INTRODUCTION The world economy is in the midst of a transformative change. One of the most visible outcomes

of this transformation is the rise of a number of dynamic emerging-market countries to the helm

of the global economy. It is likely that, by 2025, emerging economies—such as Brazil, China,

India, Indonesia, and the Russian Federation—will be major contributors to global growth,

alongside the advanced economies. As they pursue growth opportunities abroad and encouraged

by improved policies at home, corporations based in emerging markets are playing an

increasingly prominent role in global business and cross border investment. The international

monetary system is likely to cease being dominated by a single currency.

In this light it is strongly conceded that in the second half of the twentieth century, apart from the

international law on the use of armed force, no area of international law has generated as much

controversy as the law relating to foreign investment.1 Yet it has emerged as the most important

phenomenon in today's economic relations. In general terms foreign investment means the

transfer of tangible or intangible assets from one country into another for the purpose of use in

that country to generate wealth under the total or partial control of the owner of the assets. There

exist various different definitions of the term.2 Despite conflicting opinions of experts,3 the

international community led by the World Bank and IMF is continuously encouraging increment

of foreign exchange for the developing countries.4

1 WORLD BANK, LEGAL FRAMEWORK FOR THE TREATMENT OF FOREIGN INVESTMENT (1992).2 ENCYL. OF PUBLIC INT'L L. 246; I.M.F., BALANCE OF PAYMENTS MANUAL para. 408 (1980).3 The classical theory on foreign investment is based on the refutable assumption that it is wholly beneficial to the host country whereas the proponents of dependency theory reject it on the ground that it will not bring about meaningful economic development.4 MULTINATIONAL CORPORATIONS ARE ENTERPRISES WHICH OWN OR CONTROL PRODUCTION OR SERVICE FACILITIES OUTSIDE THE COUNTRY IN WHICH THEY ARE BASED, REPORT OF THE GROUP OF EMINENT PERSONS, U.N.Doc.E/5500/Add. 1 (1974).

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FOREIGN EXCHANGE

MeaningThe FEMA, 1999 defines the term 'foreign exchange' means "foreign currency and includes:- (i) 

deposits, credits and balances payable in any foreign currency; (ii) drafts, travellers cheques,

letters of credit or bills of exchange, expressed or drawn in Indian currency but payable in any

foreign currency; (iii) drafts, travellers cheques, letters of credit or bills of exchange drawn by

banks, institutions or persons outside India, but payable in Indian currency".5

Foreign exchange marketThe foreign exchange market is global, and it is conducted over-the-counter (OTC) through the

use of electronic trading platforms, or by telephone through trading desks. Some shorten the

term to “forex” or “FX”.6 Trading forex is buying one currency while at the same time selling a

different currency. Some companies who do business in other countries use forex markets to

convert profits from foreign sales into their domestic currency. Other reasons for trading forex

include speculation for profit, or to hedge against currency fluctuations.

Forex CurrencyThe most crucial component of the foreign exchange market is forex currency, which is bought

and sold in the foreign exchange marketplace. The transaction of FX currency involves the

exchange of currencies of various nations. Fluctuations in the value of a currency against that of

another offer forex traders opportunities to earn profits.7

An international currency serves to invoice imports and exports, to anchor the exchange rate of

currencies pegged to it, to effectuate cross-border payments, and to denominate international

assets and liabilities (official foreign exchange reserves, private claims, and sovereign debt). In

addition, just as domestic money serves as an alternative to bartering, an international currency

can serve as a “vehicle currency” for trading between pairs of currencies for which the liquidity

of the bilateral market is limited. Such uses are reinforcing, because currencies used for pricing

are also likely to serve as means of payment.

The supply of international currencies is influenced by the actions of governments to allow

international use and to provide the institutional and policy underpinnings that encourage the

development of financial markets and produce macroeconomic stability (Tavlas 1991). Without

5 Section 2(n), Foreign Exchange and Management Act, 1999.6 http://www.pfgbest.com/services/forex/foreignexchangebasics.pdf7 http://www.economywatch.com/forex/

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the existence of markets in various financial instruments and a reasonable amount of investor

confidence in accessing them, the currency’s usefulness in the international realm is limited.

Introducing Indian Currency: The Indian currency is known as the Rupee (International Symbol

– INR), which is divided into 100 paise. The rupee is fully convertible on the trade front under

the liberalized exchange rate management system (“LERMS”)8. All transactions under the

LERMS will take place at market-determined rates. The rupee is fully convertible on current

account. On the capital account also the rupee is gradually being made fully convertible with

residents permitted to invest abroad subject to the completion of certain formalities and non-

residents permitted to invest in most sectors except few sectors like defence etc.

Although, holding of foreign currency is permitted, but around the world, the quantity and the

amount of such holding is regulated by the respective host country wherein a member holds

forex.

Basis traits of the Foreign Exchange Market Accessibility – It’s no wonder that the Forex market has the trading volume of 3

trillion a day ‐ all anyone needs to take part in the action is a computer with an

internet connection.9

24 Hour Market ‐ The Forex market is open 24 hours a day, so that one can be right

there trading whenever one hears a financial scoop.

Narrow Focus – Unlike the stock market, a smaller market with tens of thousands of

stocks to choose from, the Forex market revolves around more or less eight major

currencies. A narrow choice means no rooms for confusion, so even though the

market is huge, it’s quite easy to get a clear picture of what’s happening.

Liquidity ‐ The foreign exchange market is the largest financial market in the world

with a daily turnover of just over $3 trillion! Now apart from being a really cool

statistic, the sheer massive scope of the Forex market is also one of its biggest

advantages. The enormous volume of daily trades makes it the most liquid market in

the world, which basically means that under normal market conditions you can buy

and sell currency as you please.

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The Market Can’t Be Cornered ‐ The colossal size of the Forex market also makes

sure that no one can corner the market. Even banks don’t have enough pull to really

control the market for a long period of time, which makes it a great place for the little

guy to make a move.10

10 http://www.etoro.com/learn/eToro-Forex-Trading-Guide.pdf

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INTERNATIONAL GOVERNING AUTHORITIES 5PGThere are few guidelines and norms regulating the foreign investment regime and corporate

conduct. Though they don't have any legal binding force, these could be regarded as gentlemen's

agreement and expected to be followed by the international community.

International Monetary FundNeeds small intro that it deals with the regulaton of forex in internatonl arena

IMF released the Guidelines for Foreign Exchange Reserve Management in September 2001.

The Guidelines for Foreign Exchange Reserve Management have been developed as part of a

broader work program undertaken by the Fund to help strengthen the international financial

architecture, to promote policies and practices that contribute to stability and transparency in the

financial sector and to reduce external vulnerabilities of member countries.11 It high lights the

importance of foreign exchange reserve and the objectives that can be attained thereby.12

The guidelines are intended to assist governments in strengthening their policy frameworks for

foreign reserve management so as to help increase their country's resilience to shocks that may

originate from global financial markets or within the domestic financial system. The aim is to

help the authorities to articulate appropriate objectives and principles for reserve management

and build adequate institutional and operational foundations for good reserve management

practices.

IMF has stated that the objective of Reserve management should seek to ensure that: (i) adequate

foreign exchange reserves are available for meeting a defined range of objectives; (ii) liquidity,

market, and credit risks are controlled in a prudent manner; and (iii) subject to liquidity and other

risk constraints, reasonable earnings are generated over the medium to long term on the funds

invested.

Impact of the guideline, are they binding, india’s stand on the guideline.

The World Bank Guidelines on Foreign InvestmentThe guidelines are based on the philosophy that "the greater flow of foreign exchange brings

substantial benefits to bear on the world economy and on the economies of developing countries

in particular".13

11 Preface, IMF Guidelines, www.IMF.org 12 What is Reserve Management and Why is it Important?, IMF Guidelines, www.IMF.org 13 WORLD BANK, 2 LEGAL FRAMEWORK FOR THE TREATMENT OF FOREIGN INVESTMENT (1992), reproduced in 31 I.L.M. 1363 (1992).

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OECD GuidelinesIn 1976, the OECD council of ministers adopted a recommendation entitled "The Declaration On

International Investment And Multinational Enterprises."14 As its name suggests, the overriding

purpose of the declaration was to promote foreign investment, calling on member countries to

respect national treatment, minimize conflicting requirements on TNCs by different governments

make transparent incentives and disincentives to investment and to enhance foreign exchange. 15

It is very interesting to note that the guidelines do not address the issue of compensating on part

of TNCs for any damage caused by their activities or for any violations which can have adverse

impact on a country’s GDP and thus welfare and development. Even the provision relating to

providing adequate education and training among employees16 and contributing to the

development of environmentally efficient public policy17 fall short of what is needed in this area.

Moreover, these are merely recommendations and do not have binding force.

UNCTADThe formation of regional economic groups does not contradict the principles underlying

multilateralism is evident from the fact that the very first United Nations Conference on Trade

and Development (UNCTAD) held in the early 1960's envisaged the role of regional economic

co-operation as potential instrument for accelerating economic growth in the developing

countries. The final act of the first UNCTAD conference held in 1964 stated: "Regional

Economic Groupings, integration or other forms of economic co-operation should be promoted

among developing countries as a means of expanding intra-regional and extra-regional trade and

encouraging their economic growth and their industrial and agricultural diversification with due

regard to the special features of development of the various countries concerned as well as their

economic and social systems".18

WTO(TRIMS) 1 pg

14 Organization for Economic Cooperation and Development (OECD), OECD Declaration on International Investment and Multinational Enterprises (July 3, 1998) available at http://www.oecd.org/daf/cmis/codes/declarat.htm. The OECD is mainly consisting of industrialized countries of the world.15 HUNTER ET AL., INTERNATIONAL ENVIRONMENTAL POLICY 1269 (2d ed. 2002).16 Art. 7. The OECD Guidelines for Multinational Enterprises (2000), available at http://www.oecd.org/dataoecd/56/36/1922428.pdf.17 Art. 8., The OECD Guidelines for Multinational Enterprises (2000), available at http://www.oecd.org/dataoecd/56/36/1922428.pdf.18

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NATIONAL GOVERNING AUTHORITIES TOTAL 5 PG

RBI

GOI(DIPP)

SEBI for FII

Illustration of exercising of powers

These governing authorities have been bestowed power under different situations. Like under

Section 5 of Foreign Exchange Management Act, 1999, certain rules have been framed for

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drawal of foreign exchange on current account. According to the said rules, drawal of foreign

exchange for certain transactions is prohibited. In respect of certain transactions drawal of

foreign exchange is permissible with the prior approval of Central Government. In respect of

some of the transaction, prior permission of RBI is sufficient for drawal of foreign exchange.

For example, (i) in respect of Payment of commission on exports made towards equity

investment in wholly owned subsidiary abroad of an Indian Company, is prohibited.(ii) Drawal

of foreign exchange for remittance of hiring charges of transponder, can be made with the prior

approval of the Central Government. (iii) So far as remittance for use of Trade Mark in India is

concerned, the necessary foreign exchange can be obtained with the prior permission of the

Reserve Bank of India.

In the case of (ii) & (iii) above, approval of concerned authority is not required if the payment is

made out of funds held in Resident Foreign Currency (RFC) Account or Exchange Earner’s

Foreign Currency (EEFC) Account of the remitter. Further foreign Exchange can be drawn only

from an ‘authorised person’19.

LAWS GOVERNING FOREIGN EXCHANGE IN INDIAThere is a German word called zeit-geist which, it can broadly be translated as the ‘spirit of

time’.20 Nothing better describes the evolution of foreign exchange regulation in India. There are

several ancillary laws dealing in foreign exchange and management, in specific there are four

which deal with foreign exchange per se:

The conservation of Foreign Exchange and Prevention of smuggling Activities Act, 1974;

The Foreign Exchange and Management Act, 1999;

The Smugglers and Foreign Exchange Manipulators (Forfeiture of Property) Act, 1976

and

The Foreign Traade (Development and Regulation) Act, 1992.

For the purpose of the present paper, the researcher is focusing only of the FEMA, 1999.

19 20

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FOREIGN EXCHANGE AND MANAGEMENT ACT, 1999In India, all transactions that include foreign exchange are regulated by the Foreign Exchange

Management Act (FEMA), 1999. It repealed the Foreign Exchange Regulations Act

(FERA),1973. FEMA has been enacted to facilitate external trade and payments and to promote

the orderly development and maintenance of foreign exchange market. It applies to all

branches,offices and agencies outside India,owned or controlled by a person resident in India.

History: From Regulation to Managment

Scenario when FERA was enacted

A quarter Century ago, FERA was enacted in 1973 when scenario called for a strict and rigid

regulatory regime.

o Foreign exchange was scarce.

o There were instances of misuse of foreign exchange.21

o India’s foreign trade was not substantial compared to what it is today, it was very

limited.

o The process of globalization had not yet started.

In such scenario, there was apprehension that regulations would be circumvented by

unscrupulous persons. Such apprehension led to enactment of Foreign Exchange Regulation Act,

1973 as a comprehensive piece of legislation. FERA was administered ruthlessly by overzealous

officers of Enforcement.22

Soon after independence, a complex web of controls imposed for all external transactions

through a legislation i.e., Foreign Exchange Regulation Act (FERA), 1947.23 The original 1947

version of FERA, enacted under the Defense of India Rules, 1939 and wartime shortage of

foreign Exchange, was meant to be temporary. In 1957, when planned economic development

failed to eliminate such shortages, FERA permanently entered the statute book. The Foreign

Exchange Regulation Act, 1947 was far less draconian than its 1973 incarnation. Foreign

Exchange Regulation Act, 1973, consisted of more rigorous framework of control.24

21 22 Dilip K. Sheth, TREATISE ON FEMA (Law and Practice), Vol. 1,1st edn. 2002, p. 3.23 Shyamala Gopinath, “Foreign exchange regulatory regimes in India- from control to management”,www.bis.org/review/r050217h.pdf (October 20, 2011)24 Dilip K. Sheth, TREATISE ON FEMA (Law and Practice), Vol. 1,1st edn. 2002, p. 2.

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Severe restrictions on current account transactions had continued till mid-1990s when relaxations

were made in the operations of the FERA. The control framework was essentially transaction

based in terms of which all transactions in foreign exchange including those between residents

and non-residents were prohibited, unless specifically permitted.25

Unlike other laws where everything is permitted unless specifically prohibited, under Foreign

Exchange Regulation Act, 1973 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. Under Foreign Exchange Regulation Act, 1973, a person was presumed guilty unless he

proved himself innocent whereas under other laws, a person is presumed innocent unless he is

proven guilty.

