Foreign Exchange Management Policy in India

Vikash Bairoliya (4);

Khagesh Chitalangiya (6);

Mehul Jain (12);

Niket Khatri (17);

Subodh M Mallya (18)

FOREIGN EXCHANGE

MANAGEMENT POLICY IN INDIA

Interim Report on Study of Foreign Exchange Management Policy

in India.

November 16, 2007

FOREIGN EXCHANGE MANAGEMENT POLICY IN INDIA 1

Table of Contents

Overview of Forex policy over the years ...........................................................................2

From Control To Management ..........................................................................................2

Capital Account Liberalization Approach ......................................................................... 3

Current Scenario ................................................................................................................ 3

Group Insights & Suggestions ........................................................................................... 4

BIBLIOGRAPHY .................................................................................................................. 5

Summary Statistics

Number of Pages: 3

Number of Graphs: 1

Table of Contents, Cover Page &

Bibliography.

November 16, 2007


OOOOVERVIEW OF VERVIEW OF VERVIEW OF VERVIEW OF FFFFOREX POLICY OVER THEOREX POLICY OVER THEOREX POLICY OVER THEOREX POLICY OVER THE YEARSYEARSYEARSYEARS

Independence ushered in a complex web of controls for all external transactions through

a legislation i.e., Foreign Exchange Regulation Act (FERA), 1947. There were further

amendments made to the FERA in 1973 where the regulation was intensified. The policy

was designed around the need to conserve Foreign Exchange Reserves for essential

imports such as Petroleum goods and food grains.

The year 1991 was an important milestone for the Economy. There was a paradigm shift in

the Foreign Exchange Policy. It moved from an Import Substitution strategy to Export

Promotion with sufficient Foreign Exchange Reserves. The adequacy of the Reserves was

determined by the Guidotti Rule1, though the actual implementation of the rule was

modified to meet our requirements.

As a result of measures initiated to liberalize capital inflows, India’s Foreign Exchange

Reserves (mainly foreign currency assets) have increased from US$6 billion at end-March

1991 to US$270 billion2 as on 9th November 2007. It would be useful to note that the

Reserves accretion can be attributed to large Foreign Capital Inflow that could not be

absorbed in the economy. This has been as a result of shift of funds from developed

economies to emerging markets like India, China and Russia.

FFFFROM ROM ROM ROM CCCCONTROL ONTROL ONTROL ONTROL TTTTO O O O MMMMANAGEMENTANAGEMENTANAGEMENTANAGEMENT

In the 1990s, consistent with the general philosophy of economic reforms a sea change

relating to the broad approach to reform in the external sector took place. The Report of

the High Level Committee on Balance of Payments (Chairman: Dr. C. Rangarajan, 1993)

set the broad agenda in this regard. The Committee recommended the following:

The introduction of a market-determined exchange rate regime within limits

Liberalization of current account transactions leading to current account

convertibility;

Compositional shift in capital flows away from debt to non debt creating flows;

Strict regulation of external commercial borrowings, especially short-term debt;

1111 The Guidotti Rule says that Usable foreign exchange reserves should exceed the

scheduled amortization of foreign currency debts during the following 12 months. However this was amended to meet the Indian requirement 2222 Source: Reserve Bank of India Weekly Statistics Publication (16th Nov 2007)

November 16, 2007


Discouraging volatile elements of flows from non-resident Indians; full freedom

for outflows associated with inflows (i.e., principal, interest, dividend, profit and

sale proceeds) and gradual liberalization of other outflows;

Dissociation of Government in the intermediation of flow of external assistance,

as in the 1980s, receipts on capital account and external financing were confined

to external assistance through multilateral and bilateral sources.

The sequence of events in the subsequent years generally followed these

recommendations. In 1993, exchange rate of rupee was made market determined; close

on the heels of this important step, India accepted Article VIII of the Articles of

Agreement of the International Monetary Fund in August 1994 and adopted the current

account convertibility. In June 2000 a legal framework, with implementation of FEMA,

was put into effect to ensure convertibility on the current account.

