1. Trade Policy Reforms

7/31/2019 1. Trade Policy Reforms

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Trade policy reforms over since 1991

have aimed at creating an environment for

achieving rapid increase in exports, raising

Indias share in world exports and making

economic growth.


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The focus of these reforms have been on

liberalization, openness, transparency and

globalization with a basic thrust on outwardorientation focusing on export promotion

restrictions and improving competitiveness

of Indian industry to meet global market

requirements.


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Reforms in industrial and trade policy were a

central focus of much of Indias reform effort

in the early stages.

Industrial policy prior to the reforms was

characterized by multiple controls over

private investment which limited the areas inwhich private investors were allowed to

operate, and often also determined the scale

of operations, the location of new investment,and even the technology to be used


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Trade policy reform has made progress, though

the pace has been slower than in industrial

liberalization. Before the reforms, trade policy

was characterized by high tariffs and pervasive

.

consumer goods were completely banned.


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For capital goods, raw materials and

intermediates, certain lists of goods were freely

importable, but for most items where domestic

substitutes were being produced, imports wereonly possible with import licenses.

The criteria for issue of licenses werenontransparent, delays were endemic and

corruption unavoidable. The economic reforms

sought to phase out import licensing and alsoto reduce import duties.


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Import licensing

was abolished relatively early for capital goods and

intermediates which became freely importable in

1993, simultaneously with the switch to a flexibleexchange rate regime. Import licensing had been

traditionally defended on the grounds that it was

necessary to manage the balance of payments, butthe shift to a flexible exchange rate enabled the

government to argue that any balance of payments

impact would be effectively dealt with through

exchange rate flexibility.


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Removing quantitative restrictions on imports

of capital goods and intermediates wasrelatively easy, because the number of

domestic producers was small and Indian

industry welcomed the move as making itmore competitive.


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Tariff protection

Progress in reducing tariff protection, the

second element in the trade strategy, has alsotaken place.

The peak duty rate was reduced and a numberof duty rates at the higher end of the existing

structure were lowered, while many low end

duties were raised to 5 percent.


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Although Indias tariff levels aresignificantly lower than in 1991, they

remain on the higher side because most

other developing countries have also

reduced tariffs in this period.

The weighted average import duty in China

and southeast Asia is currently about half

the Indian level.


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Foreign Direct Investment

Liberalizing foreign direct investment was another

important part of Indias reforms, driven by the

belief that this would increase the total volume ofinvestment in the economy, improve production

technology, and increase access to world markets.

Now100 percent foreign ownership in a large

number of industries and majority ownership in all

except banks, insurance companies,

telecommunications and airlines is allowed.


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Procedures for obtaining permission were

greatly simplified by listing industries that areeligible for automatic approval up to specified

levels of foreign equity (100 percent, 74

percent and 51 percent).

Potential forei n investors investin within

these limits only need to register with the RBI.For investments in other industries, or for a

higher share of equity than is automatically

permitted in listed industries, applications areconsidered by a Foreign Investment

Promotion Board that has established a track

record of speedy decisions.


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FERA TO FEMA


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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 chan e from FERA to FEMA

affect common citizens such as you, who

are Indian residents not engaged in

imports or exports?


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To understand the difference, one needs to

understand the underlying principles of

FERA. FERA was introduced at a time whenforeign exchange (forex) reserves of the

country were low, forex being a scarce

commodity.


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FERA therefore proceeded on thepresumption that all foreign exchange

earned by Indian residents rightfully

belonged to the Government of India and

had to be collected and surrendered to the

v n n x u y.regulated not only transactions in forex, but

also all financial transactions with non-

residents. FERA primarily prohibited alltransactions, except to the extent permitted

by general or specific permission by RBI.


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Violation of FERA was a criminal offence. If youhad ever visited a relative abroad, or had non-

resident relatives visiting you, the chances are

high that you had also violated FERA. In suchcases, it is highly likely that your relatives may

have iven ou or our visitin famil members

some small gift in forex, which you spent onbuying 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.


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Fortunately, with the winds ofliberalization 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.


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In this liberal atmosphere, the governmentrealized 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

.

FERA and FEMA therefore lies in the fact that

offences under FEMA are not regarded as

criminal offences and only invite penalties, notprosecution and imprisonment.


