transactions Criminal law ( offence was a criminal nature) Presumption of guilty mind

FEMA 1999
Regulation management of Foreign Exchange All current account transactions are permissible by law Civil law (offence through civil procedure) Prosecution has to prove that a person has committed offence

Burden of proof lies with the person Burden of proof lies with the enforcement authority and not the person implicated.

 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.

It permits only authorised person to deal in foreign exchange or foreign security. Such an authorised person, under the Act, means authorised dealer, money changer, off-shore banking unit or any other person for the time being authorised by Reserve Bank.  The Act has empowered the Reserve Bank of India (RBI) to specify, in consultation with the Central Government, the permissible capital account transactions and the limits upto which foreign exchange may be drawn for such transactions.  But it shall not impose any restriction on the drawal of foreign exchange for payments due on account of amortization of loans or for depreciation of direct investments in the ordinary course of business.

 Any person may sell or draw foreign exchange if such sale or drawal is a current account transaction. Under the Act, Central Government may, in public interest and in consultation with the Reserve Bank, impose such reasonable restrictions for current account transactions as may be prescribed.

The Reserve Bank may, at any time, cause an inspection to be made, by any officer specially authorised in writing by it in this behalf, of the business of any authorised person as may appear to it to be necessary or expedient for the purpose of:(i) verifying the correctness of any statement, information or particulars furnished to the Reserve Bank; (ii) obtaining any information or particulars which such authorised person has failed to furnish on being called upon to do so; (iii) securing compliance with the provisions of this Act or of any rules, regulations, directions or orders made thereunder.

 If any person contravenes any provision of this Act, or contravenes any rule, regulation, notification, direction or order issued in exercise of the powers under this Act, or contravenes any condition subject to which an authorisation is issued by the Reserve Bank, he shall, upon adjudication, be liable to a penalty. Restrictions are imposed on people living in India who carry out transactions in foreign exchange, foreign security or who own or hold immovable property abroad.

 Activities such as payments made to any person outside India or receipts from them, along with the deals in foreign exchange and foreign security is restricted. It is FEMA that gives the central government the power to impose the restrictions. Without general or specific permission of the Reserve Bank of India, FEMA restricts the transactions involving foreign exchange or foreign security and payments from outside the country to India the transactions should be made only through an authorised person. Exporters are needed to furnish their export details to RBI. To ensure that the transactions are carried out properly, RBI may ask the exporters to comply to its necessary requirements.

 Deals in foreign exchange under the current account by an authorised person can be restricted by the Central Government, based on public interest. Although selling or drawing of foreign exchange is done through an authorised person, the RBI is empowered by this Act to subject the capital account transactions to a number of restrictions. People living in India will be permitted to carry out transactions in foreign exchange, foreign security or to own or hold immovable property abroad if the currency, security or property was owned or acquired when he/she was living outside India, or when it was inherited to him/her by someone living outside India.