Your Excellency,
We are submitting herewith our views on Convertibility of Rupee and Exchange Rate of Rupee.
The Tarapore Committee report is an excellent report. A well defined plan of action is the rigth way of preparing and discussing national strategies.
Hopefully, our presentation will compliment the report and add a few concepts.
Some of the view presented by us are different from Government policies so far.
We submit that :
Most of the fundamentals in the Indian economy are good. We can make rupee fully convertible by 31st December, 1999 and remove all restrictions on imports and exports by 31st December, 2000.
FERA is doing more harm than good.
Modern, fast, competitive global markets do not permit a situation where businessmen have to take “prior permissions” for their legitimate business decisions. The delays cause loss of business and GDP.
Enforcement Directorate’s human rights violations are unthinkable in modern democracy.
Hopefully, our views will be of some humble use to you.
We will be glad to personally meet, discuss and elaborate our views.
ASHOK DHERE
Page No.
Forwarding Letter ................................................ 1
Abbreviations ......................................................
5
Preface ..............................................................
6
I. Conservative Approach ................................ 9 to 26
--- Summary ................................................... 9,10
II. Rethinking the Future - Road map
A radical approach .................................. 27 to 70
--- Summary ............................................... 68, 69
III. FEMA ................................................. 71 TO
77
Conclusion ..................................................... 78
| SECTION I : CONSERVATIVE APPROACH |
Page No.
1. Summary of Suggestions and Time Table ..............................................................
9, 10
2. Explanations for the suggestions ---
2.1 NRI Investments -- Repatriability .................................................................. 11
2.2 Foreigners’ Dues ........................................................................................... 12
2.3 Red Tapism .................................................................................................. 13
2.4 RBI Approach .............................................................................................. 14
2.5 Current Account Convertibility ........................................................................ 18
2.6 Government Notifications .............................................................................. 20
2.7 Principles of Drafting Laws ............................................................................ 21
2.8 Gold Import ...................................................................................................
23
| SECTION II : RETHINKING THE FUTURE |
1. Asian Finance and Trading Centres in India ..........................................................
27
2. Present status of rupee Convertibility ..................................................................
28
3. Government Monopoly over FX ..........................................................................
29
Jain Havala Case ............................................................................................. 30
Past - Outward Flight of Capital ......................................................................... 32
Current Probabilities ......................................................................................... 33
4. FX Gambling ..................................................................................................
33
5. Derivatives and Options ...................................................................................
35
6. Consistent Devaluation ...................................................................................
38
6.1 Theories in support of continuous develuation of rupee ........................... 38
6.2 Value of rupee on PPP ........................................................................ 38
6.3 World
Development Report ..................................................................
39
6.4 Competitive
Devaluations .....................................................................
43
6.5 Balance of Trade ................................................................................. 43
6.6 External Debt ..................................................................................... 44
6.7 Oil Pool Deficit ................................................................................. 45
6.8 Exports ............................................................................................ 46
6.9 Government Budget .......................................................................... 48
6.10 Infrastructure Project “ -- “ Foreign Investment .................................... 49
6.11 Vicious Cycles ................................................................................... 53
6.12 Virtuous Cycles ................................................................................. 54
7. Paradox of Balancing the Fund Flows
....................................................... 55
8. Voluntary Disclosure of Income Scheme and FERA
................................... 57
9. Enforcement Directorate ...........................................................................
59
10. Reasons for Optimism ...............................................................................
64
11. Summary of suggestions and time Table .....................................................
68
|
|
1. FEMA & RBI ........................................................................................
71
2. FEMA & ED .........................................................................................
74
3. FEMA Convertibility & Income - tax .......................................................
76
Conclusion ..............................................................................................
78
| ABBREVIATIONS |
BOP : Balance of Payments.
BOT : Balance of Trade.
CAC : Capital Account Convertibility.
DFI : Direct Foreign Investment.
ECB : External Commercial Borrowings.
ECD : Exchange Control Department.
ED : Enforcement Directorate.
FX : Foreign Exchange.
GOI : Government of India.
RBI : Reserve Bank
of Inida.
1. WE PRESENT --
(i) Suggestions for action and a time table for the same;
(ii) A background, a perception of Indian economy based
on
which we have made the suggestions; and
(iii) Brief Logic for our suggestions.
1.1 Convertibility of rupee or replacement of FERA
by FEMA can
not be considered in isolation. Several economic and political
factors have to be considered together.
Sound Economic
1.2 At present, several economic fundamentals are good and
can
Fundamentals Justify
cause substantial industrial growth. Continuing liberalisation is
a Bold Approach. full
not giving expected results as the “sentiment” is pessimistic. A
potential may be
crisis of confidence pervading at all levels does not allow
the
Achieved when the
benefits to be gained to the full potential.
Sentiment Improves.
1.3 On convertibility of rupee and exchange rage, there
are several
reasons which can change over-cautious approach into optimism.
2. ROAD MAP
2.1 You have used to words -
“ROAD MAP to convertibility”
The Words “Road Map” make one think of some of the most
modern management gurus and we refer to the book “Rethinking
the Future". Some ideas from the writing of Mr. Alwyn Toffler
and Mr. Rowan Gibson are presented Below:
Future will be
(i) “People and institutions think that the future will
be a projection
Different.
of the past. It would be continuation of the same road.
Strategies will
have to be
Nothing is farther from the truth.
different from
the past.
The road stops here.
For future, you have to make your own road and make new road
maps.
2.2 Compared to these modern thoughts,
Some theories followed in the past by Government and the RBI
appear to need a fresh look.
Some such theories are :
(i) Devaluation of Rupee helps exporter; (para II 6.6.8 page 46);
(ii) Devaluations helps achieving BOT equilibrium; (para
II
page 43);
(iii) Inflation Differential must be reflected in exchange
value of
rupees; ( para II 6.2, 6.3 page 38 & 39 );
Each of these ideas is analysed in the paragraphs stated in the
bracket.
2.3 India does not have plenty of time to achieve CAC.
(i) We have already lost a few decades -- during which
nations
poorer than India have now 3 times the Indian per capita
GDP.
Growth is in progression.
When one nation is ahead, it keeps going further much faster
than the nation behind.
We need a quantum jump for recovering the time lost in
the past.
Global forces & trends do not leave much time and options
for India.
Global forces and
(ii) World Trade Organisation and others will not allow
us to
trends do not leave
retain our import controls for long. We must achieve global
much time and
competitiveness - so that by 31st december, 2000; we can
options for India.
remove complete controls on imports.
3. Tarapore Committee Report is a landmark in liberalisation
-
Ad hoc approach is replaced by a well directed process;
and a targeted time table. The fact that you have already
started implementing recommendations is building
confidence.
4. We understand that our report is not a complete
submission.
Financial institutional structure in the country, interest rate
differences etc. are not covered by us. There are other
policy issues that are not covered.
5. Our paper is presented at two levels:
(i) Our suggestions on convertibility of rupee as a
continuation of the past. A Conservative approach.
(ii) Rethinking the future -- a fresh and radical approach
at the issue.
6. This paper concentrates on convertibility of rupee,
procedures under FERA and valuation of rupee
(exchange rate).
{ { {
Page Nos.
1. Brief Suggestions and Time Table ........................................................................ 9, 10
2. Explanations for the suggestions ....................................................................... 11 to 25
2.1 NRI Investments - Repatriability ............................................................................... 11
2.2 Foreigners’ Dues .................................................................................................... 12
2.3 Red Tapism ........................................................................................................... 13
2.4 RBI Approach ........................................................................................................ 14
2.5 Current Account Convertibility. ............................................................................... 18
2.6 Government Notifications. ...................................................................................... 20
2.7 Principles of Drafting Laws. .................................................................................... 21
2.8 Gold Import. .......................................................................................................... 23
Paragraph (1) gives suggestions in brief.
Paragraph (2) gives explanations
for the same in the same serial order.
TIME TABLE
1. BRIEF SUGGESTIONS.
1.1 NRI investments - Repatriability
Make ALL NRI holdings and investments
in India fully convertible.
This will include inheritances
within India, earnings within India,
NRO account, NRNR accounts and
all investment and loans made
under RBI permission on non-repatriation
basis.
Announce the decision for this purpose 15th Aug., 1997
Give actual effect to decision on a date not later than 31st Dec., 1997
NRI Investments - Procedures
There are several investments that
are being permitted to NRIs as
on today - under various
categories and notifications.
Make all these investments free
from procedures. The NRIs may
simply file form “DIM” - a declaration
to RBI and go ahead and
make their investments.