Scenario 25 years later

After passage of 25 years, however the entire Scenario which prevailed in 1973 underwent a

change.

o Internal economic controls had been progressively relaxed.

o Externally, the process of globalization had gained momentum.

o India’s foreign trade had substantially increased. Its economy and market had become

substantially stronger and vibrant.

Time had thus come to take serious re-look at Foreign Exchange Regulation Act, 1973. The

government of India took a step towards liberalization by announcing the New Industrial Policy

in 1991 to remove obstacles in the inward flow of foreign exchange.26 Steps were taken to

rationalize Foreign Exchange Regulation Act, 1973. While it was necessary to continue to

regulate activities of foreign companies or branches of such companies and foreign citizens in

India, special restrictions in respect of the companies registered in India were considered no

longer necessary, and the regulations on foreign investment needed simplification to attract

greater flow of foreign capital and investment. It was considered necessary to empower Reserve

Bank to impose penalties on authorized dealers for their lapses with a view to achieve effective

monitoring and ensuring compliance of its directions.

25

26

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The government had already indicated its intention in this respect by issuing notifications

through the Reserve Bank in exercise of its powers under Foreign Exchange Regulation Act,

1973.27 Along with the said principal objective, a number of other objectives were also taken into

account while overhauling Foreign Exchange Regulation Act, 1973. What was done so far

through notifications however had left a lurking apprehension in the minds of the foreign

investors, particularly from Japan. Their apprehension was that the piecemeal relaxation in

Foreign Exchange Regulation Act, 1973 through notifications may not have the same legal force

as the amendment to Foreign Exchange Regulation Act, 1973 itself.

To dispel such apprehension expressed by the circumspect foreign investors, the Government

eventually decided that Foreign Exchange Regulation Act, 1973 be formally amended so as to

give legal shape to the changes, most of which were already made in FERA, 1973 through the

notifications issued by the Reserve Bank since the advert of New Industrial Policy in July, 1991.

The FERA (Amendment) Bill was slated for discussion in the winter session of Parliament.

However, the Ayodhaya muddle28 did not allow the introduction of the Bill. The Government,

indeed, meant business and, therefore, it preferred not to wait till the next session of Parliament

for passing the FERA (Amendment) Bill. Accordingly an Ordinance was promulgated on 8th

January, 1998 by the President, Dr. Shankar Dayal Sharma. The amendment to various

provisions of FERA, 1973 came into effect immediately on the promulgation of the Ordinance.

Eventually in the Budget session of Parliament in March, 1993, the FERA Amendment Bill

(which could not be taken up for consideration in the earlier parliament session) was introduced

and passed by both the houses on March 24, 1993. This is how the Foreign Exchange Regulation

Act (Amendment) Act, 1993 was enacted with the provisions which were substantially similar to

those of the Ordinances.29

Foreign Exchange Regulation Act 1973, was enacted at a time when there was dearth of foreign

exchange in India and the main aim behind the enactment was to restrict the outflow of foreign

exchange from India. As a result it was made very stringent. With the growth of Foreign trade

and commerce the foreign exchange reserve (FOREX) position of our country improved

considerably.

27 Section 73(3), Foreign Exchange Regulation Act, 1973.28 29

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The provisions of Foreign Exchange Regulation Act, 1973 were becoming draconian, unrealistic

and anachronistic. This was accepted by the authorities and Foreign Exchange Management Act,

1999 was enacted. The objective of Foreign Exchange Management Act, 1999, was to

consolidate and amend the relating to foreign exchange with the objective of facilitating external

trade and payments and for promoting the orderly development and maintenance of foreign

exchange market in India. The law relating to exchange control in India has undergone a

substantial change in scope, content and approach by the substitution of the Foreign Exchange

Regulation Act, 1973 ( FERA ) by the Foreign Exchange Management Act, 1999 ( FEMA ),

which was passed in winter session of the Parliament in 1999.

The bill was introduced in the 13th Lok Sabha on 25th Oct'99. The presidential Assent was

received on 6th Jan 2000. Finally the Foreign Exchange Management Act, 1999, came into

operation w.e.f. 1st June 2000.The most noticeable aspect of Foreign Exchange Management

Act, 1999, is that there is no imprisonment prescribed for contraventions of the law, not even as

an alternative punishment and for the blatant and deliberate of violations.30 Foreign Exchange

Regulation Act, 1973, 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 Foreign Exchange Regulation Act, 1973, was a criminal offence liable to

imprisonment, whereas Foreign Exchange Management Act, 1999, seeks to make offenses

relating to foreign exchange civil offenses.31

The provisions of Foreign Exchange Management Act displays so much change that one could

almost de link Foreign Exchange Management Act, 1999, from Foreign Exchange Regulation

Act, 1973 and concludes that Foreign Exchange Management Act, 1999 is a new law altogether

which needs an independent reading and interpretation divorced from the earlier law and

decisions rendered there under.

The approach has sifted from that of conservation of foreign exchange to one of facilitating trade

and payments, as well as developing orderly foreign market. This definitive shift in the

objectives of foreign exchange management could be seen in the preamble to the new

legislation.32 Important aspects of transition were: Capital account convertibility, timeframe for

30 http://www.welcome-nri.com/info/project/femaact1.htm (October 20, 2011).31 32 Rama Devi R. Iyer, “Compounding of contraventions under Foreign Exchange Management Act, 1999(FEMA)”,[2006] 72 SCL…(ST.), p. 126.

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convertibility, the recommendations of Tarapore Committee and symptoms of the currency

crisis. For a clear perception of implications of the transition from FERA, 1973 to Foreign

Exchange Management Act, 1999, these aspects should be reviewed.33

Foreign Exchange Management Act, 1999, which has replaced Foreign Exchange Regulation

Act, 1973, had become the need of the hour since Foreign Exchange Regulation Act, 1973 had

become incompatible with the pro-liberalization policies of the Government of India. Foreign

Exchange Management Act, 1999, has brought a new management regime of Foreign Exchange

consistent with the emerging frame work of the World Trade Organization (WTO). It is another

matter that enactment of Foreign Exchange Management Act, 1999, also brought with it

Prevention of Money Laundering Act, 2002 which came into effect recently from 1st July, 2005

and the heat of which is yet to be felt as “Enforcement Directorate” would be investigating the

cases under Prevention of Money Laundering Act, 2002, too.34

Regulatory Structure Under Fema, 1999This is the most significant part of Foreign Exchange Management Act, 1999. All the core

sections are contained in this part. It deals with the dealing in foreign exchange, current and

capital account transactions, export, realization and reparation of foreign exchange & exemption

in certain cases.

ObjectiveThe objectives of the Foreign Exchange Management Act, 1999 have been to consolidate and

amend the law relating to foreign exchange with the following objective:

a) a facilitating external trade and payments; and

b) for promoting the orderly development and maintenance of foreign exchange market in

India.

In Foreign Exchange Management Act, 1999, only the specified acts relating to foreign exchange

are regulated, while in FERA, 1973 anything and everything that has to do with foreign

exchange was controlled. Also the aim of Foreign Exchange Management Act, 1999, is

facilitating trade as against that of FERA, which was to prevent misuse.35

33 34 35 Chinubhai R. Shah and Ms. Komal Parikh, “FERA To FEMA: A Journey from forbidden lands to semi-openpatures”, [2000] Vol. 30 No.5, ICSI Executive Chartered Secretary, p. 590.

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Furthermore, the objectives of FERA and FEMA differed in the line that first, in virtually a

reverse transition to 1947, criminal remedies have been scrapped and replaced with civil

remedies. Second, Foreign Exchange Management Act, 1999, recognizes that foreign exchange

is no longer a scarce resource requiring its optimal utilization, thus facilitating current account

convertibility and eventual transition to the capital account convertibility. However, since

Foreign Exchange Management Act, 1999, is an enabling legislation, the degree of actual

liberalism can be judged only from the tenor of the regulations and rules which have been

notified.

Scope and ApplicabilityFERA, 1973, applied to:

a) All citizens, outside India.

b) Branches and agencies, outside India. - of the companies/bodies corporate registered

incorporated in India.

Now, FEMA, 1999 applies to36:

a) All branches, offices and agencies outside India -owned/ controlled by a person resident

in India and

b) Any FEMA, 1999 contravention committed outside India -by any person to whom

FEMA, 1999 applies.

FEMA, 1999 applies to the whole of India and hence, any transaction which takes place in India

will be subject to the governance of FEMA, 1999. Thus, any transaction undertaken by

nonresident in India would need compliance of FEMA, 1999. FEMA, 1999 also applies to the

branches, offices and agencies outside India owned or controlled by a person resident in India.

The question whether FEMA, 1999 would apply to the transactions of a resident individual

which took place outside India. There are several provisions, which restrict a resident from

certain transactions outside India, such as, acquisition of immovable property. Though the

branches, etc. of residents himself can carry out transactions abroad which are otherwise not

permitted to him in India. However, the word “also” in section 1(3) seems to suggest that the

transactions of a resident person outside India would be subject to FEMA, 1999.37

36 Section 1(3), Foreign Exchange Management Act, 1999.37

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DefinitonsThe following can be made out from analyzing the definition part of Foreign Exchange

Regulation Act, 1973, & Foreign Exchange Management Act, 1999:

1. Authorized dealers and money changers have been clubbed together under the

definition of ‘Authorized person’. In addition, it also includes a “offshore banking

unit’.

2. Definitions of capital account transaction and current account transaction have been

inserted keeping in mind the possibility of introduction of capital account

convertibility.

3. Definitions of export and import on similar lines as The Customs Act, 1962 have

been inserted.

4. Definition of the term ‘service’ similar to COPRA, 1986 has been inserted. This is

done keeping in mind the export services and infotech sectors.38

5. Definition of ‘person’ has been inserted and definition of ‘person resident in India’

has been aligned with the Income tax Act, 1961. This has probably been done

considering the difficulties arising due to different definitions and different

interpretations. All non-resident accounts with the banks were on the basis of the

definition in Foreign Exchange Regulation Act, 1973. Now, according to the Foreign

Exchange Management Act, 1999, definition, very few of them will be non-resident

accounts. However, the EXIM policy definition still remains different.

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Effects due to the change.

Under FERA, 1973, all violations were subject to separate investigation and adjudication of the

Directorate of Enforcement. However, the Foreign Exchange Management Act, 1999, provides

for an opportunity for seeking compounding of contraventions. It is pertinent to note that

application of law requires that discretionary powers have to be used in a just, fair and

reasonable manner and this is expected on the part of the Compounding Authorities while

following the provisions of the Foreign Exchange Management Act, 1999, and Rules framed

thereunder.39

Provision of Foreign Exchange Management Act, 1999, on dealing in foreign exchange40

provides that no person shall without the general or special permission of Reserve Bank of India,

deal in or transfer foreign exchange or foreign security to any person other than an authorized

person, make payment outside India or receive payment in any manner otherwise through an

authorized person on behalf of person resident outside India or enter into financial transaction in

relation to acquisition of assets outside India. FEMA, 1999 has also incorporated the explanation

to section 9(1)(b) of the erstwhile FERA, 1973 by covering the possibility of an Indian receiving

the payment on behalf of a person resident outside India. In such case the person shall be deemed

to have received such payment otherwise through an authorized person. This is retention of

explanation to section 991) (b) of the erstwhile FERA, 1973. This provision means that if Mr.

‘X’ , an Indian claims to have received an amount of USD 1,000 Or INR 1,000 ( both foreign

and/or domestic currencies) on behalf of Mr’Y’ a non resident through Mr. ‘Z’, an authorized

person, there should be present an actual inward remittance of USD 1,00 or INR 1,000 to back

39 40 Section 3, Foreign Exchange Management Act, 1999.

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the transaction. Otherwise, it smells collusion between the authorised person and the resident

Indian.41

Goods and Services

The provision of FEMA, 1999, dealing with export goods and services42 appears highly

simplified compared to similar provision of FERA, 1973,43 It requires the exporter to furnish to

the Reserve bank of India correct particulars including the export value of the goods/payment for

services, and where it is not ascertainable, value which the exporter expects to receive, other

information as the Reserve Bank of India may require. While similar provision of the erstwhile

FERA, 1973 attached a lot of anti under invoicing conditions to export and cover as many

deeming provisions on the part of both the Reserve Bank of India and the exporter and even then,

it did not cover services.44

Holding Foreign Exchnage

In India, the realized foreign exchange should be sold to an authorized person in India in

exchange for rupees.45 It also includes the holding of realised amount in an account with an

authorised person in India to the extent notified by the Reserve Bank and includes use of the

realised amount for discharge of a debts or liability denominated in foreign exchange.

Exemption from holding/repatriation:

Section 4 of the FEMA, 1999 prohibits holding of foreign exchange by a resident in India.

Section 8 requires that foreign exchange earned by a resident in India is realised and repatriated

to India. However, in the following cases, the foreign exchange can be held or need not be

repatriated to India:-

1. Possession of foreign currency – possession of foreign currency or foreign coins upto

limit prescribed by RBI is permitted (section 9(a))

2. Foreign currency account – Foreign currency account can be held and operated by such

persons and within such limits as specified by RBI (Section 9(b))

3. 3 Foreign currency acquired before July 1947 – Foreign exchange acquired or received

before 8th July 1947 or income arising or accruing thereon can be held outside India

(section 9(c))

41 42 Section 7, Foreign Exchange Management Act, 1999.43 Section 18, Foreign Exchange Regulation Act, 1973.44 Section 18, Foreign Exchange Regulation Act, 1973.45 Known as “‘Repatriate to India” defined under section 2(y) of the FEMA, Act 1999.

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4. Gift or inheritance – If such foreign exchange is acquired as a gift or inheritance, that

exchange and income arising therefrom can be held as foreign exchange in India or held

abroad and need not be repatriated (Section 9(d)).

5. Foreign exchange acquired abroad – Foreign exchange acquired from employment,

business, trade, vocation, services honorarium, gifts, inheritance, or any other legitimate

means can be held as foreign exchange in India or it need not be repatriated to India

subject to limits specified by RBI (Section 9(e))

6. Any other receipts specified by RBI (Section 9(f)).

According to Section 5 of FEMA, 1999 any citizen may sell or draw foreign exchange to or from

an authorised person if such sale or drawl is a current account transaction46. Provided that the

Central Government may in public interest and in consultation with the Reserve Bank, impose

such reasonable restrictions for current account transactions as may be prescribed. Further, any

person may sell or draw foreign exchange to or from an authorised person47 for a capital account

transaction48 subject to the provisions of section 6(2).

