~ 1 ~ACKNOWLEDGEMENTFirst of all we would like to take this opportunity to thank our College for having projectsas a part of the Foreign Trade Practices and Management (COP) curriculum.We wish to express our heartfelt gratitude to the following individuals who have played acrucial role in the research for this project. Without their active cooperation thepreparation of this project could not have been completed within the specified time limit.The first person we would like to acknowledge is our teacher Professor. DyutiChatterjee, who guided us with this project with utmost cooperation and patience. Weare very much thankful to you mam, for sparing your precious and valuable time for usand for helping us in doing this project. We are also thankful to Professor. AshishMitra, who gave us an opportunity to make this project in our curriculum.
~ 3 ~IntroductionForeign Exchange Regulation Act, 1973The Foreign Exchange Regulation Act (FERA) was legislation passed by the IndianParliament in 1973 by the government of Indira Gandhi. FERA imposed stringentregulations on certain kinds of payments, the dealings in foreign exchange and securitiesand the transactions which had an indirect impact on the foreign exchange and the importand export of currency.FERA was repealed in 2000 by the government of Atal Bihari Vajpayee and replaced bythe Foreign Exchange Management Act, which liberalised foreign exchange controls andrestrictions on foreign investment.Foreign Exchange Management Act, 1999The Foreign Exchange Regulation Act of 1973 (FERA) in India was repealed on 1 June,2000. It was replaced by the Foreign Exchange Management Act (FEMA), which waspassed in the winter session of Parliament in 1999. Enacted in 1973, in the backdrop ofacute shortage of Foreign Exchange in the country, FERA had a controversial 27 yearstint during which many bosses of the Indian Corporate world found themselves at themercy of the Enforcement Directorate (E.D.). Any offense under FERA was a criminaloffense liable to imprisonment, whereas FEMA seeks to make offenses relating to foreignexchange civil offenses.FEMA, which has replaced FERA, had become the need of the hour since FERA hadbecome incompatible with the pro-liberalisation policies of the Government of India.FEMA has brought a new management regime of Foreign Exchange consistent with theemerging frame work of the World Trade Organisation (WTO). It is another matter thatenactment of FEMA also brought with it Prevention of Money Laundering Act, 2002which came into effect recently from 1 July, 2005 and the heat of which is yet to be feltas “Enforcement Directorate” would be investigating the cases under PMLA too.Unlike other laws where everything is permitted unless specifically prohibited, underFERA nothing was permitted unless specifically permitted. Hence the tenor and tone ofthe Act was very drastic. It provided for imprisonment of even a very minor offence.
~ 4 ~Under FERA, a person was presumed guilty unless he proved himself innocent whereasunder other laws, a person is presumed innocent unless he is proven guilty.Foreign Exchange Management Policy in IndiaOVERVIEW OF FOREX POLICY OVER THE YEARSIndependence ushered in a complex web of controls for all external transactions througha legislation i.e., Foreign Exchange Regulation Act (FERA), 1947. There were furtheramendments made to the FERA in 1973 where the regulation was intensified. The policywas designed around the need to conserve Foreign Exchange Reserves for essentialimports such as Petroleum goods and food grains.The year 1991 was an important milestone for the Economy. There was a paradigm shiftin the Foreign Exchange Policy. It moved from an Import Substitution strategy to ExportPromotion with sufficient Foreign Exchange Reserves. The adequacy of the Reserves wasdetermined by the Guidotti (1) Rule, though the actual implementation of the rule wasmodified to meet our requirements.As a result of measures initiated to liberalize capital inflows, India’s Foreign ExchangeReserves (mainly foreign currency assets) have increased from US$6 billion at end-March 1991 to US$270 billion (2) as on 9th November 2007. It would be useful to notethat the Reserves accretion can be attributed to large Foreign Capital Inflow that couldnot be absorbed in the economy. This has been as a result of shift of funds fromdeveloped economies to emerging markets like India, China and Russia.FROM CONTROL TO MANAGEMENTIn the 1990s, consistent with the general philosophy of economic reforms a sea changerelating to the broad approach to reform in the external sector took place. The Report ofthe 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 accountconvertibility; Compositional shift in capital flows away from debt to non debt creating flows; Strict regulation of external commercial borrowings, especially short-term debt;