15th Augu., 1997
1.2 Foreigners’ Dues
As a step towards convertibility,
Government / RBI should
announce that all funds belonging
to foreigners and foreign
companies can be immediately remitted
abroad. There are
several cases of delay in their
remittances.
Now that Indian has comfortable
FX reserves, all their dues
must be fully allowed to be remitted
abroad.
15th Aug., 1998
1.3 Read Tapism / Multiple Permissions
There should be single, final permissions.
When FIPB gives
permission, there should
be no need to go to RBI.
When Central Office of the RBI
gives a permission, there
should be no need to go to regional
office of RBI.
RBI’s policy of - “In Principle”
and “Fianal” - two stage
permissions should be abolished.
The first permission itself
should be “final”
15th Aug., 1997
1.4 The Manner of RBI’s liberalisations and permissions
need
improvement. Most
liberalisations by RBI are with several
conditions and provisos.
Almost all permissions gives by
RBI are accompanied by several
conditions.
All insignificant conditions should be removed.
All liberalisations for shares should be applicable to debentures also.
This simplification may be made effective immediately 15th Aug., 1997
1.5 Current Account Convertibility
India has announced convertibility
of rupee on the current account.
This is not fully implemented.
There are bureaucratic hurdles and
red tapism. There
restrictions amount to violation of declarations
made before the Parliament
and IMF.
Removal of all hurdles in
current account convertibility will boost
confidence in Government.
Current account convertibility
should be implemented fully and
immediately. Any delay
is further eroding confidence in RBI.
15th Aug., 1997
1.6 Government notifications on liberalisations should be
without
unnecessary and insignificant
conditions and provisos.
15th Aug., 1997
1.7 Liberalising gold import and not allowing payment for
the same
is artificial.
Allow free import of gold
and free remittance of payments. This
will considerably reduce
the havala market.
15th Aug., 1997
2. BRIEF EXPLANATIONS
2.1 NRI investment - Repatriability.
Make all NRI investments in India fully repatriable.
As the 1st step
2.1.1 We are not considering any ideology here. There is no
towards
comparison being made with residents’ rights.
convertibility, all
NRIs should be
2.1.2 Foreign exchange market and investment market; like
permitted full
share market run largely on confidence and sentiment.
remittance of
their holdings in
In the share market the promoter is most successful who
India.
gives ginuine benefits to his investor. And a promoter who
gives unexpected profits to the investors becomes
everyone’s darling.
By giving this gift of full repatriation rights to all NRIs, India
will suddenly become a centre of attraction for all NRIs.
Since this will be an unexpected bonanza; they would love
to make even more investments in India.
It is true that some NRIs will take their investments out of
India. We cannot estimate how much money will go out.
However it is a reasonable estimate that the new funds
inflow will be far more than the funds outflows.
This is, at best, an estimate. No one knows whether - on
making non-repatriable investments as repatriable
investments - the NRIs will take out more funds or bring
in more funds.
Comfortable FX
It will be calculated risk.
position permits
risk taking.
However, present is the best time to take such risk.
As per newspaper reports dated 18th June, 1997; there are
substantia FX inflows, reserves are swelling & govenrment
is worried over utilisation of increasing FX reserves ($ 28
billions). Government wants to utilise these reserves for
import of capital goods and technology.
Using a part of the increasing reserves for NRI remittances
will amount to building up more confidence in India; and
taking a clear step towards CAC.
In any case, when rupee is made fully convertible in or
around the year 2000; these remittances will be allowed.
And convertibility will be in steps. Let this be the first step.
Give NRIs an advance benefit and earn their confidence.
2.1.3 India may uppear to have political instability.
However,
there are countries which have far more instability.
To our knowledge, some of the NRIs’ sentiment is on the
following lines:
NRIs want a
Indian politics is more stable than the whole of Africa and
stable country
Latin America. NRIs living in the Middle East do not keep
for investments.
their savings in the Middle East. Indonesia is a dictatorship
- NRIs living there do not plan to retire there. All these NRIs
are constantly in search of a good, stable country for
investment. They know that what happened to Kuwait can
happen to several other city countries. These smaller
countries may not exist in the global political map after a
few decades. But India will be there as a country even after
several decades.
So far, the rich NRIs have considered U.S.A. and U.K. as
primary investment targets. There are several reasons. One
chief reason is : they have sufferred substantial losses by
investing in India.
Despite these losses, NRIs have still made and continue to
make investments in India.
GO ALL OUT to attract these investments on a large
scale, Making existing investments fully repatriable is one
such move. Other moves discussed are :
Appreciation of Rupee - Paragraphs II 10, page 64
Simplifying all procedures - Paragraphs I 2.3, 2.4 -
pages 13 & 14
2.2 Foreigners’ Dues
All foreigners
There are different cases where amounts payable to
should be allowed
foreigners are not allowed to be remitted. A few
full remittance of
illustrations are given.
their dues.
2.2.1 Foreign citizens, who worked in India might have
saved
certain amounts in India. At the time of retirement & return
abroad, they are permitted to remit Rs.10 lakhs in the first
year and Rs.5 lakhs per year thereafter.
2.2.2 Foreign companies might have shareholdings in the
companies with which they have collaborated. For some
reasons they may sell the shares and may want to remit the
sale proceeds abroad - after payment of tax. Full amounts
are not allowed immediate remittance.
When a decision is taken for full convertibility, we will have
to progress towards it in steps. Permitting foreigners to take
back their dues should be a right step in that direction.
We may first implement the repatriability for NRIs - say on
31st December, 1997. Then watch the implications for a few
months. Foreigners may be allowed full remittance with effect
from 15th August, 1998.
2.3 Red Tapism/Multiple Permissions
2.3.1 One simple method of cutting down the bureaucratic
delay:
Multitude of authorities.
Today even when FIPB clears a DFI proposal, the parties
still have to obtain a further permission from RBI. And even
in such cases, there are several instances where RBI takes
several months in granting final permission.
"Multiple
There are instances where Central Office of RBI gives a
Permissions"
permission and then a further permission is required from
for the same
regional office.
transaction
should be
Such duplications must be absolished with immediate effect.
abolished.
Once FIPB grants a permission, there should be no need at
all for obtaining any permission from RBI . If at all statistical
information is required, a simple filing of declaration after
completing the transaction may be provided for.
Similarly, where Central Office of the RBI grants a
permission, there should be no need for the applicant to go
to any regional office - except for filing a declaration.
2.3.2 A characteristic red tapism is the RBI procedure
where --
RBI first grants an approval “in principle”. This approval is
attached with several conditions.
Once the applicant fulfils all these conditions - like filing bank
certificate for inward remittances etc. - a “final” permission is
given.
Consider an illustration
RBI gives permission “in principle” to an OCB to invest in
India say Rs. 50 lakhs. The shares and securities cannot be
issued before “final permission” is given. Final permission
will be given only after the OCB sends in the remittance,
obtains a bank certificate for having paid the money into the
Indian company and fulfilling several other conditions. This
may take two or three months.
Till such time, the Indian shareholders with their paltry
investment of - say Rs. 10,000/- remain 100% shareholders
of a company which has Rs. 50 lakhs in the bank account.
There have been actual cases of disputes developing within
these two months. It is a real possibility that has to be
considered. And the OCB remains in suspense, with no
Delay caused by
powers at all under the company law and the funds in control
multiple
of other shareholders.
permissions cause
avoidable anxiety
This suspense and delay are caused only by an obcession to
ensure that all formalities are completed before RBI gives the
“final permission”
Such two step permission procedure should be abolished
with immediate effect. First permission itself should be a
“final” permission. Several irrelevant conditions should be
abolished. Some key conditions may be fulfilled by the
applicant and appropriate declarations may be filed within
the prescribed time.
Both these simplifications can be introduced with
immediate effect -- say 15th August, 1997.
2.4 Reserve Bank’s Approach
We would like to place on records to appreciation that RBI
has remained one of the finest institutions in India. Most of
the institutions having statutory authorities have not been able
to remain free from corruption, nor have they been able to
maintain professional standards. The fact that RBI has been
able to do so in current India position -- is highly
commendable.
However, we have some different ideas and strategies which
we would like to submit here. These are the differences
which any two persons in a democracy may have.
There are some human frailties also. These are universal.
Reserve Bank’s Style of Functioning
Reserve Bank has a particular style of functioning and we
give a few examples:
2.4.1 Transparency
World over people move towards transparency. Whatever
is the policy, rules and regulations; it should be clearly
written and published.
RBI, however, believes in secrecy and keeping policy
matters to itself.
(i) There is a Blue Book of instructions.
RBI officers keep
it under lock and key. Public is not allowed access to it.