Under Section 5 of Foreign Exchange Management Act, 1999, certain rules have been framed for

drawal of foreign exchange on current account. According to the said rules, drawal of foreign

exchange for certain transactions is prohibited. In respect of certain transactions drawal of

foreign exchange is permissible with the prior approval of Central Government. In respect of

some of the transaction, prior permission of RBI is sufficient for drawal of foreign exchange.

i. In respect of item No.1 i.e. Payment of Commission on exports made towards equity

investment in wholly owned subsidiary abroad of an Indian company is prohibited.

46 47 48

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ii. Drawal of foreign exchange for remittance of hiring charges of transponder, can be

made with the prior approval of the Central Government.

iii. So far as remittance for use of Trade Mark in India is concerned, the necessary

foreign exchange can be obtained with the prior permission of the Reserve Bank of

India.

In the case of (ii) & (iii) above, approval of concerned authority is not required if the payment is

made out of funds held in Resident Foreign Currency (RFC) Account or Exchange Earner’s

Foreign Currency (EEFC) Account of the remitter. Further foreign Exchange can be drawn only

from an authorised person.

Contraventions and Penalties:

Under this chapter, penalty for any kind of contravention has been specified as thrice the amount

involved, where it is quantifiable, and otherwise, up to Rs 2lakhs + Rs. 5000 per day for

continuing contravention. The provision is in total contrast to the provision of the erstwhile

FERA, 1973 which provided for imprisonment and no limit on fine.49 Also, one question which

arises here is that where the alleged person is an authorized person, whether this fine will be in

addition to the one under section 11(3), of FEMA, 1999.

However, if the person does not pay the fine within 90 days from the date of notice, then after

formalities of show cause notice and personal hearing, he can be subjected to civil detention. If

he does not respond to the notice their can be warrant of arrest. The civil detention is on the

following lines where the amount involved exceeds there can be warrant of arrest. The civil

detention is on the following lines where the amount involved exceeds Rs. 1 crore, detention for

three years. Otherwise, six months. However, it is clearly civil detention and not imprisonment.50

This is a major diversion from FERA, 1973 which contained provisions that would lead to

imprisonment even in trivial cases. Perhaps the government is of the opinion that there should be

pecuniary punishment for economic offences, where that punishment is not complied with, then,

civil detention and if that is also not complied with, then a warrant of arrest.

Under the Foreign Exchange (Compounding Proceedings) Rules 2000, the Central Government

may appoint ‘Compounding Authority’ an officer either from Enforcement Directorate or

Reserve Bank of India for any person contravening any provisions of the FEMA. The

49 Section 56, Foreign Exchange Regulation Act, 1973.50 Section 14, Foreign exchange Management Act, 1999.

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Compounding Authorities are authorized to compound the amount involved in the contravention

to the Act made by the person. No contravention shall be compounded unless the amount

involved in such contravention is quantifiable. Any second or subsequent contravention

committed after the expiry of a period of three years from the date on which the contravention

was previously compounded shall be deemed to be a first contravention. The Compounding

Authority may call for any information, record or any other documents relevant to the

compounding proceedings. The Compounding Authority shall pass an order of compounding

after affording an opportunity of being heard to all the concerns as expeditiously and not later

than 180 days from the date of application made to the Compounding Authority. Compounding

Authority shall issue order specifying the provisions of the Act or of the rules, directions,

requisitions or orders made there under in respect of which contravention has taken place along

with details of the alleged contraventions.

For example, Mr. X, an Indian national has failed to realise and repatriate foreign exchange

worth more than Rs.2 crores. Mr. X having realised that he had committed a contravention of the

provisions of the Foreign Exchange Management Act, 1999, desires to compound the said

offence. Because of his failure to realise and repatriate foreign exchange, Mr. X has contravened

the provisions of section 8 of FEMA and he is liable to the penalties leviable under Section 13,

followed by adjudication proceedings. Section 15 of FEMA permits the offending party to

Director of Enforcement or such other officers of the Directorate of Enforcement and officers of

the Reserve Bank of India as may be authorised in this behalf by the Central Government in such

manner as may be prescribed. No contravention shall be compounded unless the amount

involved in such contravention is quantifiable. Where a contravention has been compounded, no

proceeding can continue or be initiated against the person in respect of the contravention so

compounded.

Adjudication and Appeals:

The following are the provisions which differ from FERA, 1973 and are incorporated in FEMA,

1999:

1. The Appellate Tribunal for Foreign Exchange has been granted powers to hear appeals

against the orders of both the adjudicating authorities as also the Special Director

(Appeals).51 There is no provision like other laws which requires following the hierarchy

51 Section 19, Foreign Exchange Management Act, 1999.

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or qualification of a case as fit for hearing by the appellate tribunal. This means the

aggrieved person can choose to appeal directly to the appellate tribunal against the order

of the adjudicating authorities. The objective behind the introduction of an intermediary

authority like the Special Director (Appeals) is not clear.

2. The Chairperson of the Appellate Tribunal is empowered to transfer cases from one

bench to another, but only on the application of any of the parties and after notice to

them.52

3. Civil court will not have any jurisdiction to entertain any suit or proceeding which an

Adjudicating authority, Special Director (Appeals) or the Appellate tribunal are

empowered to determine under this act.53

Directorate of Enforcement54:

This chapter envisages the appointment of all officers included under the erstwhile FERA,

1973.55

The powers of search and seizure conferred by FEMA, 199956 are limited only to contraventions

mentioned in FEMA, 1999.57 Also, many other strict provisions relating to searches and seizures,

which were similar to Customs Act, 1962 have been withdrawn. This will relieve the industry,

trade and commerce from the autocracy of the office of Director of Enforcement, which had been

alleged to be the dwelling place of corruption due to unlimited powers granted to it.58

Miscellaneous:

The not so normal provision in this area is that any right, obligation, liability, proceeding or

appeal arising in relation to penalty59 will not abate with the death or insolvency of the person,

but will be shifted to the legal representative, official receiver or official assignee. But the terms

“winding up” or “liquidation” and “official liquidator” are nowhere to be found although the

term “person” includes a Company.60

52 Section 30, Foreign Exchange Management Act, 1999.53 Section 34, Foreign Exchange Management Act, 199954 Chapter IV, Sections 36-38, Foreign Exchange Management Act, 199955 Section 3, Foreign Exchange Regulation Act, 197356 Section 37, Foreign Exchange Management Act, 1999.57 section 13, Foreign Exchange management Act, 1999.58 Foreign Exchange Management Manual, 200759 Section 13, Foreign Exchange Management Act, 1999.60

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In totality, following can be made out:

1. FEMA, 1999 is much smaller enactment- 49 sections, as against 81 sections of FERA,

1973.

2. The theme of FERA, 1973 was : ‘everything that is specified is under control’. While

the theme of FEMA, 1999, is: ‘everything other than what is expressly covered is not

controlled’. Thus there is a lot of deregulation.

3. In many process of simplification, many of the “laid downs” of the erstwhile FERA,

1973 have been withdrawn.

4. Many provisions of FERA, 1973 like the ones relating to blocked accounts, Indians

taking up employment abroad, employment of foreign technicians in India, contract in

evasion of the act, vexatious search, culpable mental state etc. have no appearance in

FEMA, 1999.61

Obligations of the ExporterWith the governing authorities in place, there also exists simultaneous obligation and

responsibility on the exporter himself to ensure compliance of the laws. Thus, the duties of every

exporter of goods and services under FEMA, 1999 are:

(i) Furnishing of Information:- Every exporter of goods is required the furnish to RBI or

other prescribed authority a declaration containing true and correct material particulars,

including the amount representing full export value. If full exportable value is not

ascertainable at the time of export due to prevailing market conditions, the exporter shall

indicate the amount he expects to share indicate the amount he expects to receive on sale

of goods in a market outside India. The exporter of goods shall also furnish to RBI such

other information as may be required by RBI for the purpose of ensuring realization of

export proceeds by such exporter [section 7(i)]. RBI can direct any exporter to comply

with prescribed requirements to ensure that full export value of the goods or such

reduced value of the goods as RBI determines, is received without delay [section 7(2)].

Every exporter of services shall furnish to RBI or other prescribed authority a

declaration containing true and correct material particulars in relation to payment of

such services [section 7(3)].

61

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(ii) Realisation and repatriation of foreign exchange: Where any amount of foreign

exchange is due or has accrued to any resident in India, such person shall take all

reasonable steps to realize and repatriate to India the foreign exchange within such

period and in such manner as may be specified by RBI (section 8). Exporter of goods

and services must comply with the requirements of section 7 and 8 of FEMA, 1999

and also with the requirements under Foreign Exchange Management (Export of

Goods and Services) Regulations, 2000.

Change in the Economy.

Globalization has many meanings depending on the context and on the person who is talking

about. Though the precise definition of globalisation is still unavailable a few definitions are

worth viewing, Guy Brainbant62: says that the process of globalisation not only includes opening

up of world trade, development of advanced means of communication, internationalisation of

financial markets, growing importance of MNC’s, population migrations and more generally

increased mobility of persons, goods, capital, data and ideas but also infections, diseases and

pollution.63 The term globalization refers to the integration of economies of the world through

uninhibited trade and financial flows, as also through mutual exchange of technology and

knowledge. Ideally, it also contains free inter-country movement of labour. In context to India,

this implies opening up the economy to foreign direct investment by providing facilities to

foreign companies to invest in different fields of economic activity in India, removing

constraints and obstacles to the entry of MNCs in India, allowing Indian companies to enter into

foreign collaborations and also encouraging them to set up joint ventures abroad; carrying out

massive import liberalisation programs by switching over from quantitative restrictions to tariffs

and import duties, therefore globalization has been identified with the policy reforms of 1991 in

India.

Major measures initiated as a part of the liberalisation and globalisation strategy in the early

nineties included Allowing Foreign Direct Investment (FDI) across a wide spectrum of industries

and encouraging non-debt flows. The Department has put in place a liberal and transparent

foreign investment regime where most activities are opened to foreign investment on automatic

route without any limit on the extent of foreign ownership. Some of the recent initiatives taken to

62 63

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further liberalise the FDI regime, inter alias, include opening up of sectors such as Insurance

(upto 26%); development of integrated townships (upto 100%); defence industry (upto 26%); tea

plantation (upto 100% subject to divestment of 26% within five years to FDI); enhancement of

FDI limits in private sector banking, allowing FDI up to 100% under the automatic route for

most manufacturing activities in SEZs; opening up B2B e-commerce; Internet Service Providers

(ISPs) without Gateways; electronic mail and voice mail to 100% foreign investment subject to

26% divestment condition; etc. The Department has also strengthened investment facilitation

measures through Foreign Investment Implementation Authority (FIIA).

Foreign Exchange leading to Integration with International Economy: Globalization, Welfare and Sustenance Integration of financial markets is a process of unifying markets and enabling convergence of

risk adjusted returns on the assets of similar maturity across the markets. The process of

integration is facilitated by an unimpeded access of participants to various market segments.

Financial markets all over the world have witnessed growing integration within as well as across

boundaries, spurred by deregulation, globalisation and advances in information technology.

Central banks in various parts of the world have made concerted efforts to develop financial

markets, especially after the experience of several financial crises in the 1990s. As may be

expected, financial markets tend to be better integrated in developed countries. At the same time,

deregulation in emerging market economies (EMEs) has led to removal of restrictions on pricing

of various financial assets, which is one of the pre-requisites for market integration. Capital has

become more mobile across national boundaries as nations are increasingly relying on savings of

other nations to supplement the domestic savings.64 Harmonization of prudential regulations in

line with international best practices, by enabling competitive pricing of products, has also

strengthened the market integration process.

Integrated financial markets assume vital importance for several reasons. First, integrated

markets serve as a conduit for authorities to transmit important price signals (Reddy, 2003).

Second, efficient and integrated financial markets constitute an important vehicle for promoting

domestic savings, investment and consequently economic growth (Mohan, 2005). Third,

financial market integration fosters the necessary condition for a country’s financial sector to

64 http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/77579.pdf

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emerge as an international or a regional financial centre (Reddy, 2003). Fourth, financial market

integration, by enhancing competition and efficiency of intermediaries in their operations and

allocation of resources, contributes to financial stability (Trichet, 2005). Fifth, integrated markets

lead to innovations and cost effective intermediation, thereby improving access to financial

services for members of the public, institutions and companies alike (Giannetti et al., 2002).

Sixth, integrated financial markets induce market discipline and informational efficiency.

Seventh, market integration promotes the adoption of modern technology and payment systems

to achieve cost effective financial intermediation services.

An important objective of reforms in India has been to integrate the various segments of the

financial market for bringing about a transformation in the structure of markets, reducing

arbitrage opportunities, achieving higher level of efficiency in market operation of intermediaries

and increasing efficacy of monetary policy in the economy (Reddy, 1999, 2005d). Efficient

allocation of funds across the financial sector and uniformity in the pricing of various financial

products through greater inter-linkages of financial markets has been the basic emphasis of

monetary policy (Mohan, 2005). In the domestic sphere, integration of markets has been pursued

through strengthening competition, financial deepening with innovative instruments, easing of

restrictions on flows or transactions, lowering of transaction costs and enhancing liquidity.

