Bus Env Mod 4-3

BUSINESS ENVIRONMENT
MODULE 4 -3
FERA FEMA
Prepared by Prof. C. Krishna Kumar

Only for use in ASB Classrooms
Syllabus:
FERA & FEMA.

Background for control of foreign exchange:
At the time of independence India had huge
foreign exchange reserves held in Britain.
Higher imports and investments depleted the
reserves very fast.
India had to request aid from donor countries
and support from the IMF to tide over the
foreign exchange crisis.

In 1966, the Indian rupee was devalued to help
the balance of payment position.
In the 1970’s, the oil prices started to rise
affecting the import bill.
FERA was implemented in 1973 to tackle the
foreign exchange movements.
In 1980-81, India once again approached IMF
for support as the increasing oil prices badly
affected the balance of payments.
Poor economic management brought down the
foreign exchange reserves from $7 billion in
1980 to just over $750 million in 1991.
Foreign debt, in the same period, increased

from $18 billion to $90 billion. The interest
payments shot up and India was staring at a
default in debt servicing.

As India had enough foreign exchange reserves
only to pay for two weeks of imports, the
government approached IMF for another loan
of $2.5 billion in 1991.
The IMF loan came with conditions.

* India had to devalue its currency from Rs 20 to a
dollar to Rs 27 to a dollar.
* India had to reduce import duties that were as high
as 130%.
* All goods to be brought under Open General
Licence making it easy for importers to import
foreign goods.
* As import duties were reduced, excise duties were
increased by 20% to compensate the loss of revenue
of the government.
* All government expenditure had to be cut by 10%.
The opposition, especially the Left Front,
accused that our sovereignty was being
surrendered.
But Prime Minister Narasimha Rao and
Finance Minister Manmohan Singh had no
other alternative other than to accept the IMF
conditions.

The actions required by the IMF was followed
by a host of liberalization activities that helped
the economy move forward.
The economic reforms produced results.

By the year 2000 reserves reached $42 billion
and reached $300 billion in 2008.
Currency convertibility:
* Convertibility is the ease with which a
country's currency can be converted into gold
or another currency through global exchanges.
* India's rupee is a partially convertible
currency—rupees can be exchanged at market
rates in certain cases, but approval is required
for larger amounts.

A nation's economy may be related to whether
its currency is convertible.
Stronger currencies tend be converted more
easily than others, which indicates a stronger
economy.
Growth may be stagnant for currencies with
poor convertibility because these countries
may miss trade opportunities.

The State of Indian Currency
Until the early 1990s (pre-reform period),
anyone willing to transact in a foreign currency
would need permission from the Reserve Bank
of India (RBI), regardless of the purpose.

People wanting to engage in foreign travel,
foreign studies, the purchase of imported
goods or to get cash for foreign currencies
received (like with exports) were all required
to go through the RBI.
All such forex exchanges occurred at pre-
determined forex rates finalized by the RBI.

After liberal economic reforms were
introduced in 1991, many significant
developments occurred that impacted the way
forex transactions and businesses were
conducted.
Exporters and importers were allowed to
exchange foreign currencies for the trade of
unbanned goods and services.

There was easy access to forex for studying or
travel abroad, and a relaxation on foreign
business and investments with minimal (or no)
restrictions depending on the industry sectors.

However, Indians still require regulatory
approvals if they want to invest an amount
above a pre-determined threshold level for the
purpose of investments or purchasing assets
overseas.
Similarly, incoming foreign investments in
certain sectors like insurance or retail are
capped at a specific percentage, and require
regulatory approvals for higher limits.
As of 2019, the Indian rupee is a partially
convertible currency.
This means that although there is a lot of
freedom to exchange local and foreign
currency at market rates, a few important
restrictions remain for higher amounts, and
these still need approvals.

The regulators also pitch in from time-to-time
to keep the exchange rates within permissible
limits instead of keeping the INR as a
completely free-floating currency left to the
market dynamics.
In the case of extreme volatility in rupee
exchange rates, the RBI swings into action by
purchasing/selling U.S. dollars (kept as foreign
reserve) to stabilize the rupee.
Full convertibility would mean the rupee
exchange rate would be left to market factors
without any regulatory intervention.
There may be no limit on inflow or outflow of
capital for various purposes including
investments, remittances or asset
purchase/sale.

Current Account vs. Capital Account
Convertibility:
Any currency may be current account or capital
account convertible, or both.
Current account convertibility implies that the
Indian rupee can be converted to any foreign
currency at existing market rates for trade
purposes for any amount.
It allows for easy financial transactions for the
export and import of goods and services.
Any individual involved in trade can get foreign
currency converted at designated banks or dealers.
In the beginning of reforms, the rupee was made
partially convertible for goods, services, and
merchandise only.
During the mid-1990s, the rupee was made fully
convertible for current account for all trading
activities, remittances and so on.
(With focus on FDI, ease of repatriation of
dividends is a requirement)
However, the rupee continues to remain
capital account non-convertible.
Capital account convertibility allows freedom
to convert local financial assets into foreign
financial assets and vice-versa.

It includes easy and unrestricted flow of capital for all
purposes which may include:
• Free movement of investment capital
• Free movement of dividend payments,
• Free movement of interest payments,
• Foreign direct investments in domestic projects and
businesses,
• Trading of overseas equities by local citizens
• Trading of domestic equities by foreigners
• Ease of foreign remittances
• Sale/purchase of immovable property globally.
One can still bring in foreign capital or take
out local money for these purposes, but there
are ceilings imposed by the government that
need approvals.
If a NRI sells his ancestral property in India, he
can take the proceeds out of the country.

