From FERA to FEMA

For the past over one year, one has been reading and hearing a lot about the new Foreign Exchange Management Act (FEMA), which was to replace the Foreign Exchange Regulation Act, 1973 (FERA). FEMA was ultimately passed by Parliament in 1999, but was to take force from the date of notification. Ultimately now, it has been notified that FEMA has come into force from 1st June 2000.
Why was it necessary to replace FERA by FEMA? How different is FEMA from FERA? Is it merely change of one word, from "Regulation" to "Management"? How does the change from FERA to FEMA affect common citizens such as you, who are Indian residents not engaged in imports or exports?

To understand the difference, one needs to understand the underlying principles of FERA. FERA was introduced at a time when foreign exchange (forex) reserves of the country were low, forex being a scarce commodity. FERA therefore proceeded on the presumption that 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 (RBI) expeditiously. It regulated not only transactions in forex, but also all financial transactions with non-residents. FERA primarily prohibited all transactions, except to the extent permitted by general or specific permission by RBI.

Violation of FERA was a criminal offence. One has heard so many stories of people being imprisoned for trivial offences. The case of the eminent industrialist, S.L.Kirloskar, being proceeded against under FERA for having the princely amount of $82 (or was it $86?) in his possession is well known. If you had ever visited a relative abroad, or had non-resident relatives visiting you, the chances are high that you had also violated FERA. In such cases, it is highly likely that your relatives may have given you or your visiting family members some small gift in forex, which you spent on buying some small article which you wanted to bring back. Or you may have spent some money on hospitality towards your non-resident relatives visiting you. Strictly, speaking, till the 1990's, these were FERA violations. Thank your lucky stars that you were not considered prominent enough for being punished under FERA. FERA had become more of a tool in the hands of politicians for punishing people who refused to toe their line.

Fortunately, with the winds of liberalization blowing in the early 1990's, the Government relaxed many of the rigours of FERA by issuing notifications. Forex reserves swelled, the rupee was made convertible on current account. In this liberal atmosphere, the government realized that possession of forex could no longer be regarded as a crime, but was an economic offence, for which the more appropriate punishment was a penaly. Thus, the need of FEMA was felt. The primary difference between FERA and FEMA therefore lies in the fact that offences under FEMA are not regarded as criminal offences and only invite penalties, not prosecution and imprisonment.

FEMA now codifies in the legislation and rules itself various transactions, which had been permitted by notification under FERA. Under FEMA, all current account transactions in forex (such as expenses, which are not for capital purposes) are permitted, except to the extent that the Central Government notifies. However, so far as capital account transactions are concerned, all capital account transactions in forex are prohibited, except to the extent as may be notified by RBI.

Does this mean that you can spend unlimited forex on whatever you want, so long as it is not a capital expense, such as investment? Certain prohibitions are laid down in the Foreign Exchange Management (Current Account Transactions) Rules, 2000. You cannot remit money for purchase of lottery tickets, for subscription to banned/prescribed magazines, to football pools, sweepstakes, for payment for telephone callback services, etc. Under the rules, certain remittances can be made only with prior approval of RBI. Many of these require permission only if the spending exceeds a particular limit. In effect, this means that you can spend amounts less than that without any approval being required. Some of these remittances, not requiring approval, are:
1. Up to US $ 5,000 in every calendar year for foreign travel (increased from the limit of US $ 3,000 under FERA).
2. Up to US $ 25,000 per trip for a business trip or for attending a conference abroad, irrespective of the length of the trip (under FERA, you had limits per day plus an entertainment allowance).

3. For gifts up to US $ 5,000 per beneficiary per annum (under FERA, the limit was US $ 1,000 and restricted only to defined relatives).

4. For donations up to US $ 5,000 per beneficiary.

5. For maintenance of close relatives abroad up to US $ 5,000 per recipient.

6. For foreign studies up to US $ 30,000, or the estimate from the foreign institution, whichever is higher.

7. For meeting expenses for medical treatment abroad, up to the estimate from doctor in India or hospital or doctor abroad.

There do not seem to be any restrictions on payments to be made in forex for various sundry expenses, such as purchase of books or software for your own use, for which there were certain limits under FERA.

If you have received forex as a gift abroad or earned it from a non-resident or on a visit abroad or acquired it for spending a foreign trip, you can now retain up to US $ 2,000 in forex even after your return to India, besides any amount of coins that you may choose to keep.

Of course, since capital account transactions are still prohibited (except to the extent permitted), you still cannot invest your funds in overseas investments (unless you are an employee of a foreign company or its subsidiary and have been offered stock options in the foreign company).

Hopefully, judging by the past trends relating to liberalisation of forex regulations and the intention behind FEMA, that day will not be too far off! BSE and NSE would then need to be watch out - NASDAQ may soon replace them as the Indian investor's favourite exchange.

how to manage surplus Forex..