Why there should be such a secrecy ? If our
applications are going to be considered by a policy, we
have the right to know what it is.
Total Transparency
Initially, even the RBI’s Exchange Control Manual was
in all procedures
not available to the public. Thankfully, for the last few
under FERA/FEMA
editions, it is available to the public. RBI must publish
should be ensured.
the Blue Book also and any other policy guidelines
which RBI or GOI may be following to determine any
applications.
(ii) Agriculture
Non-Residents are not permitted to do agricultural
business in India. We are not discussing at this stage for
or against this policy decision. However, which section
of FERA, rules, regulation, notification or circular says
that RBI or GOI will not permit an NRI to do
agricultural business? It is not given in any statutory
announcement.
How can you have an important policy decision which
you keep under lock and key?
Is it Democracy of the 1990s?
2.4.2 Unnecessary and Insignificant Conditions/Red tape
Any time a permission is given by RBI, it is attached with
several insignificant conditions. Consider a few illustrations.
(i) Share Transfer
Insignificant
When RBI grants approval for transfer of shares - for
conditions in
example - by an NRI to a Resident, it provides for a
RBI permissions
condition that the cost of brokerage and share transfer
should be abolished.
fees must be borne by the NRI.
Why should RBI provide for such conditions?
Why can’t the parties to a contract decide who
should make such payments?
In practice it is an insignificant amount and any one
may pay it. However transacitons worth crores of
rupees have been held up because the RBI officer
insists on a bank’s certificate that the cost of brokerage
and stamp fee was borne by the NRI.
Why should such irritants be permitted -- which, for
totally insignificant matters cause red tape?
(ii) A.D (M.A. Series) Circular No. 20 dated October
28,
1996.
Disinvestment of shares.
In case, shares have to be transferred by private arragement
-- following conditions will apply :
(a) Shares can be sold at a price arrived at by
taking an
average of quotations for one week preceding the date
of application. The daily quotation should be average
of daily high & low. A variation of 5% on either side
can be considered.
(b) In case of share transfer with passing management
control, a price which is higher by up to a ceiling of
25% This, however, will be subject to conditions.
What is the sanctity of the share price of any week?
Promoters have manipulated the price any which way they
wanted. Investigations are going into such matters for years
together and nothing happens.
More important issue is, why should RBI decide the price?
Why can’t it be left entirely to the parties who are transacting
the business? How long can we go on with the suspicion that
if allowed, people will do wrong?
Those who want to do wrong have gone ahead & did it.
No authority has been able to prevent it. But genuine
businessmen who want to transact business with
appropriate - permissions get entangled into a cob-web
of conditionalities.
All liberalisations
It does not mean that there should be no regulatory
for shares should
mechanism. In fact we are saying that the regulatory
also be applicable
mechanism should be strengthened further so that the culprits
to debentures
are caught quickly and victims compensated. But regulators
have no business interfering with genuine businessmen and
their business transactions.
Paragraph 3 of the same circular gives detailed guideline on
thinly traded shares.
All these are permissions / liberalisations for shares.
Why not cover debentures whether fully convertible, partly
convertible or non-convertible?
In our submission, RBI or GOI should have absolutely no
say as far as price are concerned. A liberalisation for shares
must be applicable for all shares and securities.
2.4.3 Being “above the Law”
Compare the administration of Income-tax Act with the
administration of FERA.
The Income-tax department has a clear hierarchy.
Income-tax Act cannot travel beyond the Constitution.
Income-tax Rules cannot travel beyond the Act
CBDT circulars cannot travel beyond the Act and the Rules.
And all officers of the Income - tax department - from
CBDT chairman to the assessing officer cannot travel
beyond the Act, Rules, Circulars and notifications.
Consider following example under FERA :
NRI loans
RBI should not
Notification No. FERA 175/97-RB dated 27th Feb., 1997.
interfere in
Signed by Executive Director, RBI.
business
decisions.
This notification permits an Indian resident to receive loans
from NRI relatives provided that loan is interest free and
non-repatriable. The notification does not provide for any
conditions as to the use of funds.
Based on the above notification, RBI has issued circular --
A.D.(M.A.Series) Circular No.12 dated March 12, 1997.
The circular provides that the loans taken cannot be used
for, inter alia, purchase of immovable property, shares,
debentures or for relending !
We have two objections --
Why should RBI interfere in the citizen’ business decisions
-- as to the use of funds? Why should it lay down several
restrictions ? In the guise of effective monetary controls can
we as the nation allow such powers to RBI?
RBI circulars can
Secondly, how can the circular travel beyond the
not travel beyond
notification? When the notification does not provide
the law.
for end-use restrictions, can the circular provide such
restrictions?
Can the Chief General Manager, Exchange Control
Department - travel beyond what is provided by the
Executive Director?
2.5 Current Account Convertibility
2.5.1 You hav announced that rupee is now convertible
on
current account. This means that all revenue expenses
can be freely remitted outside. Incomes by Non-residents
can be freely remitted outside. This is a declaration made
by India to the International Monetary Fund (IME).
2.5.2 Article VIII of the IMF’s “Articles” is produced below:
“Section 1. Introduction
In addition to the obligations assumed under other articles of
this Agreement, each member undertakes the obligation set
out in this Article.”
“Section 2. Avoidance of restrictions on current payments
(a) Subject to the provisions of Article VII, Section
3(b)
and Article XIV, Section 2, no member shall, without the
approval of the Fund, impose restrictions on the making of
payments and transfers for current international transactions.”
Does this article permit any artificial restrictions on the
remittance of revenue expenses?
2.5.3 RBI circular - A.D.(M.A. Series) Circular No. 3
dated
16th January, 1997 gives a clear impression that there are
no restrictions on revenue expenses --
RBI can monitor
“India has accepted the obligations under Artcle VIII of the
but cannot sit in
Articles of Agreement of IMF and accordingly, all bona fide
judgement over
current account transactions would qualify for release of
current account
exchange either under the authority delegated to authorised
transactions.
dealers or after obtaining the necessary approval from
Reserve Bank.”
2.5.4 Consider following instances-
(i) There are foreign shipping companies whose containers
have been used in import of goods. The lease charges
for the containers are not being allowed to be remitted
abroad.
(ii) One company, relying on the fact that rupee is now
convertible on current account, appointed a foreign
comapany for a job. When the payment had to be
made, bank referred the matter to RBI. RBI is asking
“this job could have been done by an Indian company.
Why did you entrust it to a foreign company?” And
then RBI sent the company on a long round of obtaining
permissions from Government authorities.
3 year after its
2.5.5 Having made all declarations, when RBI does
not permit
announcement,
remittance of current account transactions -
the current account
convertibility is
It amounts to violation of the declaration made by India to
still not complete.
IMF; by the Finance Minister to Parliament. It amounts to
dishonouring RBI’s notification by RBI itself.
This shakes confidence in India and Indian institutions.
2.5.6 Why should RBI come down from its macro level policy
decision making and go into individual business decisions
of Indian businessmen?
2.5.7 RBI has a suspicion that in the name of current
account
payment, people may make capital transfers abroad. This
fear psychology may be answered in the following manners:
(i) In any case, Government is determined to make rupee
fully convertible. While we are liberalising; the fear
psychology has to give way to a liberal approach.
(ii) In the fear that someone will do wrong, you cannot
deny genuine payments.
(iii) Please also refer to paragraph II.2, page 28.
RBI should be independent of the Finance Ministry
also.
However, this independence should be at the macro
level in monetary policy matters. Can the RBI claim
to be “above the law” in individual applications?
Even Bundes Bank does not claim to be “above the
law”.
2.6 Government Notifications
The love for imposing unnecssary conditions is infectious.
Consider a notification issued by Government and the
conditions imposed :
Notification No. F10/22/90-NRI cell dated 17th July,
1992 as amended upto 5th January, 1994.
This notification permits an Indian resident to hold -
(i) Foreign Exchange in the form of coins;
Unnecessary
A limit of $ 1,000 plus coins is understandable.
stipulations in
GOI notifications
However, why the restrictions about the purpose for which
may be removed.
it is kept ?
How does one prove that he has kept the currencies for
“numismatic” purposes ? If the notes are in an album, it
may be okay. But if they are in a purse it may not be okay!
What purpose is served by imposing such restriction?
And what purpose is served by imposing a restriction that
$ 500 can be held for “personal” purposes? Imagine a
situation where a businessman, a minister or a bureaucrat
goes abroad for his official business. He returns to India
with a surplus of a $ 10 currency note in his pocket. He
knows that in a few months, he has to go abroad for another
business tour. So he retains the currency note $ 10.
