regulation of indian foreign exchange market

8/3/2019 Regulation of Indian Foreign Exchange Market

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REGULATION OF INDIAN FOREIGN

EXCHANGE MARKETUNDER FEMA

PREPARED BY

ANKIT VARDHAN(10DF016)


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Early Stages: 1947-1977

India followed the par value system of

exchange rate.

the rupees external par value was fixed at 4.15grains of fine gold

The Reserve Bank maintained the par value of

the rupee within the permitted margin of 1

per cent using pound sterling as the

intervention currency.


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The objective of exchange controls was primarily toregulate the demand for foreign exchange for variouspurposes, within the limit set by the available supply.

The Foreign Exchange Regulation Act initially enactedin 1947 was placed on a permanent basis in 1957.

In terms of the provisions of the Act, the Reserve Bank,and in certain cases, the Central Government controlled

and regulated the dealings in foreign exchangepayments outside India, export and import of currencynotes and bullion, transfers of securities betweenresidents and non-residents, acquisition of foreignsecurities, etc.


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With the breakdown of the Bretton Woods System in1971 and the floatation of major currencies, the conductof exchange rate policy posed a serious challenge to allcentral banks world wide.

In December 1971, the rupee was linked with poundsterling. Since sterling was fixed in terms of US dollarunder the Smithsonian Agreement of 1971, the rupeealso remained stable against dollar.

to overcome the weaknesses associated with a singlecurrency peg and to ensure stability of the exchangerate, the rupee, with effect from September 1975, waspegged to a basket of currencies.


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The currency selection and weights assigned

were left to the discretion of the Reserve Bank.

The currencies included in the basket and their

relative weights were kept confidential to

discourage speculation.

It was around this time that banks in India

became interested in trading in foreign

exchange.


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Formative Period: 1978-1992

Banks in India were allowed by the ReserveBank to undertake intra-day trading in foreignexchange in 1978

They were required to comply with thestipulation of maintaining square or nearsquare position only at the close of business

hours each day. The exchange rate of the rupee during this

period was officially determined by theReserve Bank in terms of a weighted basket of

currencies of Indias major trading partners.


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major banks in India started quoting two-way prices against therupee as well as in cross currencies and, gradually, trading volumes

began to increase.

This led to the adoption of widely different practices (some of them

being irregular) and the need was felt for a comprehensive set ofguidelines or operation of banks engaged in foreign exchange

business.

Guidelines for Internal Control over Foreign Exchange Business,were framed for adoption by the banks in 1981.

The foreign exchange market in India till the early 1990s, however,

remained highly regulated with restrictions on external transactions,barriers to entry, low liquidity and high transaction costs.

The exchange rate during this period was managed mainly forfacilitating Indias imports.


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By the late 1980s and the early 1990s, it wasrecognised that both macroeconomic policy andstructural factors had contributed to balance ofpayments difficulties.

Devaluations by Indias competitors hadaggravated the situation.

Although exports had recorded a higher growthduring the second half of the 1980s (from about4.3 per cent of GDP in 1987-88 to about 5.8 percent of GDP in 1990-91), trade imbalancespersisted at around 3 per cent of GDP.


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This combined with a precipitous fall in invisiblereceipts in the form of private remittances, traveland tourism earnings in the year 1990-91 led to

further widening of current account deficit. The weaknesses in the external sector were

accentuated by the Gulf crisis of 1990-91. As aresult, the current account deficit widened to 3.2

per cent of GDP in 1990-91 and the capital flowsalso dried up necessitating the adoption ofexceptional corrective steps.


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Post-Reform Period: 1992 onwards

This phase was marked by wide ranging reformmeasures aimed at widening and deepening theforeign exchange market and liberalisation of

exchange control regimes. The dual exchange rate system was replaced by a

unified exchange rate system in March 1993,whereby all foreign exchange receipts could be

converted at market determined exchange rates. The restrictions on a number of other current

account transactions were relaxed.


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On unification of the exchange rates, the nominal exchange

rate of the rupee against both the US dollar as also against abasket of currencies got adjusted lower, which almost nullified

the impact of the previous inflation differential.

