First of all we would like to take this opportunity to thank our College for having projects as 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 a crucial role in the research for this project. Without their active cooperation the preparation 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. Dyuti
Chatterjee, who guided us with this project with utmost cooperation and patience. We are very much thankful to you mam, for sparing your precious and valuable time for us and for helping us in doing this project. We are also thankful to Professor. Ashish
Mitra, who gave us an opportunity to make this project in our curriculum.
~1~
INDEX
1 2
Introduction: Foreign Exchange Regulation Act 1973 & 1999 Foreign Exchange Management Policy in India
3 4-6
3
India’s Foreign Trade
7-8
4
Foreign Trade Scenario in India
9-14
5
Foreign Exchange Rates & Risk
15-17
6
Bibliography
18
~2~
The Foreign Exchange Regulation Act (FERA) was legislation passed by the Indian Parliament in 1973 by the government of Indira Gandhi. FERA imposed stringent regulations on certain kinds of payments, the dealings in foreign exchange and securities and the transactions which had an indirect impact on the foreign exchange and the import and export of currency. FERA was repealed in 2000 by the government of Atal Bihari Vajpayee and replaced by the Foreign Exchange Management Act, which liberalised foreign exchange controls and restrictions on foreign investment.
The Foreign Exchange Regulation Act of 1973 (FERA) in India was repealed on 1 June, 2000.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 was passed in the winter session of Parliament in 1999. Enacted in 1973, in the backdrop of acute shortage of Foreign Exchange in the country, FERA had a controversial 27 year stint during which many bosses of the Indian Corporate world found themselves at the mercy of the Enforcement Directorate (E.D.). Any offense under FERA was a criminal offense liable to imprisonment, whereas FEMA seeks to make offenses relating to foreign exchange civil offenses. FEMA, which has replaced FERA, had become the need of the hour since FERA had become incompatible with the pro-liberalisation policies of the Government of India. FEMA has brought a new management regime of Foreign Exchange consistent with the emerging frame work of the World Trade Organisation (WTO). It is another matter that enactment of FEMA also brought with it Prevention of Money Laundering Act, 2002 which came into effect recently from 1 July, 2005 and the heat of which is yet to be felt as “Enforcement Directorate” would be investigating the cases under PMLA too. Unlike other laws where everything is permitted unless specifically prohibited, under FERA nothing was permitted unless specifically permitted . Hence the tenor and tone of the Act was very drastic. It provided for imprisonment of even a very minor offence. ~3~
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 .
Independence ushered in a complex web of controls for all external transactions through a legislation i.e., Foreign Exchange Regulation Act (FERA), 1947. There were further amendments made to the FERA in 1973 where the regulation was intensified. The policy was designed around the need to conserve Foreign Exchange Reserves for essential imports such as Petroleum goods and food grains. The year 1991 was an important milestone for the Economy. There was a paradigm shift in the Foreign Exchange Policy. It moved from an Import Substitution strategy to Export Promotion with sufficient Foreign Exchange Reserves. The adequacy of the Reserves was determined by the Guidotti (1) Rule, though the actual implementation of the rule was modified to meet our requirements. As a result of measures initiated to liberalize capital inflows, India’s Foreign Exchange Reserves (mainly foreign currency assets) have increased from US$6 billion at endMarch 1991 to US$270 billion (2) as on 9th November 2007. It would be useful to note that the Reserves accretion can be attributed to large Foreign Capital Inflow that could not be absorbed in the economy. This has been as a result of shift of funds from developed economies to emerging markets like India, China and Russia.
In the 1990s, consistent with the general philosophy of economic reforms a sea change relating to the broad approach to reform in the external sector took place. The Report of the 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 account convertibility; Compositional shift in capital flows away from debt to non debt creating flows; Strict regulation of external commercial borrowings, especially short-term debt;
~4~
(1) The Guidotti Rule says that Usable foreign exchange reserves should exceed the scheduled 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 freedom for outflows associated with inflows (i.e., principal, interest, dividend, profit and sale proceeds) and gradual liberalization of other outflows; Dissociation of Government in the intermediation of flow of external assistance, as in the 1980s, receipts on capital account and external financing were confined to external assistance through multilateral and bilateral sources.
The sequence of events in the subsequent years generally followed these recommendations. In 1993, exchange rate of rupee was made market determined; close on the heels of this important step, India accepted Article VIII of the Articles of Agreement of the International Monetary Fund in August 1994 and adopted the current account convertibility. In June 2000 a legal framework, with implementation of FEMA, was put into effect to ensure convertibility on the current account.
Globalization of the world economy is a reality that makes opening up of the capital account and integration with global economy an unavoidable process. Today capital account liberalization is not a choice. The capital account liberalization primarily aims at liberalizing controls that hinder the international integration and diversification of domestic savings in a portfolio of home assets and foreign assets and allows agents to reap 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 and managed through a combination of administrative measures, gradual opening up of prudential restrictions and safeguards to contain these risks.