This would be a violation of S. 14 of FERA.
The man has neither kept the amount for “numismatic”
purposes; nor for “personal” purposes. He has kept it for
“business” purposes.
The businessman or minister or bureaucrat can be arrested
for this reason. He can be taken to the enforcement office,
detained overnight and third degree methods can be used to
get a confessional statement.
For all such human rights violations, the Finance Ministry
would be directly and morally responsible.
We recommend a simple permission that “any Indian resident
can hold foreign exchange worth upto U.S. $ 1,000”.
2.7 Principles of drafting Laws
We refer to your lecture at Mumbai on 13th June, 1997 on
the subject of “New Companies Bill”. Following table, first
column is extract of your talk as reported in Times of India,
Mumbai, 14th June. Second column gives our comparison
with FEMA.
All the principles
1. Government will have no
Government & RBI should have
enunciated by you
discertion in company affairs. no discretion in individual
for new Company
matters. Their authority should
Law should also be
be only at macro policy level
carried to FEMA.
matters.
2. Bureaucratic meddling has
Government and RBI have
managed to spike many ideas. spiked innumerable investment
ideas and damaged economy.
-- under FERA.
3. Dangers of giving Government Because of
enforcement
discretionary powers are clear. directorate, giving discretionary
powers is criminal.
Because foreign investment and
foreign exchange are very
important for the economy, it is
even more important (than
company law) that Government,
RBI and ED should have no
discretionary powers and ED
should be wound up.
4. Company law shall be “maket It is
important that the Foreign
driven” rather than-
exchange flows - both in and
“bureaucracy driven”
out of the country should be
market driven.
A consistent attempt to force
the flows has resulted in the
massive outward flight of the
capital.
5. We got professionals and
Do the same for FEMA &
judges to draft company law Anti-Money Laundering
(AML) laws.
6. Company law should be potent FEMA should be
such an
instrument in fuelling growth
instrument.
and development.
AML should keep away mafia
& drug traffickers.
Summary
Businessman should be left to himself. Nowmally, he is
supposed to work honestly. Regulatory system should strike
when a businessman is found doing something wrong. At
such times, the punishment and compensation should be
quick, decisive and exemplary.
Your approach stated in the above referred talk by you
may please be carried to FEMA and Anti - Money
Laundering laws.
The policy of “prior permissions” and bureaucrats sitting in
judgement over business decisions is a “colonical” approach
and must be abolished at the earliest.
2.8 Gold Import
2.8.1 A prohibition to import gold was a gift of a billion dollar
business by the Government to the smugglers and the
havala racketeers.
Artificial restrictions
When gold import was liberalised, initially, the smugglers
on import of gold
were worried. Soon they relised that they do not have to
and payments for
worry. Government has still left good business for the
imported gold
smugglers and havala racketeers.
should be done
away with.
Government imposed two conditions that --
(i) Only an NRI who had been out of India for at
least
six months could import five Kilogrammes of gold;
and
(ii) No payment (outward remittance) will be permitted
for gold import.
In paragraph II 3.2, page 30 - we have discussed how
Government regulations create a market for the smugglers
and then a complimentary market for the havela racketeer
for payment for smuggled goods.
2.8.2 It is a practical fact of life that primarily,
a normal NRI has
no interest in bringing mint gold and keeping it in India.
Some NRIs may bring small amounts as a favour to friends
& relatives. But no one gives gold to any one free of
charge. He would want the price of gold and would want
to take the price back to the country of his residence. This
is not permitted by law.
Under the present scheme, a regular gold jeweller who
wants to sell jewellery in India cannot import gold.
Normal NRIs also would not want to bring in the gold.
So honest businessmen are out.
2.8.3 Smuggler is in
Instead of sending the gold through the porous border of
India, he can now send it officially through the customs.
He has to only catch hold of the cooks and drivers in the
Middle East, give them a free return ticket and send the
gold through these carriers. Customs cannot prevent the
carriers. The smuggler has to arrange to collect the gold at
the Indian airport. The carrier goes home, meets his
relatives and goes back to the Middle East for his job.
2.8.4 The havala racketeer also has not lost his business.
In fact,
his business has increased. Now more gold comes in India
and outward payment is not allowed. Government
probably believes that since outward payment is not
allowed through the banking channel, it doesn’t have to
face the impact on BOP.
2.8.5 This is wishful thinking.
Full payment for all imported gold has to go out. Only, it
goes out through the havala market.
It has its own impact on the BOP. The NRI remittances
which would have come in through the banking channel do
not come in. It gets set off against the smugglers’ gold
import transactions.
This has even more impact that the impact of normal
payments for imported gold. A payment by havala system
carries a premium ranging between 10% and 15%.
2.8.6 We recommend that --
(1) Import of gold (mint) should be freely allowed to
anyone who wants to import. Very soon accredited
Similarly, silver,
businessmen and institutions will star importing and
and diamond
trading gold.
imports and exports
should be freely
(2) All licensing and other procedures for import of gold,
allowed.
silver and diamonds should be scrapped. A jewellery
exporter should have absolutely no need for any
permission and no fear of any inspector knocking his
doors.
This may help the Belgium based diamond merchants
to set up shop in India rather than Belgium.
(3) Free, official payments should be allowed to anyone
who is importing these items.
This will be a concrete step towards real convertibility
on current account. And it will also wipe out the havala
markets.
Havala Market
While the havala market is going on, no one can have
obliterates a
a fair idea of the implications of any liberalisation or
clear vision of
other measure on the Balance of payments.
the impacts of
liberalisation.
Measures discussed so far, which can increase
outward flow of FX may be introduced in steps-
Free Gold import and
remittances
15th Aug., 1997
Full Current Account
convertibility
15th Aug., 1997
All NRI dues - fully
repatriable
31st Dec., 1997
All Foreigners and
foreign Companies
dues to be allowed
immediate remittance
15th Aug., 1998
{ { {
1. Asian Finance and Trading Centres in India. .....................................................
27
2. Present status of rupee Convertibility. ...............................................................
28
3. Government Monopoly over FX. .....................................................................
29
Jain Haval Case .....................................................................................
31
Past - Outward Flight of Capital ............................................................
32
Current Probabilities. .............................................................................
33
4. FX Gambling. ................................................................................................
33
5. Derivatives and Options. ................................................................................
35
6. Consistent Develuation. .................................................................................
38
6.1 Theories in support of continuous devaluation of rupee.......................... 38
6.2 Value of rupee on PPP. ....................................................................... 38
6.3 World Development Report. ............................................................... 39
6.4 Competitive Devaluations. ................................................................... 43
6.5 Balance of Trade. ............................................................................... 43
6.6 External Debt. .................................................................................... 44
6.7 Oil Pool Deficit. ................................................................................. 45
6.8 Exports. ............................................................................................ 46
6.9 Government Budget. .......................................................................... 48
6.10 Infrastructure Project - Foreign Investment. ....................................... 49
6.11 Vicious Cycles. ................................................................................. 53
6.12 Virtuous Cycles................................................................................. 54
7. Paradox of Balance the Fund Flows ............................................................
55
8. Voluntary Disclosure of Income Scheme and
FERA..................................... 57
9. Enforcement Directorate. .............................................................................
59
10. Reasons for Optimism . ...............................................................................
64
11. Summary of suggestions and Time Table. .....................................................
68
ASIAN FINANCE AND TRADING CENTRES IN INDIA
1.1 Finance Centres
The target in
1.1.1 Mumbai can be an Asian Finance Centre with established
drafting FEMA
associations allover the world. Madras and Bangalore can
should be to
develop as finance centres attracting NRIs from the Middle
encourage growth
- East and the South - East. Calcutta may specialise on
of Asian finance
China, Nepal and Bhutan. Delhi can be a Finance Centre
and trading
establishing relations with Russia and Europe.
centres in India.
1.1.2 While drafting FEMA and anti - Money Laundering laws, it
should be considered that the laws do not come in the way
of natural development of India as an international finance
centre.
1.1.3 The specialisations stated above should not be directed by
law. They may come about naturally.
1.1.4 The moment, draftsman start developing the law with this idea
in mind, entire concept of controlling the Indian residents will
be replaced by a Globalisation concept.
1.1.5 As an important step towards establishing international
exchanges in India, trading in all GDRs and ADRs of Indian
companies should be permitted on Indian stock exchanges.
For introduction of trading in FX denominated securities,
necessary institutional infrastructure should be created - SEBI
competent to deal with it. By a law it should be provided that
no state Government or other authorities can levy and tax or
stamp duty on these transactions. Custodial companies should
be established. This will be a complete package of issues by
itself.