~ 5 ~(1) The Guidotti Rule says that Usable foreign exchange reserves should exceed thescheduled amortization of foreign currency debts during the following 12 months.However this was amended to meet the Indian requirement(2) Source: Reserve Bank of India Weekly Statistics Publication (16th Nov 2007) Discouraging volatile elements of flows from non-resident Indians; full freedomfor outflows associated with inflows (i.e., principal, interest, dividend, profit andsale proceeds) and gradual liberalization of other outflows; Dissociation of Government in the intermediation of flow of external assistance, asin the 1980s, receipts on capital account and external financing were confined toexternal assistance through multilateral and bilateral sources.The sequence of events in the subsequent years generally followed theserecommendations. In 1993, exchange rate of rupee was made market determined; closeon the heels of this important step, India accepted Article VIII of the Articles ofAgreement of the International Monetary Fund in August 1994 and adopted the currentaccount convertibility. In June 2000 a legal framework, with implementation of FEMA,was put into effect to ensure convertibility on the current account.CAPITAL ACCOUNT LIBERALIZATION APPROACHGlobalization of the world economy is a reality that makes opening up of the capitalaccount and integration with global economy an unavoidable process. Today capitalaccount liberalization is not a choice. The capital account liberalization primarily aims atliberalizing controls that hinder the international integration and diversification ofdomestic savings in a portfolio of home assets and foreign assets and allows agents toreap 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 andmanaged through a combination of administrative measures, gradual opening up ofprudential restrictions and safeguards to contain these risks.CURRENT SCENARIOThe 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 overgoods and services, and minimizing risk and volatility in returns. After the East Asiancrisis of 1997, India has followed a policy to build higher levels of Foreign ExchangeReserves that take into account not only anticipated current account deficits but also
~ 6 ~liquidity at risk arising from unanticipated capital movements. Accordingly, the primaryobjectives of maintaining Foreign Exchange Reserves in India are safety and liquidity;maximizing returns is considered secondary. In India, reserves are held for precautionaryand transaction motives to provide confidence to the markets, both domestic and external,those foreign obligations can always be met.The Reserve Bank of India (RBI), in consultation with the Government of India,currently manages Foreign Exchange Reserves. As the objectives of reserve managementare liquidity and safety, attention is paid to the currency composition and duration ofinvestment, so that a significant proportion can be converted into cash at short notice.Deployment of Foreign Exchange as on 31stJuly 2010Source: The Reserve Bank of IndiaGROUP INSIGHTS & SUGGESTIONSAs part of the group suggestions and insights, we will touch upon how the foreignexchange reserves can be deployed in a manner that will fetch higher returns withoutcompromising on the goals that are currently set for these investments. This is an additionto Capital Account Convertibility Issues.53, 27%47, 24%92, 46%7, 3%SecuritiesDeposits with foreigncommerical banksDeposits with othercentral banks; BIS & IMFGold
~ 7 ~INDIA’S FOREIGN TRADE: August 2010.EXPORTS (including re-exports)Exports during August, 2010 were valued at US $ 16644 million (Rs. 77509 crore)which was 22.5 per cent higher in Dollar terms (18.0 per cent higher in Rupee terms)than the level of US $ 13586 million (Rs.65670 crore) during August, 2009.Cumulative value of exports for the period April-August 2010 was US $ 85273million (Rs 392811 crore) as against US $ 66326 million (Rs. 322424 crore)registering a growth of 28.6 per cent in Dollar terms and 21.8 per cent in Rupee termsover the same period last year.IMPORTSImports during August, 2010 were valued at US $ 29679 million (Rs.138211 crore)representing a growth of 32.2 per cent in Dollar terms (27.4 per cent in Rupee terms)over the level of imports valued at US $ 22449 million ( Rs. 108506 crore) in August,2009. Cumulative value of imports for the period April-August, 2010 was US $141894 million (Rs. 653828 crore) as against US $ 106605 million (Rs. 518024 crore)registering a growth of 33.1 per cent in Dollar terms and 26.2 per cent in Rupee termsover the same period last year.