Advantages of full convertibility:
Indicates less regulation and a sign of stability
of the market
Opens the market to a large number of global
investors who may come in since they can
bring the money and take it out without any
regulations
Gives easy access of finances to businesses

Local businesses can raise capital directly from
overseas sources instead of going through
ADRs and GDRs.
Indian banks can borrow or lend to foreign
banks in foreign currencies.

Disadvantages:
* Market can become volatile
* Can result in forex rates drops, inflation,
devaluation (as RBI will not step in to halt the
fall of the rupee)

Indian businesses may take US $ loans at low
rates. If Indian rupee depreciates, these low
rate loans suddenly becomes extremely
expensive.

Countries like India and China try to keep their
currencies undervalued to make exports
competitive.
If rupee is freely convertible, this advantage
will be lost.

Foreign Exchange Regulation Act (FERA)
1973:
This act was to regulate certain aspects of the
conduct of businesses outside India by Indian
companies and inside India by foreign
companies.

FERA was considered a draconian (excessively
harsh) law.
Following the economic liberalization in 1991,
changes were made to the act in 1993.

Objectives of FERA:
FERA was enacted when India had a huge
shortage of foreign exchange.
India was a controlled economic regime and
FERA was to ensure conservation and proper
utilization of foreign exchange resources of the
country.
(Objective was not to let foreign exchange go
out of the country except for absolutely
essential items)
Foreign Exchange Management Act
(FEMA)-1999:
The economic liberalization and better forex
positions made the govt bring in FEMA to
replace FERA.

According to FERA 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.

Features of FEMA:
FEMA is applicable all over India and also
applies to all branches, offices, and agencies
outside India, owned or controlled by a person
resident in India.

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 that gives the central government
the power to impose the restrictions.

FEMA served to make transactions for external
trade and easier – transactions involving
current account for external trade no longer
required RBI’s permission.
Free transactions on current account became
possible subject to reasonable restrictions that
may be imposed.

Transactions involving foreign exchange or
foreign security and payments from outside the
country to India should be made only through
an authorised person.
(FEMA included banks in the list of authorised
person in addition to foreign exchange dealers)

However, RBI imposes restrictions on capital
account transactions.
Residents of India will be permitted to carry
out transactions in foreign exchange, foreign
security or to own or hold immovable property
abroad if the currency, security or property was
owned or acquired when he/she was living
outside India, or when it was inherited by
him/her from someone living outside India.
Investment overseas:
With globalization, Indian companies were
also permitted to have strategic presence in
overseas locations in terms of branches and
factories.
China is heavily investing in agriculture at
overseas destination to ensure food safety.
India has also permitted domestic companies to
invest in agricultural activities abroad.
More than 80 Indian companies have invested
about Rs 11,300 crore in buying huge
plantations in countries in eastern Africa, such
as Ethiopia, Kenya, Madagascar, Senegal and
Mozambique that will be used to grow food
grains for the domestic market.

Indian companies can now take advantage of
global opportunities and also acquire
technological and other skills for their adoption
in India.
Indian companies are now free to invest up to
their net worth outside India without any
ceiling.

Indian companies have upgraded their
technology and expanded to more efficient
scales of production and refocused their
activities to areas of competence.
Increasingly, Indian companies are looking to
become global players.
Relaxation in taking foreign exchange out of
the country has permitted such overseas
expansions.
FERA vs FEMA:
* FERA was mainly formulated to deal with
deep crunch of foreign exchange as a
regulatory measure to conserve foreign
exchange.
* FEMA was brought in mainly to amend the
laws related to foreign exchange to facilitate
external trade and payments and to develop and
manage the foreign exchange market in India.
* FERA had 81 different and complex
provisions
*FEMA has only 48 simple sections within the
act.
* FEMA has widened the definition of
authorized person and has included banks in it.

* Under normal laws everything is permitted
unless specifically prohibited. Under FERA,
everything was prohibited unless specifically
permitted.
* Imprisonment was the punishment even for
minor offences under FERA.

* Offences under FERA was treated as
criminal offences while under FEMA treated as
civil offences.
* Under FERA, a person was presumed guilty
unless he proved himself innocent,
whereas under other laws a person is presumed
innocent unless he is proven guilty.

The Directorate of Enforcement (ED) is a law
enforcement agency and economic intelligence
agency responsible for enforcing economic
laws and fighting economic crime in India.
It is part of the Department of Revenue,
Ministry of Finance, Government Of India.
The prime objective of the Enforcement
Directorate is the enforcement of two key Acts
of the Government of India namely,
the Foreign Exchange Management Act 1999
(FEMA) and
the Prevention of Money Laundering Act 2002
(PMLA).
The Enforcement Directorate is also jokingly
called the FEMA Head Office.
University questions:

Q. “While focused on regulation of foreign
exchange, FEMA seeks to manage it.”
Critically comment on the statement.
Substantiate your standpoint clearly. (5 marks;
April 2018)
Q. Bring out the objectives of FERA & FEMA

(5 marks; Nov 2018)

Q. “FEMA is more suitable for wisely utilizing
foreign exchange for economic development of
India than the erstwhile FERA.” Elucidate (2
marks; Nov 2017).
Q. “FEMA is more conducive for fast

economic development than the erstwhile
FERA.” Comment (5 marks; April 2017).

Q. Point out the relevance of FEMA as against
FERA (2 marks; Dec 2012).


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BUSINESS ENVIRONMENT

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Foreign debt, in the same period, increased

Prepared by Prof. C. Krishna Kumar

The IMF loan came with conditions.

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

The economic reforms produced results.

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

Q. Bring out the objectives of FERA & FEMA

Prepared by Prof. C. Krishna Kumar

Q. “FEMA is more conducive for fast

Prepared by Prof. C. Krishna Kumar

Prepared by Prof. C. Krishna Kumar

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