1.2 Trading Centre
1.2.1 Hongkong developed as an international trading centre based
on China.
Dubai developed as an international trading centre because,
inter alia, India and Pakistan controlled and regulated
international trading. Left India do its own international
trading.
WTO will force
1.2.2 Whether we like it or not, with World Trade Organisation, we
us to open up
have no options. We will have to open up our economy for
trade earlier than
imports from everywhere. India is trying to postpone these
we would like.
pressures and asking for nine or seven years time.
Why ?
1.1.3 Because Inida is convinced that India cannot withstand global
competition.
As long as RBI and Controller of Imports and Exports will
regulate & control business, India will remain unable to
compete globally.
1.1.4 Imagine 25 cities in Inida developing like Hongkong, Dubai
and Singapore. This will be possible only when S. 18 of
FERA is scrapped and the entire Import policy is scrapped
(except drugs and weapons trafficking). Stop forcing every
exporter of goods and services for bringing in their FX
earnings into India. When the entire control atmosphere will
go, the exporter will be truly left free to do his business.
Ultimate aim should be that theses cities should be Global
finance and trading centres.
2. PRESENT STATUS OF RUPEE CONVERTIBILITY
Several authorities are taking exchange regulation very
seriously. RBI considers investments abroad permissions
ceremoniously with all the seriousness. If any one is caught
with a violation of FERA, the poor man is half dead even
before the ED pronounces final punishment. This seriousness
of exchange regulation is only for those who want to abide by
the law.
Rupee IS fully
Those who want to circumvent or violate the law, rupee is
convertible for
already fully convertible.
those who do not
care for the law.
Let us see some example.
2.1 RBI and Commerce Ministry used to take inordinately long
time in permitting joint ventures abroad. And they would
simply refuse permissions to partnership firms and individuals.
Diamond merchants found out the simplest method of sending
one family member abroad and making him nonresident. No
permission would be required from any Indian authorities. This
is one industry which is most successful in the field of setting up
business abroad. Most of the industries / group closely
supervised by RBI / ministry are not successful.
2.2 Businessmen, politicians and bureaucrats who wanted to
transfer capital in or out of India have always treated rupee
as convertible. They have transferred money at their will and
more efficiently than the banking system.
2.3 Dr. Man Mohan Singh had estimated that Indian residents’
black money in the Swiss banks is worth $ 50 billions.
This was in the year 1991.
Mr. Forbes (Jr.), Chairman, Forbes maganize had estimated, in
the year 1996 that Indian residents’ total weath abroad may be
near $ 150 billions.
No Indian authorities can make any dent in this situation - except
by announcing “immunity schemes”! All the Government
authorities are like the stable chowkidars running up and down
after the horses have bolted. They take out all their rage on the
timid and sick horses who could not run away and hence are still
withing India.
Strictest of the
2.4 Under the Indian judicial system, it was very difficult
to ensure
laws are
that the ED could have won any cases agains FERA violators.
ineffective against
This was because, proving an offence and mala fide intention;
smuggling and
taking exemplary penal action against smugglers was most
havala.
difficult. So Government adopted some unique methods. It
acquired massive powers under FERA which do not exist
under any other laws in India. And Government brought in
COFEPOSA & SAFEMA with even more powers.
With all these powers, the smuggling and havala transactions
have gone on unabated. In reality, the real big smuggler,
businessman or politician is never punished for diverse reasons.
It is only the small businessman who is terrorised and the
non-resident investor who is scared away.
Redundancy and harmfulness of FERA is established.
The reason for such a situation are discussed in the next
paragraph.
3. GOVERNMENT MONOPOLY OVER FOREIGN
EXCHANGE
3.1 Legislative Package
In the early fifties, Government decided to establish a total
monopoly over all foreign exchange resources.
FERA provided that all FX earned by any Indian resident
belonged to the Govenment of India and even an exchange
earner cannot use it for his requirements. All dealing in FX
including rate determination was the monopoly of GOI and
RBI.
A whole package
Import licensing sought to ban import of goods considered
of laws to
luxuries and reduce the import of other items. Import licensing
establish
was supposed to regulate / reduce the demand for FX.
Government
monopoly over
Customs duties made imported products costlier and provided
FX.
revenue to the Government.
Both - import licensing and customs duties provided tremendous
protection to the Indian industrialists and businessmen.
SAFEMA & COFEPOSA are supposed to deal with hardened
smugglers.
A perfect combination of laws to establish Government
monopoly over foreign exchange.
3.2 Impact of FX legislation
Import licensing created a wall, a barrier around India. Goods
which were available outside India were not available within
India.
Customs duties made imported products costlier.
Law abiding businessmen would not deal with goods not
allowed to be imported.
The package
All these together created a dream market for the smuggler.
really gave a
He had a ready market, almost no competition and a
dream market for
tremendous price difference between Dubai and Mumbai.
the smuggler.
The havala market for NRI remittances developed to
compliment the smuggling by completing the cycle of payment
for smuggled goods.
No legal system can even eliminate such a profitable business.
Government believed that by passing a set of laws, it can
achieve its targets even if they are coutrary to market forces.
The smuggler used the same set of laws to increase his business
and profits phenomenally.
All the laws are
The smuggler had a profitable business with no direct and
ineffective
indirect taxes and no investment in factories etc. He
against
commanded such huge financial clout that he could establish
smugglers.
influence with the politicians, customs officers, businessmen
and film stars.
For any economist, this was a telling result of Government’s
attempt to contradict market forces. But Government and its
institutions refused to see the writing on the wall.
So nature has caused a dramatic scene with double impact.
3.3 The Jain Havala Case
3.3.1 In the Jain havala case top politicians of almost all parties have
been alleged to have resorted to havala or bribes. They may
be innocent. But public feeling may be different.
The issue is, the market forces can be so strong that any one can
get tempted. And a large majority of people are prepared to
believe that almost anyone could be involved in violation of
FERA.
The law has lost ALL respect from public minds. It is an
unenforceable law which terrorises only the law abiding
citizens.
3.3.2 There is another implication of the Jain Havala Case. Consider
market practices.
Normally, an Indian resident transfers money into or out of
India through the havala agents. Once the transaction is
completed, there will be no evidence left - except - the havala
agent’s diary. In most cases of such FERA violations, the ED’s
main reliance is havala agent’s daiary or similar nothings in
different forms.
Everyone knows that a third party’s writing cannot amount to
an evidence of any material value before a Court of Law.
Hence the usual course adopted by the ED was / is to terrorise
and browbeat the accused into signing a confession. The
confessions are dictated by the ED officers and the accused
signs on the dotted line. Armed with the havala agent’s records
and the accused person’s confession, the ED could prosecute
the people.
3.3.3 In the Jain Havala Case, ED could not force the accused into
signing any confessions. And all cases fell flat.
3rd party
However, there is an important development. The courts
evidence is not
have now clearly held that the havala agent’s records are no
good.
evidence. Even the persons accused to be havala agent have
been acquitted.
Jain Havala Case
3.3.4 Now all the lawyears and the public will be emboldened.
has further
Except for the persons caught in the act of transfer of money,
diluted ED's
no one may be successfully prosecuted.
authority.
Whatever little teeth that the enforcement directorate had, have
been extracted by the Jain Havala Case.
FERA will have no powers to deter the powerful who want to
violate FERA. But it will continue to be a source of terror for
the ordinary people.
3.4 Causes of outward flight of capital : Past :
3.4.1 We had high tax regime.
Income-tax 97%
Wealth-tax 8%
Estate Duty 85%
Excessive Taxes,
These rates, in addition to artificial additions and disallowances.
Regulations and
devaluations
No person (almost) who was in these tax brackets could
have caused
remain honest.
outward flights
of capital.
3.4.2 Indirect taxes in the form of import duties, excise and sales
tax
were also very high.
3.4.3 Excessive economic regulation from all sides frustrated genuine
enterpreneurs.
3.4.4 Rupee was continuously depreciating. Anyone who kept
his
wealth in India rupee, lost. On the other hand people who
transferred their wealth abroad, benefited.
All these together were, inter alia, the causes of flight of capital
outwards.
They also made India economy a high cost economy
incompetent to compete in open, global markets.
3.5 Current Probabilities
That nightmare is a past.
Today India has a direct tax rate regime which is most
favourable to the businessman.
Indirect taxes are coming down.
Bureaucracy and red tapism has started - through extremely
slowly - going down.
