RIZVI INSTITUTE OF MANAGEMENT

STUDIES & RESEARCH

Sr. No Particulars Page no.

1. Introduction to FERA

2. Need to introduce FERA

3. Objectives of FERA

4. About FERA

5. Definitions under FERA

6. Era of 1991- Indian Forex Crisis

7. Asian Crisis of 1997 due to CAC

8. Indonesia & Crisis

9. Introduction of FEMA

10. Need to introduce FEMA

11. Definitions under FEMA

12. A Step ahead from FERA to FEMA

13. Difference between FERA & FEMA

14. Recent Amendments to FEMA

15. Capital Account Convertibility (CAC)

16. ECB

17. FCCB

18. FDI

19. FDI Charts

20. Case Study on violation of FERA- ITC Ltd

21. Case Study on violation of FERA- Reliance Infra

Introduction to FERA

The origin of the Foreign Exchange Regulation Act dates back to the year of Indian

independence, 1947. At that time, it was legislated as a temporary measure to regulate the inflow

of foreign capital in the form of branches and concerns with the substantial non-resident interest,

and the employment of foreigners and later in 1957, it was placed permanently. Gradually, there

arose the need to conserve foreign exchange owing to the rapid industrialization in the country.

Consequently, The Foreign Exchange Regulation Act, 1973 was passed with some important

changes in the old version which contained very harsh laws. Every offence under the act was

made punishable with imprisonment. Thereafter, FERA 1973 was amended in order to remove

unnecessary restrictions in respect of companies registered in India and to simplify the

regulations regarding foreign investment in order to attract better flow of foreign capital and

investment.

The Foreign Exchange Regulation Act (FERA) was legislation passed by the Indian Parliament

in 1973 by the government of Indira Gandhi and came into force with effect from January 1,

1974. 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.The bill was formulated with the aim of

regulating payments and foreign exchange. It applies also to all citizens of India outside India

and to branches and agencies outside India of companies or bodies corporate, registered or

incorporated in India.

Need to Introduce FERA

a) FERA was introduced at a time when foreign exchange (Forex) reserves of the country were

low, Forex being a scarce commodity.

b) 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).

c) It regulated not only transactions in Forex, but also all financial transactions with non

residents. FERA primarily prohibited all transactions, except to the extent permitted by general

or specific permission by RBI.

Objective of FERA

The main objective of the 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 the foreign exchange resources of

the country;

Proper utilization of foreign exchange, so as to promote the economic development of the

country.

The basic purpose of FERA was:

To help RBI in maintaining exchange rate stability.

To conserve precious foreign exchange.

To prevent/regulate foreign business in India.

Definitions under FERA

"Authorized dealer" means a person for the time being authorized under section 6 to deal

in foreign exchange;

"Certificate of title to a security" means any document used in the ordinary course of

business as proof of the possession or control of the security, or authorizing or purporting

to authorize, either by an endorsement or by delivery, the possessor of the document to

transfer or receive the security thereby represented;

"Currency" includes all coins, currency notes, banks notes, postal notes, postal orders,

money orders, cheques, drafts, traveller's cheques, letters of credit, bills of exchange and

promissory notes;

"Foreign exchange" means foreign currency and includes -

(i) all deposits, credits and balances payable in any foreign currency, and any drafts,

traveller's cheques, letters of credit and bills of exchange, expressed or drawn in

Indian currency but payable in any foreign currency;

(ii) any instrument payable, at the option of the drawee or holder thereof or any other

party thereto, either in Indian currency or in foreign currency or partly in one and

partly in the other;

"Indian custom waters" means the waters extending into the sea to a distance of twelve

nautical miles measured from the appropriate base line on the coast of India and includes

any bay, gulf, harbor, creek or tidal river;

"Money-Changer" means a person for the time being authorized under section 7 to deal in

foreign currency;

"Owner", in relation to any security, includes any person who has power to sell or

transfer the security, or who has the custody thereof or who receives, whether on his own

behalf or on behalf of any other person, dividends or interest thereon, and who has any

interest therein, and in a case where any security is held on any trust or dividends or

interest thereon are paid into a trust fund, also includes any trustee or any person entitled

to enforce the performance of the trust or to revoke or vary, with or without the consent

of any other person, the trust or any terms thereof, or to control the investment of the trust

moneys;

Era of 1991- Indian Forex Crisis

There was no one particular reason why the economy was in such a bad shape in 1991 before

India opened up its economy. There is a basket of reason, to begin with the industrial policy

prevailing prior to the launching of the reforms. The heavy industry was a state monopoly. Other

industries were either subject to strict industrial licensing or reserved for the small-scale sector.

The tight control of the government on industry was aptly captured by a leading cartoonist in a

1980s comic strip showing the industry minister tell his staff, “We shouldn’t encourage big

industry that is our policy, I know. But I say we shouldn’t encourage small industries either. If

we do, they are bound to become big”

The reforms of the last 10 years have gone a long way toward freeing up the domestic economy

from state control. State monopoly has been abolished in virtually all sectors, which have been

opened to the private sector. The License Raj is a thing of the past. The small scale industry

reservation still persists but even here progress has been made. Apparel, with its large export

potential, was recently opened to all investors.

In the area of international trade, in 1991, import licensing was pervasive with goods divided

into banned, restricted, limited permissible, and subject to open general licensing (OGL). The

OGL category was the most liberal but it covered only 30 percent of imports. Moreover, certain

conditions had still to be fulfilled before the permission to import was granted under the OGL

system. Imports were also subject to excessively high tariffs. The top rate was 400 percent. As

much as 60 percent of tariff lines were subject to rates ranging from 110 to 150 percent and only

4 percent of the tariff rates were below 60 percent. The exchange rate was highly over-valued.

Strict exchange controls applied to not just capital account but also current account transactions.

Foreign investment was subject to stringent restrictions. Companies were not permitted more

than 40 percent foreign equity unless they were in the high-tech sector or were export-oriented.

As a result, foreign investment amounted to a paltry $100-200 million annually. Today, import

licensing has been completely abolished. This includes textiles and clothing, which remain

protected in developed countries through the multi-fiber arrangement. The highest tariff rate has

come down to 45 percent (including the tariff surcharge and the so-called Special Additional

Duty) with the average tariff rate declining to less than 25 percent. The foreign investment

regime is as liberal as in other developing Asian countries.

These reforms have paid handsomely. The economy has grown at more than 6 percent coupled

with full macroeconomic stability. This compares with a growth rate of 3.5 percent during 1950-

1980. The rate of inflation has been low and foreign exchange reserves are sufficient to finance

imports for more than eight months. Rising incomes have helped bring down poverty. According

to official figures, the proportion of poor in total population has declined from 40 percent in

1993-1994 to 26 percent in 2000.

The crisis was caused by currency overvaluation; the current account deficit and investor

confidence played significant role in the sharp exchange rate depreciation. The economic crisis

was primarily due to the large and growing fiscal imbalances over the 1920s. During mid-

eighties, India started having balance of payments problems.Precipitated by the Gulf War,

India’s oil import bill swelled, exports slumped, credit dried up and investors took their money

out. Large fiscal deficits, over time, had a spillover effect on the trade deficit culminating in an

external payments crisis. By the end of 1990, India was in serious economic trouble.

The gross fiscal deficit of the government (center and states) rose from 9.0 percent of GDP in

1980-81 to 10.4 percent in 1985-86 and to 12.7 percent in 1990-91. For the center alone, the

gross fiscal deficit rose from 6.1 percent of GDP in 1980-81 to 8.3 percent in 1985-86 and to 8.4

percent in 1990-91. Since these deficits had to be met by borrowings, the internal debt of the

government accumulated rapidly, rising from 35 percent of GDP at the end of 1980-81 to 53

percent of GDP at the end of 1990-91. The foreign exchange reserves had dried up to the point

that India could barely finance three weeks’ worth of imports.

In mid-1991, India's exchange rate was subjected to a severe adjustment. This event began with a

slide in the value of the Indian rupee leading up to mid-1991. The authorities at the Reserve

Bank of India took partial action, defending the currency by expending international reserves and

slowing the decline in value. However, in mid-1991, with foreign reserves nearly depleted, the

Indian government permitted a sharp depreciation that took place in two steps within three days

(July 1 and July 3, 1991) against major currencies.

Aftermath of Crisis & need for a Stricter & Broader Law

The economy was open for foreign investment & a strict law was required to govern the capital

flow. The risk could arise in future if there is a reverse flow of foreign funds out of the country.

Another issue was regarding allowing the funds to only limited sectors. A highly sensitive sector

such as defense, Railways, Banking, etc. was not open for foreign investment in the initial stage.

The details will be covered in the further parts. Also, private players were allowed to operate in

the banking sector which increased the complexity in regulating the forex. In the post LPG era,

IMF was putting pressure on India to make the rupee fully convertible against dollar. But on

account of Asian Crisis of 1997, the Government pushed the Capital Account Convertibility

issue. Rupee as of now is still partially floated, that is, it has current account convertibility

(Trade transactions) but it is not freely convertible on Capital Account or Capital Transactions.

Post LPG, Foreign funds started flowing in the country, this required a strict FDI norms in order

to avoid any confusion amongst investor & better administration of funds within country. FERA

was not well equipped to solve such an issue. Hence, a broader term was required to define &

direct such transactions. Also, the companies were now allowed to borrow money in foreign

currency, that is, External Commercial was allowed. A law was required to govern such activity

as FERA did not cover such aspects.

Based on our Experience we have defined a narrow study of FEMA, 1999. We will cover

following important topics which are governed by the act. In the end we will give an overview of

current developments & how FEMA has been successfully governing the foreign capital in & out

of the country. Following are the topics that are covered by the group:

Capital Account Convertibility (CAC)

Introduction to FEMA & Need to introduce FEMA

Recent Amendments to FEMA

ECB & FCCB

FDI & Recent Developments

Case Study on violation of FERA- ITC Ltd

Case Study on Violation of FEMA- Reliance Infra

Capital account convertibility

Capital Account Convertibility refers to the freedom to convert local financial assets into foreign

financial assets and vice versa at market determined rates of exchange (Tarapore Committee). It

is associated with changes of ownership in foreign/domestic financial assets and liabilities and

embodies the creation and liquidation of claims on, or by, the rest of the world.

IMF’s ROLE IN CAC

Convertibility is an IMF clause that all the member countries must adhere to in order to work

towards the common goals of the organization. However convertibility can be looked into from

various perspectives and incorporated accordingly by the member nations. An economy can

choose to be

Partially convertible on CURRENT ACCOUNT

Partially convertible on CAPITAL ACCOUNT

Fully convertible on current account

Fully convertible on capital account

It is important to state here that “The IMF’s mandate is conspicuous on current account

convertibility as current account liberalization is among the IMF’s official purposes outlined in

its Articles of Agreement, but it has no explicit mandate to promote capital account

liberalization. Indeed, the Articles give the IMF only limited jurisdiction over the capital account

however the IMF has given greater attention to capital account issues in recent decades, given

the increasing importance of international capital flows for macroeconomic stability and

exchange rate management in many countries. Thus there is no official binding over any member

state to opt for full capital account convertibility but it has been a constant component of the

IMF’s advisory reports on member countries.

Evolution of CAC in India economic and financial scenarios:

Though the rupee had become fully convertible on current account as early as 1991 (LPG Model

& forex crisis), the RBI has been adopting a cautious approach towards full float of the rupee,

particularly after the 1997 south-east Asian currency crisis. While there has been a substantial

relaxation of foreign exchange controls during the last 10 years, the current account

convertibility since 1994 means that both resident Indians and corporate have easy access to

foreign exchange for a variety of reasons like education, health and travel. They are allowed to

receive and make payments in foreign currencies on trade account. The next logical step in the

same direction would be full convertibility, which would remove restrictions on capital account.

