Foreign Exchange Regulation Act (FERA), Foreign Exchange Management Act (FEMA), Liberalized Remittance Scheme (LRS), Foreign Contribution (regulation) Act, (FCRA)

 

FERA to FEMA: 

India has enacted the Foreign Exchange Regulation Act (FERA) and the Foreign Exchange administration Act (FEMA), to govern cross-border transactions, the administration of reserve currencies, and the movement of foreign currency internationally.

Foreign Exchange Regulation Act (FERA):

• FERA came into effect  in 1974 with the provisions of  severe restrictions on currency exchange transactions, including bans on the possession, disposal, and usage of foreign currency. 
• There was control on business dealings between Indian citizens and foreigners. 
• There was provision of harsh fines and provisioning of criminal liabilities in case of  violations. 
• The strict and complex restrictions of FERA discouraged foreign investment and stifled economic growth. 

In order to free up the market and abolish governmental control, FEMA was established in 1991.

The Foreign Exchange Management Act (FEMA):

• FEMA was an outcome of 1991-Economic Reforms and became operative and enforceable in June 2000. 
• Its objectives were to simplify Foreign Exchange limitations, promote Foreign Investment, and ease Trade and payments between nations.
• The main regulatory authority for foreign exchange activities was established as the Reserve Bank of India (RBI). 
• Most of the restrictions of FERA regime were done away with .
• The necessity under FERA for RBI approval of foreign exchange dealings has ultimately been eliminated by FEMA to facilitate the free flow of foreign investments.
• FERA considered violations as criminal offences with the penalty of jail, while FEMA treated breaches as civil offences with monetary fines that could lead to detention for non-payment. 

Liberalized Remittance Scheme (LRS):  

• Introduced on February 4, 2004, Liberalized Remittance Scheme (LRS) allows all resident individuals, including minors, to remit up to USD 2,50,000 freely per financial year.
• This amount is for any permissible current or capital account transaction or a combination of both.

The Foreign Contribution (regulation) Act, (FCRA):

Background of FCRA:

The FCRA was enacted during the Emergency in 1976 when government was apprehensive of foreign powers interfering in India’s affairs by channeling funds through NGO's.

Features of FCRA:

• It regulates the acceptance/prohibition and utilization of foreign contribution by foreign sources.
• All associations, groups, and NGOs that wish to accept foreign donations are required by law to register with the FCRA for 5 years.
• The contributions can be received for social, educational, religious, economic, and artistic goals. 
• It is required to file annual returns similar to those for income tax. 
• Political parties ,media, journalists ,judge ,govt servants are not allowed to receive any funds under this. 
• As per amendments in FCRA in 2020, FCRA rules have become very stringent in the sense that any NGO receiving the funds, though directly not involved with political party but is found engaged in political activities like bandh, strikes will be considered at par with political party for the FCRA reference.

Foreign Currency Convertible Bonds (FCCB),Foreign Currency Exchangeable Bond (FCEB), VRR vs PIS

Examples of Off-Shore Bonds:

Foreign Currency Convertible Bonds (FCCB):

• Foreign Currency Convertible Bonds are offshore Quasi-debt instruments.
• The principal and interest in respect of bond is payable in foreign currency. 
• The issuer is able to convert the bond into stock at a pre-determined conversion rate at which the issuer is granted a certain number of shares. 
• The coupon rates on FCCB’s are generally lower than  bank interest rates, reducing the cost of debt financing. 
• On conversion debt into equity, the debt of company is reduced. 

Foreign Currency Exchangeable Bond (FCEB):

• Foreign Currency Exchangeable Bonds are offshore Quasi-debt instruments.
• These debts are unique in the sense that these debt are exchangeable into equity shares of another  company which is called the Offered Company. 
• The Issuing Company and the Offered Company of an FCEB need to be a part of the same promoter group.
•  The Issuing Company should compulsorily hold the equity shares of the Offered Company at the time of issuance of the FCEB until redemption or exchange of these bonds.

Voluntary Retention Route (“VRR”):

• RBI in 2022 introduced the VRR which  enables FPIs to invest in debt markets in India.
• VRR exempts FPIs from certain macro-prudential and other regulatory prescriptions.
• However, VRR imposes a minimum retention period of three years and the requirement to invest 25% of the committed portfolio size within one month and the remaining amount within three months from the date of allotment.