Today Indian
Today, Indian economy offers a rate of return higher than the
economy favours
rate offered by most of the countries. The foreigner is not
a flight of capital
prepared for bureaucracy and its damages. But the Indian
inwards.
businessman is accustomed to it. Indians know that if only
they could bring back all their wealth kept abroad in tax
havens, they could earn more in India. (- net of exchange loss
and Indian taxes).
They are not bringing in full amounts because of the fear of
FERA - FEMA and tax laws.
The VDS scheme as announced is not adequate (See
paragraph 8, Page 51).
If FERA is totally scrapped and FEMA does not have sections
comparable to S.9 and 16 of FERA, there can be an inward
flight of capital. Slowly at first but a strong current in two to
three years time.
4. FX GAMBLING
4.1 In the past, FERA had three objectives:
4.1.1 Conservation of precious foreign exchanges;
4.1.2 Regulating / preventing foreign business presence within India;
4.1.3 Stabilising conversion rate of Indian rupee.
4.2.1 Today GOI and RBI are more concerned with utilisation of
surplus reserves rather than conservation of scarce FX.
4.2.2 And instead of preventing foreign investment, Government is
going all out of its way to attract foreign investment. So the
entire paradigm has to be shifted.
4.2.3 Only important issue is to maintain stability of Indian rupee.
4.3 Today, speculation in Indian rupee is restricted
and gambling
is just not allowed.
4.4 In the words of “Asian Wall Street Journal”
FX dealing is really
a “gamblers’ den”. Once a currency is fully convertible, there is
very little control that a Central Bank can exercise over
gamblers playing havoc with its currency. People like George
Soros are on the look out for any currency which has a wide
disparity between the prevalent market rate of the currency and
a value which in their perception is the sustainable value. When
why find a currency, they go all out with their gambling to wipe
out this difference.
If these gamblers decide to gamble on Indian rupee and if RBI
ever tried to intervene, the current FX reserves of around $28
billions can be used up in a day.
4.5 This danger has to be answered in two manners:
4.5.1 Rupee rate should be brought to a “sustainable” level.
(This
does not necessarily mean depreciation of rupee.)
Main objective of
FX markets must be made deeper and broader.
FEMA should be
maintaining
India’s international trade and investment should increase
Rupee stability.
considerably.
4.5.2 Unit this situation is achieved, RBI should be entrusted with
powers that could prevent gambling in Indian rupee - whether
by Indian gamblers or foreign gamblers.
4.6 The objectice and drafting of the legislation;
and administration
of the legislation should be towards protecting Indian rupee
from FX gamblers.
4.7 RBI should be given a period of three
years within which it
must create a situation enabling full convertibility of rupee.
4.8 It may also be appreciated that the gamblers
generally cannot
decide a rate. The rates are determined by market forces.
Gamblers only try to find out a currency where the rate
supported by a Central Bank is different from the rate which
market forces can sustain. If the difference is large, they strike
and make a killing.
4.9 Can India consider appreciating rupee with full convertibility?
4.10 Market rate of rupee is Rs.36/- per
dollar. PPP rate is
Rs.9/- per dollar.
A rate which may achieve an “equilibrium” between exports
and imports may be arrived at by annual adjustment of
inflation difference between India and U.S.A. Assume for a
moment that this rate may be Rs.40/-
4.11 An Apprehension :
If rupee is fully convertible and RBI tries to even maintain a
rate of Rs.38/- ; then the FX gamblers can strike and force
Maintaining
the rate to go down to Rs.40/-.
regular inward
flows is touch.
This may not be correct.
Easy options
have damaged
4.12 In the market the rate is determined
by total “Balance of
economy.
Payments” and not just by “Balance of Trade”.
If the total inward flows are larger than the total outward
flows, then the rupee should go up. And FX gamblers cannot
disturb such appreciating currency.
4.13 The issue is whether inward remittances
can be sustained!
If the inward remittances cannot be sustained; then very
soon there may be a need to depreciate the rupee.
Such uncertainties cause difficulties for the economy.
4.14 Real answer to this question is to ensure
an economic, tax
and legislative environment where sustained inflows of capital
are maintained. This is a tough task.
GOI and RBI have so far opted for the easier option of
continuously depreciating rupee.
5. DERIVATIVES & OPTIONS (D & O)
5.1 In 1991-92 when share market started
going through the
roof, Government was happy and claimed it to be the result
of liberalisation. When someone raised the issue that SEBI
and other regulatory mechanisms were not capable of dealing
with liberalised markets, the answers from the Government
were - “let us liberalise first. We will take care of regulation
a little later.”
In 1992 when the securities scam was exposed, the whole
Government was paralysed and economy went down.
5.2 When the scamsters were exposed
fully, it was known to the
public that several promising peoples’ lives were ruined - by
a few people.
The public response and the newspaper editorials and articles
were blaming that the Government was at the fault.
The scamsters are free. If they address a seminar, the hall
will be full. It they give interviews, leading financial papers
publish them on front pages.
5.3 Securities scam was not the last.
M.S. Shoes and other small
& big scams keep coming out. Every time Government is
blamed.
5.4 In our view, the nation is swept over by a wave of greed.
The small investor is greedy. He wants 50% returns in less
than one year.
The promoters are greedy. They want premiums based on
project reports.
Merchant Bankers and other intermediaries are greedy. For
their fees, they will support any scamster.
No statutory authority can save the situation when everyone
is greedy. The greedy people deserve what they get.
Indian
5.5 Despite this clear position, when
CRB scam broke out, all
Government
the editorials and articles were screaming at the Government.
carries a heavy
Everyone wanted to decide which authority was at fault -
burden of harsh,
RBI or SEBI or ROC! Mr. Bhansali, his brokers and the
unjustified
investors were a non-issue.
criticism.
You carry a heavy burden of public criticism. Which is
some times unjustified also.
5.6 In this situation, you want to permit
Derivatives and Options!!!
Most potent instruments that the gamblers use.
After Barings Bank’s insolvency, its chairman (now
retired) Lord Baring confessed that “I do not understand
Derivatives and Options.”
D & O have
How many persons within Indian regulartory authorities
strong potential
understand D & O?
of bringing about
crises.
What market intelligence mechanisms do you have to catch
the culprits?
If without adequate preparations you open up these volatile
instruments, are you not inviting fresh crises in the economy
- Similar to the securities scam of 1992 & CRB scam of
1997 !
6. DEVALUATION
6.1 Government has consistently devalued
the rupee. Probably
following theories / stratgies are behind this policy.
6.1.1 Inflation differential between India and its major
trading
partner must be compensated by devaluation / depreciation
of the rupee. (paragraphs 6.2 & 6.3)
6.1.2 Devaluation helps exporters. (Paragraph 6.4, 6.5 & 6.8)
Indian rupee is
6.1.3 Devaluation curbs imports and thus gives protection
to
undervalued.
indigenous industry.
6.1.4 Devaluation of Rupee creates equilibrium in Balance
of
Trade account. (Paragraph 6.5)
We believe that the Indian rupee is extremely under valued.
All the above stated theories are not applicable to Indian
economy at the present time.
Purchasing power parity and Demand and Supply are two
important theories for determination of exchange rate. Let
us consider both the methods one after the other. Let us
consider Indian rupee and U.S.$. The principles will apply
to several other currencies.
6.2 Value of Rupee on Purchasing Power Parity (PPP)
6.2.1 We can compare similar baskets of goods and compare their
cost in Bombay (or Delhi or any other metropolitan city )
and New York ( or Washington etc.). An easy and
comprehensive method of considering a basket of goods may
be monthly cost of living for a family of four.
In New York, a family spending $ 2000 per month can live a
lower middle class standard of living. A similar standard of
living may be enjoyed by a family in Bombay for Rs. 4,000
per month.
This would give a conversion rate of Rs. 2 per U.S.$.
PPP value of
There are several forces other than consumer goods prices
rupee is Rs.9/$
which should go into determining the exchange rate. It is
generally accepted amongst economists that in India, the
difference between the PPP rate and the market rate is in
the ratio of four. For a market rate of Rs. 36, the PPP rate
should be Rs.9 per dollar.
6.2.2 World Bank, in its annual report for the year 1997
has given
per capital, annual GNPs of various countries in terms of
market rates and PPP rates. As far as India is concerned,
the ratio of four between the two rates is roughly followed
for several years.
We believe that based on PPP, the real value of the rupee
should be Rs.9 per dollar.
6.2.3 We are aware of the strong objections which such
a
statement provokes and we shall deal with each one of them
(So far as we are able to do so.)
Before dealing with all these objections we submit two issues:
(a) We are not suggesting that the price should be brought
back to Rs.9/- We suggest that rupee should be
allowed to apprecate by 2% to 5% per year if the BOP
pressures cause such an appreciation.
