Protectionism, Banana wars,Trump tariffs, Green protectionism, Carbon Border Adjustment Mechanism

 

PROTECTIONISM: 

Policy of restricting imports by using different tools like tariffs, Quotas, embargoes, subsidies and administrative barriers.

Rationale of Protectionism:

• Countries impose tariffs on goods to protect local industries, raise revenue and protect domestic jobs threatened on account of closure of the industries on account of  the  rise of imports.
• War and economic depressions led to increase in protectionism while peace and prosperity promotes Free Trade.

Classic Tools used by Governments:

Banana wars:

• Historically for a long time, European Union (EU) imposed substantial tariffs on banana imports from Latin America to protect African, Caribbean and Pacific (ACP) Countries as ACP countries were its colonies.
• Exporters had to pay €176 (£141) per Tonne of bananas. 
• In 2012, an agreement has seen these tariffs reduced.

EU Common Agricultural Policy (CAP):

• EU still impose substantial tariff rates on many agricultural markets. 
• The objective is to increase prices for domestic European farmers in order to increase their income.

Import Tariffs by Indian Government:

• In 2020, the Indian government introduced import tariffs on a range of products, including electronic goods, toys, and furniture. 
• The tariffs were intended to promote domestic manufacturing and reduce India's dependence on imported goods.

Illegal Subsidies:

• Many a times countries gives subsidy or support to a domestic export industry and it directly affects international trade.
• This gives the exporters an unfair advantage in the world market.
• Importing countries impose Countervailing Duties to counter this type of protectionism.

For example:

1. European airlines have been criticised for receiving ‘unfair’ support from their government. 
2. China subsidies for its car industry during the years 2009 through 2011,
3. Subsidies given by US to its firm involved in green technology, such as EV. 

Trump tariffs:

• In March 2018, President Trump imposed tariffs on steel (25%) and aluminum (10%) from most countries.
• President Trump raised tariffs on imports of many Chinese goods such as fridges, washing machines and clothes.
• In 2025, Trump has also announced for reciprocal tariffs.

Green protectionism:

• Green protectionism combines environmental concerns with economic measures. 
• This approach is focused to address global ecological challenges, such as climate change and environmental sustainability. 
• A key initiative in green protectionism is the European Union's Carbon Border Adjustment Mechanism (CBAM). 

Carbon Border Adjustment Mechanism (CBAM). :

• CBAM aims to check carbon footprints by imposing a import tariffs on certain goods from countries with less stringent climate policies.
• CBAM ensures that the carbon emissions associated with the production of imported goods are accounted for.
• Starting with industries like steel, cement, and aluminium, the CBAM seeks to level the playing field for European companies undergoing green transitions and encourages global partners to adopt similar environmental standards.

Negatives of Protectionism:

• Free Trade Agreements (FTA)s minimize trade restrictions between economies promoting prosperity and economic growth through specialization and exchange. 
• Protectionism increases restriction and hence affects prosperity and economic growth.
• 2018-2019 US-China trade war ultimately affected around $450 billion in annual trade.
• US-China Trade war was blessing in disguise for other world countries as Countries apart from US and  China  saw their global exports increase as a result of the US-China trade war. 
• Other countries were able to benefit from economies of scale to increase their exports even beyond the gap initially left by the US-China trade war.

Currency Convertibility, Current and Capital Account Convertibility, Liberalized Exchange Rate Management scheme,

 

Currency Convertibility:

Currency Convertibility refers to the ability to convert domestic currency into foreign currencies and vice versa to make payments for Balance of Payment transactions at market determined Exchange Rate.

Currency may be convertible on both current and capital accounts.

Current Account Convertibility of Currency: 

Current Account convertibility means that currency is convertible for the purposes of Current Account  ie, exports and imports of merchandise and invisibles only. 

Capital Account Currency of Currency: 

Capital account convertibility means convertibility on Capital Account. 

• Degree of BOP convertibility of any country depends on the level of economic development and degree of maturity of its financial markets. 
• So, Advanced Economies (AEs) are almost fully convertible while Emerging Market Economies (EMEs) are convertible to different degrees.

Advantages of Currency Convertibility:

• Market rate remains generally higher than the officially determined Exchange Rate. 
• Exporters receive more Rupees for the received Foreign Exchange from  exports  and hence increasing exports. 
• Being convertible there is easy access of foreign currency ,hence increasing trade .
• It acts as a self balancing mechanism to deal with BOP deficit.
• If BOP deficit is due to over-valued exchange rate, the currency depreciates as it is market driven which gives boost to exports by lowering their prices on the one hand and discourages imports by raising their prices on the other. 
• In case of surplus BOP, due to the under-valued exchange rate, the currency appreciates increasing the imports.
• Currency convertibility is prerequisite for the success of globalization giving boost to the inte­gration of the world economy. 