Financial markets in India have also increasingly integrated with the global financial system as a

result of calibrated and gradual capital account liberalisation in keeping with the underlying

macroeconomic developments, the state of readiness of the domestic financial system and the

dynamics of international financial markets (Reddy, 2005a).65

Worldwide, foreign direct investment (FDI) represents a major source of funding for capital

intensive projects. This is more so for emerging economies including India. As a result of

persistent tapping of this source of fund by emerging economies in the last two decades, the FDI

level as of now stands at approximately 35 percent of global FDI in emerging economies. 66 In

1991, India adopted a massive liberalization program and since then FDI inflow has been

increasing tremendously in India. The main objective of the liberalization program was to bring

stability, economic growth and development via the liberalization, privatization and globalization

(LPG) program. The liberalization policy of Indian Government of 1991 emphasized undertaking

65 66

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regulatory measures such as deregulations, tax reforms, initiation of privatization and opening

Indian economy to investments from abroad. Implicitly, it resulted in restructuring of its previous

trade regime to ensure greater integration of the Indian economy with other international

economies.67

Since 1991, Indian economy has made rapid strides towards integration with world economies

and has been able to establish a mutually beneficial inter-linkage with them. In a way, the major

structural changes under the economic liberalization program continued till 1995. As India

moved from policies of import substitution to export promotion, it was able to attract more and

more FDI. In addition, several other factors favoured Indian economy such as economic growth

above global average, fast growing population with ever increasing young population and

consumers, lower interests rates and relatively stable financial systems, lower wages and

production costs, low inflation rate and increasingly reformed exchange rate system, etc. These

factors ensured that India continued to attract an increasingly large chunk of FDI and as of now,

India has become the second favorite destination for FDI inflows for next three years (Ernst &

Young, 2010).68

STRENGTHENING DOMESTIC REGULATIONS

Perhaps the most realistic recommendation is to strengthen the domestic environmental

regulation of developing countries. Again, a human rights approach to address environmental

degradation issues caused by foreign invest-ment must be incorporated in the domestic

legislation. Governments will be bound to create pressure on corpora-tions if they are under

public scrutiny. If we look at the statistics of foreign investment,69 developed coun-tries are on

both ends of exporting and receiving foreign investment. The reason they praise the notion of

foreign investment is partly the strict environmental regulations that prevent them from

endangering their eco-system. However, a question may arise about how this would solve the

problem of corrupt governments ignoring pub-lic opinion as in many developing countries.

67 Monica Singhania and Akshay Gupta, Determinants of foreign direct investment in India, J.I.T.L. & P. 2011, 10(1), 64-8268 Monica Singhania and Akshay Gupta, Determinants of foreign direct investment in India, J.I.T.L. & P. 2011, 10(1), 64-8269 "Top five outward investors countries are USA (24%), UK (14%), Germany (11%), France (7%) and Japan (6%); investment recipients are USA (24%), China (10%), UK (8%), France (6%) and Belgium (4%);" DUNOFF ET AL., INTERNATIONAL LAW: NORMS, ACTORS, PROCESS: A PROBLEM ORIENTED APPROACH (2000).

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F. EXTRATERRITORIALITY OF JURISDICTION

The mandatory provision of home country jurisdiction over corporations in the absence of

adequate remedy from other forums could prove to be fruitful in this area of law. The idea is to

propose the flipside of foreign direct in-vestment--foreign direct liability. Powerful nations have,

however, invented processes to avoid that kind of jurisdic-tion.70 The bilateral investment

agreements or multilateral agreement on investment can include detailed provisions to this effect.

It is important to note that the preference should be given to the victim's choice of forum and it

should not pose any threat to sovereignty of the affected state.

Impacts Of Globalization

Indian economy had experienced major policy changes in early 1990s. The new economic

reform, popularly known as, Liberalization, Privatization and Globalization (LPG model) aimed

at making the Indian economy as fastest growing economy and globally competitive. The series

of reforms undertaken with respect to industrial sector, trade as well as financial sector aimed at

making the economy more efficient.71

"(G)lobalization must mean more than creating bigger markets. To survive and thrive, a global

economy must have a more solid foundation in shared values and institutional practices."72

Positive Impact

Globalization is the new catchphrase in the world economy, dominating the globe since the

nineties of the last century. People relied more on the market economy, had more faith in private

capital and resources, international organizations started playing a vital role in the development

of developing countries. The impact of globalization has been fair enough on the developing

economies to a certain extent. It brought along with it varied opportunities for the developing

70 The use of the forum non conveniens doctrine by United States courts in cases like In re Union Carbide Corp. Gas Plant Disaster at Bhopal India in Dec. 1984, 634 F. Supp. 842 (S.D.N.Y. 1986) and Dow Chemical Co. v. Alfaro, 786 S.W.2d 674 (1990); and the Law of Comity doctrine in cases like Sequihua v. Texaco, 847 F. Supp. 61 (S.D. Tex. 1994) and Aquinda v. Texaco, 945 F. Supp. 625 (S.D.N.Y 1996); and the various restrictions on availing the Alien Torts Claims Act before the 1980s can be considered in this context. The Alien Tort Claims Act provides that district courts shall have jurisdiction over civil actions "by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States." Alien Tort Claims Act, 28 U.S.C. 1350 (1988).71 Dr. C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister, RESPONDING TO GLOBALIZATION: INDIA’S ANSWER, at 4th Ramanbhai Patel Memorial Lecture on Excellence in Education, February 25, 2006 available at www.eac.gov.in 72 Kofi Annan's Millennium Declaration obtained from www.un.org.

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countries. It gave a fillip for better access to the developed markets. The technology transfer

promised better productivity and thus improved standard of living.

Negative Impact

Globalization has also thrown open varied challenges such as inequality across and within

different nations, volatility in financial market spurt open and there were worsening in the

environmental situation. Another negative aspect of globalization was that a majority of third

world countries stayed away from the entire limelight. Till the nineties, the process of

globalization in the Indian economy had been guarded by trade, investment and financial

barriers. Due to this, the liberalization process took time to hasten up. The pace of globalization

did not start that smoothly.

Economic integration by 'globalization' enabled the cross country free flow of information, ideas,

technologies, goods, services, capital, finance and people. This cross border integration had

different dimensions - cultural, social, political and economic. More or less the economic

integration happened through four channels -

o Trade in goods and services

o Movement of capital

o Flow of finance

o Movement of people

Advantages of globalization

The gains from globalization can be cited in the context of economic globalization:

Trade in Goods and Services - From the theoretical aspect, international trade ensures

allocating different resources and that has to be consistent. This specialization in the

processes leads to better productivity. We all know from the economic perspective that

restrictive trade barriers in emerging economies only impede growth. Emerging

economies can reap the benefits of international trade if only all the resources are utilized

in full potential. This is where the importance of reducing the tariff and non-tariff barriers

crop up.

Movement of Capital - The production base of a developing economy gets enhanced due

to capital flows across countries. It was very much true in the 19th and 20th centuries.

The mobility of capital only enabled savings for the entire globe and exhibited high

investment potential. A country's economic growth doesn't, however, get barred by

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domestic savings. Foreign capital inflow does play an important role in the development

of an economy. To be specific, capital flows either can take the form of foreign direct

investment or portfolio investment. Developing countries would definitely prefer foreign

direct investment because portfolio investment doesn't have a direct impact on the

productive capacity expansion.

Financial Flows - The capital market development is one of the major features of the

process of globalization. We all know that the growth in capital and mobility of the

foreign exchange markets enabled better transfer of resources cross borders and by large

the global foreign exchange markets improved. It is mandatory to go in for the expansion

of foreign exchange markets and thus facilitate international transfer of capital. The

major example of such international transfer of funds led to the financial crisis - which

has by now become a worrying phenomenon.

Thus, globalization has the fair and rough share of its impacts and thus we can surely hope for

more advancement in the global economy due to this process.

Foreign exchange leading to welfare:

In theory:

A financial system consists of financial institutions—e.g., commercial banks—and financial

markets—e.g., stock and bond markets. At a broader level, a robust and efficient financial

system promotes growth by channeling resources to their most productive uses and fostering a

more efficient allocation of resources. A stronger and better financial system can also lift growth

by boosting the aggregate savings rate and investment rate, speeding up the accumulation of

physical capital.

Financial development also promotes growth by strengthening competition and stimulating

innovative activities that foster dynamic efficiency. According to Demirgüç-Kunt and Levine

(2008), the overall function of a financial system is to reduce information and transactions costs

impeding economic activity, and its five core functions are to (i) produce ex ante information

about possible investments and allocate capital; (ii) monitor investments and provide corporate

governance after providing finance; (iii) facilitate the trading, diversification and management of

risk; (iv) mobilize and pool savings; and (v) ease the exchange of goods and services.

In evidence:

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Economic theory and intuition suggest a number of plausible channels through which financial

development can have a positive effect on economic growth. Predictably, a large and growing

empirical literature has sprung up to examine the relationship between finance and growth. At a

broader level, the literature looks at the impact on gross domestic product (GDP) growth of (i)

the depth of the financial system, as measured by indicators such as the ratio of total liquid

liabilities to GDP, the ratio of bank credit to GDP, or the ratio of stock market capitalization to

GDP; and (ii) the structure of the financial system, as measured by indicators such as the ratio of

bank credit to stock market capitalization. The balance of evidence from the empirical literature

strongly indicates that financial depth has a significant positive effect on growth whereas

financial structure (the relative weight of banks versus capital markets) does not have any

appreciable effect Financial Development and Economic Growth in Developing Asia on growth.

More specifically, bank development and stock market development exerts a significant positive

effect on growth, as does overall financial development. Although a shift from banks to capital

markets is often viewed as evidence of financial development, countries with market-based

financial systems do not perform better than those with bank-based systems.

Conclusively, Critics of economic globalization have identified that the competition between

countries for investment may result in a neglect of environmental concerns; that national

governments are gradually losing their influence over important domestic issues; and that

globalization undermines the traditional balance of power between rich and poor.73

In the Brundtland Report, the commission recognized two key concepts of sustainable

development. One of them is the concept of needs, in particular the essential needs of the world's

poor, to which overriding priority should be given. The other is the idea of limitations imposed

by the state of technology and social organization on the envi-ronment's ability to meet present

and future. Thus, foreign investment could be called an effective tool of achieving sustainable

development if it meets the criteria.

However, the reality remains far from satisfying. Whereas the positive role of foreign investment

in alleviating poverty is facing uncertainty from various economists, many times they can be

seen as contradictory forces against sustainable development. Globalization of market economy

73 Jan McDonald, The Multilateral Agreement on Investment: Heyday or MAI-Day for Ecologically Sustainable Development? 22 MELBOURNE UNIV. L.R. 617, 620 (1998).

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and the growth of multinational corporations present a conflict with the goal of sustainable

development which requires local participation and control over development choices.74

Environmental disasters, such as the 1984 isocyanate gas leak in Bhopal, India that killed several

thousand people, highlight the problems that occur when foreign investment brings

environmentally hazardous technologies to coun-tries with neither the environmental law

framework nor the technical infrastructure to address the resulting the envi-ronmental

problems.75

might argue that foreign investment also brings in opportunities for environmental protection and

sustainable development. However the tendency to offer lowest possible environmental

protection laws to attract foreign in-vestment can prove fatal to the interest of developing

countries. In a recent study,76 researchers concluded that FDI-led integration has done little to

promote sustainable industrial development in a developing country. Be-sides the most alarming

effect of foreign investment is trying to get corporations to comply with host country laws, let

alone ensuring adequate compensation after an environmental wrong has been done.

International Commitments.

Regulation in Practice

Governing Bodies under FEMA, 1999:

Constitution

Functions

Powers

Obligations

Outcome of Foreign Exchange:

Investment Aspect

Indian economy has experienced major policy changes in early 1990. Adoption of Liberalization,

privatization and Globalization (LPG) model made it an attractive avenue of investment for

whole world. This opened boundaries and sent an invitation to outsiders that we are more open to

work together. Apart from relaxed regulatory control of the government, the availability of

74 HUNTER ET AL., INTERNATIONAL ENVIRONMENTAL POLICY 1269 (2d ed. 2002).75 HUNTER ET AL., INTERNATIONAL ENVIRONMENTAL POLICY 1269 (2d ed. 2002).76 KEVIN GALLAGHER ET AL., SUSTAINABLE INDUSTRIAL DEVELOPMENT? THE PERFORMANCE OF MEXICO'S FDI-LED INTEGRATION STRATEGY (2003).

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affluent resources has lured the entrepreneur and the government of various countries to make it

a hub of their operation.77

‘Investment’ is usually understood as financial contribution to the capital of an enterprise or

purchase of shares in the enterprise. ‘Foreign investment’ is investment in an enterprise by a

Non-Resident irrespective of whether this involves new capital or re-investment of earnings.

Foreign investment is of two kinds – (i) Foreign Direct Investment (FDI)78 and (ii) Foreign

Portfolio Investment (includes Foreign Institutional Investors79).80

BILATERAL INVESTMENT REGULATIONS

In the absence of any multilateral instruments regulating foreign investment, the regime is

currently operated through bilateral investment treaties. Though a recent phenomenon,81 these

treaties embody the principle rules in this area. There exist a large number of bilateral investment

treaties between industrialized capital exporting countries and developing countries that have, as

one of their objectives,82 increasing the legal protection of the private bodies investing under the

treaties.

It doesn't come as a surprise that the bilateral treaties include in themselves encouragement and

protection of foreign investment as their statement of purpose and mostly deal with treatment of

foreign investment, repatriation of profit, nationalization and compensation, compensation in

cases of emergency situations, protection of commitments, dispute resolution, etc.83

How investment brings forex?

Process of investment bringing forex:

77 Doing Business in India, Professional Development Committee The Institute of Chartered Accountants of India (Set up by an Act of Parliament) New Delhi, The Institute Of CharteredAccountants of India, February 3, 2009. 78 2.1.12 of CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India.79 2.1.15 of CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India.80 CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India.81 "According to a list of treaties that appears in (1989) 4 ICSID Rev 189, the first bilateral investment treaty was the one concluded between Germany and Pakistan in 1959." M. SORNARAJAH, THE INTERNATIONAL LAW ON FOREIGN INVESTMENT (1994).82 Some critics argue that to be the sole objective of BITs.83 M. SORNARAJAH, THE INTERNATIONAL LAW ON FOREIGN INVESTMENT (1994).

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A person resident outside India other than NRIs/PIO may make an application and seek prior

approval of Reserve Bank for making investment by way of contribution to the capital of a firm

or a proprietorship concern or any association of persons in India. The application will be

decided in consultation with the Government of India.84 Thus, it is apparent that the foreign

exchange in any form or way does not go unregulated. This however, has to be qualified by

reasonable regulation and supervision, for excess would lead to repetition of the history of a

closed economy which will only make sustenance highly unsustainable.

Foreign exchange through FDI can be by various mechanism like issuance of ADR, GDR, FVC

investing into IVCU, ECB, FCCB, through partner ship firms / proprietary concerns. This is

regulated by RBI, FEMA, GOI through DIPP, SEBI for conversion and regularization of shares

and debentures and notifications and rules thereunder and is annually or bi-annually

accompanied by the FDI circulars which provide for the procedural and substantive aspects of

these concepts.