The 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 over goods and services, and minimizing risk and volatility in returns. After the East Asian crisis of 1997, India has followed a policy to build higher levels of Foreign Exchange Reserves that take into account not only anticipated current account deficits but also ~5~
liquidity at risk arising from unanticipated capital movements. Accordingly, the primary objectives of maintaining Foreign Exchange Reserves in India are safety and liquidity; maximizing returns is considered secondary. In India, reserves are held for precautionary and 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 management are liquidity and safety, attention is paid to the currency composition and duration of investment, so that a significant proportion can be converted into cash at short n otice.
7, 3%
Securities 53, 27% Deposits with foreign commerical banks Deposits with other central banks; BIS & IMF
92, 46% 47, 24%
Gold
st
Deployment of Foreign Exchange as on 31 July 2010 Source: The Reserve Bank of India
As part of the group suggestions and insights, we will touch upon how the foreign exchange reserves can be deployed in a manner that will fetch higher returns without compromising on the goals that are currently set for these investments. This is an addition to Capital Account Convertibility Issues.
~6~
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 $ 85273 million (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 terms over the same period last year.
Imports 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 terms over the same period last year.
~7~
The trade deficit for April - August, 2010 was estimated at US $ 56620 million which was higher than the deficit of US $ 40279 million during April -August, 2009. DEPARTMENT OF COMMERCE ECONOMIC DIVISION EXPORTS & IMPORTS : (PROVISIONAL) (Rs. Crores) AUG
APRIL-AUG
EXPORTS (including re-exports) 2009-2010
65670
322424
2010-2011
77509
392811
18.0
21.8
2009-2010
108506
518024
2010-2011
138211
653828
27.4
26.2
2009-2010
-42836
-195600
2010-2011
-60702
-261017
%Growth 2010-2011/2009-2010 IMPORTS
%Growth 2010-2011/2009-2010 TRADE BALANCE
~8~
Exports, Imports and Trade Balance ($ m) 1984-85 to 2008-09 Rate of Change Year to
Exports
Imports
Trade Balance
Export
Import
(percent) 1984-85
9878
14412
-4534
4.5
-5.9
1985-86
8904
16067
-7162
-9.9
11.5
1986-87
9745
15727
-5982
9.4
-2.1
1987-88
12089
17156
-5067
24.1
9.1
1988-89
13970
19497
-5526
15.6
13.6
1989-90
16612
21219
-4607
18.9
8.8
1990-91
18143
24075
-5932
9.2
13.5
1991-92
17865
19411
-1546
-1.5
-19.4
1992-93
18537
21882
-3345
3.8
12.7
1993-94
22238
23306
-1068
20.0
6.5
1994-95
26330
28654
-2324
18.4
22.9
1995-96
31797
36678
-4881
20.8
28.0
1996-97
33470
39133
-5663
5.3
6.7
1997-98
35006
41484
-6478
4.6
6.0
1998-99(P)
33218
42389
-9171
-5.1
2.2
1999-2000
36822
49671
-12849
10.8
17.2
2000-01
44560
50536
-5976
21.0
1.7
2001-02
43827
51413
-7586
-1.6
1.7
2002-03
52719
61412
-8693
20.3
19.4
2003-04
63843
78150
-14307
21.1
27.3
2004-05
83535
111516
-27982
30.8
42.7
2005-06
103092
149167
-46076
23.4
33.8
~9~
2006-07
126361
185749
-59388
22.6
24.5
2007-08
162904
251439
-88535
28.9
35.4
2008-09
168704
287759
-119055
3.6
14.4
Foreign exchange reserves (US $ m) 1995 to 2005 Reserves
Transactions with IMF Foreign
Gold
RTP
SDRs
currency Assets
Total (2+3+4)
Outstanding Drawals Repurchases
repurchase obligations
1995-96
4561
-
82
17044
21687
-
1710
2374
1996-97
4054
-
2
22367
26423
-
977
1313
1997-98
3391
-
1
25975
29367
-
615
664
1998-99
2960
-
8
29522
32490
-
102
287
1999-00
2974
-
4
35058
38036
-
-
-
2000-01
2725
-
2
39554
42281
-
-
-
2001-02
3047
-
10
51049
54106
-
26
-
2002-03
3534
672
4
71890
75428
-
-
-
2003-04
4198
1311
2
107448
112959
-
-
-
2004-05
4500
1438
5
135571
141514
-
-
-
2005-06
5755
756
3
145108
151622
-
-
-
2006-07
6784
469
2
191924
199179
-
-
-
2007-08
10039
436
18
299230
309723
-
-
-
-
-
-
2008-09 November
7861
854
3
238968
247686
~ 10 ~
December
8485
877
3
246603
255968
-
-
-
Jan,2009
8884
830
3
238894
248611
-
-
-
Feb,2009
9746
816
1
238715
249278
-
-
-
March,2009
9577
981
1
241426
251985
-
-
-
Balance of Payments ($ m) 1995-
1996-
1997-
1998-
1999-
2000-
96
97