Portfolio Investment Scheme (PIS): 

• Portfolio Investment Scheme (PIS) is an instrument for Non-Resident Indians (NRIs) to invest in Indian stocks and bonds.
• NRE / NRO Account of an NRI is pre -requisite for PIS.
• There is a ceiling on the number of particular shares in your portfolio investment and the thresholds are set up by RBI and monitored daily. 
• PIS can-not engage in the business of chit funds, agricultural or plantation activities, real estate business related to agricultural or farmland, construction of farmhouses, etc. 
• NRIs are not permitted to carry out any intraday trading or short selling of shares.

Participatory Notes (P-Notes), Offshore bonds vs Onshore Bonds

 

Participatory Notes (P-Notes):

• P-Notes are instruments issued by a SEBI registered Foreign Institutional Investors (FII) to overseas investors, who wish to invest in the Indian stock markets without registering themselves with the market regulator, SEBI. 
• The underlying Indian security instrument may be equity, debt, derivatives or may even be an index.
• They are easy to operate rather than the cumbersome rules that India has for its foreign investors.

 Features of P-Notes:

• The investor in PN does not own the underlying Indian security, which is held by the FII who issues the PN.
• Investors in PNs derive the economic benefits of investing in the security without actually holding it.
• Investors benefit from fluctuations in the price of the underlying security since the value of the PN is linked with the value of the underlying Indian security. 
• The PN holder also does not enjoy any voting rights in relation to security/shares hold through PN.

 Controversary about P-Notes :

• P-notes have been controversial instruments since the very inception as these are freely traded overseas without any control of SEBI.
• P-Notes remain opaque as the identity of the investor is known only to FII and not to the SEBI.
• It is understood that P-notes are being used for money laundering. even by promoters of listed companies.
• Whenever government attempted to regulate them, market start tumbling, which prevents the government to take the harsh step. 

Participatory Notes Crisis of 2007:-- 

On 16th October 2007, SEBI proposed curbs on P-Notes but mere proposal resulted in sharp fall of 1744 points on 17th October 2007 followed by further volatilities.

Offshore bonds: 

                                

• Raising of debt by Indian Companies from global market in Rupee denominated /Dollar denominated is referred to as Offshore bonds. 
• It enables borrower to have access to foreign currency investments.
• These bonds are subjected to different tax rules depending upon tax treaties between countries.
• Offshore markets exposure may induce improvements in domestic bonds markets such as strengthening of domestic market infrastructure, improving investor protection and removing tax distortions that hinder domestic market development etc.

Onshore Bonds: 

                                           

• Onshore bonds are issued by financial entities to raise money from the investors located within the borrower 's home country.
• It is typically in local currency.

Foreign Exchange Reserves, Reserve Tranche Position

 

Foreign Exchange Reserves:

• Assets held as reserve by a central bank in the form of foreign currencies, Gold and  SDR .
• RBI is the custodian of FOREX and  has the primary responsibility of collection, compilation and dissemination of data relating to foreign exchange reserves.
• Most of the foreign exchange reserves are held in US dollars.

 India’s Forex Reserve include:

•       Foreign Dollar assets

•       Gold reserves

•       Special Drawing Rights

•       Reserve tranche with IMF

Forex as on Jan 2025 is 629 .5 Billion US $ with the components as mentioned in the image taken from RBI Report:

Reserve Tranche with IMF :

• Out of total SDR contribution of a country, 25% is kept in the form of gold and foreign currencies while 75 % is kept in the form of local currency and this 25 % is referred to as Reserve Tranche.
• This Reserve tranche provides for unconditional drawing right of the country on the IMF.
• The Reserve Tranche Portion (RTP) of the quota can be accessed by the member nation at any time. 
• This RTP amount remains with IMF and is available as per the demand of the contributing country without any service fee.

Reserve Tranche Position=

        SDR Quota - Own Currency = Foreign Currency/SDRs paid initially for membership.

*As per website of MOSPI,India’s Reserve Position in the International Monetary Fund is not included as part of foreign exchange reserves as they may not be available on immediate demand, although some countries do include these balances as part of their reserves.But RBI considers reserve tranche as part of foreign reserve.