Convertibility of Indian Rupee:

In the seventies and eighties many countries switched over to the free convertibility of their currencies into foreign exchange.

 As a part of 1991-Economic reforms, Rupee was made partially convertible from March 1992 under the “Liberalised Exchange Rate Management scheme”

Liberalized Exchange Rate Management scheme (LERMS):

• 60 % of all receipts on current account could be converted freely into Rupees at market determined exchange rate quoted by authorised dealers, while 40 per cent of them was to be surrendered to Reserve Bank of India at the officially fixed exchange rate.
• These 40 per cent exchange receipts on current account was meant for meeting Government needs for foreign exchange and for financing imports of essential commodities. 
• This partial convertibility of Rupee on current account was adopted so that essential imports could be made available at lower exchange rate to ensure that their prices do not rise much. 
• Further, full convertibility of Rupees at that stage was considered to be risky in view of large deficit in balance of payments on current account. 
• In March’ 1994, Rupee was fully convertible at current account, However, on capital account Rupee remained nonconvertible.

Capital Account Convertibility of Rupee: 

Capital Account Convertibility is conversion of Indian financial assets into foreign financial assets and back, at an exchange rate fixed by the foreign exchange market and not by RBI.

The Tarapore Committee mentioned the following benefits of capital account convertibility to India:

1. Availability of large funds to supplement domestic resources and thereby promote economic growth.

2. Improved access to international financial markets and reduction in cost of capital.

3. Incentive for Indians to acquire and hold international securities and assets, and

4. Improvement of the financial system in the context of global competition.

Accordingly, the Tarapore Committee recommended for capital account convertibil­ity.

Preconditions for Capital Account Convertibility:

• Fiscal deficit should be 3.5 per cent.
• The Governments should fix the annual inflation target between 3 to 5 %
• Interest Rates should be deregulated, gross non-paying assets (NPAs) should be reduced to 5 per cent, the CRR should be reduced to 3 %.

Why Tarapore recommendations could not implemented:

• The difficulty with the Tarapore Committee recommendation was that it recommended Capital Account convertibility to be achieved in a 3 year period – 1998 to 2000.
• The period was too short and the pre-conditions and the macroeconomic indicators could not be achieved in such short period. 
• The Committee failed to appreciate the political instability in the country at that time, and the complete absence of political will and vision to carry forward the process of economic reforms and economic liberalisation.
• The outbreak of Asian financial crisis at this time was also responsible for shelving the recommendation of Tarapore Committee.

The second Tarapore Committee had drawn up a roadmap for 2011 as the target date for fuller capital convertibility of Rupee and mentioned that the conditions were quite favourable.

But economic events, especially global financial crisis of 2007-09,greatly affected the economic situation and hence recommendations could not be implemented.

Issues with Currency Convertibility:

• Market determined Exchange Rate is higher than the officially fixed exchange rate, prices of essential imports rise which may generate cost-push inflation in the economy. 
• If current account convertibility is not properly managed and monitored, market exchange rate may lead to the depreciation of domestic currency and speculations make it more volatile.
• Such situation can lead to situation of Capital Flight from the country as it happened in 1997-98 in case of South East Asian Tigers. 
• Empirical evidences suggests that free capital accounts were not necessary for the phenomenal growth recorded by countries in the diverse parts of the world. 
• All developed countries have adopted full convertibility, but the 2008 crises of USA and current turmoil of European Union has raised several questions while China has written its success story without full capital account convertibility.
• As Jagdish Bhagwati observes in his celebrated 1998 paper, “After all, China and Japan, different in politics and sociology as well as historical experience, have registered remarkable growth rates. Western Europe’s return to prosperity was also achieved without capital account convertibility.”
• Any deterioration in fiscal conditions, inflation management, balance of payments, or any other macroeconomic shock may cause a cessation or reversal of capital flows

What does the regime for capital account transactions look like today?:--

• There is virtually no restriction on Foreign Direct Investment (FDI). 
• Any foreign individual or firm or any other association of people can invest in any Indian company or set up an Indian company through FDI which essentially means long term engagement with influence on management. 
• FDI has a nexus with a whole lot of other issues including taxation, domestic investment climate, infrastructural support, ease of business and so on. 
• Reforms in such issues  will be far more that any liberalisation of capital flows into Indian financial markets.