~ 8 ~TRADE BALANCEThe trade deficit for April - August, 2010 was estimated at US $ 56620 million whichwas higher than the deficit of US $ 40279 million during April -August, 2009.DEPARTMENT OF COMMERCEECONOMIC DIVISIONEXPORTS & IMPORTS : (PROVISIONAL)(Rs. Crores)AUG APRIL-AUGEXPORTS (including re-exports)2009-2010 65670 3224242010-2011 77509 392811%Growth 2010-2011/2009-2010 18.0 21.8IMPORTS2009-2010 108506 5180242010-2011 138211 653828%Growth 2010-2011/2009-2010 27.4 26.2TRADE BALANCE2009-2010 -42836 -1956002010-2011 -60702 -261017
~ 16 ~Foreign Exchange RatesIntroduction:Exchange Rate is the price of one country’s money in terms of other country’s money.When we say that exchange rate of Indian rupee is 48.40 per U.S dollar, we mean than48.40 Indian rupees are required to purchase one U.S. dollar. When his exchange ratebecomes 48.90 we say that the value of Indian rupee has against the U.S dollar on theother hand when the exchange rate becomes 48.10 we say that Indian rupee hasappreciated against the U.S. dollar.Factors affecting Foreign Exchange Rates:► Fundamental factors► Political and psychological factors► Technical factors- Capital movement- Relative inflation rates- Exchange rates policy and intervention- Interest rates► Speculation► OthersDetermination of Exchange Rates:►Balance of payments►Demand and supply►Purchasing power of party►Interest rate►Relative income levels►Market expectations
~ 17 ~Types of Exchange Rates: Spot Exchange Rates Forward Exchange RatesSpot Exchange RatesA spot exchange rate is a rate at which currencies are being traded for delivery on thesame day for e.g. an Indian importer may need U.S. $ to pay for the shipment that has justarrived. He will have to purchase the $ in the market to make payment for the import.The rate at which he will buy the $ in the market is known as spot exchange rate.Forward Exchange Rates:The forward rate is a price quotation to deliver the currency in future. The exchange rateis determined at the time of concluding the contract, but payment and delivery are notrequired till maturity. Foreign exchange dealers and Banks give the forward ratequotations for delivery in future according to the requirement of their clients.Foreign Exchange Rate RiskWhen you conduct business overseas, you will have to convert currencies involved atsome prevailing exchange rate. The price of one countrys currency in terms of anothercountry is called the exchange rate. When the currency of one country depreciates (dropsin value), there will be a corresponding appreciation of value in another countryscurrency. Depreciation occurs when it takes more currency to purchase the currency ofanother country. Appreciation is just the opposite; the currency is able to purchase moreunits of the other countrys currency. Since most currencies are valued according to themarketplace, there are constant changes to exchange rates. This gives rise to exchangerate risk.There are several ways to reduce exchange rate risk. Two popular approaches are hedgingand netting. Hedging is where you buy or sell a forward exchange contract to coverliabilities or receivables that are denominated in a foreign currency. Forward exchange
~ 18 ~contracts offset the gains or losses associated with foreign receivables or payables.A verypopular form of hedging is the Interest Rate Swap. Interest rate swaps are arrangementswhereby two companies located in different countries agree to exchange or swap debt-servicing obligations. This swap helps each company avoid the risks of changes in theforeign currency exchange rates. Due to the popularity of interest rate swaps, most majorinternational banks offer interest rate swaps for organizations concerned about foreignexchange rate risks when making interest payments. The costs charged by banks forinterest rate swaps are relatively low.Another solution to foreign exchange rate risk is the use of netting. Netting is the practiceof maintaining an equal level of foreign receivables against foreign payables. The netposition is zero and thus exchange rate risk is avoided. If you expect the currency todepreciate in value, than you should hold a net liability position since it will take fewerunits of currency to pay the foreign currency debt. If you expect the currency toappreciate in value, then you would want to have a net receivable position to takeadvantage of the increased purchasing power of the foreign currency.There are other vehicles for dealing with exchange rate risk, such as option hedges andother types of derivatives. However, the costs and risks associated with these types ofarrangements can be much higher than a simple approach such as the interest rate swap.If you have exchange rate exposure, then take a look at simple hedges and netting asways of avoiding foreign exchange rate risk.
~ 19 ~BibliographyWebsites: http://rbi.org.in http://mospi.gov.in http://imf.org http://treasury.worldbank.orgPublications: Bank of International Settlement – 2005 Following the Singapore model - S. Venkataramanan The Hindu Business Line Stanford Institute for Economic Policy ResearchDatabases: CMIE RBI Database (link from http://rbi.org.in) CSO Database on Foreign Exchange Reserves