For the purpose of computation of indirect Foreign investment, Foreign Investment in Indian

company shall include all types of foreign investments i.e. FDI; investment by FIIs(holding as on

March 31); NRIs; ADRs; GDRs; Foreign Currency Convertible Bonds (FCCB); fully,

compulsorily and mandatorily convertible preference shares and fully,compulsorily and

mandatorily convertible Debentures regardless of whether the said investments have been made

under Schedule 1, 2, 3 and 6 of FEM (Transfer or Issue of Security by Persons Resident Outside

India) Regulations, 2000.85

The Leaders welcomed the signing of the SAARC Agreement on Trade in Services and

expressed that this will open up new vistas of trade cooperation and further deepen the

integration of the regional economies.86

84 CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India.85 ? CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India.86 SIXTEENTH SAARC SUMMIT, 28-29 April 2010, Thimphu Silver Jubilee Declaration“Towards a Green and Happy South Asia”, SAARC/SUMMIT.16/15

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Realization of the importance of development of communication system and transport

infrastructure and transit facilities specially for the landlocked countries to promote intra-

SAARC trade.87

The Leaders called for collaborative efforts to achieve greater intra-regional connectivity and

endorsed the recommendation to declare 2010-2020 as the “Decade of Intra-regional

Connectivity in SAARC”.88

Developing Asia’s financial systems have largely escaped the paralysis experienced by their

counterparts in the European Union (EU) and the US during the global financial crisis. Even

during the climax of the crisis, credit flowed more or less normally from the financial system to

the real economy. In particular, commercial banks, the bedrock of the region’s financial system,

continue to provide financing for the region’s firms and households. The region was not

completely free from financial instability but the bouts of instability were intermittent and

sporadic rather than systematic and persistent.89

In fact, the primary impact of the global financial crisis on developing Asia was not financial at

all but transmitted through the trade channel, as the recession in the industrialized countries

dulled their appetite for the region’s exports. A major explanation for why the region’s financial

systems were largely unscathed by the momentous upheaval in the global financial markets was

that the region’s financial institutions had very low levels of direct and indirect exposure to

subprime assets such as mortgage backed securities and collateralized debt obligations. The lack

of exposure to toxic assets, in turn, is widely believed to have been due to the relative lack of

financial sophistication.90

For those with floating exchange rate regimes, a critical element would be the development of

the necessary institutional policy frameworks, market microstructure, and financial institutions

that can ensure the smooth functioning of foreign exchange markets 87 SIXTEENTH SAARC SUMMIT, 28-29 April 2010, Thimphu Silver Jubilee Declaration“Towards a Green and Happy South Asia”, SAARC/SUMMIT.16/1588 SIXTEENTH SAARC SUMMIT, 28-29 April 2010, Thimphu Silver Jubilee Declaration“Towards a Green and Happy South Asia”, SAARC/SUMMIT.16/1589 Gemma Estrada, Donghyun Park, and Arief Ramayandi, Financial Development and Economic Growth in Developing Asia, ADB Economics Working Paper Series, No. 233 | November 2010, Asian Development Bank.90 Gemma Estrada, Donghyun Park, and Arief Ramayandi, Financial Development and Economic Growth in Developing Asia, ADB Economics Working Paper Series, No. 233 | November 2010, Asian Development Bank.

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Security Aspect

The Leaders strongly condemned terrorism in all its forms and manifestations and expressed

deep concern over the threat which terrorism continue s to pose to peace, security and economic

stability of the South Asian region. They reiterated their firm resolve to root out terrorism and

recalled the Ministerial Declaration on Cooperation in Combating Terrorism adopted by the

Thirty-first Session of the Council of Ministers in Colombo. They emphasized that the linkages

between the terrorism, illegal trafficking in drugs and psychotropic substance, illegal trafficking

of persons and firearms all continue to remain a matter of serious concern and reiterated their

commitment to address these problems in a comprehensive manner. The Leaders emphasized the

need to strengthen regional cooperation to fight terrorism and transnational organized crimes.

They reaffirmed their commitment to implement the SAARC Regional Convention on

Suppression of Terrorism and its Additional Protocol and SAARC Convention on Narcotic

Drugs and Psychotropic Substances. They re-emphasized the importance of coordinated and

concerted response to combat terrorism. The Leaders also recognized in this regard the value of

the proposed UN Comprehensive Convention on International Terrorism and noted the progress

made during the recent rounds of negotiations and called for an early conclusion of the

Convention.

Further Integration with World Economies?

European Union Foreign Exchange Regulatory Structure.

As Europe has followed a trajectory of ever-increasing economic integration, the euro has come

to represent a growing proportion of international transactions and foreign exchange reserve

holdings

India and its relation with its neighbors. (The neighbouring countries in the north

are China, Nepal and Bhutan, in the east, Bangladesh and Myanmar, and in the

west, Pakistan and Afghanistan.)

India and China

India and China are the two great giants of Asia. Besides being the most populous countries, they

are also two of the most ancient civilisations of the world. Historically, several historians have

successfully traced the cultural linkages dating back to 2nd century BC.

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As a result of the communist revolution in 1949, China became the People’s Republic of China

(PRC), under the leadership of Mao Tse Tung. Nehru regarded India as China’s rival for the

leadership of the non-white people of the world. India, on the other hand, tried India and the

World its best to come close to China. It was the first non-communist country to recognize

communist China in 1949. India fully supported China’s claim for membership in the United

Nations. It also acknowledged China’s claim over Formosa (Taiwan). It refused to be a party to

peace treaty with Japan without China. In the Korean crisis too, India refused to brand China as

aggressor when China intervened on behalf of North Korea. In fact, India supported China even

though the Western bloc especially USA was displeased with it.

Nehru’s China policy received the first jolt in 1950, when China occupied Tibet in 1950. It is

important to remember in this context that India had long term interests in Tibet because it was a

buffer lying between India and China. India even enjoyed certain special privileges in Tibet.

Therefore direct Chinese control over Tibet was likely to endanger these, and India’s security.

India’s suggestions for a peaceful settlement of the Tibet problem were treated as interference by

the communist regime. Gradually the Tibetans grew restless under China’s yoke and rose in

revolt in 1959. China ruthlessly suppressed the movement and declared Tibet as an integral part

of China. The head of Tibet, Dalai Lama took shelter in India while Tibet lost whatever

autonomy it still enjoyed. The granting of political shelter to Dalai Lama by India added to

China’s distrust.

China appreciated India’s neutral and mediatory role in easing the Korean problem (1950- 53).

Thus, began a period of friendship between the two countries, with the signing of the Sino-Indian

Treaty of friendship in 1954. This treaty put a seal of approval upon Chinese suzerainty over

Tibet. The Preamble of the treaty embodies the famous ‘Panchsheel Principles’ about which you

have studied (lesson number 26). This agreement initiated a period of relaxed relationship,

marked by the slogan of Hindi Chini Bhai Bhai. It is interesting to note that at the Bandung

Conference (1955), Nehru actively brought China into the hold of the Afro-Asian solidarity.

Boundary Dispute between India and China

The 1950s were marked by the boundary dispute between India and China, the flash point of

which unfortunately caused a war between the two countries in 1962. China first started to claim

large parts of Indian territory in North East Frontier Agency (NEFA, now Arunachal Pradesh)

and Ladakh by publishing maps in which these were shown as included in China.

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China continued extending its borders and also constructed a 110 mile long road across Aksai

China area (Ladakh) of India in 1956-57. In 1959, China put claim to some 50, appa sq. miles of

Indian territory and also denied the validity of McMahon Line.

By this time Tibet had been fully integrated into China; it was in a strong position at the India-

China border with Chinese troops posted all along. While the two countries were in dispute over

the McMahon line issue, China launched a massive attack on India in October 1962, in the

NEFA as well as the Ladakh sector. After overrunning large areas of Indian territory, China

announced a unilateral ceasefire after occuping huge territory of India 200 sq. miles in the North

Eastern sector and 15,000 sq. miles in Ladakh.

A futile attempt to work out a peaceful settlement between the two countries was made by Sri

Lanka. The Colombo Proposals failed because China refused to agree on conditions contained in

them. For long in the years following the war, China–India relations did not show any

improvement. In fact, China went out of the way to make friends with Pakistan, just to isolate

and contain India.

Normalisation of Relations

Although the two countries resumed diplomatic relations in 1976 by exchanging ambassadors.

The efforts of normalisation of Sino-Indian relations received a boost when the then Prime

Minister Rajiv Gandhi paid a successful five day visit to China in 1988. The two countries

pledged to settle the border dispute through dialogue. Several high level visits followed including

visit by Ex-Prime Minister Atal Bihari Vajpayee in 2003. The two countries agreed to keep the

border dispute apart, and develop friendly relations in other fields. Until the border dispute is

resolved, both countries agreed to maintain peace and tranquility on the Line of Actual Control

(LAC).

One could see a clear shift in the Chinese attitude towards India. The fact that erstwhile USSR

had mended fences with China, there were no more apprehensions from the South. Moreover,

China’s post-1979 economic transformation demanded big markets for its massive production

under economic liberalisation. President Jiang Zemin’s visit to India in 1996 witnessed a major

consolidation of this progress. This was first ever visit of China’s head of State to India. China’s

withdrawal of support to Naga and Mizo rebels; meaningful silence on the status of Sikkim

(China considered Sikkim’s status as that of an independent state) and a neutral stand on

Kashmir issue could be seen as positive shift in Chinese attitude towards India.

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Nevertheless, there was suddenly a brief setback in the mutual ties of the two after the nuclear

explosions by India during 1998. These were followed by sharp Chinese reaction and its leading

role in getting the resolutions condemning the tests in UN and similar fora, passed. These tests

by India were seen as neutralising Chinese prominence in the region.

But the Chinese posture of neutrality during the Indo-Pak military showdown in Kashmir, Kargil

sector in 1999 exhibited China’s inclination to toe a softer and friendly line with India. In fact,

Chinese refusal to interfere in the conflict forced Pakistan for cessation of hostilities with India.

However, Ex-Prime Minister Atal Bihari Vajpayee’s 2003 visit to China is a renewed effort in

the promotion of close and cordial ties between the two neighbours. The border agreement has

recognised the Nathula Pass in Sikkim as a border pass, implying that China no more considers

Sikkim as an independent state. Another positive breakthrough was the Joint Declaration that

underlined the need to explore a framework of a boundary settlement at political level of bilateral

relations. This is an acknowledgement that the key issue in resolving the dispute is political. This

is seen as Beijing’s readiness to give up its policy of delaying dialogue. India’s National Security

Advisor and Chinese Vice Minister have been appointed for holding the tasks. The developments

at the diplomatic and political levels have been supplemented by fresh initiatives at the economic

level to strengthen bilateral relations. The border trade between India and China has crossed $ 10

billion quickly.

India and Pakistan

No two countries in the world have so much in common as India and Pakistan. Yet they have

perpetually been in a state of undeclared war with varying degree of intensity. Pakistan’s

aggression in Kargil (1999) brought the two countries even on the verge of a nuclear

confrontation. The legacy of suspicion and mistrust predates the partition of India in 1947.

During the freedom struggle the Muslim League, under the leadership of Mohammad Ali Jinnah

propounded the two-nation theory, in support of a separate Muslim state. Jinnah insisted that

since Hindus and Muslims were two communities, two separate states must be constituted for the

two communities. The Indian National Congress (INC)’s long rejection of and reluctant

acceptance of partition gave room for suspicion in Pakistan that India would try to undo the

partition and divide Pakistan. Moreover, Pakistan was concerned at the possibility of India’s

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domination in the region and its inability to match India’s power all by itself. Pakistan developed

a perception that it is an incomplete state without Kashmir being incorporated into it. On the

other hand, India perceives Kashmir’s accession and integration into India as an essential

element of its secular and federal democratic structure.

The Kashmir Issue

At the time of partition Jammu and Kashmir (J&K) was one of those several princely states, the

fate of which was left uncertain in 1947. Pakistan desired that Kashmir with Muslim majority

population should join Muslim country, Pakistan. But the popular leader of National Congress

opposed Pakistan’s ideology. Maharaja Hari Singh did not take a decision until Pakistan sent

armed intruders into the Kashmir valley in October 1947. Seeking Indian help to repulse the

Pakistani intruders Maharaja signed the ‘Instrument of Accession’ making Jammu and Kashmir a

part of Indian Union. On this occasion, as true democrat, Prime Minister Nehru assured that after

Pakistani aggression was cleared, the future status of the state would be decided on the basis of

wishes of the people of Kashmir. Since India did not want an open clash with Pakistan, it

referred the matter to the United Nations. Indian forces saved Srinagar from the invaders, pushed

back the Pakistanis from the Kashmir Valley. But the whole of Kashmir could not be recaptured,

at it would have meant direct and difficult war between the two new nations. India sought United

Nations help in 1948. A ceasefire came to be implemented on January 1, 1949. It left a large part

of Jammu and Kashmir (nearly 2/5 of the State) under Pakistan’s possession, which we call

Pakistan Occupied Kashmir (POK). In 1950s the UN mediators put forward several plans to

resolve the dispute, but they failed to bridge the differences between the two conuntries.

The problem of Kashmir is still pending. Plebiscite was to be conducted only after Pakistan

withdrew its forces from the occupied territory, as per the UN resolution of 1948, which Pakistan

refused to comply. Hence India pleaded that the wishes of the people were ascertained in 1954 in

the form the direct election to the Constituent Assembly which satisfied the accession of Jammu

and Kashmir to India. The mediation come to an end. Pakistan was desperate to capture Kashmir.

Thinking that India’s army was weak after defeat in the war with China in 1962, Pakistan tried

through a war to take Kashmir in 1965. But Indian forces defeated the Pakistani designs.

Moreover, Pakistan suffered another humiliation, when its eastern wing, 1000 miles away from

West Pakistan successfully waged independence struggle in 1971. India played a key role in the

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war to liberate Bangladesh. The birth of Bangladesh proved to be the final burial of two-nation

theory on the basis of which Pakistan put a claim to Kashmir. Pakistan was reduced to one fourth

of the size of India. This altered the power equation in South Asia in India’s favour.

In order to normalise relations India invited Pakistan for an agreement, the result of which was

the Shimla Pact of 1972. This Shimla agreement however bears important significance as the two

countries agreed to seek the settlement of all bilateral problems, including Kashmir, mutually

without the intervention of any third party. Thus under the Shimla Pact, the Kashmir issue cannot

be raised in international or any other forum, although Pakistan has not hesitated to ignore the

sprit of the agreement. The agreement also talked about the return of Prisoners of War (POW).