(b) We will highlight the losses due to devaluation of rupee.
Rupee value through demand and supply forces is discussed
in paragraph 10.2 page 64.
6.3 World Development Report 1997
In this annual report, World Bank gives per capita annual
GNP of several countries for the year 1997. Local currency
GNP is converted into U.S. currency in two manners:
(i) At market rate; and
(ii) At Purchasing Power Parity.
6.3.1 World Development Report per capital GNP
Following countries have their local currencies’ market
values higher than the PPP rates.
____________________________________________
Country Name GNP at Market GNP at PPP
Ratio
Rates
Rates
____________________________________________
U.S.A 26,980 26,980 1.00
Sweden 23,750 18,540 1.28
Germany 27,510 20,070 1.37
France 24,990 21,030 1.19
Switzerland 40,630 25,860 1.97
Denmark
29.890
21,230 1.41
____________________________________________
Following countries have their local currency values at
market rates lower than the PPP rates.
____________________________________________
Country Name GNP at Market GNP at PPP
Ratio
Rates
Rates
____________________________________________
China 620 2,920 0.21
Brazil 3,640 5,400 0.67
India 340 1,400 0.24
Bangla Desh 240 1,380 0.17
Indonesia 980 3,800 0.26
Malaysia 3,890 9,020 0.43
Thailand 2,740 7,540 0.36
Kuwait 17,390 23,790 0.73
Russia
2,240
4,480 0.50
____________________________________________
6.3.2 Observations
1. It is not just that
poor countries have their currencies valued
lower than the purchasing power. Even the rich countries of
the Middle-East have their currencies valued low.
Common factor in all countries having low value of
currencies is that they are suppliers of raw materials and
other “low value addition” items.
Common factor in all countries having high value of
currencies is that they have experts in economics. These
people negotiate and manipulate world markets in such a
manner that the terms of international trade are in their
favour.
They benefit when they import low cost raw materials. They
benefit when they export finished products - because they
Wealthy nations
get higher values than added by them.
force developing
nations to lower
2. We believe that it is
a manner of clever bargaining to make
the value of their
all suppliers lower their currencies. Encourage them to a
currencies.
competition in devaluing their currencies. Enjoy the fruits of
low cost supplies.
This is the reason why (as per newspaper reports) a U.S.
official had come to India in the year 1997 and urged the
Indian Minister for agriculture to devalue Indian currency so
that Indian foodgrains can be competitive in the world
market. It was a great satisfaction to read in the paper that
the honourable minister had refused to oblige.
When these western experts fail in persuading one country,
they go and persuade some other country. If one major raw
materials supplier devalues its currency, others have to follow.
Powerful
This can be a reason why Pakistan has recently devalued its
countries write
currency.
the rules of
international
3. The Western World experts
advise us as if it is in “OUR
trade in their
interest” what actually is against our interest and “IN their”
favour.
interest. IMF, World Bank and other agencies are used as
a tool in implementing their policies.
4. There is a co-relation between the following two statements -
“Some of the rich countries have their currencies valued high.”
“Because their currencies are rated high, they are rich.”
5. These are the world
trade practices. We cannot consider
them sentimentally or politically. The most powerful countries
write the rules of the game. And they write the rules in their
own favour.
We have to play the game of international trade.
If we appreciate the purpose of their rules, we are better
Offsetting
prepared for the game.
inflation
differential is
6. The issue is, rupee
is already extremely undervalued. There
out of question.
is no need to depreciate the value of rupee and offset the
inflation differential between India and U.S.A.
6.4 Competitive Devaluations
India’s competitors in the world trade are other “commodity/
low value products suppliers” like China, Bangla Desh,
Pakistan, Brazil etc.
When Indian Government devalues the rupee to help Indian
exporters, all these countries aslo devalue their currencies.
Competitive
In this cycle of competitive devaluation; none of the raw
devaluations
material supplier country benefits.
only benefit the
wealthy nations.
The western, developed nations benefit in terms of getting
their raw materials cheaper from all the countries.
We must not start the self damaging cycle of devaluations.
If, however, a major competitor starts the devaluation, we
can not prevent the vicious cycle.
It is necessary that in all the trade and cultural blocs and
outside the blocs, wherever India can influence opinions; it
must convince the competitor to co-operate and to stop this
cycle of competitive devaluations.
6.5 Devaluation and Balance of Trade (BOT)
It is believed that a devaluation of the currency helps
achieving an equilibrium in the Trade Balance. It makes
export more attractive & imports costlier. So exports
increase & imports reduce. Thus an equilibrium is achieved.
Last forty years experience shows that we have never
achieved a position where exports are equal to or more than
imports. Wherever there is a massive devaluation, there is
With inelastic
some short-term fall in imports, a jump in exports and we
imports and little
may see that for one year or so the trade deficit is very small.
export surpluses;
devaluation can
However, our imports are largely inelastic. Through import
not help BOT.
licensing we have always avoided all the imports that could
be avoided. And what cannot be avoided has to be imported
at any price. Devaluation only causes a cost-push-inflation.
Until the economy settles after a devaluation shock, there may
be a short period drop in imports. A sustained reduction in
imports can only be achieved by import substitution and
increase in indigenous production.
Our exports of goods cannot be increased beyond a point.
There is no exportable surplus. India itself is a large market.
For most of the last 50 years it has remained a seller’s
market - with large demands going unsatisfied.
Our trade deficits have largely been fulfilled by NRI
remittances and by foreign aids.
Exports have never been able to fully finance our imports.
In other words the policy of continuous devaluation has failed
to achieve the objective of making the exports exceed the
imports, or even to balance the trade.
If this policy has not succeeded for fifty years, how much
more time can we give to this policy?
It is necessary to finance - for the next five to ten years, the
trade deficit by-
(i) Return of Indian residents’ money held abroad;
(ii) NRI investments; and
(iii) DFI.
In this much period we must make the economy a low cost
economy with high productivity so that our exports can
finance our imports.
6.6 Consider the loss in external debt due to devaluation of rupee.
6.6.1 INDIAN GOVERNMENT’S EXTERNAL DEBT
6.6.2 During Dr. Manmohan Singh’s term as Finance Minister
-
Debt in US $ has grown from 84 billions to 92 billions (less
than 10% increase). Debt in Rupees has almost doubled
from 1630 billions to 3150 billions. The reason - Devaluation
of the rupee from Rs.18 per dollar to Rs. 33.5 per dollar (in
March `96).
This is a telling impact of rupee depreciation.
Assuming a 5% average interest cost on external debt, the
additional cost due to devaluation is Rs.72 billions.
$ 92 Bn x (33.5 _ 17.9) = Rs.1435 Bn. Increase in loan due
to devaluation.
5% of Rs. 1435 Bn = Rs.72 billion increase in interest cost
due to devaluation.
Devaluation has
The devaluation policy has imposed an increased burden of
transferred
Rs. 1,43,500 crores on the next governemt - whcih finds it
wealth of
impossible to curb the mounting debt servicing costs.
Rs.1,43,500/-
crores from India
The loss of Rs. 1,43,500 crores is a transfer of wealth to
to the lending
foreign lenders and a read loss to India. It does not get
countries.
reflected in the budget or counted in fiscal deficit - so people
do not consider the loss. It has to be paid in hard cash/
exports.
6.7 OIL POOL Deficit.
6.7.1 The Oil Pool deficit is because the cost of
Crude Oil has
increased and the retail price of petroleum products cannot
be increased. The deficit is balooning and no viable solution
is in sight.
Let us analyse the problem with a “Paradigm shift”
Some of the factors which determine the ultimate petroleum
products price are given below.
_____________________________________________
Factors
Remarks
Illustrated
Figures
_____________________________________________
1. International Beyond the Control
of $ 17 per barrel
Crude price in GOI or IOC. Taken
dollars
for granted
2. Conversion rate Taken for Granted that Present
Rs.36
of $ and rupee rupee must depreciate
will conti-
for inflation differential ously fall
3. Customs, Excise Must keep increasing
Sales Tax,
as government needs
Octroi
more revenue
4. Refining costs Well within control
& margins,
Distribution
costs and
margins
_____________________________________________
(Note: This is an extremely simplified table emphasising a
few key factors in price determination)
Given these parameters, the price of petroleum products
has to keep increasing. Petroleum being an important
source of energy, chemicals and feed stock for several
industries; every price increase translates into general
inflation. Government’s attempt to control inflation are
thwarted by the increase in petroleum price.
6.7.2 Can we Control Petroleum price without causing
oil
pool deficit?