Following are the pre-requisites for Capital Account Convertibility in India:

Jumping into capital account convertibility game without the downside of the step can harm the

economy. The Committee on capital account convertibility (CAC) or Tarapore Committee was

constituted by the Reserve Bank of India for suggesting a roadmap on Full convertibility of

rupee on Capital Account.

The Committee submitted its report in 1997. The Committee observed that there is no clear

definition of CAC. The CAC as per the standards refers to the freedom to convert the local

financial assets or vice versa at the market determined rate of exchange.

The Tarapore Committee observed that the Capital controls can be useful in Insulating the

economy of the country for the volatile capital flows during the transitional periods and also in

providing time to the authorities, so that they can pursue discretionary domestic policies to

strengthen the initial conditions.

The CAC Committee recommended the implementations of the Capital Account. Convertibility

for 3 year period viz.1997-98, 1998-99 and 199-2000.But this committee had laid down some

pre conditions are as follows:

Gross fiscal deficit to the GDP ratio has to come down from a Budgeted 4.5 percent in

1997-98 to 3.5% in 1999-2000.

A consolidated sinking fund has to be set up to meet government’s debt repayment needs;

to be financed by increase in RBI’s profit transfer to the government and disinvestment

proceeds .

Inflation rate should remain between an average 3-5 percent or 3-year period 1997-2000.

Gross NPAs of the public sector banking system needs to brought down from the present

13.7% to 5% by 2000. At the same time, average effective CRR needs to be brought

down from the current 9.3% to 3%.

RBI must have a Monitoring Exchange Rate Band of plus minus 5% around a real neutral

Real Effective Exchange rate RBI should be transparent about the change in REER.

External sector policies should be designed to increase current receipts to GDP ratio and

bring down the debt service ratio from 25% to 20%

Proper indicators should be used for evaluation adequacy of foreign exchange reserves to

safeguard against any contingency. Plus, a minimum net foreign asset to currency ratio of

40 per cent should be prescribed by law in the RBI Act.

The above committee’s report was not translated into any actions. India is still a country with

partial convertibility. However, some important measures in that direction are taken and they are

summarized as below:

The Indian corporate were allowed full convertibility in a automatic route up to $ 500

million overseas ventures .This means that the limited companies are allowed to invest in

foreign countries.

Indian corporate were allowed to prepay their external commercial borrowings via

automatic route if the loan is above $ 500 million.

Individuals were allowed to invest in foreign assets , shares up to $200000 per year.

Unlimited amount of Gold was allowed to be imported.

The Second Tarapore committee on Capital convertibility

Reserve Bank of India appointed the second Tarapore to set out the framework of Fuller Capital

Account Convertibility. The committee was established by RBI in consolidation with

government to revisit the subject of fuller capital account convertibility in the context of the

progress in economic reforms , the stability of the external and financial sectors, accelerated

growth and global integration.

The report of the committee was made public by RBI on 1st September 2006. The report, the

committee suggested 3 phrases on adapting the fully convertibility of rupee in Capital Account.

1. First phase in 2006-07

2. Second phase in 2007-2009

3. Third Phase in 2011

Following were some of the important recommendations of the committee:

The ceiling for External Commercial Borrowings (ECB) should be raised for automatic

approval

NRI should be allowed to invest in Capital Markets.

NRI deposits should be given tax benefits.

Improvement on the Banking regulations.

FII (Foreign Institutional Investors) should be prohibited from investing fresh money

raised to participatory notes.

Existing PN holders should be given a exit route to phrase out completely the PN notes.

At Present the rupee is fully convertible on current account, but partially convertible on capital

account

Benefits of CAC for INDIA

It allows domestic residents to invest abroad and have a globally diversified investment

portfolio; this reduces risk and stabilizes the economy. A globally diversified equity

portfolio has roughly half the risk of an Indian equity portfolio. So, even when conditions

are bad in India, globally diversified households will be sustained by offshore assets; will

be able to spend more, thus propping up the Indian economy.

Our NRI movement will benefit tremendously if and when CAC becomes a reality. The

reason is on account of current restrictions imposed on movement of their funds. As the

remittances made by NRI’s are subject to numerous restrictions which will be eased

considerably once CAC is incorporated.

It also opens the gate for international savings to be invested in India. It is good for India

if foreigners invest in Indian assets; this makes more capital available for India’s

development, that is, it reduces the cost of capital. When steel imports are made easier,

steel becomes cheaper in India. Similarly, when inflows of capital into India are made

easier, capital becomes cheaper in India.

Controls on the capital account are rather easy to evade through unscrupulous means.

Huge amounts of capital are moving across the border anyway. It is better for India if

these transactions happen in white money. Convertibility would reduce the size of the

black economy, and improve law and order, tax compliance and corporate governance.

Most importantly convertibility induces competition against Indian finance. Currently,

finance is a monopoly in mobilizing the savings of Indian households for the investment

plans of Indian firms. No matter how inefficient Indian finance is, households and firms

do not have an alternative, thanks to capital controls. Exactly as we saw with trade

liberalization, which consequently led to lower prices and superior quality of goods

produced in India, capital account liberalization will improve the quality and drop the

price of financial intermediation in India. This will have repercussions for GDP growth,

since finance is the ‘brain’ of the economy.

Drawbacks of CAC for INDIA

During the good years of the economy, it might experience huge inflows of foreign

capital, but during the bad times there will be an enormous outflow of capital under “herd

behavior”. For example, the South East Asian countries received US$ 94 billion in 1996

and another US$ 70 billion in the first half of 1997. However, under the threat of the

crisis, US$ 102 billion flowed out from the region in the second half of 1997, thereby

accentuating the crisis. This has serious impact on the economy as a whole, and can even

lead to an economic crisis as in South-East Asia.

There arises the possibility of misallocation of capital inflows. Such capital inflows may

fund low-quality domestic investments, like investments in the stock markets or real

estates, and desist from investing in building up industries and factories, which leads to

more capacity creation and utilisation, and increased level of employment. This also

reduces the potential of the country to increase exports and thus creates external

imbalances.

An open capital account can lead to “the export of domestic savings” (the rich can

convert their savings into dollars or pounds in foreign banks or even assets in foreign

countries), which for capital scarce developing countries would curb domestic

investment. Moreover, under the threat of a crisis, the domestic savings too might leave

the country along with the foreign ‘investments’, thereby rendering the government

helpless to counter the threat.

Entry of foreign banks can create an unequal playing field, whereby foreign banks select

the most creditworthy borrowers and depositors. This aggravates the problem of the

farmers and the small-scale industrialists, who are not considered to be credit-worthy by

these banks. In order to remain competitive, the domestic banks too refuse to lend to

these sectors, or demand to raise interest rates to more “competitive” levels from the

‘subsidised’ rates usually followed.

International finance capital today is “highly volatile”, i.e. it shifts from country to

country in search of higher speculative returns. In this process, it has led to economic

crisis in numerous developing countries. Such finance capital is referred to as “hot

money” in today’s context. Full capital account convertibility exposes an economy to

extreme volatility on account of “hot money” flows.

It does not seem that the Indian economy has the competence of bearing the strains of

free capital mobility given its slowing growth rate and poor investor confidence. Most of

the pre-conditions stated by the Tarapore committee had been well complied in the period

of 2003-2007 rally. The forex reserves at $ 290 bn are a matter of concern for RBI as

well as the Government of India. FDI inflows have dried up & inflation is well above

comfort level. At this moment, India can’t take a risk of making Capital Account fully

convertible as it will result in higher outflows as against inflows of funds.

It must not be forgotten that CAC is a big step and integrates the economy with the global

economy completely thereby subjecting it to international fluctuations and business

cycles. Thus due caution must be incorporated while taking this decision in order to avoid

any situation that was faced by Argentina in the early 80’s or by the Asian economies in

1997-98.

If CAC is fully convertible then what will be the impact on India?

If excess Inflow:

Full capital account convertibility is like an exclusive badge to the developed economies

and not help developing country India is still a developing country. It can be too risky if

we allow full capital account convertibility. Risk involve in Exchange rate will be very

volatile so it will affect India Forex reserve.

Full convertibility may lead to massive inflows of foreign currency that may lead to

excessive liquidity problem in the economy and the result would be increase “Inflation”.

To suck the excess liquidity RBI will have to issue debt papers, bond, etc. along with

increasing repo and CRR rates. This will put heavy burden on the RBI, because it has to

pay interest rates for huge amounts and this may lead to more problems if inflows don't

stop (the value of the debt paper the RBI sells to the banks decreases as its market supply

increases).

Excessive capital inflow will lead to currency appreciation. This will have negative effect

on the country’s export, jobs and will affect balance of trade because Imports will exceed

exports.

Scenario can also exist where there would be increases in short term FIIs due to more

inflow of capital rather than long term FDIs, thus leading to volatility in the system.

If excess out flow:

Excessive outflow of capital will affect the economic growth and currency will be highly

depreciated.

The instability in the international markets (for ex: like the subprime crisis and fears of a

recession, oil crisis) then out flow of currency will be high and speculations will lead to

flight of capital at large scale.

At a time of uncertainty in International market outflow will be very high and lead to

Country required higher foreign exchange reserve to maintain stability in foreign

exchange.

Excess out flow of foreign exchange led to less GDP growth, high BOP crisis, high requirement

of foreign exchange reserve.

Asian Crisis of 1997 due to CAC

The Asian financial crisis was a period of financial crisis that gripped much of Asia beginning in

July 1997, and raised fears of a worldwide economic meltdown. The crisis started in Thailand

with the financial collapse of the Thai baht after the Thai government was forced to float the baht

(due to lack of foreign currency to support its fixed exchange rate), cutting its peg to the U.S.

dollar, after exhaustive efforts to support it in the face of a severe financial overextension that

was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that

made the country effectively bankrupt even before the collapse of its currency. As the crisis

spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and

other asset prices, and a precipitous rise in private debt.

Though there has been general agreement on the existence of a crisis and its consequences, what

is less clear are the causes of the crisis, as well as its scope and resolution. Indonesia, South

Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos

and the Philippines were also hurt by the slump. The People's Republic of China, Taiwan,

Singapore, Brunei and Vietnam were less affected, although all suffered from a loss of demand

and confidence throughout the region.

Foreign debt-to-GDP ratios rose from 100% to 167% in the four large Association of Southeast

Asian Nations (ASEAN) economies in 1993–96, and then shot up beyond 180% during the worst

of the crisis. In South Korea, the ratios rose from 13 to 21% and then as high as 40%, while the

other northern newly industrialized countries fared much better. Only in Thailand and South

Korea did debt service-to-exports ratios rise.

Although most of the governments of Asia had seemingly sound fiscal policies, the International

Monetary Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currencies of

South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis. The efforts

to stem a global economic crisis did little to stabilize the domestic situation in Indonesia, after 30

years in power, President Suharto was forced to step down on 21 May 1998 in the wake of

widespread rioting that followed sharp price increases caused by a drastic devaluation of the

rupiah (Devaluation by 70%).

Indonesia & Crisis

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 the preceding years, as the rupiah had strengthened respective

to the dollar, this practice had worked well for these corporations; their effective levels of debt

and financing costs had decreased as the local currency's value rose.

In July 1997, when Thailand floated the baht, Indonesia's monetary authorities widened the

rupiah currency trading band from 8% to 12%. The rupiah suddenly 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 the Jakarta Stock

Exchange touched a 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 1997, it intensified in November when the

effects of that summer devaluation showed up on corporate balance sheets and trade was affected

by massive fire in forests of Indonesia. 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

through selling rupiah, undermining the value of the latter further. In February 1998, President

Suharto sacked Bank Indonesia Governor J. Soedradjad Djiwandono, but this proved

insufficient. Suharto resigned under public pressure in May 1998 and Vice President B. J.

Habibie was elevated in his place. Before the crisis, the exchange rate between the rupiah and the

dollar was roughly 2,600 rupiah to 1 USD.