Though Pakistan’s territory in India’s possession was returned, a new cease-fire line (in place of

the old cease-fire line of 1948–49) was drawn, which is known as the LoC, Pakistan found ways

other than open war to destabilise India by encouraging and assisting terrorism in Punjab, and the

State-sponsored militancy in Jammu and Kashmir since the mid 1980s. Pakistan still continues to

encourage terrorist and separatist tendencies in Kashmir, operating mainly from terrorist training

camps situated in POK.

The sanctity of the LoC that came to be agreed upon between India and Pakistan under the

Shimla Agreement of 1972, was violated by Pakistan in May 1999 as a part of a big plan. This

was done when the Pakistani forces infiltrated into India, after crossing the line of control in

Kargil, Drass and Batelik sectors of J &K. Indian army once again gave a befitting defeat in a

war that continued for about 60 days. The purpose of Pakistani operation in Kargil was to create

a crisis with a threat of nuclear war, which would in turn ensure intervention by the United States

in its favour on Kashmir dispute. Neither United States nor China came to Pakistan’s help. In

fact, Pakistan had a diplomatic and military defeat.

Nuclear Tests and Efforts Towards Improvement of

Relations

Indo-Pakistan relations acquired an entirely new dimension in the context of nuclear tests by

both India and Pakistan in May 1998. The relations between the two neighbours hit a India and

the World new low. India has been facing a nuclear threat arising out of China’s clandestine

support to build up of the nuclear weapon capability of Pakistan since the mid-seventies. No

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doubt, Pakistan’s nuclear policy is targeted against India The extreme bitterness and tension

between India and Pakistan in the aftermath of the nuclear tests of May 1998 did bring with it an

increasing realisation on both sides that things could not continue in the same manner

indefinitely. That, some meeting ground between the two neighbours has to be found. Thus,

foreign secretary level talks started, and a direct bus service between Delhi and Lahore was

proposed. Prime Minister Vajpayee’s Bus Diplomacy in 1999 marked a tremendous goodwill

between the two countries. The Lahore Declaration signed at the time underlined the need for

resolving all outstanding issues, including that of Kashmir, through peaceful means. While India

agreed to bring Kashmir onto the agreed agenda along with other areas of mutual benefits,

Pakistan conceded to bilateralism. The reference to the ‘composite and integrated’ dialogue

process implied that the two would not be a hostage to any single issue. Despite the rupture

caused by the Kargil war and the terrorist attack against our Parliament (December 2001) the

unconditional dialogue has been resumed. The emphasis in these talks is to promote people to

people contacts across LoC, and also improve economic ties between India and Pakistan Change

of government in India has not meant any deviation from our commitment to peaceful and

prosperous co-existence with Pakistan.

India and Srilanka

Sri Lanka, earlier known as Ceylon (until 1972), is a small island country situated in the Indian

Ocean to the south of India. Its total area is 25,332 sq. miles. Of all countries, it has geographical

proximity to India. Only 18 miles wide shallow water in the Palk Straits separates Jaffna in

northern Sri Lanka from the Southernmost tip of the Indian state of Tamil Nadu. Its geostrategic

location in the Indian Ocean (at the centre of commercial and strategic sea and air routes) and its

closeness to US naval base in Deigo Garcia indicates its importance far beyond its size,

population and resources. The history of cultural relations between India and Sri Lanka dates

back to the ancient times. Out of the total population of Sri Lanka, about 64 percent believe in

Buddhism and about 15 percent believe in Hinduism. Sri Lanka became a British colony in early

19th century. It was granted independence on February 4, 1948.

India-Sri Lanka relations have generally been cordial, though there have been occasions of

tense relations due to the ethnic conflict between Tamils and the Sinhalese. Despite ethnic

problems, India has never sought to impose its will on Sri Lanka and has always based its foreign

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policy towards this southern neighbour on mutual understanding and friendship. An important

area of common interest between the two neighbours is the foreign policy of non alignment. Sri

Lanka has generally stood neutral in Sino-Indian disputes. In fact, it made efforts to mediate

between India and China after the war of 1962. Sri Lanka also showed understanding when India

become nuclear. Recently in 2005, India extended valuable help to Sri Lanka after Tsunami

devastated the coastal areas of that country.

Problem of Indian Tamils

Jaffna province of Sri Lanka has large concentration of Tamil population. The problem became

serious when Tamilians began demanding a national homeland or “Eelam” in northern Sri

Lanka. It is important to understand that there are essentially two categories of Tamilians in Sri

Lanka: The Ceylon Tamils whose forefathers had migrated to Sri Lanka centuries ago. They are

estimated to be one million. The second category is of Indian Tamils whose forefathers were

taken by the Britishers as plantation workers in the 19th century. They are another one million,

many of them without citizenship. The problem of their status dominated early India-Sri Lanka

relations. The conflict with Ceylon Tamils came later. The Sinhalese fear Tamil domination,

which is the principal reason behind the ethnic conflict.

The difference between the two communities was exploited by British rulers in order to check

the growing Sinhalese nationalism. The Tamils were allowed to enter the administration

structure and thus gradually took control of the trade and profession. Scarce economic resources

and opportunities plus the majority pressure from its own people forced the Government of Sri

Lanka to pass series of steps to reducing the importance of Tamils- Indian and the Ceylonese.

The representation of Tamilians in public service in 1948 was 30 percent, but by 1975 it had

fallen to mere 5 percent. The Sinhalese were encouraged to settle down in Tamil dominated areas

in large numbers. The citizenship law of 1948 and 1949 had deprived about 10 lakh Indian

Tamils of political rights. The Tamil youth who had lost faith in non-violence organised

themselves into Liberation Tigers. The aim of these ‘Tigers’ is a sovereign Tamil State of Eelam.

The issue of Tamilians, and the policy pursued by government cast a dark shadow on Indo-Sri

Lanka relations. India from time to time complained against the discriminatory policy of the

Ceylon government. The agreement of 1964 sought to solve the problem of stateless persons

(Indian Tamils) in Sri Lanka. About 3 lakhs of these people were to be granted Sri Lankan

citizenship and about 5 lakh 25 thousand persons were to be given citizenship of India. These

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people were given 15 years time to shift to India in instalments. Later in 1974, the fate of the rest

1 lakh 50 thousand stateless persons was decided. It was agreed between the two countries that

half of them were to be given citizenship of Sri Lanka and rest would become Indian nationals.

Thus, the issue of stateless persons was sorted out peacefully between the two countries. A

territorial dispute arose between India and Sri Lanka over the ownership of one mile India and

the World long and only 300 yard wide small island known as Kacchativu, in 1968. In 1974

under the agreement signed between the two countries, India accepted Sri Lankan ownership of

the island.

Tamil Separatism

The ethnic problem between Tamils and Sinhalese had a long history. It assumed serious

proportions in 1983. As the gulf between the communities developed, militancy, separatist

organisations became active. Tamil United Liberation Front (TULF) demanded separate

homeland for Tamils in 1988 – Tamil Eelam. A reign of terror was unleashed against the

agitating Tamils in 1983. During 1983 – 86, about 2 lakh Tamils were rendered homeless. The

worst racial riots in the history of the country made thousands of Tamils refugees in India.

India offered to help resolve the crisis but it was interpreted as “Indian intervention in Sri Lanka”

on behalf of the Tamils. When the situation became grim, India and Sri Lanka signed an

agreement in 1987. India offered military assistance under the Accord. Indian Peace Keeping

Force (IPKF) was sent to Sri Lanka to help restore normalcy in the country. The deployment of

IPKF was also an extension of India’s policy of reminding Sri Lanka and outside powers that if

their involvement inside the region were to have an anti- Indian orientation, New Delhi would

not remain a mute spectator.

Though the accord of 1987 was a triumph of Indian diplomacy, it proved to be costly for India.

India lost about 1200 soldiers and it costed Rs. 2 crore a day on IPKF in the height of its

involvement. The worst part was that the Tamils turned against IPKF and a fighting broke out

between the two. Rajiv Gandhi, the architect of India-Sri Lanka Accord of 1987 was assassinated

in 1991 at the behest of LTTE (Liberation Tigers of Tamil Eelam) leader,Velupillai Prabhakaran.

Areas of Mutual Cooperation

Systematic efforts at strengthening economic ties have been taken by India and Sri Lanka since

the 1990s, especially after the withdrawal of Indian troops. In 1998, the two countries set up an

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Indo Sri Lankan Foundation for increasing bilateral exchanges in various fields. They have

agreed on a free trade area to facilitate trade, which has gone up greatly.

India encouraged Sri Lanka to invite the peace process between the Tamils and the Sinhalese. In

1998 Sri Lanka invited Norway to work out a peaceful solution to the ethnic problem. India

stands for unity of Sri Lanka The greatest milestone of this process was the cease-fire agreement

of 2002 between LTTE and Sri Lanka and the revival of the dialogue between the two. From

India’s long term point of view, Norway recognized India’s legitimate interests in Sri Lanka and

stated that it has no desire to come in the way of any Indian initiative to end the conflict in the

region.

Does SAARC or ACU have the potential to be next “monetary union” in the lines of

EU?

Regional economic integration is one of the most important trends in th contemporary world

economy. Over the past decade and a half, the worl economy has seen the emergence of many

strong regional trading blocs I different parts of the world. These include EU (European Union),

NAFTA (Nort American Free Trade Area), CIS (Commonwealth of Independent States), LAl

(Latin American Integration Association), ASEAN (Association of South Ea: Asian Nations),

and DECD (Organisation for Economic Co-operation an Development), among others. Countries

have responded by forming region trading blocs to mobilize their resources to strengthen their

competitiveness in tl world market.91

The term 'Regional Economic Co-operation' means, the collaboration of a group of nations

comprising the region on economic matters to exploit the greater benefits than what would be

possible in the course of normal economic relationships without co-operation. Regional

Economic Co-operation can be in different forms. In a very simple form, the extent of co

operation among nations may be confined to specific or selected economic issues such as mutual

trade agreements and preferential tariff In a very broad form, It can cover a wide range of

91 VENKATESH M, A STUDY ON INDIA'S TRADE RELATIONSHIP WITH SAARC COUNTRIES WITH SPECIAL REFERENCE TO SAPTA, School Of Management Studies Cochin University Of Science And Technology, Kerala, 2006

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economic issues like trade tariffs, technology, investment, joint ventures, fiscal and monetary

policies.92

SAARC:

Over the past 20 years, world trade has grown twice as fast as real GDP deepening economic

integration and raising living standards.93 The role of foreign trade in economic development is

considerable and both are intimately connected. Trade can stimulate growth if exports are

tending to increase faster than imports or be a brake on growth if imports are tending to increase

faster than exports. The dramatic growth of cross-border investment and international trade over

the past two decades combined with explosive growth in global communications and technology.

However, it is generally accepted that the gains to a nation from free international trade may

more than outweigh the losses to particular domestic firms and workers. Although free trade is

often strongly advocated, many countries believe that the expansion in trade is best accomplished

through the establishment of Regional Economic Association (REA) / Integration (REI).

However, the emerging WTO regime has in no way undermined the process of regionalism. It

has wide ranging implications for the global economy.

The South Asian Association for Regional Co-operation (SAARC) comprises the seven countries

of South Asia. i.e., Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka.

SAARC is a manifestation of the determination of the people of South Asia to work together

towards finding solutions to their common problems in a spirit of friendship, trust and

understanding and to create an order based on mutual respect, equity and shared benefits.94 The

primary objective of the Association is the acceleration of the process of economic and social

development in member states, through collective action in agreed areas of co-operation

The region suffers from massive balance of payments burden, mass unemployment, high

population growth rate, large concentration of poverty, low rate of economic growth, constant

92 Bhagavati Jagadish, "Regionalism and Multilateralism: An Overview" in "The New Regionalism in Trade Policy". The World Bank.93 Adam Smith, " An inquiry into the nature and causes of the Wealth ofNations", Oxford Clarendon Press 1970.94 ESCAP, "Economic and Social Survey of Asia and the Pacific" 2003

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food shortage, worsening terms of trade, largely illiterate, considerable malnourished, and also

the least gender sensitive region of the globe.95

SAPTA: In December 1991, the Sixth Summit held in Colombo approved the establishment of

an Inter-Governmental Group (IGG) to formulate an agreement to establish a SAARC

Preferential Trading Arrangement (SAPTA) by 1997.

Given the consensus within the SAARC, the framework Agreement on SAPTA was finalized in

1993, and formally came into operation in December 1995, well in advance of the date stipulated

by the Colombo Summit.96 The Agreement reflected the desire of the SAARC countries to

promote and sustain mutual trade and economic co-operation within the SAARC region through

exchange of concessions. Since 1997, attempts have been made to clear the duck for the smooth

transition of region from SAPTA to SAFTA. Owing to geo-political situation in the region, the

ambitioustarget of SAFTA implementation had been deferred to 2003, recently in-principle

agreement has been reached to implement SAFTA. The present study reveals that there are

enormous opportunities for forging closer economic relations among SAARC countries. These

opportunities could be fully utilized through the twin processes of trade liberalization and

industrial restructuring which are complementary io each other. The SAARC Preferential Trade

Arrangement (SAPTA) is the first step in trade liberalization. However, the scope of SAPTA has

to be sufficiently widened in order to derive substantial benefits from preferential trading

arrangements. It is suggested that the SAARC countries adopt a combined approach for tariff

elimination, tariff reduction and preferential or concessional tariffs. This process will help in

moving quickly towards the creation of a Free Trade Area in the SAARC region.

It is necessary to emphasise that, in any regional organization, smaller countries may feel that

greater trade co-operation with their larger neighbors may result in larger countries taking over

their economies. India occupies seventy percent of the SAARC region, both geographically and

economically, and the remaining six nations of SAARC have borders only with India and not

with each other. As thebiggest, and the most industrialized trading partner among the SAARC

countries,

95 IGSAC 11, "SAARC: Moving Towards Core Areas of Coopertion"(AReport of the Independent Group on South Asian Co-operation),Colombo, 199296 Bhuyan A.R, "Regional Co-operation in South Asia: Outlook andProspects under SAPTA". South Asia Survey Vol.3 1996

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India has to recognize that a special responsibility devolves on her and take a lead in making the

Regional Economic Co-operation a reality in South Asia. It is time that the member countries

come still closer to achieve economic development through increased regional self-reliance.

What is needed is the will and a powerful leadership to bring the countries together as partners in

mutual progress. Here lies India's role... !!!

Other associated aspects: time, government control, economy, sustenance etc.

Conclusion

Provisions of FERA are in consonance with the present trend of globalisation and liberalisation

adopted by the Indian Government to encourage India's foreign trade. FEMA is an improvement

over FERA.