With the rupee becoming fully convertible on all current

account transactions, the risk-bearing capacity of banksincreased and foreign exchange trading volumes started rising.

The reform phase began with the Sodhani Committee (1994)

which in its report submitted in 1995 made several

recommendations to relax the regulations with a view to

vitalising the foreign exchange market


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Foreign Exchange Management Act

The bill passed in the winter session of Parliament in

1999 FEMA became an act on the 1st day of June, 2000 &

It extends to the whole of India.

FERA had become incompatible with the pro-

liberalisation policies of the Government of India. FEMA has brought a new management regime of

Foreign Exchange consistent with the emergingframework of the World TradeO

rganisation (W

TO

).


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Switch from FERA

The introduction of Foreign Exchange Regulation Act was done in1974, a period when Indias foreign exchange reserve position

wasnt at its best.

A new control in place to improve this position was the need of the

hour.

FERA did not succeed in restricting activities, especially theexpansion of TNCs (Transnational Corporations).

The concessions made to FERA in 1991-1993 showed that FERA

was on the verge of becoming ions involving current account for

external trade no longer required RBIs permission.

The deals in Foreign Exchange were to be managed instead of

regulated.

The switch to FEMA shows the change on the part of the

government in terms of foreign capital


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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.


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It permits only authorised person to deal in foreign

exchange or foreign security. Such an authorised person,

under the Act, means authorised dealer, money changer,

off-shore banking unit or any other person for the time

being authorised by Reserve Bank.

The Act has empowered the Reserve Bank of India

(RBI) to specify, in consultation with the CentralGovernment, the permissible capital account

transactions and the limits upto which foreign

exchange may be drawn for such transactions.

But it shall not impose any restriction on the drawalof foreign exchange for payments due on account of

amortization of loans or for depreciation of direct

investments in the ordinary course of business.


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Any person may sell or draw foreign exchange

if such sale or drawal is a current account

transaction.

Under the Act, Central Government may, in

public interest and in consultation with the

Reserve Bank, impose such reasonable

restrictions for current account transactions asmay be prescribed.


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The Reserve Bank may, at any time, cause an inspection to bemade, by any officer specially authorised in writing by it inthis behalf, of the business of any authorised person as mayappear to it to be necessary or expedient for the purpose of:-

(i) verifying the correctness of any statement, information orparticulars furnished to the Reserve Bank;

(ii) obtaining any information or particulars which suchauthorised person has failed to furnish on being calledupon to do so;

(iii) securing compliance with the provisions of this Act or ofany rules, regulations, directions or orders madethereunder.


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If any person contravenes any provision of thisAct, or contravenes any rule, regulation,notification, direction or order issued in exerciseof the powers under this Act, or contravenes anycondition subject to which an authorisation isissued by the Reserve Bank, he shall, uponadjudication, be liable to a penalty.

Restrictions are imposed on people living in India

who carry out transactions in foreign exchange,foreign security or who own or hold immovableproperty abroad.


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Activities such as payments made to any person outside India

or receipts from them, along with the deals in foreign

exchange and foreign security is restricted. It is FEMA thatgives the central government the power to impose the

restrictions.

Without general or specific permission of the Reserve Bank of

India, FEMA restricts the transactions involving foreign

exchange or foreign security and payments from outside the

country to India the transactions should be made only

through an authorised person.

Exporters are needed to furnish their export details to RBI. To

ensure that the transactions are carried out properly, RBI mayask the exporters to comply to its necessary requirements.


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Deals in foreign exchange under the current

account by an authorised person can be restricted by

the Central Government, based on public interest.

Although selling or drawing of foreign exchange is

done through an authorised person, the RBI is

empowered by this Act to subject the capitalaccount transactions to a number of restrictions.

People living in India will be permitted to carry out

transactions in foreign exchange, foreign security or

to own or hold immovable property abroad if thecurrency, security or property was owned or acquired

when he/she was living outside India, or when it was

inherited to him/her by someone living outside India.

regulation of indian foreign exchange market

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