Objectives of Holding Forex Reserves:

• Reserves provide a level of confidence to markets and investors that a country can meet its external obligations in case of any emergency.
• Forex Reserve provides support system and confidence for monetary and exchange rate management.
•  It Limits external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed. 
• All international transactions are settled in US dollars and are therefore needed to support our imports. 
• It serves as a cushion in the event of a Balance of Payment (BoP) crisis on the economic front. 
• The rising reserves have also helped the rupee to strengthen against the dollar. 

GLOBAL DEPOSITORY RECEIPT (GDR),American depositary receipt (ADR)

 

GLOBAL DEPOSITORY RECEIPT (GDR) :

• Global Depository Receipt (GDR), is a certificate issued by a Depository Bank (Depository Bank of  London) which purchases shares of foreign companies (TCS) and deposits them in their account. 
• GDRs represent ownership of number of  shares belonging to a  foreign company (TCS).
• GDR's are commonly used by investors in developed markets to invest in companies from emerging markets .

To Understand:

Let there is an investor "X" in Britain  & wishes to invest in any INC "TCS"

        Depository Bank of  London will purchase TCS share 

                           ⇓

        "X" will purchase TCS share from Depository Bank of  London

                           ⇓

                  Depository Bank of London will issue GDR to X.

Advantages of GDR to issuing company:

• Increase the accessibility to foreign capital markets,
• Increase in the visibility of the issuing company globally
• Rise in the capital because of foreign investors

Advantages of GDR to investor: 

• Diversification of investment, hence reducing risk
• Providing an opportunity for the investor to invest in foreign companies

American depositary receipt (ADR):

• GDR in case of USA is known as ADR.
• It is a Negotiable certificate issued by a U.S. bank against  shares in a foreign stock (eg stock of any Indian  company being traded at US stock exchange ) that is traded on a U.S. exchange. 
• ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. 
• ADRs help to reduce administration and duty costs that would otherwise be levied on each transaction.

Advantages of GDR for US investor:

• ADRs are an easy and cost-effective way for US investors  to buy shares in a foreign company. 
• They save money by reducing administration costs and avoiding foreign taxes on each transaction. 

Advantages of GDR to issuing company:

Foreign entities get more U.S. exposure, allowing them to tap into the wealthy North American equities markets.

Components of FDI, Horizontal & Vertical FDI, Indirect Foreign Investment

Components of FDI:

• Equity Capital, 
• Reinvested Earnings and
• Intra-Company Loans. 

Equity capital: It is investment in equity.

Reinvested Earnings: These are retained profits on the FDI which are reinvested in the market.

Intra-Company Loans: Borrowing and Lending of funds between parent enterprises and affiliate enterprises.

TYPES OF FDI:

Horizontal FDI:- 

When a company invests in the same industry in totality  in which it operates back in its own country .

Vertical FDI:-

• When a company expands only a part of the production process to another country is referred to as Vertical FDI.
• This fragmentation of business benefits enterprises, since the production costs in other countries can be way lower than the country of origin.

Indirect Foreign Investment /Downstream Investment: 

• Investment by an Indian company (owned / controlled by foreigners) into another Indian entity is considered as Indirect Foreign Investment (IFI). 
• Indian entity which has received indirect foreign investment shall comply with the entry route, sectoral caps, pricing guidelines and other attendant conditions as applicable for foreign investment.

FPI,FDI,Foreign Venture Capital Investors (FVCI), Overseas Direct Investment

 

Entry Routes for Foreign Investment in India:

There are broadly three entry routes are there for foreign investment in India: 

(a) Foreign Portfolio Investor (“FPI”) ; 

(b) Foreign Direct Investment (“FDI”); and

 (c) Foreign Venture Capital Investor (“FVCI”).

Foreign Portfolio Investment (FPI):

FPIs are short term investments in the form of:

• Debt and Equity in listed Company  ; or 
• Non Convertible Debentures (NCD) in Un-Listed company at stock exchange. 

Such investment is subject to the total holding by each FPI, investment in listed company should be less than 10% of the total paid-up equity.

FOREIGN DIRECT INVESTMENT (FDI): 

• FDI is a long-term investment made from abroad alongwith technology, entrepreneurship, capital and managerial know-how. 
• FDI is about being shareholder in the company so FDI is equity holder exclusively and debt is never categorized as FDI. 

Technically,

FDI is the investment by a person resident outside India 

(a) in an unlisted Indian company; or 

(b) in 10 percent or more in a listed Indian company. 