CCCCAPITAL APITAL APITAL APITAL AAAACCOUNT CCOUNT CCOUNT CCOUNT LLLLIBERALIZATION IBERALIZATION IBERALIZATION IBERALIZATION AAAAPPROACHPPROACHPPROACHPPROACH

Globalization of the world economy is a reality that makes opening up of the capital

account and integration with global economy an unavoidable process. Today capital

account liberalization is not a choice. The capital account liberalization primarily aims at

liberalizing controls that hinder the international integration and diversification of

domestic savings in a portfolio of home assets and foreign assets and allows agents to

reap the advantages of diversification of assets in the financial and real sector. However,

the benefits of capital mobility come with certain risks which should be categorized and

managed through a combination of administrative measures, gradual opening up of

prudential restrictions and safeguards to contain these risks.

CCCCURRENURRENURRENURRENT T T T SSSSCENARIOCENARIOCENARIOCENARIO

The main objectives in managing a stock of reserves for any developing country, including

India, are preserving their long-term value in terms of purchasing power over goods and

services, and minimizing risk and volatility in returns. After the East Asian crises of 1997,

India has followed a policy to build higher levels of Foreign Exchange Reserves that take

into account not only anticipated current account deficits but also liquidity at risk arising

from unanticipated capital movements. Accordingly, the primary objectives of

maintaining Foreign Exchange Reserves in India are safety and liquidity; maximizing

returns is considered secondary. In India, reserves are held for precautionary and

FOREIGN EXCHANGE MANAGEMENT POLICY IN INDIA

transaction motives to provide confidence to the markets,

those foreign obligations can always be met.

The Reserve Bank of India (RBI), in consultation with the Government of India,

currently manages Foreign

management are liquidity and

composition and duration of investment, so that a significant proportion can be

converted into cash at short notice.

GGGGROUP ROUP ROUP ROUP IIIINSIGHTS NSIGHTS NSIGHTS NSIGHTS &&&& SSSSUGGESTIONSUGGESTIONSUGGESTIONSUGGESTIONS

As part of the group sug

foreign exchange reserves can be deployed in a manner that will fetch higher

returns without compromi

investments. This is in additi

Deployment of Foreign Exchange as on 31st July 2007

Securities

Deposits with foreign commercial banks

November 1

FOREIGN EXCHANGE MANAGEMENT POLICY IN INDIA

transaction motives to provide confidence to the markets, both domestic and external,

those foreign obligations can always be met.


Foreign Exchange Reserves. As the objectives of reserve

management are liquidity and safety, attention is paid to the currency


converted into cash at short notice.

Source: Reserve Bank of India

UGGESTIONSUGGESTIONSUGGESTIONSUGGESTIONS

group suggestions and insights, we will touch upon how the


ns without compromising on the goals that are currently set for these

in addition to Capital Account Convertibility Issues

53 ; 27%

92 ; 46%

47 ; 24%

7 ; 3%


Deposits with other central banks,

Deposits with foreign commercial banks Gold (including gold deposits)

November 16, 2007

4

both domestic and external,


. As the objectives of reserve

safety, attention is paid to the currency


Source: Reserve Bank of India

gestions and insights, we will touch upon how the


are currently set for these

Issues.


central banks, BIS & IMF

November 16, 2007


BIBLIOGRAPHYBIBLIOGRAPHYBIBLIOGRAPHYBIBLIOGRAPHY

Websites

http://rbi.org.in

http://mospi.gov.in

http://imf.org

http://treasury.worldbank.org

Publications

Bank of International Settlement – 2005

Following the Singapore model - S. Venkitaramanan

The Hindu

Business Line

Stanford Institute for Economic Policy Research

Databases

CMIE

RBI Database (link from http://rbi.org.in)

CSO Database on Foreign Exchange Reserves

Documents

Foreign Exchange Management Policy in India