98
99
2000
01
1. Imports (CIF)
43670
48948
51187
47544
55383
59264
2. Exports (FOB)
32311
34133
35680
34298
37542
44894
3. Trade balance (2-1)
-11359
-14815
-15507
-13246
-17841
-14370
a) Receipts
17665
21405
23244
25770
30312
34447
b) Payments
12216
11209
13237
16562
17169
22656
(2312)
(2201)
(2912)
(3045)
(3186)
(3542)
c) Net
5449
10196
10007
9208
13143
11791
5. Current account (net)
-5910
-4619
-5500
-4038
-4698
-2579
I. Foreign Investments
4615
5963
5353
2312
5117
4588
a) Inflow
5643
7824
9266
5892
12240
14294
b) Outflow
1028
1861
3913
3580
7123
9706
c) Net
4615
5963
5353
2312
5117
4588
II. Loans (3)
2201
4795
4799
4418
1601
4531
Year to
4. Invisibles
of which: Interest & service payments on loans and credits)
6. Capital account (net)
~ 11 ~
i) External Assistance a) Inflow
2933
3056
2885
2726
3074
2942
b) Outflow
2066
1955
2000
1927
2183
2532
c) Net
867
1101
885
799
891
410
a) Inflow
8399
14664
14416
12045
9986
20134
b) Outflow
7065
10970
10502
8426
9276
16013
c) Net
1334
3694
3914
3619
710
4121
a) Receipts
6453
8018
8910
8897
10659
12772
b) Payments
5691
5789
9803
8199
8532
11961
c) Net
762
2229
-893
698
2127
811
IV. Rupee Debt Service
-952
-727
-767
-802
-711
-617
a) Receipts
748
2629
3815
4610
4572
3992
b) Payments
3285
2883
2463
2801
2262
4282
c) Net
-2537
-254
1352
1809
2310
-290
VI. Errors & omissions
600
-594
167
-175
656
-588
7. Total Capital (I..VI)
4689
11412
10011
8260
11100
8435
8. Overall Balance (5+7)
-1221
6793
4511
4222
6402
5856
-
-
-
-
-
-
ii) Commercial Borrowings
III. Banking
V. Other Capital (net)
9. Monetary movement a) IMF Transactions i) Purchases
~ 12 ~
ii) Repurchases
1715
975
618
393
260
26
iii) Net
-1715
-975
-618
-393
-260
-26
b) (Inc)/dec in reserves
2936
-5818
-3893
-3829
-6142
-5830
India's external debt (Rs bn) - 2006 to 2009
~ 13 ~
R
2008
PR
Year to
2006
2007
I. Multilateral
145,503
154,053
157,901
A. Government borrowing
133,800
141,746
(i) Concessional
105,852
(a) IDA
End-June 2009
PR
End-Sep. PR
End Dec. QE
2009
2009
170,269
182,594
193,297
144,627
155,456
165,771
175,057
108,448
107,395
114,576
120,061
123,852
104,457
107,019
105,947
113,042
118,450
122,245
(b) Others
1,395
1,429
1,448
1,534
1,611
1,607
(ii) Non-concessional
27,948
33,298
37,232
40,880
45,710
51,205
(a) IBRD
19,626
21,864
22,631
24,548
26,820
28,583
(b) Others
8,322
11,434
14,601
16,332
18,890
22,622
B. Non-Government Borrowing
11,703
12,307
13,274
14,813
16,823
18,240
(i) Concessional
0
0
0
0
0
0
(ii) Non-concessional
11,703
12,307
13,274
14,813
16,823
18,240
(a) Public Sector
8,510
9,315
10,352
11,449
12,693
13,855
(i) IBRD
4,594
4,550
4,690
5,390
5,993
6,773
(ii) Others
3,916
4,765
5,662
6,059
6,700
7,082
(b) Financial Institutions
2,628
2,414
2,350
2,781
3,130
3,335
(i) IBRD
630
655
593
647
700
728
(ii) Others
1,998
1,759
1,757
2,134
2,430
2,607
(c) Private Sector
565
578
572
583
1,000
1,050
(i) IBRD
0
0
0
0
0
0
(ii) Others
565
578
572
583
1,000
1,050
II. Bilateral
70,302
70,034
78,777
80,442
88,259
103,823
A. Government borrowing
54,593
53,810
59,391
59,413
64,903
75,687
(i) Concessional
54,468
53,810
59,391
59,413
64,903
75,687
(ii) Non-concessional
125
0
0
0
0
0
B. Non-government borrowing
15,709
16,224
19,386
21,029
23,356
28,136
(i) Concessional
6,949
1,727
1,736
1,852
1,897
1,951
(a) Public sector
5,285
1,241
1,225
1,262
1,293
1,289
(b) Financial institutions
1,664
486
511
590
604
662
(c) Private sector
0
0
0
0
0
0
(ii) Non-concessional
8,760
14,497
17,650
19,177
21,459
26,185
(a) Public Sector
3,628
7,420
10,097
11,135
12,285
14,561
b) Financial Institutions
2,386
3,828
3,735
3,820
3,930
4,238
(c) Private Sector
2,746
3,249 3,818 ~ 14 ~
4,222
5,244
7,386
III. IMF
0
0
0
0
0
0
IV. Export credit
24,175
31,237
41,542
47,566
57,241
67,567
(a) Buyers' credit
16,088
23,617
33,321
39,241
48,270
57,543
(b) Suppliers' credit
3,351
2,941
3,057
3,159
3,327
3,442
4,736
4,679
5,164
5,166
5,644
6,582
0
0
0
0
0
0
117,991
180,669
249,920
262,987
285,822
320,567
73,508
107,145
160,971
172,140
184,722
215,217
41,112
68,020
82,914
84,555
94,468
98,524
(c) Export credit - bilateral credit (d) Export credit - defence purchase V. Commercial borrowing (a) Commercial bank loans (b) Securitized borrowings
a
b
~ 15 ~