Investments under the FDI route are subject to entry routes, sectoral caps, pricing guidelines, and attendant conditionalities.

FDI vs FPI:

• When total holding of the FPI in a listed Company increases to 10% or more of the paid-up share capital, the total investments of the FPI are re-classified as FDI.
• FPI is considered ‘hot money’ as it is more speculative and volatile and hence have limited potential in economic development of the country while FDI is comparatively more stable and contributes in the economic development of the country.
• FDIs own controlling stake in a company by investing in its physical assets while FPIs invest only in financial assets.
• Significant tax benefit for FPIs as securities held as FPIs are subjected to capital gains while FDI income is subjected to corporate income (which is subject to higher rate of tax).
• FII inflows have a very high service burden among all the foreign resources ie FDI, foreign borrowings, NRI deposits.
• Actually FII comes to earn good returns from the market and exchange rate speculations. 
• FDI is regulated primarily by India's Department of Promotion of Industry and International Trade (DPIIT), under its Foreign Exchange Management Act regime (FEMA Regime) while SEBI REGULATES FPI.
• The FPI route is considered attractive for debt investments given debt investments by FPIs are not classified as external commercial borrowings, which is far more regulated.

Foreign Venture Capital Investors (FVCI):

• Foreign investor, who is registered under the Regulations and proposes to make investment in accordance with the Regulations.
• RBI has restricted investment by FVCIs to investment in: 

(a) Indian companies engaged in 10 permitted sectors (including infrastructure, biotechnology and IT related to hardware and software); 

(b) start- ups irrespective of the sectors; and 

(c) units of a venture capital fund and AIF. 

Investments by FVCIs in capital instruments are subject to sectoral caps on foreign investment in India and attendant conditions.

Why choose the FVCI route?

The key benefits that the FVCI route provides are exemptions from: 

(a) the pricing guidelines stipulated under the FEMA Regulations, and 

(b) pre-issue capital lock-in requirements prescribed under the regulations governing issue of securities. 

• Therefore, foreign investors seeking to make investments in the ten permitted sectors, start-ups  made investments  under the FVCI route.
• Investments under the FVCI route are subjected to at least two-third of its investible funds in equity  and the remaining one-third of investible funds in debt in which the FVCI already has equity investment.

Overseas Direct Investment (ODI): 

• Overseas Direct Investment (ODI) is what Indian residents are investing abroad in the form of assets (opposite of FDI) abroad, shares abroad (opposite of FPI) like Western firms like JAGUAR, Novelis have been acquired by Indians abroad.
• It also includes Reserve Assets held by RBI in the form of  Foreign currencies that RBI is holding. 

FOREIGN TRADE POLICY SINCE INDEPENDENCE, Features of FTP 2023

FOREIGN TRADE POLICY SINCE INDEPENDENCE:

1969 -1984:

1st Foreign Trade Policy (FTP) came in 1969 in the form of Export-Import policy and it was revised after every one year which continued till 1984.

1985 to 1991:

During this period, Foreign Trade Policy (FTP) was revised after every 3 years.

1992 to 2004:

Foreign Trade Policy (FTP) during this period was revised after every 5 years but with sunset clause.

2004-23: Foreign Trade Policy (FTP) during this period was revised after every 5 years. FTP of 2023 was unique in the sense that it doesnot have any sunset clause .

Features of FTP 2023:

The Key Approach to the policy is based on these 4 pillars: 

(i) Incentive to Remission,  

(ii) Export promotion through collaboration - Exporters, States, Districts, Indian Missions, 

(iii) Ease of doing business, reduction in transaction cost and e-initiatives and 

(iv) Emerging Areas – E-Commerce Developing Districts as Export Hubs and streamlining SCOMET policy.

• The policy targets exports of $ 2 trillion by 2030.
• Greater faith is being reposed on exporters through automated IT systems with risk management .
• The policy emphasizes upon moving away from an incentive regime to a facilitating regime .
• Merchandise Exports from India Scheme (MEIS) and Service Exports from India Scheme (SEIS) have  been phased out in 2021 in the wake of the reservation of USA at WTO.
• MEIS has been replaced by Remission of Duties and Taxes on Exported Products (RODTEP).
• The FTP 2023 encourages recognition of new towns through “Towns of Export Excellence Scheme” and exporters through “Status Holder Scheme”.
• The FTP aims at building partnerships with State governments and taking forward the Districts as Export Hubs (DEH) initiative to promote exports at the district level and accelerate the development of grassroots trade ecosystem.