Domestic financial market integration in India has been largely facilitated by wide-ranging

financial sector reforms introduced since the early 1990s. Financial markets in India have

acquired greater depth and liquidity. In the process, various market segments have also become

better integrated over the years. A high degree of correlation between the long-term government

bond yield and the short-term Treasury Bills rate indicates the significance of the termstructure

of interest rates in financial markets.

Integration of the foreign exchange market with the money and the government securities

markets has facilitated liquidity management by the Reserve Bank. However, the equity market

has relatively low correlation with other market segments. A sharp improvement in correlation

between the reverse repo rate and money market rates in recent years implies enhanced

effectiveness of the monetary policy transmission mechanism.

A key feature of global financial integration during the past three decades has reflected in the

shift in the composition of capital flows to developing and emerging market economies,

especially from official to private flows. Regional integration has served as a major catalyst to

the global integration process during the past two decades. East and South East Asian economies,

in particular, have achieved substantial integration. Apart from Asia’s growing integration with

the rest of the world, increasing integration within Asia also reflects the growing intraregional

trade and financial flows. Evidence from price-based measures suggests that financial market

integration in Asia has been increasing. The stock markets in Asia are more integrated than the

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money and the bond markets. In the region, Japan, Hong Kong and Singapore serve as the nodal

centres for other stock markets.

There is evidence of India’s growing international integration through trade and cross border

capital flows. India’s trade and financial links with Asia are also growing amidst recent

initiatives taken to promote regional cooperation. Emerging Asia has become the ‘growth centre’

of the world due to shifting of production base to the region. This is likely to stimulate greater

financial integration in the region. India’s financial integration within the region and with the

international financial markets is likely to increase in future in view of its robust growth

prospects. However, if benefits are to be maximized from a more integrated economy, the need is

to pursue efforts towards a greater sophistication of financial markets and financial market

instruments that allow risks to be shared more broadly and capital to flow into the most

productive sectors. There would also be a need to constantly review the risk management

practices so that financial institutions and financial markets continue to remain resilient to

adverse external developments.

Introduction97

The Indian attitude to foreign investment has been ambiguous. As a hangover of the colonial

past, there has been caution as to what types of foreign firms have operated in India and many

foreign firms fled India. Whether this psyche has diffused or not, *40 in present times India had

barely managed a few billion dollars a year as foreign direct investment (FDI) inflows. The sums

hovered around the $1 billion mark for several years, and in 2004 the sums were $3.7 billion out

of annual global FDI flows of over $650 billion. By the beginning of the twenty first century, the

share of foreign direct investment in the capital stock of India had been one of the lowest in the

97 SUMIT K. MAJUMDAR, FOREIGN EXCHANGE LEGISLATION TRANSFORMATION AND ENTERPRISE DEMOGRAPHY IN INDIA, E.J.L. & E. 2008, 25(1), 39-56.

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world. Also, in relation to the size of the economy, the share of foreign direct investment was

less than one percent of the national income.

Nevertheless, recent growth in inflows has been substantial compared to the extremely low

values of around $150 million at the time of economic liberalization in 1991. A tracking of the

values of the foreign direct investment inflows over the period from 1991-1992 to 2003-2004, as

given in Fig. 1, shows that the values increased from $155 million to over $3.7 billion, and the

trend, if exponentially estimated, is very clearly upward sloping.1

The decline in the role of foreign firms in the Indian economy was particularly exacerbated by

the introduction of the Foreign Exchange Regulation Act (FERA) legislation in 1973. The

legislation incorporated within the framework of FERA was the instrument used to implement

changes in property rights regimes that would put foreign firms at a disadvantage in India. These

legal regime changes operated via the legal framework of the Indian Companies Act, 1956.

While the FERA legislation was promulgated after the hike in oil prices to save foreign exchange

needed to pay for critical imports such as food and petroleum, at the same time the maximum

shareholding by foreign firms in Indian companies was limited to 40%. Other than this rule,

several other rules put into operation by FERA involved the usage of foreign exchange within

the Indian economy. This was so that outflows repatriated abroad, say to foreign owners, would

be minimized. Nevertheless, the consequences were dysfunctional. The incentives that normally

percolate down to businesses when rights are guaranteed disappeared. The FERA provisions

relating to ownership limits continued till 1991, but the other provisions of FERA were changed

in 1999.

A change of government in 1977 had brought together a coalition of political partners which had

ambiguous attitudes towards foreign firms. Firms such as IBM and Coca-Cola were given

marching orders out of India. Firms such as Siemens and Bechtel were welcomed with open

arms. The rules limiting foreign ownership to 40% continued for almost two decades and were

only eliminated in 1991 after the reforms were introduced. There has been a resurgence of

entrepreneurial activity in India after that date. Not only has domestic entrepreneurship expanded

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substantially, but foreign firms have started to make investments in India again. Approvals were

made automatic for foreign ownership levels of 51% in 1991 in Indian companies, and for

ownership levels of up to 74% in 1997, save for a few sectors thought to be critical such as the

media sector.

Tabular or graphic material set at this point is not displayable.

*41 In 1999 FERA was transformed into the Foreign Exchange Management Act (FEMA). The

FEMA legislation simplifies the maze of controls, procedures and bureaucratic minutiae that

have to be observed by all those undertaking to set up and operate a business in India. The

changes in the legislative regimes as well as removal of administrative lacunae make India an

attractive investment destination for foreign firms, inducing them to set up operations in India.

The transformation of FERA to FEMA can be considered a considerable step forward in the

institutional evolution of India after over two decades of the backward steps taken in 1973.

The legislative change embodied in FEMA modernizes the legal framework and brings it in line

with best practice in developed countries. FEMA takes current account convertibility as a base

and allows for progressive liberalization of the capital account. It is more transparent than FERA

and, unlike FERA, is a civil law. Thus, the psychological change that FEMA has brought in is

that it is a civil law, whereas FERA was a criminal law, operated, in effect, by a country that was

economically a police state. Nor does FEMA embody the FERA presumption of mens rea, which

placed the burden of proving innocence on the citizen. As an institutional change, it signals that

India is taking a positive attitude to business and will welcome foreign transactions on the

current and capital account. Thus, traders and investors from abroad are now welcome in India.

1.1 Contours of the present study

Using a unique data base that was put together for the purposes of this analysis from the records

of the Department of Company Affairs (DCA) of the Government of India, and using time series

regression techniques, I evaluated the extent to which *42 the introduction of FERA and the

transformation to from FERA to FEMA had made an impact on the presence of foreign firms in

India's corporate sector.

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The DCA data are organized as a time-series for the period 1957-1958 to 2001-2002, and

contains details on: (1) the number of foreign companies in India; (2) the number of domestic

private companies in India; (3) the number of government companies in India; and (4) the total

number of companies in India. The data cover the entire population of enterprises making up the

corporate sector in India and provide a full picture of the evolution of India's corporate economy

for almost five decades. These have been the critical post-war and post-independence decades

when the basic structure of India's economy was being developed.

The evolution of an economy is a historical phenomenon contingent on several policies. What

organizations come into existence and how they evolve are fundamentally influenced by the

institutional framework (North 1991). An assessment of the evidence shows how the growth of

foreign firms in the Indian economy has been influenced by the prevailing institutional rules.

From the data, it was possible to calculate: (i) the proportion of foreign companies to the total

number of companies in the corporate sector as a whole; (ii) the proportion of domestic private

companies to the total number of companies in the corporate sector as a whole; and (iii) the

proportion of government companies to the total number of companies in the corporate sector as

a whole.

The structural constraints that were endangered by the institutions in place in India will have had

positive or negative effects on the diffusion of different types of firms within the Indian

economy. In fact, a constellation of constraints were put in place. The constraints would have

reduced the set of opportunities available to each type of firm and, thereby, led to a withdrawal

of that type of firm from the economy. These statistics calculated provide the overall picture on

the evolution of the industrial structure of India for over a 45 year period. I then evaluated how

far the foreign exchange legislation that the Indian government had adopted retarded or

promoted the presence of foreign firms within the economy.

This study of foreign firms' presence in the Indian economy is cast in a unique corporate

demography framework. A corporate demography framework focuses on the life events of firms,

such as entry or exit, and bases itself on a population perspective. Corporate demography

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abstracts from the individual firm and focuses on population characteristics such as count of the

number of firms in the population. The corporate demography framework is evolutionary,

putting stress on natural selection of firms by events among which several can be important

institutional or regulatory events which alter the environment for conducting business (Frech

2002).

In addition, the study also contributes to the evolving literature on FDI in India. A substantial

literature has described the contours of evolving FDI in India, primarily tracking the flows of

FDI, the sectors into which FDI flows and the regional flows of FDI. The early works are by

Kidron (1965) and Kurian (1966). The contemporary analyses are by the Asian Development

Bank (2004), Athreye and Kapur (2001), Bajpai and Sachs (2000), Balasubramanyam and

Mahambare (2003), Chhibber and Majumdar (2005), Gakhar (2006), Gupta (2005), Majumdar

(2007), Sen and Pan (2007) and UNCTAD (2006).

*43 A parallel literature, by, inter-alia, Agarwal (2001), Agrawal (2005), Bhat et al. (2004),

Chakraborty and Basu (2002), Chhibber and Majumdar (1999), Dua and Rashid (1998), Feinberg

and Majumdar (2001), Kathuria (2002), Kumar and Aggarwal (2005), Kumar and Pradhan

(2005), Majumdar (2007), Nunnenkamp (2004), Pradhan (2002) and Sahoo and Mathiyazhagan

(2003), has evaluated the consequences of FDI on various aspects of economic and industrial

performance. The current study looks specifically at the impact of one critical legislative change,

that relating to foreign exchange transactions in India, and evaluates its impact on the population

of foreign firms within India's economy.

2 Analysis

2.1 The framework

The model evaluated in this article is as follows:

Tabular or graphic material set at this point is not displayable.

where FOREIGN is the log of the proportion of foreign firms in India's corporate sector over

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each of the years t (t = 1, 2, 3…45) for the 45 year period evaluated. Of the explanatory

variables, the variable FERA is a dummy variable capturing the periods before FERA was

promulgated and the period after the non-ownership provisions were dispensed with in 1999

after the withdrawal of FERA and the promulgation of FEMA; the variable FEMA is a dummy

variable capturing the periods after the promulgation of FEMA; the variable GOVERNMENT

captures the proportional extent of government firms participating in India's corporate economy

in each time period t and the variable PRIVATE captures the proportional extent of domestic

private sector firms participation in India's corporate economy in each time period t.

A number of macro-economic time-series control variables are also introduced. These are

FOODGRAINS which is the natural log of foodgrains production capturing agricultural growth

within the economy, EXCHANGE which is the natural log of foreign exchange reserves, GNP

which is the growth in gross national product at factor cost and INVISIBLES, which measures in

mean-deviation terms the earnings made within the economy on the invisibles account, and the

residual error term is ##.

2.2 Foreign exchange policies affecting foreign firms in India

2.2.1 The Foreign Exchange Regulation Act

The first of the policies that directly affected foreign firms have revolved around the, now

notorious, 1973 FERA, based on an earlier Foreign Exchange Regulation Act promulgated in

1947, and later repealed, the provisions of which would ensure that *44 India was quite willing

to wave foreign firms goodbye from its shores. The basic policy that was put into place by FERA

in 1973 was the inability of the majority of foreign companies to hold more than 40% shares in

their Indian companies. Thereby, foreign firms lost control of their Indian operations.

Other than that, there were several restrictions on the use of foreign exchange. By and large,

other than the ownership constraints, FERA was not transformed into FEMA until 1999. Severe

restrictions on current account transactions continued till the mid-1990s when relaxations were

made in the operations of the FERA. The framework was essentially transaction-oriented based

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in terms of which all transactions in foreign exchange including those between residents and

non-residents were prohibited, unless specifically permitted.

2.2.2 The transformation of FERA to FEMA

A major institutional change that has taken place in 1999 has been the translation of FERA to

FEMA. The FERA variable in the regression equation is a dummy variable with 1 signifying the

existence of the FERA in its manifestations other than for ownership which as been separately

controlled for. Thus, the years preceding 1973 and after 1999 are coded 0 while the other

intervening years are coded as 1. The FERA legislation was promulgated during a period of

economic crisis, when a left wing mind set was in place among India's policy makers and the

principal objective of the FERA legislation was to stop the unnecessary flow of foreign exchange

out of the country. The change to FEMA reflects more than a legislative re-write of rules and

procedures. There has been a change of mind set, with the realization that globalization is

irreversible, and the statutes have been re-written to make the participation of Indian firms in the

global economy much easier.

The specifics of the legislation apply towards making current transactions with firms based in

India and those abroad easier, paperwork has been simplified and the role of the government is

less intrusive. In addition, regulatory structures, that monitor compliance, have been re-designed

so as to be compatible with regulatory structures elsewhere in the world. Other than making

foreign currency transactions easier, and providing positive incentives to do so, versus the

negative control mentality that characterized FERA, the new FEMA legislation simplifies the

maze of controls, procedures and bureaucratic minutiae that have to be observed by all those

undertaking to set up and operate a business in India. These processes slow down considerably

the pace of activity and make Indian items uncompetitive, especially in today's context where

time compression is a source of critical competitive advantage. Removal of these administrative

lacunae makes India potentially attractive as a destination for foreign firms wishing to make

investments.

2.2.3 The history behind and logic of FEMA

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Consistent with the philosophy of economic reforms in the 1990s changes in the broad approach

to reform in the external sector took place. The 1993 Report of a *45 High Level Committee on

the Balance of Payments, chaired by Dr. C. Rangarajan, set the agenda. The Committee

recommended the introduction of a marketdetermined exchange rate regime within limits,

liberalization of current account transactions leading to current account convertibility, shifts in

capital flows away from debt to non debt creating flows, regulation of external commercial

borrowings especially short-term debt, discouraging volatile elements of flows from non-resident

Indians, full freedom for outflows associated with inflows and gradual liberalization of other

outflows, and the disassociation of Government in the intermediation of flow of external

assistance (Gopinath 2005).

In 1997, a Committee on Capital Account Convertibility (CAC), constituted by the Reserve

Bank of India and chaired by S. S. Tarapore, indicated the preconditions for Capital Account

Convertibility. The Tarapore Committee had also recommended change in the legislative

framework governing foreign exchange transactions. Accordingly, FERA which formed the

statutory basis for exchange control in India was repealed and replaced by FEMA. The

philosophical approach shifted from that of conservation of foreign exchange to one of

facilitating trade and payments as well as developing orderly foreign exchange markets, and

from a negative attitude of control to a positive attitude of management (Gopinath 2005).