The rate plunged to over 11,000 rupiah to 1 USD on 9 January 1998, with spot rates over 14,000

during January 23–26 and trading again over 14,000 for about six weeks during June–July 1998.

On 31 December 1998, the rate was almost exactly 8,000 to 1 USD. Indonesia lost 13.5% of its

GDP that year.

Impact of 1991-1997 Crisis

India survived near-crisis situations twice in the 1990s. The internal and external constraints

shape the country’s ability to respond to the crises. India’s success can be attributed to four sets

of decisions taken during the period 1991–1997: Devaluation, Involvement of the IMF, Partial

liberalization of the Domestic financial sector, and Gradual opening up of the external sector.

It analyzed the options, political opposition, and eventual outcomes for each set of decisions.

India’s ownership of its reform program helped set the pace of reform, while close interaction

between technocrats and the IMF added credibility. But the balance between entrenched

traditional interest groups and the demands of new interests determined the scope of reform

Notwithstanding the weakening fundamentals, one key factor that reduced vulnerability was the

absence of private sector external debt. Unlike many other countries, individuals and firms could

not raise foreign currency–denominated debt, and the banking sector was not allowed to hold

financial assets abroad. One effect of this was that the private sector’s interests were geared more

toward internal deregulation than toward external liberalization.

In reaction, and in parallel to these developments, the economic situation worsened. By

September 1990, net inflows of Non-Resident Indiandeposits had turned negative. Access to

commercial borrowing had becomemore costly, and by December even short-term credit was

restricted. Foreign exchange reserves fell to $1.2 billion in January 1991. By the time anew

government took over in June, reserves could cover only two weeks ofimports. India was close

to defaulting on its sovereign debt for the first timein its history

In 1997–1998 the Asian financial crisis again threatened India. Macroeconomic fundamentals

were vastly different, but political instability and external shocks were common in both episodes.

In 1997, India was much less vulnerable, both relative to 1991 and to most East Asian

economies. The fiscal deficit, although still high, had declinedsince the early 1990s. The current

account deficit had fallen to 1.25 percentof GDP in 1996–1997. External debt as a proportion of

GDP (24.7 in 1996-1997) was a fraction of that of Indonesia (61.3) or Thailand (62). The debt

Service ratio had fallen fourteen percentage points since 1990 to 21.2 percent in 1996–1997.

The better fundamentals influenced expectations of crisis. In 1996, theIMF calculated that East

Asian countries had balance-of-payments (BOP)crisis probabilities ranging from 25 percent for

the Philippines to 65 percent for Thailand. India’s probability was just 11 percent. But as in

1990–1991, India was again experiencing political instability. A minority coalition government

twice lost parliamentary support of theCongress Party during 1996–1998. In May 1998, the two-

month-old BJP-ledgovernment engineered nuclear tests, inviting widespread sanctions. Fresh

commitments from the World Bank, Asian Development Bank, and bilateraldonors ceased.

The pressures of 1991 and 1997 were managed against a backdrop ofinternational and domestic

constraints faced by policymakers. Many in India viewed foreign investment and international

financial institutions with greatsuspicion. A highly regulated economy was considered necessary

to keepcontrol over limited economic resources.

These constraints variously shaped the scope and speed of policy changes, as can be seen by

examining four key decisions: devaluation in 1991; the IMF program of 1991–1993; partial

internal financial liberalization from 1994 onward; and thegradualist change in the exchange rate

and external sector.

Introduction of FEMA

The Foreign Exchange Management Act (1999) or in short FEMA has been introduced as a

replacement 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-

liberalization policies. A significant change that the FEMA brought with it, was that it made all

offenses regarding foreign exchange 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. The act is also applicable to all branches, offices and

agencies outside India owned or controlled by a person who is a resident of India.

The FEMA head-office, also known as Enforcement Directorate is situated in New Delhi and is

headed by a Director. The Directorate is further divided into 5 zonal offices in Delhi, Mumbai,

Kolkata, Chennai and Jalandhar and each office is headed by a Deputy Director. Each zone is

further divided into 7 sub-zonal offices headed by the Assistant Directors and 5 field units

headed by Chief Enforcement Officers.

Need to introduce FEMA

Foreign Exchange Management Act (FEMA), which was to replace the Foreign Exchange

Regulation Act, 1973 (FERA) was ultimately passed by Parliament in 1999, and it has been

notified that FEMA has come into force from 1st June 2000.

FERA 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) expeditiously. It regulated not only transactions in forex, but also all

financial transactions with non-residents. FERA primarily prohibited all transactions, except to

the extent permitted by general or specific permission by RBI.

Violation of FERA was a criminal offence. The case of the eminent industrialist, S.L.Kirloskar,

beingproceeded against under FERA for having the princely amount of $82in hispossession is

well known. If a person had ever visited a relative abroad, or had non-resident relatives

visiting them, the chances are high that they had also violated FERA. In such cases, it is highly

likelythat the relatives may have given him or his visiting family members some small gift in

forex,which they spent on buying some small article which they wanted to bring back. Or they

may havespent some money on hospitality towards their non-resident relatives visiting them.

Strictly,speaking, till the 1990's, these were FERA violations. FERA had become more of a tool

inthe hands of politicians for punishing people who refused to toe their line.

Fortunately, with the winds of liberalization blowing in the early 1990's, the Government relaxed

many of the rigors 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 a crime, but was an economic offence, for

which the more appropriate punishment was a penaly. Thus, the need of FEMA was felt. The

primary difference between FERA and FEMA therefore lies in the fact that offences under

FEMA are not regarded as criminal offences and only invite penalties, not prosecution and

imprisonment.

FEMA now codifies in the legislation and rules itself various transactions, which had been

permitted by notification under FERA. Under FEMA, all current account transactions in forex

(such as expenses, which are not for capital purposes) are permitted, except to the extent that the

Central Government notifies. However, so far as capital account transactions are concerned, all

capital account transactions in forex are prohibited, except to the extent as may be notified by

RBI.

Certain prohibitions are laid down in the Foreign Exchange Management (Current Account

Transactions) Rules, 2000. You cannot remit money for purchaseof lottery tickets, for

subscription to banned/prescribed magazines, to football pools, sweepstakes,for payment for

telephone callback services, etc. Under the rules, certain remittances can bemade only with prior

approval of RBI. Many of these require permission only if the spending exceeds a particular

limit. In effect, this means that you can spend amounts less than that without any approval being

required.

Some of these remittances, not requiring approval, are :

Up to US $ 5,000 in every calendar year for foreign travel (increased from the limit of US

$ 3,000 under FERA).

Up to US $ 25,000 per trip for a business trip or for attending a conference abroad,

irrespective of the length of the trip (under FERA, you had limits per day plus an

entertainment allowance).

For gifts up to US $ 5,000 per beneficiary per annum (under FERA, the limit was US $

1,000 and restricted only to defined relatives).

For donations up to US $ 5,000 per beneficiary.

For maintenance of close relatives abroad up to US $ 5,000 per recipient.

For foreign studies up to US $ 30,000, or the estimate from the foreign institution,

whichever is higher.

For meeting expenses for medical treatment abroad, up to the estimate from doctor in

India or hospital or doctor abroad.

Important definitions under FEMA

1. Capital Account Transaction –

"Capital account transaction" means a transaction which alters the assets or liabilities, including

contingent liabilities, outside India of persons resident in India or assets or liabilities in India of

person resident outside India, and includes transactions referred to in sub-section (3) of section 6.

2. Current Account Transaction –

"Current account transaction" means a transaction other than a capital account transaction and

without prejudice to the generality of the foregoing such transaction includes,-

Payments due in connection with foreign trade, other current business, services, and

short-term banking and credit facilities in the ordinary course of business.

Payments due as interest on loans and as net income from investments.

Remittances for living expenses of parents, spouse and children residing abroad, and

Expenses in connection with foreign travel, education and medical care of parents, spouse

and children;

3. Foreign portfolio investment -

It is investment into financial instruments such as stocks and bonds in which the objective is not

to engage in business but to merely generate dividend income and capital gains. The larger

portion of international investment flows in the world today is FPIs.

4. Forward contract - An arrangement between two parties to trade specified amounts of two

Currencies at some designated future due date at an agreed price. More than a formal hedge

against unforeseen changes in currency prices, it guarantees certainty in the foreign exchange

rate at the contract's delivery date.

5. Forward swap - The most common type of forward transaction, forward swaps comprise

60 per cent of all foreign exchange transactions. In a swap transaction, two companies

immediately exchange currency for an agreed-upon length of time at an agreed exchange

rate. At the end of the time period, each company returns the currency to the former

owner at the original exchange rate with an adjustment for interest rate differences.

A Step ahead from FERA to FEMA

Enactment of FEMA has brought in many changes in the dealings of Foreign Exchange, as

compared to FERA. Some of them are restrictive, and some has widened the scope.

However some of the relevant progresses made, from FERA to FEMA, are as follows:

1. Withdrawal of Foreign Exchange

Now, the restrictions on withdrawal of Foreign Exchange for the purpose of current Account

Transactions, has been removed. However, the Central Government may, in public interest in

consultation with the Reserve Bank impose such reasonable restrictions for current account

transactions as may be prescribed.

FEMA has also by and large removed the restrictions on transactions in foreign Exchange on

account of trade in goods, services except for retaining certain enabling provisions for the

Central Government to impose reasonable restriction in public interest.

2. Omission of Criminal Proceedings

Under FERA, any contravention was a criminal offence and the proceedings were governed by

the code of Criminal Procedure. Moreover the Enforcement Directorate had powers to arrest any

person, search any premises, seize documents, initiate proceeding.

Now all these have been done away with, and contravention of FEMA is no more a Criminal

offence, and only monetary penalty, i.e. civil proceedings are applicable. Civil imprisonment is

provided, only in case of default to pay fine

3. Residential Status

The definition of "Residential Status" under FEMA has gone through considerable change. It has

now been made compatible with the definition provided under "Income Tax" Act.

The residential status is now based on the physical stay of the person in the country. The period

of 182 days as provided, indicates that it is not necessary that there should be a continuous period

of stay. The period of stay would be calculated by adding up all the days of stay of the individual

in the country.

An Indian resident becomes a non-resident when he goes abroad and takes up a job or engages in

business. A major change in the definition of residential status of partnerships and firms in worth

noticing. Earlier, under FERA, a branch was considered a resident of a place where it was

situated. Now, under FEMA, an office, branch or agency outside India owned or controlled by a

person resident in India will be considered a resident in India for the purposes of this Act.

For example, a person residing in India has a branch in Mauritius; such branch will be

considered a resident in India.

4. Immovable Property outside India

Earlier, under FERA, there was no restriction placed on foreign citizens who were residents of

India, for acquiring immovable property outside India.

Now FEMA prohibits a resident to acquire, own process, hold or transfer any immovable

property situated outside India. This restriction applies irrespective of whether the resident is an

Indian citizen or foreign citizen. With this provision being effective a foreign citizen who is a

resident in India has to take approval of Reserve Bank of India for selling or buying any

immovable property situated outside India

5. Immovable Property In India

Earlier, under FERA, a foreign citizen could acquire or transfer immovable property in India

only after seeking permission from the Reserve Bank.

Now, under FEMA, the control of Reserve Bank is determined by the residential status of a

person. Only a non-resident as defined within the meaning of FEMA would require permission

of the Reserve Bank to acquire or transfer an immovable property in India. The distinction based

on citizenship has been abolished and that based on resident ship has been introduced

6. Export of Services

FERA had no provision for export of services. Now, FEMA has included payment received by

an Exporter of Services in its ambit.

Every Exporter, who receives payment from outside India, for his services rendered is obliged to

furnish details of payment to the 'Reserve Bank.