E-commerce in new FTP 2023:

• E-Commerce exports are a promising category that requires distinct policy interventions from traditional offline trade. 
• Various estimates suggest E-Commerce export potential in the range of $200 to $300 billion by 2030. 
• FTP 2023 outlines the intent and roadmap for establishing e-commerce hubs and related elements such as payment reconciliation, book-keeping, returns policy, and export entitlements. 

ANALYSIS of FTP 2023:

• There is need for a robust market information and intelligence system for export expansion and diversification.
• There is need of an interactive market information and intelligence system backed up with the required policy support such as incentives, tax exemptions, export assistance, and facilitation is the crux of the export promotion efforts of a country.
• World trade is a demand function, so correspondingly, the supply-side capabilities have to be created or achieved. 

Generalized System of Preferences (GSP)

 

Generalized System of Preferences (GSP):

• Generalized System of Preferences (GSP) is a preferential tariff arrangement granted by the developed countries to developing countries and Least Developing Countries (LDC) to promote economic growth in those countries.
• GSP is an umbrella that comprises the bulk of preferential schemes to promote exports from developing countries to the developed countries..
• It involves reduced Most Favored Nations (MFN) Tariffs or duty-free entry of eligible products exported by beneficiary countries to the markets of donor countries.

Benefits of Generalized System of Preference:

• Developing countries increase and diversify their trade with the developed nations, hence facilitating the Economic growth and development of developing countries.
• Company Competitiveness is boosted by GSP as it reduces costs of imported inputs used by companies to manufacture goods
• GSP promotes Global values by supporting beneficiary countries in affording worker rights to their people, enforcing intellectual property rights, and supporting the rule of law.

India and GSP:

• India has been the beneficiary of the GSP regime and accounted for over a quarter of the goods that got duty-free access into the US in 2017.
• USA removed India from the list of countries receiving GSP treatment in June 2019.
• Even after US withdrawal of GSP, India continues to enjoy tariff preference from many countries including Australia, Russia and Japan, as well as the European Union (EU), among others.

Capital/Financial Vs Current Account, Official Reserve Sale, BOP & Capital account

 

           

Understanding Capital/Financial  and Current Account : 

Capital account deals with the change in ownership of a country’s assets,

                                                              while

  Current Account reflects the change in a country’s net income.

Ex. In case of a factory acquisition by an MNC in India, payment of dollars by MNC will result in Inflows of dollars alongwith lose of ownership by Indian on  the factory.

Income by that MNC will be a part of Current account while acquisition of factory is part of Capital Account.

 Capital and financial  Account:

• Those transactions, which cause a change in the ownership of assets or liabilities of a country.
• Capital and financial account has two categories of the capital and financial account. 
• Many a times ,this account is commonly referred to as Capital Account but its a misnomer as the so-called capital account portion is in fact small or even negligible for many countries. 

Capital account:

• It includes acquisition or disposal of “intangible nonfinancial assets and proprietary rights” such as trademarks, patents, copyrights, leasing agreements, and mineral rights. 
• Debt forgiveness is included in this subaccount, as part of capital transfers

 Because the capital account is typically small, the name for this part of the BOP is often abbreviated as “financial account.” 

Financial account :

• Direct investment, which is further divided into equity capital and reinvested earnings;
• Portfolio investment, which includes long-term debt and equity securities, money market instruments, and tradable financial derivatives, including dollarnd interest rate swaps;
• Other investment, such as trade credits and general borrowing, and IMF credit; and
• Change in Foreign Exchange Reserves 

Change in Foreign Exchange Reserves:

When BOP is not Zero despite exhaustion of all tools, then country could use its forex reserves to neutralise it.

Official Reserve Sale: 

When all tools of Capital and financial Accounts are exhausted and Current Account Deficit still remains, then RBI sells Foreign Reserves to ensure the Zero BOP.

Correlation between Balance of Payment and Capital Account:

• Balance of Payments of a country should be balanced .
• If a country has current account Deficit, it must be financed either  by selling assets or by borrowing abroad. 
• Thus, any current account deficit must be financed by a capital account surplus, that is, a net capital inflow or selling of the assets :

Current account + Capital account =0