2.2.4 Definitional and intellectual changes brought about by FEMA

Several changes have been brought by FEMA. The procedural changes include reduction of

complexity. FERA consisted of 81 sections and was a considerably complex piece of legislation

while FEMA is much simpler and consists of 49 sections. A presumption of negative intent and

joining hands to commit an offence existed in FERA while these presumptions abatement have

been excluded in FEMA. Standard terms in international trade and finance such as capital

account transaction, current account transaction, person, service etc. were not defined in FERA

but have been defined in detail in FEMA. The definition of authorized person in FERA was

narrow while it has been widened to include banks, money changes and off shore banking units,

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among others, in FEMA. Also, there was a substantial difference in the definition of resident

under FERA and tax legislation, while the provisions of FEMA are now consistent with the

Indian tax legislation.

Any offence under FERA was a criminal offence, punishable with imprisonment as per the code

of criminal procedure extant in India. In FEMA, offences are considered to be civil offences only

punishable with a monetary fine as a penalty with imprisonment prescribed only for failure to

pay the penalty. The monetary penalty under FERA was five times the amount involved while

under FEMA the quantum of penalty has been decreased to three times the amount involved.

FERA conferred wide powers on police officers to conduct searches while the scope and power

of search and seizure has been curtailed in FEMA. FEMA is no longer, psychologically,

legislation that is enforced by an economic police state. The Directorate of Enforcement is no

longer a commercial Gestapo.

*46 2.2.5 Procedural changes brought about by FEMA

The Act of 1999 (FEMA) contains the substantive and procedural aspects of Foreign Exchange

Regulations. The detailed provisions in regard to various aspects connected with foreign

exchange regulations are found in the rules, regulations and notifications under FEMA issued or

promulgated by the Government of India or the Reserve Bank of India. The Government of

India, in exercise of the powers conferred on it under Section 46 of FEMA, has made various

sets of rules, namely the Foreign Exchange Management (Current Transactions) Rules, 2000, the

Foreign Exchange (Compounding Proceedings) Rules, 2000, the Foreign Exchange Management

(Adjudication Proceedings and Appeal), Rules, 2000, the Foreign Exchange (Authentication of

Documents) Rules, 2000 and the Foreign Exchange Management (Encashment of Draft, Cheque,

Instrument and Payment of Interest) Rules, 2000. These govern the implementation of FEMA.

Additionally, the implementation process for enforcement and appeals has been made transparent

and independent. In the FERA regime, appeals against the actions of the Directorate of

Enforcement, housed in the Department of Economic Affairs in the Ministry of Finance, which

operated like a commercial Gestapo, would first be decided by an Adjuticating Office, and

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appeals against the decisions of this authority would go before a Foreign Exchange Regulation

Appellate Board, a nonindependent operational unit of the Ministry of Law. Appeals against the

decisions of the Foreign Exchange Regulation Appellate Board would be decided by a High

Court of Judicature. Thus, an independent judicial authority would only enter the adjudicating

process at the last stage.

Within the FEMA framework, appeals against the actions of the Directorate of Enforcement are

first decided by an Adjuticating Authority, and appeals against the decisions of this authority go

before the Special Director (Appeals), an independent position equivalent to the Director of

Enforcement. Appeals against the decisions of the Special Director (Appeals) lie before a

completely independent Appellate Tribunal for Foreign Exchange. Appeals against the decisions

of the Appellate Tribunal for Foreign Exchange are then decided by a High Court of Judicature.

Thus, additional competencies have been included to deal with disputes and independent judicial

processes enter the adjudicating process at an earlier stage. These changes enhance the reliability

of the system in the eyes of entrepreneurs and investors.

2.2.6 Crowding out by government and private firms

There are two allied institutional concerns. These have been captured by two variables,

GOVERNMENT capturing the proportion of government firms participating in India, and the

variable PRIVATE capturing the proportion of domestic private sector firms. An ownership issue

that has predated FERA has been the role accorded to state-owned firms in the Indian economy.

The core presumption underlying the promotion of government companies was that it was better

for firms *47 owned by the government to drive forward and enjoy the fruits of industrial

development in India.

The underlying theoretical premise was that private firms, whether domestic or foreign, would

not have either the best interests of a nascent Indian economy at heart or the capabilities to drive

forward the process of industrial development. For example, the profit motive would

predominate and the necessary basic items required by the mass of India's population would not

be on the product development agenda of such firms. The first impact of such a policy would be

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that the growth of state-owned enterprises would have crowded out foreign firms. In an

economy, growing at a finite rate, if one type of firm grows at a faster pace than others the other

types of firms are surely likely to lose their relative standing in the overall corporate economy.

Crowding out by private and government enterprises of foreign firms is the reduction of

opportunities by one group of firms, in the sense described by Elster (1979), for another so that

the relative position of the first group can be enhanced. From the mid-1950s, the thrust on the

state-owned sector as an instrument of industrial progress ensured that growth of this sector

made the growth of domestic private and foreign firms that much more difficult. Other than the

growth of government owned firms, the second related phenomenon that would impact on

foreign firms' growth would be the growth of domestic private firms, given that domestic

entrepreneurship in India had been somewhat limited in the past and there was a clamor for

catch-up. Thus, an autarkic mind set, the growth in the number of government firms and in the

growth of private firms will have crowded out foreign firms from the Indian corporate landscape.

3 Results and evidence

3.1 The corporate demography of India

The approach that I initially take is to highlight the demography of India's corporate sector, in a

relatively straightforward way, and first describe the different patterns of growth displayed by

three types of firms that are important within the context being evaluated: foreign firms, private

domestic firms and government firms. Table 1 provides details of the basic statistics.

Table 1 shows the average number of foreign, domestic private and government firms within

India's corporate sector for the overall period 1957-1958 to 2001-2002. The average numbers in

total, for each category, may not provide as much insights as the proportions that each category

bears to the whole. The proportion of foreign firms in India is less than 1% of India's firms but

their share has ranged from a high of 1.94% of all firms in India in the period between 1957-

1958 to 1972-1973, to a low of 0.186% of all firms in India in the period from 1991-1992 to

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2001-2002. This is shown in panel C. Clearly, there has been a substantial rise and fall in the

proportion of foreign firms within India's corporate economy.

facie evidence shows that the 1973 measure, which created a draconian 40% maximum

ownership limit for foreign firms operating in India, has had a substantially negative and

significant effect in retarding the entry of foreign firms into India.

The growth in the number of foreign firms is also counter balanced by the crowding out that the

presence of government firms and domestic firms has on the presence of foreign firms.

Whenever there has been a growth in the presence of government firms in the economy, there

has been a decline in the proportion of foreign firms. Similarly, whenever there has been a

growth in the proportion of domestic private firms there has been a decline in the proportion of

foreign firms.

The estimates for model (B) where the FEMA variable is included show that FEMA is positive

and significant (t statistic: 3.53; p < 0.01) at the conventional levels. The GOVERNMENT and

PRIVATE variables are again both highly significant (t statistics are 3.45 and 88.70 respectively

with the value of p < 0.001). The evidence now shows that the 1999 measure, which has now

eliminated the draconian FERA policies, relating to maximum ownership limit for foreign firms

operating in India as well as transforming the transactions landscape, has had a substantially

significant effect in promoting the entry of foreign firms into India.

In model (C) where the FERA and FEMA variables are both included, the FERA variable is

negative but non-significant while FEMA is positive and significant (t statistic: 3.57; p < 0.01) at

the conventional levels. The GOVERNMENT and PRIVATE variables are once again both highly

significant (t statistics are 3.08 and 79.66 respectively with the value of p < 0.001).

*52 4 Discussion

A first finding established is that the transition in 1973 from an ownership regime where

holdings of 51% were allowed to one where the maximum limit was 40% had a large negative

impact on foreign firms' willingness to participate in the Indian economy. The negative

coefficient for the FERA variable versus the positive sign for the FEMA variable, which

implicitly also captures the ownership transition, shows this to be the case. Since this policy has

been reversed foreign firms' presence in India has significantly increased. Clearly, the 51%

ownership limit is crucial as an incentive for foreign firms to make investments.

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Following the guidelines of the International Monetary Fund, the Reserve Bank of India

classifies equity ownership of more than 25% as enabling control. Below that level, foreign firms

are assumed to be relatively passive investors. At just over a 25% level of shareholding, foreign

firms have the ability to block members' special resolutions which are necessary to make

significant strategic changes. The passage of special resolutions, under the Indian Companies Act

of 1956, requires that those holding 75% of the shares vote in favor. The government, in

reducing the maximum permissible foreign ownership limit to 40% in 1973, had thought that

foreign firms with 40% shareholding would have effective control. Nevertheless, the ability to

block a special resolution has not been adequate as a means of obtaining control. The role of

foreign firms would be reduced to that of a minority shareholder because those shareholders

owning the residual 60% of the shares could pass the necessary ordinary resolutions which

required that 51% vote in favor.

An argument could be made that a 51% holding was not critical if the holdings of the other

shareholders were widely dispersed. Where several small stake holders have only a small

resultant benefit from engaging in collective action then the motivation to engage in collective

action becomes low. Thus, with only a 40% stake, a foreign firm would be able to execute its

plans. Nevertheless, this would mean only a negative ability to achieve its objectives by blocking

a special resolution that went against its interests. Indian corporate law, however, requires that

51% of the votes be cast in favor if an ordinary resolution is to be passed. The ability to exercise

its abilities in a positive way would mean that a foreign firm would have to engage in proxy

contests so as to acquire the necessary majority. These would add layers of costs and

uncertainties to the decision making process.

The second important finding is that the transition from FERA to FEMA has had significant

impact in attracting foreign firms to India. Attitudinal as well as transactional transformations in

the management of the Indian economy have taken place, as shown by the several legislative

changes that were put through in the new FEMA. From being an economic police state, where

the Directorate of Enforcement once operated like a commercial Gestapo, the transaction

environment has been transformed to reflect India's increasingly enhanced role in the global

economy and participation therein will be on globally accepted terms. Both the simplification of

transactions, clarification of rules and the provision of independent appellate authorities serve to

reduce the uncertainties that foreign participants will feel, and the reduction of such

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uncertainties, via the legislation and implementation of FEMA, have served to attract foreign

firms into India.

*53 The presence of foreign firms matters for overall productivity within an economy. Capital is

the source of productivity and national wealth (de Soto 2000). Productive efficiency is the most

significant measure of economic performance, since a continuing high level of productivity

eventually provides the financial outcomes from undertaking economic activity and the funds to

make further capital investments. A literature (for instance, Dunning 1993; Grossman and

Helpman 1991; Helpman 1984; Hymer 1976 [1960]) shows that foreign firms' performance is

superior relative to that of other firms within an economy, and a key view is that foreign firms

have superior capabilities and intangible capital which lead them to become international players

in the first place (Caves 1996).

Such firms possess international marketing capabilities, location advantages in other countries, a

global operations network, in-depth knowledge of foreign markets (de la Torre 1974) and the

ability to manage the international political economy dimension (Helleiner 1988). Such

capabilities help foreign firms become productive relative to domestic firms within an economy,

and the foreign firms within an economy have been shown to be better in performance relative to

domestic firms (Balasubramanyam et al. 1996; Majumdar 1998). In addition, whether for

comparative advantage reasons (Ricardo 1817), to exploit India's current cost advantage, factor

endowments reasons (Hecksher 1950; Ohlin 1933), or demand similarities with the foreign firms'

countries of origin (Lindner 1961), foreign firms, too, may find India an attractive investment

destination.

The international mobility of capital has ensured that availability of capital is no longer an issue

for economic development to take place. A comparison is made with China. India's share of

world trade is less than one percent while China's is six times as large. Companies that do invest

in the Indian economy also make investments one hundred times larger in China (Jalan 2005).

The attitude that India has displayed towards foreign investment, from the early 1970s onwards,

has been replaced by a change of spirit. This change can have eventual significant productivity

consequences.

The first policy change was the automatic approval for foreign firms to hold 51% ownership. The

second change has been the extension of automatic approvals for having ownership stakes of up

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to 74% in all but a few sectors such as media and telecommunications. This took place in 1997.

The third important change has been the transformation of FERA to FEMA. The transformation

of the transactions environment and the creation of independent adjudication bodies ensure that

Indian institutional practices converge to best practices observed elsewhere and make India as

attractive an investment destination of choice as any developed country. Nevertheless, a

guarantee that these rules will not be changed again is important otherwise the country's ability

to make credible commitments is in doubt.

5 Conclusion

Using a data base on India's corporate sector, I evaluated the extent to which institutional

changes that have taken place in India have made an impact on the presence of foreign firms in

the economy. The data are organized as a time-series for *54 the period 1957-1958 to 2001-

2002, and cover the entire population of enterprises making up the corporate sector in India. The

data provide a comprehensive picture of the evolution of India's corporate economy for almost

five decades, and while there are limitations of aggregative data sets in capturing the nuances of

relational problems there is the necessity to evaluate phenomena and generalize for the sake of

reaching useful policy conclusions.

In the period after reforms commenced in 1991, the number of foreign firms in India has

increased very substantially. The growth in numbers averages 8.5% for the period from 1991-

1992 to 2001-2002 and since 1995-1996 has averaged 10% per year. While the proportion for

foreign firms to the total number of firms as a whole has dropped, because of the unleashing of

domestic private entrepreneurial activity in India, this statistic shows a positive growth from

1997 to 1998 onwards. The growth portends a significant interest in India by the suppliers of

foreign capital. Thus, foreign firms are interested in becoming an increasing presence in the

Indian economy, with positive performance consequences expected.

The control rights regime changes have had significant effects on providing incentives for

foreign firms to operate in India. The automatic availability of such rights, permitting ownership

of 51% after 1991 and 74% in some sectors after 1997, has been a major factor affecting the

motivation of foreign firms to operate in India. In addition, the transformation of FERA to

FEMA in 1999 has had a positive effect in inducing foreign firms to enter India. The new FEMA

legislation simplifies the controls to be observed by those undertaking to set up and operate a

business in India. Removal of the lacunae, the transformation of the transactions environment

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and the creation of independent adjudication bodies ensure that Indian institutional practices are

as good as any elsewhere and make India an attractive investment destination of choice.

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