For example; a Doctor, or Engineer or Lawyer or Accountant or any other professional may give

opinions or consultation to people outside India, via internet or mail, and his fees may be

credited to his credit account. Then he is obliged to furnish details of such payment to Reserve

Bank.

7. Inclusion of New Terms

Some new terms like "Capital Account Transactions, Current Account Transactions"; have been

included in FEMA. Reserve Bank has been confirmed with powers and with consultation with

central government to specify maximum permissible limit upto which exchange is admissible for

such transactions.

Difference between FERA & FEMA

Sr.

NoDIFFERENCES FERA FEMA

1PROVISIONS FERA consisted of 81 sections, and

was more complex

FEMA is much simple, and

consist of only 49 sections.

2

FEATURES Presumption of negative intention

(MensRea ) and joining hands in

offence (abatement) existed in

FEMA

 

These presumptions of Mens

Rea and abatement have been

excluded in FEMA

3

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

 

4

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 )

5 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.

6

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 under

FERA, 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 "

The appellate authority under

FEMA is the special Director

Foreign Exchange Regulation

Appellate Board went before High

Court

( 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)

9

RIGHT OF

ASSISTANCE

DURING

LEGAL

PROCEEDINGS.

FERA did not contain any express

provision on the right of on

impleaded person to take legal

assistance

FEMA expressly recognizes the

right of appellant to take

assistance of legal practitioner or

chartered accountant (32)

10

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

Recent Amendment to FEMA:

Opening of Foreign Currency Accounts Outside India:

Earlier, Indian Companies which needed to open foreign currency accounts outside India

neededto take the approval of the RBI. This was a cumbersome and time consuming process.

This has now been liberalized by the Foreign Exchange Management (Foreign Currency

Accounts by a Person Resident in India) (Second Amendment) Regulations, 2001issued by the

RBI on December 5th 2001.

Under these regulations, an Indian Entity can now open a Bank Account outside India without

any prior approval from the RBI / Authorize Dealer, subject to the following limits on

remittances :

Source of

Remittance

Amount which can

be remitted for

initial expenses

Amount which can

be remitted for

recurring expenses

A 100% EOU or a

unit in EPZ or in a

Hardware

Technology Park or

in a Software

Technology Park,

within two years of

establishment of the

Unit

From out of its

Current A/c or out of

its EEFC(exchange

earner foreign

currency account)

A/c

No Limit No Limit

Other Companies From out of its

Current A/c

2 per cent of the

average annual

sales/income or

turnover during last

two accounting years

of the Indian Entity.

1 per cent of the

average annual

sales/income or

turnover during last

two accounting years

of the Indian Entity.

From out of its EEFC

A/c

No Limit No Limit

Two way Fungibility for ADR / GDRs

Two Way fungibility of ADR / GDR issued by Indian Companies was permitted by the

Government of India & the RBI. The RBI has now, vide APDIR Circular No: 21 dated February

13th 2002, issued operative guidelines for the 2 way fungibility of ADR / GDR.

Earlier, once a company issues ADR / GDR, and if the holder wanted to obtain the

underlyingequity shares of the Indian Company, then, such ADR / GDR would be converted into

shares ofthe Indian Company. Once such conversion has taken place, it was not possible to

reconvert theequity shares into ADR / GDR.

The present rules of the RBI make such reconversion possible, to the extent of ADR / GDR

which have been converted into equity shares and sold in the local market. This would take place

in the following manner:

Stock Brokers in India have been authorized to purchase shares of Indian Companies for

reconversion.

The Domestic Custodian would coordinate with the Overseas Depository and the Indian

Company to verify the quantum of reconversion which is possible and also to ensure that the

sectoral cap is not breached.

The Domestic Custodian would then inform the Overseas Depository to issue ADR / GDR to the

Overseas Investor.

Investment outside India by Indian Companies:

Pursuant to the Union Budget, outbound investment by Indian Companies has been further

liberalized. The highlights of these changes are: Indian Companies are now permitted to invest

up to 100 Million US Dollars per financial year under the automatic route, provided the other

conditions as specified in FEMA Notification No: 19/2000 dated 3rd May 2000 are complied

with. Earlier the limit for investment under the Automatic Route was 50 Million US Dollars per

financial year.

Companies which do not have access to foreign exchange for overseas investments are permitted

to purchase foreign exchange from the Authorized Dealers up to 50% of their net worth. Earlier,

the limit was 25% of their net worth

PERSON OF INDIAN ORIGIN (PIO) UNDER FEMA

FEMA,1999 has not given definition of Person of Indian Origin. However, Reserve Bank of

India in its various FEMA Notifications issued under FEMA, 1999 has defined a  Person of

Indian Origin as under:

I. For the purpose of  opening non-resident bank accounts in India PIO means a citizen of any

country other  than that of Bangladesh or Pakistan if

He at any time held Indian passport

He or either of his parents or any of his grandparents was a citizen of India by virtue of the

Constitution of India of the Citizenship Act, 1955 or

The person is a spouse of an Indian citizen or a person referred to in sub-clause a) or b) above

For the purpose of Investing in shares/debentures etc in India person of Indian origin means a

citizen of  any country other than that of Bangladesh or Pakistan if

He at any time held Indian passport; or

He or either of his parents or any of his grandparents was a citizen of India by virtue of

the  Constitution of India of the Citizenship Act, 1955

The person is a spouse of an Indian citizen or a person referred to in sub-clause a) or b)

II. For the purpose of acquiring immovable property in India person of Indian Origin means a

citizen of any country other than that of Bangladesh or Pakistan or Sri Lanka or Afghanistan or

China or Iran or Nepal  and Bhutan if

He at any time held Indian passport; or

He or either of his parents or any of his grandparents was a citizen of India by virtue of the

Constitution of India of the Citizenship Act 1955 or

III. For the purpose of establishing Branch  of Office in India  PIO means a citizen of any

country other than that of Bangladesh or Pakistan or Sri Lanka or Afghanistan or China Or Iran

if

He at any time held Indian passport; or

He or either of his parents or any of his grandparents was a citizen of India by virtue of the

Constitution of India of the Citizenship Act 1955 or

The person is a spouse of an Indian citizen or a person referred to in sub-clause a) or b) above.

1. For the purpose of acquiring PIO Card PIO means a citizen of any country other than that

of Bangladesh or Pakistan, if

1. He at any time held an Indian Pass port; or

1. He/she or either of his /her parents or grandparents or great grandparents was born

in India and permanently resident in India as defined in the Government of India

Act, 1935 and other territories that became part of  India thereafter provided

neither was at any time a citizen of any country as may be specified by Central

Government  from time to time

2. Who is spouse of a citizen of India or a Person of Indian Origin as mentioned

above

FEMA guidelines provide Indian companies to access funds from abroad by following

methods:-

• External Commercial Borrowings (ECB):- It refers to commercial loans in the form of bank

loans, buyers’ credit, suppliers’ credit, securitized instruments (e.g. floating rate notes and fixed

rate bonds, non-convertible, optionally convertible or partially convertible preference shares)

availed of from non-resident lenders with a minimum average maturity of 3 years.

• Foreign Currency Convertible Bonds (FCCBs):- It refers to a bond issued by an Indian

company expressed in foreign currency, and the principal and interest in respect of which is

payable in foreign currency.

• Preference shares - (i.e. non-convertible, optionally convertible or partially convertible). These

instruments are considered as debt and denominated in Rupees and rupee interest rate will be

based on the swap equivalent of LIBOR plus spread.

• Foreign Currency Exchangeable Bond (FCEB):- FCEB is a bond expressed in foreign currency,

the principal and interest in respect of which is payable in foreign currency, issued by an Issuing

Company and subscribed to by a person who is a resident outside India, in foreign currency and

exchangeable into equity share of another company, to be called the Offered Company, in any

manner, either wholly, or partly or on the basis of any equity related warrants attached to debt

instruments. The FCEB may be denominated in any freely convertible foreign currency.

ECB

External Commercial Borrowings (ECB) refer to commercial loans [in the form of bank loans,

buyers’ credit, suppliers’ credit, securitized instruments (e.g. floating rate notes and fixed rate

bonds)] availed from non-resident lenders with minimum average maturity of 3 years. By simple,

foreign currency borrowings raised by the Indian companies from sources outside India are

called ECB and ECBs act as an additional source of funds for companies to finance its

Investment needs.

Benefits of ECB

The ECBs route provides an Indian company with the foreign currency funds that may not be

available in India; the cost of funds at times works out to be cheaper as compared to the cost of

rupee funds and the availability of the funds from the International market is huge compared to

the domestic market. Moreover corporate can raise a large amount of funds depending on the risk

perception of the International market.

Corporates (registered under the Companies Act except financial intermediaries (such as banks,

financial institutions (FIs), housing finance companies and NBFCs) are eligible to raise ECB

under the automatic route. However Individuals, Trusts and Non-Profit making Organizations

are not eligible to raise ECB.

The external debt to GDP ratio which is an indicator of an economies debt servicing capability,

showed a steady improvement, dropping to 17.4 per cent in March 2005 as compared to 38.7

percent in end-March, 1992.It is noteworthy to mention that debt owed to the International

Monetary Fund (IMF) was fully extinguished by 2000-01.ECBs can be used as a borrowing

means for any purpose (rupee-related expenditure as well as imports)except for investment in

stock market and speculation in real estate.

External Commercial Borrowing can be raised only for investments such as import of capital

goods (as classified by DGFT in the Foreign Trade Policy), new projects,

modernization/expansion of existing production units in the industrial sector including small and

medium enterprises and infrastructure sector - in India. Infrastructure sector is defined as power,

telecommunication, railways, road including bridges, seaport and airport industrial parks and

urban infrastructure (water supply, sanitation and sewage projects). ECB proceeds can also be

utilized for overseas direct investment in Joint Ventures /Wholly Owned overseas subsidiaries

subject to the existing guidelines on Indian Direct Investment. Utilization of ECB proceeds is

permitted in the first stage acquisition of shares in the disinvestments process

ECB can be accessed under two routes, viz.:-

A) Automatic Route:-

Access of funds under Automatic Route does not require RBI/GOI approval. Corporate including

hotel, hospital, software sectors (registered under the Companies Act 1956) and Infrastructure

Finance Companies (IFCs) except financial intermediaries such as banks, FIs, HFCs, and NBFCs

are eligible to raise ECB. Units in SEZs are allowed to raise ECB for their captive requirements.

NGOs engaged in micro finance activities are eligible to avail of ECB (subject to certain

conditions). Trusts and Non-Profit making organizations are not eligible to raise ECB.

ECB can be raised by borrowers from internationally recognized sources such as

Overseas organizations and individuals may provide ECB to NGOs engaged in micro finance

activities subject to complying with some safeguards outlined in the RBI circular

Amount and Maturity

The maximum amount of ECB which can be raised by a corporate is USD 500 million or

equivalent during a financial year.

ECB up to USD 20 million or equivalent in a financial year with minimum average

maturity of three years.

ECB above USD 20 million and up to USD 500 million or equivalent with a minimum

average maturity average maturity of five years.

ECB up to USD 20 million can have call / put option provided the minimum average

maturity of three years is complied with before exercising call / put option.

International banks International capital markets

Multilateral financial institutions (IFC,ADB,CDC) Suppliers of Equipment

Foreign Collaborators Foreign Equity Holders

All-in-cost ceilings

All-in-cost includes rate of interest, other fees and expenses in foreign currency except

commitment fee, pre-payment fee, and fees payable in Indian Rupees. Moreover, the

payment of withholding tax in Indian Rupees is excluded for calculating the all-in-cost.