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FEMA now codifies in the legislation and rulesitself 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

Central Government notifies. However, so far as

capital account transactions are concerned, all

capital account transactions in forex areprohibited, except to the extent as may be

notified by RBI.


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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 maybe notified by RBI.


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CAPITAL AND CURRENT ACCOUNT CONVERTIBILITY (CAC)


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Capital account convertibility is a feature of a

nation's financial regime that centers on the

ability to conduct transactions of local financial

assets into foreign financial assets freely and atmarket determined exchange rates.

It is sometimes referred to as CAC.


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CAC was first coined as a theory by the RBI in

1997 by the Tarapore Committee, in an effort tofind fiscal and economic policies that would

enable developing Third World countries

transition to globalized market economies.However, it had been practiced, although

without formal thought or organization of policy

or restriction, since the very early 90's. ArticleVIII of the IMFs Articles of Agreement is agreed

by most economists to have been the basis for

CAC, although it notably failed to anticipateproblems with the concept in regard to outflows

of currency.


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WHAT IS CURRENT AND CAPITAL ACCOUNT?


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In an open economy, we buy from abroad (Import)and we sell to abroad. (export)

Similarly Indians invest abroad, foreigners investin India.

So lot of mone incomin and out oin .

Current and Capital accounts are nothing butmethod of classifying that incoming and outgoing

money.


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As you know, Balance of Payment (bop)= Import Export.

This BoP is calculated under two heads:

Current Account and Capital Account.


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CURRENT AND CAPITAL ACCOUNT

CONVERTIBILITY


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Convertibility = converting one currency into

another. Like rupee to dollar, yen topoundanything.

Since money is incoming and outgoing. People

will need to convert the money into different

currencies based on their requirements.

e c ass e e ncom ng an ou go ng

money into Current and Capital account.

Similarly we classify the procedure involved inconverting that money. In brief


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which is reversible & why?


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Current account =Money sent and received

during import and export

You sold something (exported) and received

,

(until you spend it on something else!) So

Current account is permanent and

irreversible.


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Capital account = Money sent and receivedduring investment and borrowing.

Suppose Japanese guy buys factory in India(capital account), sells it after 5 years and takes

c e ey.

So Capital account inflow is NOT PERMANENT

and hence reversible (because he took back themoney he invested in India).


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PRO AND CONS


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ARGUMENT IN FAVOR OF FULL CAPITALACCOUNT CONVERTIBILITY

It facilitates foreign investments and borrowing.So competition is increased = more factories =

= good for economy.


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ARGUMENTS AGAINST OF FULL CAPITAL

ACCOUNT CONVERTIBILITY

Local producers have to compete withInternational giants. So they lose market and

customers

(


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Counter-argument#1: Business is about

survival of the fittest, so perform or perish, noneed to get sentimental about Swadeshi.

Why should consumer pay for not-so-good

yet expensive domestic quality, if a foreigner

is offering better stuff at cheaper price?

Counter argument#2: If a few Indians lose

the customers, many more Indians get jobsin those new factories started by foreigners.


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What if foreigners buy lot of factories in

India and suddenly they find that investing

money in France is better than in India.

So they immediately sell all those factories,

et their Ru ees converted into Euro and run

away! Thatll lead to huge job loss andcollapse in Indian economy


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(Counter argument#1: Its a two way street: if

Foreigners can do that, Indians can also do it while

investing abroad.

(Counter argument#2: Sudden outflow of money

happens only when governing institutions have weak

foundations and policies. [e.g. when Govt. is busyfirefighting Sugar-Onion prices without any long-term

vision, it makes cronies get involved in speculative

business.If every country has sound economicpolicies, then itll be attractive to invest in every

country.


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Then there will be no sudden outflow or inflow

of money in any country and hence no-one will

be misusing the full capital account

convertibility.


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On which account does the

eye?


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There is no this or that answer.

Government needs to keep an eye on

both accounts to make changes intrade policies, tax rates etc.

But since Capital account inflows come

with a risk (of sudden outflow

collapsing the economy), soGovernment should keep a closer eye

on Capital account.

Documents

1. Trade Policy Reforms