IT IS now more than two years since the global financial meltdown, but the global economy still suffers from severe economic imbalances on account of large current account deficits run by some countries and the huge foreign exchange reserves that are held by the surplus countries. In 2006, the US current account deficit accounted for as much as 2% of world GDP. These imbalances have come about because of several factors. In the 1970s, it was inflation in the West on the back of the oil cartel raising crude oil prices to stratospheric levels that transferred unimaginable wealth to avery few in west Asia.


In more recent times, it has been the insatiable appetite for cheap consumer goods in the West that has helped some Asian countries accumulate huge foreign exchange reserves. The large foreign exchange reserves held by the trade-surplus countries have, in turn, created a massive demand for safe assets for investment of these surpluses, and this is seen as one of the root causes of the global financial meltdown in 2008.

Over the last decade, while the robust export-led growth in several countries in the emerging market space led to generation of significant current account surpluses, these markets have not attained the maturity to create sufficiently-liquid stores of value in which the surpluses can be invested. These surpluses, therefore, find their way to safe assets that are largely issued by the developed countries.

Among such financial assets are sovereign and quasi sovereign bonds issued by nations that are seen to respect property rights and have well-tested bankruptcy procedures, resilient, liquid and deep financial markets with minimal risks of government expropriation.

Some developed countries are privileged to be in a position to issue large volumes of these safe assets that has resulted in falling yields on their bond issuances. The incessant rise in gold prices can also be largely ascribed to the growing demand for safe assets.

In his recent paper on this subject, Ricardo Caballero of MIT has argued that it is this insatiable hunger for safe debt instruments and the scarcity of such instruments that created the setting for the large global banks to exploit the opportunity. These banks effectively addressed the safe asset shortage phenomenon at a profit by creating synthetic safe assets from the securitisation of lower quality ones by slicing and dicing them to various tiers, ably assisted by willing credit rating agencies but at the cost of exposing the economy to the systemic panic that unfolded in 2008.

It is worth considering the possible policy options that are available to address the acute shortage of safe assets. The surplus countries can moderate their demand for safe assets by partly investing in riskier assets. The memories of the Asian financial crisis of the mid-1990s are possibly too fresh for these newly-surplus countries to consider taking higher levels of risks with their reserves.

Despite the current global slowdown, over the last 12 months itself, Asian countries have generated a current account surplus of around three quarters of $1 trillion. Their holding of foreign exchange reserves is in excess of $6 trillion, around two-thirds of the global foreign exchange reserves.

The key takeaway from the global financial meltdown of 2008 and the ongoing sovereign credit crisis is that a suitable framework should soon be put in place for addressing the potential systemic problems that has widespread acceptance across countries. Such a framework would need an agreement on the holding of a diversified portfolio of assets across the risk spectrum by the surplus countries instead of a concentrated portfolio of safe assets.

THE diversified investment portfolios of sovereign wealth funds of countries such as Singapore, Abu Dhabi, Norway and even China in a small way are examples that more of the surplus nations would need to follow. The surplus countries have a significant stake in the stability of the global financial system and, therefore, the choice before them is to either facilitate an orderly adjustment in the global imbalances or run the risk of defaults on the huge financial claims held by them that they can ill-afford. Getting an agreement in place to address the massive global imbalances, therefore, should not be an impossible task.

Another policy alternative is for the asset-producing countries to supply adequate triple-A assets even beyond their fiscal needs that, in turn, would require them to invest in riskier assets themselves. The Troubled Asset Relief Program (Tarp) that enabled the US government to purchase assets and equity from financial institutions to strengthen the financial sector in the aftermath of the subprime mortgage crisis is an example of such a policy in action.

Although the programme was much criticised, in retrospect, it should be conceded that it was indeed appropriate for solving the systemic crisis because the fear that the government would be left holding companies such as General Motors, Citigroup and AIG for several years have not come true. Most of these investments made to bail out the marquee US companies have been repaid and the rest appear to be on track to repay.

While Tarp was a fire-fighting exercise, it is worthwhile developing a widely-acceptable institutional mechanism to manage systemic risks in an orderly manner with private investors absorbing the consequences of most shocks, but the government providing some form of mandatory fee-based insurance against alarge systemic event.

The move to increase capital requirements of banks has to be seen in this light. Another alternative is to have contingent capital injections in banks through convertible bonds that get compulsorily converted when the financial strength of a bank falls below a pre-determined threshold. The imbalance between the demand for, and supply of, safe assets has indeed worsened over the last two years, with several sovereign bonds being downgraded and many others on the verge of being downgraded.

It takes several years to set right such imbalances even when effective policy interventions are in place. It is, therefore, imperative that an institutional mechanism to address such systemic problems is put in place soon.......