The all-in-cost ceilings for ECB are reviewed from time to time. The following ceilings

are valid till reviewed:

Average Maturity Period All-in-cost Ceilings over 6 month LIBOR*

Three years and up to five years 200 basis points

More than five years 350 basis points

* For the respective currency of borrowing or applicable benchmark

B. APPROVAL ROUTE

Proposals falling under the category include:-

a) On lending by the EXIM Bank for specific purposes (case to case basis).

b) Banks and financial institutions which had participated in the textile or steel sector

restructuring package as approved by the Government.

c) ECB with minimum average maturity of 5 years by NBFC to finance import of

infrastructure equipment for leasing to infrastructure projects.

d) Infrastructure Finance Companies (IFCs) i.e. NBFCs, categorized as IFCs, by RBI

(beyond 50% of their owned funds) for on-lending to the infrastructure sector as defined

under the ECB policy and subject to compliance of certain stipulations.

e) Foreign Currency Convertible Bonds (FCCBs) by Housing Finance Companies.

f) Special Purpose Vehicles (SPV) or any other entity notified by the RBI, set up to finance

infrastructure companies / projects exclusively.

g) Financially solvent Multi-State Co-operative Societies engaged in manufacturing.

h) SEZ developers for providing infrastructure facilities within SEZ.

i) Eligible Corporate under automatic route other than in the services sector viz. hotels,

hospitals and software sector can avail of ECB beyond USD 750 million per financial

year.

j) Corporate in the service sector for availing ECB beyond USD 200 Mn. Per financial year.

k) Cases falling outside the purview of the automatic route limits and maturity indicated,

etc.

Amount and Maturity

1. Corporates can avail of ECB of an additional amount of USD 250 million with average

maturity of more than 10 years under the approval route, over and above the existing

limit of USD 500 million under the automatic route, during a financial year. Other ECB

criteria such as end-use, all-in-cost ceiling, recognized lender, etc., need to be complied

with. Prepayment and call / put options, however, would not be permissible for such ECB

up to a period of 10 years.

2. Corporates in infrastructure sector {as defined in paragraph 1(A) (v) (a)} can avail ECB

up to USD 100 million and Corporates in industrial sector can avail ECB up to USD 50

million for Rupee capital expenditure for permissible end- users within the overall limit

of USD 500 million per borrower, per financial year, under Automatic Route.

3. NGOs engaged in micro finance activities can raise ECB up to USD 5 million during a

financial year. Designated AD bank has to ensure that at the time of drawdown the forex

exposure of the borrower is hedged.

4. Corporates in the services sector viz. hotels, hospitals and software companies can avail

ECB up to USD 100 million, per borrower, per financial year, for import of capital

goods.

All-in-cost ceilings

All-in-cost includes rate of interest, other fees and expenses in foreign currency except

commitment fee, pre-payment fee, and fee payable in Indian Rupees. Moreover, the payment of

withholding tax in Indian Rupees is excluded for calculating the all-in-cost.

The current all-in-cost ceilings are as under: The following ceilings are valid till reviewed:

Average Maturity Period All-in-cost Ceilings over 6 month LIBOR*

Three years and up to five years 200 basis points

More than five years 350 basis points

* For the respective currency of borrowing or applicable benchmark

COMPLIANCE WITH ECB GUIDELINES

The primary responsibility to ensure that ECB raised / utilized are in conformity with the ECB

guidelines and the Reserve Bank regulations / directions is that of the concerned borrower and

any contravention of the ECB guidelines will be viewed seriously and will invite penal action

under FEMA 1999 ( cf. A.P. (DIR Series) Circular No.31 dates February 1, 2005). The

designated AD bank is also required to ensure that raising / utilization of ECB is in compliance

with ECB guidelines at the time of certification.

External Commercial Borrowing of last 5 years

Automatic Route:

2007 2008 2009 2010 20110

5,000,000,000

10,000,000,000

15,000,000,000

20,000,000,000

25,000,000,000

30,000,000,000

2,258

1,2861,064

1,524

2,622Automatic Route

Approval Route:

2007 2008 2009 2010 20110

2,000,000,000

4,000,000,000

6,000,000,000

8,000,000,000

10,000,000,000

12,000,000,000

14,000,000,000 1,279

981

532

858

1,038Approval Route

Above graph we can see that India external commercial borrowings(ECB) through Automatic

Route in 2007 is 2250 crore, 2008 is reduce to 1200 crore again reduce in 2009 is only 1000

crorer. The reason of decrease of ECB is in 2008 US crisis and in 2009 Euro crisis and interest

rate are also not vary favorable. In 2012 is 2600 crore which is higest in last 5 year. Because

market candition is improving and Interest rate also very feverable for Indian companies.

Reliance industries ltd and Tata steel who has borrower $500 million borrower in 2008. sterlite

industies has borrow $500million in 2009. Indian Oil corporation borrow $500 in 2010. Adani

power has borrow $475 million in 2008.

Latest Amendments in the ECB guidelines

External Commercial Borrowings (ECB) – Rationalization and Liberalization September 23,

2011 A.P. (DIR Series) Circular No.27

Enhancement of ECB limit under the automatic route

(a) Eligible borrowers in real sector-industrial sector-infrastructure sector can avail of ECB up to

USD 750 million or equivalent per financial year under the automatic route as against the present

limit of USD 500 million or equivalent per financial year.

(b) Corporates in specified service sectors viz. hotel, hospital and software, can avail of ECB up

to USD 200 million or equivalent during a financial year as against the present limit of USD 100

million or equivalent per financial year subject to the condition that the proceeds of the ECBs

should not be used for acquisition of land.

Issue of Foreign Currency Convertible Bonds by Indian Companies.

Earlier, Indian Companies required approval of the Government of India before issue of

Foreign Currency Convertible Bonds (FCCBs). The RBI has vide FEMA Notification

No: 55 dated March 7th2002, liberalized these rules. Accordingly: Indian Companies

seeking to raise FCCBs are permitted to raise them under the Automatic Route up to US

50 Million Dollars per financial year without any approval.

The FCCBs raised shall be subject to the sectoral limits prescribed by the Government of

India. Maturity period for the FCCBs shall be at least 5 years and the "all in cost" at least

100 basis points less than that prescribed for External Commercial Borrowings.

Foreign Currency Exchangeable Bonds (FCCB)

The Issuing Company shall be part of the promoter group of the Offered Company and

shall hold the equity share/s being offered at the time of issuance of FCEB. The Offered

Company shall be a listed company, which is engaged in a sector eligible to receive FDI

and eligible to issue or avail of FCCB or ECB.

Entities complying with the FDI policy and adhering to the sectors caps at the time of

issue of FCEB can subscribe to FCEB. Prior approval of the Foreign Investment

Promotion Board, wherever required is to be obtained.

An Indian company, which is not eligible to raise funds from the Indian securities market,

including a company which has been restrained from accessing the securities market by

the SEBI are not be eligible to issue FCEB. Entities prohibited to buy, sell or deal in

securities by the SEBI will not be eligible to subscribe to FCEB.

FOREIGN DIRECT INVESTMENT

Foreign Direct Investment (FDI), a source of investment from investors other than the host

country, is considered as a major contributor in accelerating the economic growth of a country.

Recognizing the potential of FDI, the Indian Government over years has taken various steps on

policy and implementation front to encourage greater inflow of FDI under automatic route and

has shifted its stringent regime to liberal one.

Enduring efforts are being made to open up Indian economy to international participation and

attracting international investments by raising sectoral caps and relaxing conditions attached to

the same. Department of Industrial Policy & Promotion (DIPP), Foreign Investment Promotion

Board (FIPB), Secretarial of Industrial Assistance (SIA) and Reserve Bank of India (RBI) are the

nodal agencies which monitor the regulatory and administrative aspects of FDI in India.  This

article aims at enlightening the recent developments in context of liberalization of the prevailing

FDI norms in India.

Recent Sector Specific developments are discussed as follows.

SINGLE BRAND RETAILING

 DIPP on January 10, 2012 enhanced the limit of FDI in Single Brand Retail Trading from 51%

to 100% 2, subject to terms and conditions stated below. 100% FDI in Single Brand Retail

Trading aims at (a) attracting investments in production and marketing; (b) improving the

availability of such goods for the consumer; (c) encouraging increased sourcing of goods from

India; and (d) enhancing competitiveness of Indian enterprises through access to global designs,

technologies and management practices.

 ♦    Terms And Conditions

The conditions for 51% ‘Single Brand’ product retail trading, which continues to apply in the

revised policy allowing 100% FDI in this sector are: 

1. Products to be sold should be of ‘Single Brand’ only;

2. Products should be sold under the same brand internationally;

3. Products should be branded during manufacturing;

4. Foreign Investor should be the owner of the brand.

In addition to the aforesaid conditions, the revised policy prescribes that in respect of proposals

involving FDI beyond 51%, there should be mandatory sourcing of at least 30% of the value of

the products sold from Indian small Industries/village and cottage Industries, artisans and

craftsmen. Small Industries has been defined as Industries which have a total investment in plant

and machinery not exceeding USD 1 Million. The aforesaid valuation is the value ascertained at

the time of installation of plant and machinery, not including depreciation. If at any time, the

valuation of plant and machinery exceeds the aforesaid sum of USD 1 Million, the given industry

would not qualify as ‘Small Industry’. The aforesaid compliance would be ensured by the FDI

company through self-certification, to be subsequently checked by the statutory auditors of the

FDI company from its audited accounts.

 

♦    Procedure

 

An application has to be filed with SIA seeking permission of the Indian Government for 100%

investment in Single Brand product retail trading. The application should specifically indicate

the product/product categories which are proposed to be sold under a ‘Single Brand’. Any

addition to the product/product categories to be sold under ’Single Brand’ would require a fresh

approval of the Indian Government. All the applications filed would be processed in DIPP, to

determine whether the products proposed to be sold satisfy the notified guidelines, before being

considered by FIPB for Government approval.

 

PHARMA SECTOR

 In the year 2001, Indian Government allowed 100% FDI in Pharmaceutical sector that such a

move will bring in new investments, which will help in expanding the sector. Conversely, the

foreign companies took over the existing businesses from the local players and increased their

market share significantly rather than making new investments in the pharmaceutical sector.

Considering these aspects, Indian Government decided to tighten FDI norms in this sector on

November 08, 2011 by doing away with the automatic approval of FDI 3 in the existing

Pharmaceutical companies. The revised policy in the Pharmaceutical sector stands as under:

 

Greenfield Investments – Greenfield Investments herein refers to FDI made for augmenting the

new projects. Under the revised policy, no changes have been made with respect to the

Greenfield Investments. FDI, up to 100 percent, under the automatic route, under which the

investors would only have to inform the RBI about the inflows and no specific government nod

is required, would continue to be permitted for Greenfield Investments.  

 

Brownfield Investments – Brownfield Investments herein refers to FDI made for extension or

expansion of existing facilities. Under the revised policy, FDI, up to 100 percent, have been

permitted for brown field investments under the government approval route. In cases of

Brownfield Investments, FDI would be allowed through FIPB approval path for a period of up to

six months. In this period, the Indian Government will put in place the essential enabling

mechanism for oversight by the Competition Commission of India (CCI). After six months, the

oversight will be done by CCI in accordance with the Indian competition laws. Also, for any

merger or acquisition, the overseas investor will have to seek permission from FIPB.

 

Revision in the FDI policy in Pharmaceutical sector is only a procedural filter and not a roll-

back. This move of the Indian Government is to encourage more and more Greenfield

Investments in the India in Pharmaceutical sector instead of Brownfield Investments which may

have adverse effect on the availability of inexpensive healthcare. The impact of the revised

policy would lengthen the timeline for FDI in the existing companies in the Pharmaceutical

sector.

 

LIMITED LIABILITY PARTNERSHIP FIRMS

 

FDI in limited liability partnership (LLP) firms was allowed by the Indian Government on May

20, 2011 4. The foreign investors would need to fulfill the following requirements before

investing in LLPs in India:

1. FDI in LLPs would be allowed, through the Government approval route, in those

sectors/activities where 100% FDI is allowed, through the automatic route and there are

no FDI-linked performance related conditions.