CURRENCY SWAP, Currency swap between Companies, Central Banks

CURRENCY SWAP:

• Currency swap is an agreement between two cross-border entities where one of them agrees to provide a loan to another in a foreign currency. 
• These entities can be either companies, countries or the central banks 
• The repayment takes place in foreign currency/Dollar at a fixed date and a pre decided Exchange Rate
• The interest rate charged on such loans is usually lesser than that available in the foreign market.

Currency swap between Companies:

Let us take the example:

• US-based company XYZ Inc. which can borrow in the US at an interest rate of 5%, but the company requires a loan in Pound sterling for investment in the UK, where the prevailing interest rate is 8%.
•  At the same time, a UK-based company ABC is willing to invest in a US project but funds to ABC in US are available at 9% in comparison to the UK’s 6% interest rate.
• Company XYZ & Company ABC can benefit by entering into a fixed-for-fixed currency swap contract.
• US-based company XYZ Inc. ------ Borrow a US dollar loan at 5% in US ------------Lend the proceeds to the UK-based company ABC Plc. at that rate. 
• UK-based company ABC Plc. -------Borrow a Pound sterling loan at 6% -------------Lend it to the US-based company XYZ Inc.

Win -Win Situation for Co. XYZ Inc. & Co. ABC Plc.:

XYZ Inc. saved 2% (= 8% – 6%) in interest rate, while ABC Plc. saved 4% (= 9% – 5%). This is how the participating parties benefit from a currency swap.

How Bilateral Currency Swap between central banks works:

• Currency Swap was very much popular During the financial crisis -2008 as banks were reluctant to lend to one another because of the financial uncertainty.
• This resulted in the increase in the cost of borrowing, as lenders demanded higher interest rates to compensate for rising counterparty risk.
• This issue was very critical in case of Foreign Currencies as developing countries were looking for Dollars for trade.

• In the example, there is currency Swap between USA and Sri Lanka. 
• USA provide Dollars in Jan 2024 with commitment to give it back on Jan 2029 with predefined Exchange Rates and date. 

Importance and issues of FDI, FDI Policies in India since Independence

Why Countries Seek FDI: 

• FDI supplements domestic investment as Domestic capital is inadequate for purpose of economic growth.
• FDI is non debt capital and brings capital, technical know how and increases competitiveness of the economy .
• ⇓FDI Improves forex position of the country alongwith helping in capital formation by bringing fresh capital . 
• The association of FDI players in global marketing network play a major role in the promotion of exports .

Issues with FDI :  

• Role of FDI depends whether it crowds out or crowds in the domestic investments.
• In case of crowding out, Small Domestic enterprises find it difficult to compete with companies bringing FDI and feels that they may ultimately be edged out of business. 
• These MNC's have deep pockets and have ability to monopolise and take over the highly profitable sectors;
• These MNC's invest more in machinery and intellectual property than in wages of the local people;
• Government has less control over the functioning of such companies as they are subsidiary of an overseas company.

CO RELATION BETWEEN FDI AND FOREX: 

                               The MNC will need INR to carry out day to day job or purchase.

                                ⇊

                               FDI- Foreign Currency will be converted to INR 

                                                                         Foreign Currency 

   Company                                                  ⇄                                            RBI

                                                                                INR     

                                                        ⇊

                     Forex with RBI will increase

Why India has become FDI attractive :

• Unlike China, FDI in India is not export growth oriented as India does not impose any export obligation on MNC affiliate which attracts MNC's.
• Huge market size, growth prospects in tier-2 and tier-3 cities and growth  of infra are the motivating factors for attrracting FDI.
• Rise of high-tech sectors, market size, and digital and technological improvements are also driving India’s growth trajectory, making it an attractive investment destination.
• Innovative FDI initiatives by government in industries such as asset reconstruction firms, broadcasting, pharmaceuticals, single-brand retail trading etc are also promoting FDI investments.
• The Atmanirbhar Bharat aims to increase FDI in the defence sector by 74% through an automated route.The percentage of FDI inflows into the insurance sector has been boosted by the government from 49% to 74%.
• Policies like Production-Linked Incentive (PLI) programmes, Make in India , PM Gati Shakti, Foreign Trade Policy, Liberal FDI norms, PTAs and FTAs and the National Single Window System (NSWS) are motivating investors to set up manufacturing units in India. 