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 than 48.40 Indian rupees are required to purchase one U.S. dollar. When his exchange rate becomes 48.90 we say that the value of Indian rupee has against the U.S dollar on the other hand when the exchange rate becomes 48.10 we say that Indian rupee has appreciated against the U.S. dollar.
► Fundamental factors ► Political and psychological factors ► Technical factors - Capital movement - Relative inflation rates - Exchange rates policy and intervention - Interest rates ► Speculation ► Others
►Balance of payments ►Demand and supply ►Purchasing power of party ►Interest rate ►Relative income levels ►Market expectations
~ 16 ~
Spot Exchange Rates Forward Exchange Rates
A spot exchange rate is a rate at which currencies are being traded for delivery on the same day for e.g. an Indian importer may need U.S. $ to pay for the shipment that has just arrived. 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.
The forward rate is a price quotation to deliver the currency in future. The exchange rate is determined at the time of concluding the contract, but payment and delivery are not required till maturity. Foreign exchange dealers and Banks give the forward rate quotations for delivery in future according to the requirement of their clients.
When you conduct business overseas, you will have to convert currencies involved at some prevailing exchange rate. The price of one country's currency in terms of another country is called the exchange rate. When the currency of one country depreciates (drops in value), there will be a corresponding appreciation of value in another country's currency. Depreciation occurs when it takes more currency to purchase the currency of another country. Appreciation is just the opposite; the currency is able to purchase more units of the other country's currency. Since most currencies are valued according to the marketplace, there are constant changes to exchange rates. This gives rise to exchange rate risk. There are several ways to reduce exchange rate risk. Two popular approaches are hedging and netting. Hedging is where you buy or sell a forward exchange contract to cover liabilities or receivables that are denominated in a foreign currency. Forward exchange ~ 17 ~
contracts offset the gains or losses associated with foreign receivables or payables.A very popular form of hedging is the Interest Rate Swap. Interest rate swaps are arrangements whereby two companies located in different countries agree to exchange or swap debtservicing obligations. This swap helps each company avoid the risks of changes in the foreign currency exchange rates. Due to the popularity of interest rate swaps, most major international banks offer interest rate swaps for organizations concerned about foreign exchange rate risks when making interest payments. The costs charged by banks for interest rate swaps are relatively low. Another solution to foreign exchange rate risk is the use of netting. Netting is the practice of maintaining an equal level of foreign receivables against foreign payables. The net position is zero and thus exchange rate risk is avoided. If you expect the currency to depreciate in value, than you should hold a net liability position since it will take fewer units of currency to pay the foreign currency debt. If you expect the currency to appreciate in value, then you would want to have a net receivable position to take advantage of the increased purchasing power of the foreign currency. There are other vehicles for dealing with exchange rate risk, such as option hedges and other types of derivatives. However, the costs and risks associated with these types of arrangements 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 as ways of avoiding foreign exchange rate risk.
~ 18 ~
Websites: http://rbi.org.in http://mospi.gov.in http://imf.org http://treasury.worldbank.org
Publications: Bank of International Settlement – 2005 Following the Singapore model - S. Venkataramanan The Hindu Business Line Stanford Institute for Economic Policy Research
Databases: CMIE RBI Database (link from http://rbi.org.in) CSO Database on Foreign Exchange Reserves
~ 19 ~