2. LLPs with FDI would not be allowed to operate in agricultural/plantation activity, print

media or real estate business.

3. LLPs with FDI will not be eligible to make any downstream investments.

4. An Indian company, having FDI, would be permitted to make downstream investment in

LLPs only if both the company and LLP are operating in sectors where 100% FDI is

allowed, through the automatic route and there are no FDI-linked performance related

conditions.

5.  Foreign capital participation in the capital structure of the LLPs will be allowed only by

way of cash considerations, received by inward remittance, through normal banking

channels, or by debit to Non Residential External Accounts(NRE)/Foreign Currency Non

Resident(FCNR) account of the person concerned, maintained with an authorized

dealer/authorized bank; and

6. Foreign Institutional Investors (Flls) and Foreign Venture Capital Investors (FVCIs) will

not be permitted to invest in LLPs. LLPs will also not be permitted to avail External

Commercial Borrowings (ECBs).

7. For the purpose of determination of the designated partners in respect of LLPs with FDI,

the term "resident in India" would have the meaning, as defined for "person resident in

India", under Section 2(v) (i) (A) & (B) of the Foreign Exchange Management Act, 1999.

8. In case LLP has a body corporate as a designated partner, the body corporate should only

be a company registered under the Companies Act, 1956 and not any other body, such as

an LLP or a trust.

9. The designated partners will be responsible for compliance with the above conditions and

liable for all penalties imposed on the LLP for their contravention.

10. Conversion of a company with FDI into an LLP will be allowed only if the above

stipulations are met and with the prior approval of FIPB/Government.

 

The FDI approval in LLPs would help a great deal in attracting larger FDI inflow in the country.

This move of the Indian Government is highly appreciated as this will benefit the Indian

economy in the long run by creating more employment opportunities and bringing in

international best practices and latest technologies in the country.

 

MANUFACTURING SECTOR

 

Indian Government way back in the year 2006 permitted 100% FDI in manufacturing of cigars

and cigarettes, under government approval route, subject to obtaining industrial license under the

Industries (Development and Regulation) Act, 1951. In response to the growing public

opposition against FDI into this sector and fulfilling its commitments towards anti-smoking

regime, Indian Government imposed a ban on FDI in manufacturing of cigars and cigarettes on

May 10, 2010 5 and placed “Manufacturing of cigars, cheroots, cigarillos and cigarettes, of

tobacco or of tobacco substitutes” under the list of sectors where FDI is prohibited. Indians

welcomed this move of the Indian Government as this supports their long-standing drive against

smoking.

PROPOSED REFORMS IN CIVIL AVIATION

 Civil Aviation sector includes Airports, Scheduled and Non-Scheduled domestic passenger

airlines, Helicopter services / Seaplane services, Ground Handling services, Maintenance and

Repair organizations; Flying training institutes; and Technical training institutions. Presently,

FDI up to 49 percent is allowed by the Indian Government in Aviation sector, with a restriction

on the foreign airlines from making investment in the domestic airline companies. The Civil

Aviation Ministry considered liberalization of the rules on foreign investment in Aviation sector

and issued a draft cabinet note, which provided that the existing restrictions in the Aviation

sector needs to be removed. This is under consideration.

Sectors Prohibited for Foreign Direct Investment

FDI is prohibited in only the following activities:

(a)Retail Trading (except single brand product retailing)

(b) Atomic Energy

(c) Lottery Business including Government /private lottery, online lotteries,etc.

(d)Gambling and Betting including casinos etc.

(e)Business of chit fund

(f) Nidhi company

(g)Trading in Transferable Development Rights (TDRs)

(h)Real Estate Business or Construction of Farm Houses

(i) Activities/sectors not opened to private sector investment e.g. Railways

(j) Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco

Substitutes.

India’s Foreign Direct Investment Flows

FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012

22.8

34.8

41.937.7

34.8

46.6

13.3

18.5 18.614.8

16.814.6

FDI Inflow FDI Outflow

India’s International Trade

India’s total merchandise trade increased over three-fold from US$ 252 bn in FY 2006 to US$

794 bn in FY 2012

Trade-GDP ratio increased from 30.2% in FY 2006 to 42.9% in FY 2012

Exports-GDP ratio increased from 12.4% in FY 2006 to 16.5% in FY 2012

Share of India in world merchandise export – 1.67% in 2011; Rank– 19 (up from 28th in 2006)

40%

5%

25%2%

21%

2%5%

India’s Export in 2001-02

ASIA AFRICA EUROPE CISNORTH AMERICA LACOTHERS

52%

7%

19%

1%12%

4% 5%

India's Export in2011-12

ASIA AFRICA EUROPE CISNORTH AMERICA LACOTHERS

India’s export in 2001-02 was around USD 44bn whereas it is around USD 305bn

We see that the direction of exports is moving towards southern countries particularly Asia and

Africa, share of Asia and Africa have increased at a decent rate.

India’s Trade Basket

Top Export Items ( FY 2012, USD bn) Top Export Items ( FY 2012, USD bn)

Petroleum products

Gems & Jewellery

Pharma Products

Transport Equipment

Machinery & Instruments

Readymade Garments

Manufacturers of Metals

Electronic Goods

rubber Glass product

cotton yarn & Fabric

0 10 20 30 40 50 60

56

47

24

21

14

14

10

9

7

7

Petroleum Crude

Gold & Silver

Electronic Goods

Pearls & Precious Stones

Non Electrical Machinary

Organic and Inorganic chemicals

coal, cokes & Briquettes

Transport Equipment

Metalliferrous ores & Products

Iron & Steel

0 50 100150200

155

62

33

31

30

19

17

14

13

12

Sectored Pattern of Indian Outward FDI

Regional ODI Flows

24%

19%8%7%6%

6%

6%

5%

4%3% 12%

MauritiusSingaporeAustraliaNetherlandsPanamaU.KUSABristish Virgin IslandUAESwitzerlandOthers

Destination analysis of Indian ODI flow reveals that the share of developing and

emerging countries is relatively higher vis-à-vis that of developed countries

Mauritius was the largest destination of Indian ODI in 2011-12, followed by Singapore

Other important ODI destinations among emerging markets include Australia, Netherlands,

Panama, UK and USA.

Agriculture Forestry and fishing7% Wholesale retail Trade,

Restaurants and hotels12%

Construction12%

Transport Storage and communication

15%Insurance Real Estateand Business services

21%

Manufacturing34%

Although we can see that Major flow is from Mauritius but the only reason lie behind such a

major chunk of flow is due to Tax benefits. As it’s a complete tax heaven country. The major

flows are still contributed from UK, USA & Singapore. The Indian government is working on

its policies to implement certain tax reforms for such regions or countries.

Amount of FDI MID

1948

March

1964

March

1980

March

1990

March

2000

March

2010

In crores 256 565.5 933.2 2705 18486 1,23,378

There is a considerable decrease in the tariff rates on various importable goods.

The above shows FDI inflows in India from 1948 – 2010.FDI inflows during 1991-92 to March

2010 in India increased manifold as compared to during mid 1948 to march 1990

The measures introduced by the government to liberalize provisions relating to FDI in 1991 lure

investors from every corner of the world. There were just few (U.K, USA, Japan, Germany, etc.)

major countries investing in India during the period mid 1948 to march 1990 and this number has

increased to fifteen in 1991. India emerged as a strong economic player on the global front after

its first generation of economic reforms. As a result of this, the list of investing countries to India

reached to maximum number of 120 in 2008. Although, India is receiving FDI inflows from a

number of sources but large percentage of FDI inflows is vested with few major countries.

Mauritius, USA, UK, Japan, Singapore, Netherlands constitute 66 percent of the entire FDI

inflows to India.

FDI inflows are welcomed in 63 sectors in 2008 as compared to 16 sectors in 1991.

The FDI inflows in India during mid 1948 were Rs, 256 crores. It is almost double in March

1964 and increases further to Rs. 916 crores. India received a cumulative FDI inflow of Rs.

5,384.7 crores during mid 1948 to march 1990 as compared to Rs.1,41,864 crores during August

1991 to march 2010. It is observed from that there has been a steady flow of FDI in India after its

independence. But there is a sharp rise in FDI inflows from 1998 onwards. U.K. the prominent

investor during the pre and post independent era stands nowhere today as it holds a share of 6.1

percent of the total FDI inflows to India.

Case Study on violation of FERA- ITC Ltd

ITC was started by UK-based tobacco major BAT (British American Tobacco). It was called the

Peninsular Tobacco Company, for cigarette manufacturing, tobacco procurement and processing

activities. In 1910, it set up a full-fledged sales organization named the Imperial Tobacco

Company of India Limited. To cope with the growing demand, BAT set up another cigarette

manufacturing unit in Bangalore in 1912. To handle the raw material (tobacco leaf)

requirements, a new company called Indian Leaf Tobacco Company (ILTC) was incorporated in

July 1912. By 1919, BAT had transferred its holdings in Peninsular and ILTC to Imperial.

Following this, Imperial replaced Peninsular as BAT's main subsidiary in India.

By the late 1960s, the Indian government began putting pressure on multinational companies to

reduce their holdings. Imperial divested its equity in 1969 through a public offer, which raised

the shareholdings of Indian individual and institutional investors from 6.6% to 26%. After this,

the holdings of Indian financial institutions were 38% and the foreign collaborator held 36%.

Though Imperial clearly dominated the cigarette business, it soon realized that making only a

single product, especially one that was considered injurious to health, could become a problem.

In addition, regular increases in excise duty on cigarettes started having a negative impact on the

company's profitability. To reduce its dependence on the cigarette and tobacco business, Imperial

decided to diversify into new businesses. It set up a marine products export division in 1971. The

company's name was changed to ITC Ltd. in 1974. In the same year, ITC reorganized itself and

emerged as a new organization divided along product lines. In 1975, ITC set up its first hotel in

Chennai. The same year, ITC set up Bhadrachalam Paperboards. In 1981, ITC diversified into

the cement business and bought a 33% stake in India Cements from IDBI. This investment

however did not generate the synergies that ITC had hoped for and two years later the company

divested its stake. In 1986, ITC established ITC Hotels, to which its three hotels were sold. It

also entered the financial services business by setting up its subsidiary, ITC Classic.

In 1994, ITC commissioned consultants McKinsey & Co. to study the businesses of the company

and make suitable recommendations. McKinsey advised ITC to concentrate on its core strengths

and withdraw from agri-business where it was incurring losses. During the late 1990s, ITC

decided to retain its interests in tobacco, hospitality and paper and either sold off or gave up the

controlling stake in several non-core businesses. ITC divested its 51% stake in ITC Agrotech to

ConAgra of the US. Tribeni Tissues (which manufactured newsprint, bond paper, carbon and

thermal paper) was merged with ITC.

By 2001, ITC had emerged as the undisputed leader, with over 70% share in the Indian cigarette

market. ITC’ popular cigarette brands included Gold Flake, Scissors, Wills, India Kings and

Classic.

Allegations :

A majority of ITC’s legal troubles could be traced back to its association with the US based

Suresh Chitalia and Devang Chitalia (Chitalias). The Chitalias were ITC’s trading partners in its

international trading business and were also directors of ITC International, the international

trading subsidiary of ITC. In 1989, ITC started the ‘Bukhara’ chain of restaurants in the US,

jointly with its subsidiary ITC International and some Non-Resident Indian (NRI) doctors.

Though the venture ran into huge losses, ITC decided to make good the losses and honour its

commitment of providing a 25% return on the investments to the NRI doctors. ITC sought

Chitalias’ help for this.

According to the deal, the Chitalias later bought the Bukhara venture in 1990 for around $1

million. Investors were paid off through the Chitalias New-Jersey based company, ETS Fibers,

which supplied waste paper to ITC Bhadrachalam. To compensate the Chitalias, the Indian Leaf

Tobacco Division (ILTD) of ITC transferred $4 million to a Swiss bank account, from where the

money was transferred to Lokman Establishments, another Chitalia company in Liechtenstein.