FDI ENTRY IN INDIA:

Independence to 1965-67:

• Post independence ,domestic funds were limited and basic infrastructure was to be developed so there was  receptive attitude with cautious towards FDI .
• There was non discriminatory treatment to FDI until mid of 60’s. 

1965-1980's :

Till mid of 1960’s local manufacturing base was developed with the flow of FDI  but it was accompanied by a lot of outflow in the form of remittances of dividends ,profits, royalties and technical fee .

1980-1990 :

• Outflow during 1965-80's led  policy makers to make  FDI  policy to be restrictive and selective post 1980's.
• Restriction on FDI was there if it was not entering without technology .
• Stake above 40 % ownership  was not allowed and it was allowed only in priority areas.

1991 onwards :

Paradigm shift from restrictive and selective to open door policy. 

The present FDI policy :

Characterized by Negative Listing permitting FDI in all the fields except a few in negative list. 

There are 3 methods of FDI entry in India :

1.Prohibited sectors                                                          

2.FDI is allowed upto a certain limit

3.100 % FDI :

• with automatic approval 
• with the approval of the government

At present, FDI is prohibited  in :

 a) Lottery Business 

b) Gambling and Betting including casinos etc. 

c) Chit funds 

d) Nidhi company 

e) Trading in Transferable Development Rights (TDRs)

f) Real estate business which shall not include development of townships, construction of residential /commercial premises, roads or bridges and Real Estate Investment Trusts (REITs) registered and regulated under the SEBI (REITs) Regulations 2014.

g) Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes

 h) Activities/sectors not open to private sector investment e.g. (I) Atomic Energy and (II) Railway operations (other than permitted activities mentioned in permitted sectors).

Correspondent Banks, NOSTRO Account, VOSTRO Account

 

Correspondent Banks: 

• Correspondent bank is financial institution acting as a third-party intermediary between domestic and international banks.
• Correspondent bank acts as an agent of a foreign bank to conduct business transactions with the domestic bank on its behalf.
• Domestic bank will work with a correspondent bank to set up a Nostro account - meaning our account, on your books.
• The foreign correspondent will call the same account a vostro account - meaning your account, on our books.

NOSTRO Account:

• Word “NOSTRO” is derived from the Latin word “Ours”. 
• NOSTRO account is a bank account, that a bank (Let SBI of India) holds in a foreign country’s   bank (Let Citi Bank of USA) in that country. 
• NOSTRO account is used by banks (SBI) to facilitate foreign exchange transactions and to hold funds that belong to their customers who have accounts in foreign currencies (Dollar).

VOSTRO Account:

• Word “VOSTRO” is derived from the Latin word “Yours”. 
• VOSTRO account is a type of bank account that is held by a foreign bank (SBI) at a domestic bank (Citi bank) in the domestic bank’s currency (Dollar).
•  In other words, a VOSTRO account is a foreign bank’s account at a domestic bank.
• Actually the account remains same but what differs is the nomenclature .

The same account in this case (SBI account in US Citibank ) is NOSTRO to SBI while it is VOSTRO account for Citibank.

Rupee denominated debt, Masala Bond

 Rupee Denominated Debt:

• External debt of India that is denominated in India’s domestic currency, the Rupee. 
• The contractual liability is settled in foreign currency.
• These bonds are beneficial for the borrower in the sense that exchange rate variation risk is  borne by the creditor and not by the borrower. 
• So, the borrower always pays back the foreign currency equivalent of the rupee denomination valued at the spot exchange rate prevailing at that point in time. 

At the time of borrowing:

Creditor (Dollar)-------------------converted to INR------------------- Borrower 

At the Time of giving back:

Borrower (INR)-------------------converted to Dollar------------------- Creditor

In India rupee denominated debt comprises: 

• Rupee denominated NRE account
• Non-Resident Ordinary Rupee (NRO) account,
• Foreign Institutional Investors (FII) investment in Government Treasury-Bills
• Dated and FII investment in corporate debt securities .
• Masala bond 

Masala Bond:

Masala bonds, are first Rupee denominated off-shore bonds, used by Indian entities to  borrowings from overseas markets .

Features :

• These bonds are issued to foreign investors in rupee denominations and settled in US dollars
• Those foreign investors who want to take exposure of the Indian market invest in these bonds. 
• Being Rupee denominated, the currency risk lies with the investor and not the issuer, unlike money  raised in foreign currency loans.    
• It benefits the Indian borrower from currency fluctuation as there is no risk of loss due to rupee depreciation as the issuance of these bonds is in Indian currency rather than foreign currency.

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.