Lokman Establishments made the payment to the Chitalias. This deal marked the beginning of a

series of events that eventually resulted in the company being charged for contravention of

FERA regulations.

During the 1980s, ITC had emerged as one of the largest exporters in India and had received

accolades from the government. In the early 1990s, ITC started exporting rice to West Asia.

When the Gulf war began, ITC was forced to withdraw rice exports to Iraq, which resulted in

large quantities of rice lying waste in the warehouses. ITC tried to export this rice to Sri Lanka,

which however turned out to be a damp squib because the rice was beginning to rot already.

There were discussions in the Colombo parliament as to the quality of the rotting rice. This

forced ITC to import the rice back to India, which was not allowed under FERA.

There were a host of other such dubious transactions, especially in ITC’s various export deals in

the Asian markets. The company, following the Bukhara deal, had set up various front

companies (shell or bogus companies) with the help of the Chitalias. Some of the front

companies were Hup Hoon Traders Pvt. Ltd., EST Fibers, Sunny Trading, Fortune Tobacco Ltd.,

Cyprus, Vaam Impex & Warehousing, RS Commodities, Sunny Snack Foods and Lokman

Establishment, the one involved in the Bukhara deal. These front companies were for export

transactions. It was reported that ITC artificially hiked its profits by over-invoicing imports and

later transferring the excess funds as export proceeds into India. Analysts remarked that ITC did

all this to portray itself as the largest exporter in the country.

In 1991, ITC asked all its overseas buyers to route their orders through the Chitalias. The

Chitalias over-invoiced the export orders, which meant they paid ITC more than what they

received from overseas buyers. For instance, in an export deal to Sri Lanka, ITC claimed to have

sold rice at $350 per ton – but according to ED, the rice was actually sold for just $175 per ton.

ITC compensated the difference in amount to the Chitalias through various means including

under invoicing other exports to them, direct payments to Chitalia companies and through ITC

Global Holdings Pvt. Ltd. (ITC Global), a Singapore-based subsidiary of ITC. ITC Global was

involved in a number majority of the money laundering deals between ITC and Chitalias.

However, by 1995, ITC Global was on the verge of bankruptcy because of all its cash payments

to the Chitalias. It registered a loss of US $ 16.34 million for the financial year 1995-96, as

against a profit of US $1.7 million in 1994-95. The loss was reportedly due to the attrition in

trade margins, slow moving stock and bad debts in respect of which provisions had to be made.

It was also reported that ITC Global incurred a loss of $20 million on rice purchased from the

Agricultural Products Export Development Authority (APEDA), which was underwritten by the

Chitalias. By the time this consignment was exported to S Armagulam Brothers in Sri Lanka

through Vaam Impex, another ITC front company, there was an acute fall in international rice

prices. The consignee (S Armagulam Brothers) rejected the consignment because of the delay in

dispatch. Following this, ITC bought back that rice and exported it to Dubai, which was against

FERA.

This resulted in huge outstanding debts to the Chitalias, following which they turned against ITC

and approached BAT complaining of the debts and other financial irregularities at ITC in late

1995. BAT, which was not on good terms with Chugh, reportedly took this as an opportunity to

tarnish his reputation and compel him to resign. BAT appointed a renowned audit firm Lovelock

and Lewes to probe into the irregularities at ITC. Though the audit committee confirmed the

charges of financial irregularities at ITC during the early 1990s and the role of the Chitalias in

the trading losses and misappropriations at ITC during the year 1995-96, it cleared Chugh of all

charges. Chugh agreed to resign and BAT dropped all charges against him. He was given a

handsome severance package as well as the ‘Chairman Emeritus’ status at ITC. However

according to industry sources, though the Chitalias were on good terms with ITC, it was BAT,

which instigated the Chitalias to implicate the top management of ITC. BAT reportedly wanted

to ‘step in as a savior’ and take control of ITC with the active support of the FI nominees on the

board, which had supported ITC before charges of unethical practices surfaced.

Meanwhile, the Chitalias filed a lawsuit against ITC in US courts to recover their dues. They

alleged that ITC used them to float front companies in foreign countries in order to route its

exports through them. They also alleged ITC of various wrongdoings in the Bukhara deal. These

events attracted ED’s attention to the on goings at ITC and it began probing into the company’s

operations. ED began collecting documents to prove that ITC had violated various FERA norms

to pay the NRI Doctors.

FERA Violations

The ED found out that around $ 83 million was transferred into India as per ITC’s instructions

on the basis of the accounts maintained by the Chitalia group of companies. According to the ED

officials, the ITC management gave daily instructions to manipulate the invoices related to

exports in order to post artificial profits in its books. A sum of $ 6.5 million was transferred from

ITC Global to the Chitalias’ companies and the same was remitted to ITC at a later date. Another

instance cited of money laundering by ITC was regarding the over-invoicing of machinery

imported by ITC Bhadrachalam Paperboards Ltd., from Italy. The difference in amount was

retained abroad and then passed to the Chitalias, which was eventually remitted to ITC.

The ED issued charge sheets to a few top executives of ITC and raided on nearly 40 ITC offices

including the premises of its top executives in Kolkata, Delhi, Hyderabad, Guntur, Chennai and

Mumbai. The charge sheets accused ITC and its functionaries of FERA violations that included

over-invoicing and providing cash to the Chitalias for acquiring and retaining funds abroad, for

bringing funds into India in a manner not conforming to the prescribed norms, for not realizing

outstanding export proceeds and for acknowledging debt abroad TABLE II

Overview of FERA Violations by ITC

ILTD transferred $4 million to a Swiss bank account. The amount was later

transferred to

Lokman Establishment, which in turn transferred the amount to a Chitalia company in

the US.

ITC also made payments to non-resident shareholders in the case of certain

settlements without

The permission of the RBI. This was against Sections 8(1) and 9(1)(a) of FERA;

ITC under-invoiced exports to the tune of $1.35 million, thereby violating the

provisions of

Sections 16(1)(b) and 18(2);

ITC transferred funds in an unauthorized manner, to the tune of $0.5 million outside

India

Suppressing facts with regard to a tobacco deal. This was in contravention of Section a

(1) read

with Section 48;

ITC acquired $0.2 million through counter trade premium amounting to between 3 and 4

per

cent on a total business of 1.30 billion, contravening Section 8(1);

The company had debts to the tune of 25 million due to over-invoicing in coffee and

cashew

Exports during 1992- 93 to the Chitalias, contravening Section 9(1)(c) read with Section

26(6);

G. K. P. Reddi, R. K. Kutty, Dr. E. Ravindranath and M. B. Rao also violated the

provisions of

Sections 8(1), 9(1) (a), 9(1) (c), 16(b), 18(2) and 26(6) read with Section 68 of FERA.

The ED also investigated the use of funds retained abroad for personal use by ITC executives.

Though the ED had documentary proof to indicate illegal transfer of funds by top ITC

executives, nothing was reported in the media. The top executives were soon arrested. In

addition, the ED questioned many executives including Ashutosh Garg, former chief of ITC

Global, S Khattar, the then chief of ITC Global, the Chitalias, officials’ at BAT and FI nominees

on ITC board.

Meanwhile, the Chitalias and ITC continued their court battles against each other in the US and

Singapore. ITC stated that the Chitalias acted as traders for ITC’s commodities including rice,

coffee, soybeans and shrimp. ITC accused the Chitalias of non-payment for 43 contracts

executed in 1994. ITC sued the Chitalias seeking $12.19 million in damages that included the

unpaid amount for the executed contracts plus interest and other relief. Following this, the

Chitalias filed a counter-claim for $55 million, accusing ITC of commission defaults (trading

commission not paid) and defamation.

In August 1996, the Chitalias indicated to the Government of India and the ED their willingness

to turn approvers in the FERA violation case against ITC, if they were given immunity from

prosecution in India. The government granted the Chitalias, immunity under section 360 of the

Indian Criminal Procedure Act, following which the Chitalias were reported to have provided

concrete proof of large scale over-invoicing by ITC mainly in the export of rice, coffee and

cashew nuts. In another major development, a few directors and senior executives of ITC turned

approvers in the FERA violation case against the company in November 1996. A top ED official

confirmed the news and said that these officials were ready to divulge sensitive information

related to the case if they were given immunity against prosecution, as granted to the Chitalias.

The same month, the High Court of Singapore appointed judicial managers to take over the

management of ITC Global. They informed ITC that ITC Global owed approximately US $ 49

million to creditors and sought ITC’s financial support to settle the accounts. Though ITC did not

accept any legal liability to support ITC Global, it offered financial assistance up to $26 million,

subject to the consent and approval of both the Singapore and Indian governments.

In December 1996, most of the arrested executives including Chugh, Sapru, R. Ranganathan, R

K Kutty, E Ravindranathan, and K.P. Reddi were granted bail. ITC sources commented that

BAT instigated the Chitalias to sue and implicate its executives. BAT was accused of trying to

take over the company with the help of the financial institutions (FIs), who were previously on

ITC’s side. In November 1996, BAT nominees on the ITC board admitted that BAT was aware

of the financial irregularities and FERA violations in ITC. However, BAT authorities feigned

ignorance about their knowledge of the ITC dealings and charges of international instigation

against ITC.

According to analysts, ITC landed in a mess due to gross mismanagement at the corporate level.

Many industrialists agreed that poor corporate governance practices at ITC were principally

responsible for its problems. They remarked that nominees of the FI and BAT never took an

active part in the company’s affairs and remained silent speculators, giving the ITC nominees a

free hand. R.C. Bhargava, Chairman, Maruti Udyog, said, “It is difficult to believe that FIs and

BAT nominees had no idea of what was going on.

The Aftermath – Setting Things Right

Alarmed by the growing criticism of its corporate governance practices and the legal problems,

ITC took some drastic steps in its board meeting held on November 15, 1996. ITC inducted three

independent, non-executive directors on the Board and repealed the executive powers of Saurabh

Misra, ITC deputy chairman, Feroze Vevaina, finance chief and R.K. Kutty, director. ITC also

suspended the powers of the Committee of Directors and appointed an interim management

committee. This committee was headed by the Chairman and included chief executives of the

main businesses to run the day-to-day affairs of the company until the company had a new

corporate governance structure in place.

ITC also appointed a chief vigilance officer (CVO) for the ITC group, who reported

independently to the board. ITC restructured its management and corporate governance practices

in early 1997. The new management structure comprised three tiers- the Board of Directors

(BOD), the Core Management Committee (CMC) and the Divisional Management Committee

(DMC), which were responsible for strategic supervision, strategic management, and executive

management in the company respectively.

Through this three-tiered interlinked governance process, ITC claimed to have struck a balance

between the need for operational freedom, supervision, control and checks and balances. Each

executive director was responsible for a group of businesses/corporate functions, apart from

strategic management and overall supervision of the company

However, the company’s troubles seemed to be far from over. In June 1997, the ED issued show

cause notices to all the persons who served on ITC’s board during 1991-1994 in connection with

alleged FERA violations. The ED also issued notices to the FIs and BAT nominees on the ITC

board charging them with FERA contravention. In September 1997, the ED issued a second set

of show-cause notices to the company, which did not name the nominees of BAT and FIs. These

notices were related to the Bukhara restaurant deal and the irregularities in ITC’s deals with ITC

Global.

In late 1997, a US court dismissed a large part of the claim, amounting to $ 41 million, sought by

the Chitalias from ITC and ordered the Chitalias to pay back the $ 12.19 million claimed by ITC.

The Chitalias contested the decision in a higher court, the New Jersey District court, which in

July 1998 endorsed the lower court’s order of awarding $ 12.19 million claim to ITC. It also

dismissed the claim for $ 14 million made by the Chitalias against ITC. The judgment was in

favor of ITC as the US courts felt that the Chitalias acted in bad faith in course of the legal

proceedings, meddled with the factual evidence, abused information sources and concealed

crucial documents from ITC. Following the court judgment, the Chitalias filed for bankruptcy

petitions before the Bankruptcy Court in Florida, which was contested by ITC.

In early 2001, the Chitalias proposed a settlement, which ITC accepted. Following the

agreement, the Chitalias agreed to the judgment of the Bankruptcy Court, which disallowed their

Bankruptcy Petitions. As a part of this settlement ITC also withdrew its objections to few of the

claims of Chitalias, for exemption of their assets. However, ITC’s efforts to recover its dues

against the Chitalias continued even in early 2002. The company and its directors inspected

documents relating to the notices, with the permission of the ED, to frame appropriate replies to

the notices. It was reported that ITC extended complete cooperation to the ED in its

investigations.

However, the ED issued yet another show-cause notice (the 22 notice so far) to ITC in June

2001, for violating section 16 of FERA, in relation to ITC’s offer to pay $ 26 million to settle

ITC Globals debts (under section 16 of FERA, a company should take prior permission from the

RBI, before it can forgo any amount payable to it in foreign exchange). ITC replied to the

showcase notice in July 2001, stating it did not accept any legal liabilities while offering

financial support to ITC Global. On account of the provisions for appeals and counter-appeals,

these cases stood unresolved even in early 2002. However, ITC had created a 1.9 million

contingency fund for future liabilities.

Although the company went through a tough phase during the late 1990s, it succeeded in

retaining its leadership position in its core businesses through value additions to products and

services and through attaining international competitiveness in quality and cost standards.

Despite various hurdles, the company was a financial success, which analysts mainly attributed

to the reformed corporate governance practices.

Case Study on Violation of FEMA- Reliance Infra

The Reserve Bank of India (RBI) has asked the Anil Dhirubhai Ambani Group firm, Reliance

Infrastructure (earlier, Reliance Energy), to pay just under Rs 125 crore as compounding fees for

parking its foreign loan proceeds worth $300 million with its mutual fund in India for 315 days,

and then repatriating the money abroad to a joint venture company. These actions, according to

an RBI order, violated various provisions of the Foreign Exchange Management Act.

In its order, RBI said Reliance Energy raised a $360-million ECB on July 25, 2006, for

investment in infrastructure projects in India. The ECB proceeds were drawn down on November

15, 2006, and temporarily parked overseas in liquid assets. On April 26, 2007, Reliance Energy

repatriated the ECB proceeds worth $300 million to India while the balance remained abroad in

liquid assets. It then invested these funds in Reliance Mutual Fund Growth Option and Reliance

Floating Rate Fund Growth Option on April 26, 2007. On the following day, i.e., on April 27

2007, the entire money was withdrawn and invested in Reliance Fixed Horizon Fund III Annual

Plan series V. On March 5, 2008, Reliance Energy repatriated $500 million (which included the

ECB proceeds repatriated on April 26, 2007, and invested in capital market instruments) for

investment in capital of an overseas joint venture called Gourock Ventures based in British

Virgin Islands.

RBI said, under FEMA guidelines issued in 2000, a borrower is required to keep ECB funds

parked abroad till the actual requirement in India. Further, the central bank said a borrower

cannot utilise the funds for any other purpose. “The conduct of the applicant was in

contravention of the ECB guidelines and the same are sought to be compounded,” the RBI order

signed by its chief general manager Salim Gangadharan said.

During the personal hearing on June 16, 2008, Reliance Energy, represented by group managing

director Gautam Doshi and Price waterhouse Cooper’s executive director Sanjay Kapadia,

admitted the contravention and sough compounding. The company said due to unforeseen

circumstances, its Dadri power project was delayed. Therefore, the ECB proceeds of $300

million were bought to India and was parked in liquid debt mutual fund schemes, it added.

Rejecting Reliance Energy’s contention, RBI said it took the company 315 days to realise that

the ECB proceeds are not required for its intended purpose and to repatriate the same for

alternate use of investment in an overseas joint venture on March 5, 2008.

Reliance also contended that they invested the ECB proceeds in debt mutual fund schemes to

ensure immediate availability of funds for utilisation in India.

“I do not find any merit in this contention also as the applicant has not approached RBI either for

utilizing the proceeds not provided for in the ECB guidelines, or its repatriation abroad for

investment in the capital of the JV,” the RBI official said in the order.

In its defense, the company said the exchange rate gain on account of remittance on March 5

2008, would be a notional interim rate gain as such exchange rate gain is not crystallized.

But RBI does not think so. “They have also stated that in terms of accounting standard 11 (AS

11), all foreign exchange loans have to be restated and the difference between current exchange

rate and the rate at which the same were remitted to India, has to be shown as foreign exchange

loss/gain in profit and loss accounts.

However, in a scenario where the proceeds of the ECB are parked overseas, the exchange rate

gains or losses are neutralized as the gains or losses restating of the liability side are offset with

corresponding exchange losses or gains in the asset. In this case, the exchange gain had indeed

been realized and that too the additional exchange gain had accrued to the company through an

unlawful act under FEMA,” the order said.

It said as the company has made additional income of Rs 124 crore, it is liable to pay a fine of Rs

124.68 crore. On August this year, the company submitted another fresh application for

compounding and requested for withdrawal of the present application dated April 17, 2008, to

include contravention committed in respect of an another transaction of ECB worth $150 million.

But RBI said the company will have to make separate application for every transaction and two

transactions are different and independent and cannot be clubbed together.

Conclusion

Impact of progression from FERA to FEMA on Economy & Markets

Let us conclude the impact on the following

Rupee Progress

Exports & Imports

FDI allowance and its impact on Forex Reserve, GDP growth rate, Sensex

Rupee Progress

From the above chart Table we can see that after the Progression of FERA to FEMA since 2000

the Rupee has been depreciated against USD. After the peak recession time of 2008-09, Indian

Rupee was hovering around 44-46 per dollar mark for almost 2 years, till mid of 2011. It then

Years Rates

199019 1990 17.49221

1991 22.71165

1992 28.15582

1993 31.29108

1994 31.39386

1995 32.41807

1996 35.506

1997 36.36451

1998 41.35611

1999 43.05267

2000 44.93512

2001 47.15597

2002 48.60898

2003 46.57064

2004 45.12676

2005 43.92993

2006 45.24078

2007 41.48935

2008 43.78233

2009 48.3688

2010 45.65775

2011 46.45992

2012 53.14322

started to slide and breached the 50 per dollar mark in late 2011, mainly due to economic crisis

in Europe. The other major reasons which has led to rupee depreciation are

Policy Impacts

India’s back foot play in refreshing the economic policies due to internal political reason is sited

as a major cause for Rupee depreciation. The suspense of FDI in multi-brand retail can be w well

known example for this. Even though India made a few policy revivals in the area of single

brand retail market, pharma etc, these were not enough to attract more foreign direct investment

to India. Once we open your market, we have to consistently renew our economic policies and

agendas to attract more investment without affecting our domestic interests. Although currently

FDI has been allowed in multi Brand Retail, Aviation, Pharma etc the effect of the same was

seen on the entire market was bullish where it Indian Markets gave a good amount of return.

Reduction in export and increase in import 

According to Finance Ministry, because of reduction in export and increase in import, on one

side the fiscal deficit has increased and on the other, current account deficit is rising. Europe was

an important export destination for the country and reduction in the demand there adversely hit

Indian exports. Economic recovery was poor and fragile in European countries and this has

affected India’s changes to become a net exporter. 

Political Uncertainty and Corruption 

A coalition government has its own limitation. It chains the Government from initiating

proactive economic reforms. Hope we all remember what happened when the railway fare was

raised a little bit in the last Union railway budget. Also the second regime of UPA was engulfed

by a series of corruption. Starting from Common wealth games scan to Anna Hazare’s campaign

were enough to change the mindset of many foreign investors. The current campaign of agiaqnst

the FDI allowance in Multi- Brand retail shows the political instability which is one of the

drawback which has its effects

High Deficits 

Currently we are facing huge pressure from the deficit side - both fiscal and current account.

Government of India is spending a worthy amount as subsidies for fertilizers, food and oil. This

has resulted in widening the deficit gap. High deficits are considered as reasons for weakness in

local economy and can repel foreign investors.

Exports:

India's chief exports include computer software, agricultural products (cashews, coffee), cotton

textiles and clothing (ready-made garments, cotton yarn and textiles), gems and jewellery, cut

diamonds, handicrafts, iron ore, jute products, leather goods, shrimp, tea, and tobacco. The

country also exports industrial goods, such as appliances, electronic products, transport

equipment, light machinery as well as chemical and engineering products. India imports rough

diamonds, cuts them, and exports the finished gems. India's main exports in 2005 included USA

16.7%, UAE 8.5%, China 6.6%, Singapore 5.3%, UK 4.9%, Hong Kong 4.4%. India's services

contributed about 35% of the total exports as of 2010-11.

 

Total Exports by India:

Source: Indian Ministry of Commerce and Industry

 

1997-98 2002-03 2005-06 2010-11

Rs 130,101 Cr. Rs. 250,130 Cr. Rs. 454,800 Cr. Rs. 9,00,471 cr

Note:

India's exports as a percentage of GDP is set to double since 1998.

India's export growth is the second fastest in the world after China's.

Imports:

Capital goods and fuel, each account for about a quarter of Indian imports. Other imports of

India include edible oils, fertilizer, food grains, iron and steel, industrial machinery, professional

instruments and transportation equipment. Chemicals, precious and semi-precious stones and

non-ferrous metals are the other major imports. India's main import partners included China

7.3%, US 5.6%, Switzerland 4.7%.

Total Imports by India:

Source: Indian Ministry of Commerce and Industry

 

1997-98 2002-03 2005-06 2007-08

Rs 154,176 Cr. Rs. 297,206 Cr. Rs. 630,527 Cr. Rs. 949,133 Cr.

Deficits:

The value of India's imports is greater than the value of its exports. India uses foreign loans to

finance the extra imports. With exports and earnings on the invisibles account improving, the

trade deficit in 2000/01 narrowed to $5.73 billion from $12.9 billion in the year-ago period.

Current account deficit was about US$ 3.7 billion or about 1.4 percent of GDP in 1996-97, down

from 3.2 percent in 1990-91.

Sensex:

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20120

5000

10000

15000

20000

25000

3,955 3,262 3,377

5,8386,602

9,390

13,942

20,286

9,647

17,464

20,509

15,517

17,885

SENSEX

Sensex has perform well after implementation of FEMA, in 2000 sensex was at 4000 able to

reach 20,200 in 2007. In 2008 market was fall due to US subprime crisies and in 2009 Euro

sovering debt crisis in 2009. In 2010 sensex able to reach 20,500.

Inidan stock market FII money play verry important rle for development of market.

GDP growth of India:

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110

2

4

6

8

10

12

5.83

3.90

4.60

6.90

8.10

9.20 9.70

9.90

6.20 6.60

10.06

7.20

% GDP Growth

GDP growth of the country has been improved after implementation of FEMA. Country has been

able to grow more than 8% from 2004 to 2008 and also reach 10% in 2010. So, FEMA play a

huge role in growth of the country.

Thus various reforms in percentage of FDI in various sector like Aviation, Multi-Brand retail and

Broadcasting .In future it is predicted that the inflow of FDI in the country will grow and this

grow in the inflow would lead to generate employment and also help in appreciation of Indian

currency. Thus such liquidity in various sectors would help to a substantial amount of growth in

GDP of the country. Also when the FDI of 49% was approved in various sector it had its direct

impact on the stock market. Thus such deregulations from the Exchange authority has brought

about considerable changes in the Indian Economy