Let us challenge the assumption “Taken for Granted”
No Devaluation,
Consider a possibility that the conversion rate of Rs. 36/$
No Oil Pool
were reduced to say Rs.31/$. (The rate before the latest
Deficit.
devaluation/depreciation of rupee).
Entire, current, annual deficit in the oil pool account would
be wiped out.
It may be contended that we cannot revalue the rupee. It is
a controversial contention with which we do not agree.
However, without discussing the controversy, one can at
least agree that the devaluation has caused an increase in
crude oil cost by 15% and created the oil pool deficit.
For last two years, Government has not been able to solve
the issue of oil pool deficit. If no devaluation had been made,
there would be no problem of oil pood deficit.
CONCLUSION
If the Government wants that -
(i) Serious problems like oil pool deficit do not
recur;
and that
(ii) Inflation is controlled;
It must (a) Stop any fruther depreciation
of rupee; and
(b) Start revaluing the rupee.
6.8 Impact on Exports
6.8.1 Several items of exports have very high import
content - like
diamond and gold jewellery exports. They have little benefit
on account of rupee depreciation. With every depreciation,
their own costs of purchase go up proportionately and they
have to increase the export prices.
Exports get
Items like cotton yarn which have negligible direct import
caught up in
content are also affected.
Inflation -
Devaluation -
Where the exporter does not suffer a cost increase, the
Inflation - cycle
foreign buyer (who know detailed cost sheets of Indian
exporter) forces a price cut. All the benefits go to the
foreign buyer.
Every devaluation causes rise in energy prices, transport
prices and a general inflation with a multiplier impact . So
some cost increase is felt by all exporters.
Every cost increase/inflation reduces the exporter’s profita-
bility and competitive power. Hence he lobbys for further
devaluation.
Thus devaluation causes inflation which reduces export
competitiveness necessitating further devaluation.
It becomes a self supporting cycle of continuous devaluation
and inflation making the country with a high cost internal
economy.
6.8.2 Exporters in India have not been able to establish
their brand
names outside India. They do not have large distribution
networks for exports. They cannot undertake extensive
advertising compaigns in North America or Western Europe.
Low value of
Most of our exports are “low value addition” items.
rupee incapacitate
exporters.
This situation has emerged because of low value of rupee.
A multimillionaire in terms of Indian rupees is a ‘no-body’
in terms of U.S.$. How can he spend substantial amounts
in FX for marketing and distribution!
The only method he has learned for exporting his
“commodity” products is by “under-cutting”. GOI helps
him by devaluing the rupee.
This is not the right way of earning real values by exports.
Real way is by at least having the rupee value equal to its
PPP value - facilitating exporters in creating their global
establishments. And having an export of goods and
services based on values offered and not based on
under-cutting.
6.9 Government Budget
Devaluation increases the cost of imported product.
Together with customs duties the inflationary impact is
multiplied.
Inflation forces the pay commission to increase wages and
dearness allowances.
Devaluation
A large part of the benefit to the Central Government in
causes increase in
terms of increase in customs revenue is wiped out due to
fiscal deficit.
an increase in Government expenses.
This and other cost increases - cause increase in capital and
revenue expenses of Central and State governments of India.
These result in higher fiscal deficit;
on increase in taxes;
or both.
This causes further inflation.
Another self supporting vicious cycle of devaluation -
inflation - devaluation starts.
6.10 Infrastructure Projects - Foreign Investment
Rupee Depreciation Illustration
Continuously depreciating rupee makes infrastructure
projects unviable.
This is one of the reasons why adequate investment is not
forthcoming in the infrastructure industry.
This concept is illustrated by an example for a road project.
Roads
Consider the example of a new Road Project and examine
reasons why private sector investment is not coming in.
1.1 Assume a road project where the
foreign loan component is
$100 millions
1.2 Interest Payable 7% p.a
1.3 Loan repayment 20 equal instalments $ 5 millions
1.4 Company expects a net profit of 10% p.a.
2.1 Rupee rate in the year July, 1991 Rs.18 per U.S.$
2.2 Rupee rate in the year June, 1997
Rs.36 per U.S.$
6 years
2.3 Annual compounded rate of depreciation
of rupee
12.25%
2.4 If past in projected into future, an
investor in India should be prepared for
at least 10% depreciation of rupee
every year.
IMPACT OF RUPEE DEPRECIATION
|
|
|
|
|
|
|
|
|
|
|
|
|
100.00
|
7.00
|
12.00
|
36.00
|
432.00
|
432.00
|
17.00
|
22.00
|
792.00
|
|
|
95.00
|
6.65
|
11.65
|
39.60
|
461.34
|
419.40
|
16.15
|
21.15
|
761.40
|
|
|
90.00
|
6.30
|
11.30
|
43.56
|
492.23
|
406.80
|
15.30
|
20.30
|
730.80
|
|
|
85.00
|
5.95
|
10.95
|
47.92
|
524.68
|
394.20
|
14.45
|
19.45
|
700.20
|
|
|
80.00
|
5.60
|
10.60
|
52.70
|
558.70
|
381.60
|
13.60
|
18.60
|
669.60
|
|
|
75.00
|
5.25
|
10.25
|
57.98
|
594.28
|
369.00
|
12.75
|
17.75
|
639.00
|
|
|
70.00
|
4.90
|
9.90
|
63.78
|
631.38
|
356.40
|
11.90
|
16.90
|
608.40
|
|
|
65.00
|
4.55
|
9.55
|
70.15
|
669.97
|
343.80
|
11.05
|
16.05
|
577.80
|
|
|
60.00
|
4.20
|
9.20
|
77.17
|
709.96
|
331.20
|
10.20
|
15.20
|
547.20
|
|
|
55.00
|
3.85
|
8.85
|
84.89
|
751.24
|
318.60
|
9.35
|
14.35
|
516.60
|
|
|
50.00
|
3.50
|
8.50
|
93.37
|
793.69
|
306.00
|
8.50
|
13.50
|
486.00
|
|
|
45.00
|
3.15
|
8.15
|
102.71
|
837.10
|
293.40
|
7.65
|
12.65
|
455.40
|
|
|
40.00
|
2.80
|
7.80
|
112.98
|
881.27
|
280.80
|
6.80
|
11.80
|
424.80
|
|
|
35.00
|
2.45
|
7.45
|
124.28
|
925.90
|
268.20
|
5.95
|
10.95
|
394.20
|
|
|
30.00
|
2.10
|
7.10
|
136.71
|
970.64
|
255.60
|
5.10
|
10.10
|
363.60
|
|
|
25.00
|
1.75
|
6.75
|
150.38
|
1015.07
|
243.00
|
4.25
|
9.25
|
333.00
|
|
|
20.00
|
1.40
|
6.40
|
165.42
|
1058.68
|
230.40
|
3.40
|
8.40
|
302.40
|
|
|
15.00
|
1.05
|
6.05
|
181.96
|
1100.86
|
217.80
|
2.55
|
7.55
|
271.80
|
|
|
10.00
|
0.70
|
5.70
|
200.16
|
1140.90
|
205.20
|
1.70
|
6.70
|
241.20
|
|
|
5.00
|
0.35
|
5.35
|
220.17
|
1177.92
|
192.60
|
0.85
|
5.85
|
210.60
|
|
Total
|
|
73.50
|
173.50
|
|
15727.81
|
6246.00
|
|
|
10026.00
|
COLUMN EXPLANATIONS
1. Gives opening balance
of outstanding loan in $ millions.
Opening loan is $ 100 millions. Annual repayment is $ 5
millions. Opening conversion rate - Rs.36/- $.
2. Interest payment in
$ millions on the reducing balance.
Rate 7% p.a.
3. Total debt servicing
in $ millions (interest + $ 5 million
loan repayment).
4. If rupee is depreciated
continuously @ 10% per year -
the annual rates of rupee, per U.S.$.
5. Total payments required
in Rs. millions; at depreciating
rupee (3 x 4)
6. Total payments required
in Rs. millions at constant rupee
(3 x Rs.36)
7. Interest on opening
balance (1), in $ if rate of interest
were 17%.
8. Total debt servicing
in $ millions (7 + $ 5mn.)
9. Total payment in rupees
millions (8 x Rs.36)
OBSERVATIONS (Para 6.10 continued.)
1.1 Loan repayment over 20 years and
rate of
interest is 7% p.a. total payment in 20 years
Loan $ 100 mn. +
Interest $ 73.50 mn.
___________
$ 173.50 mn.
$ 173.50 mn.
==========
1.2 If rate of rupee is constant @
Rs.36
Continuous
per dollar; interest rate is 7% p.a., total
depreciation of
payments
Rs.6,246 mn.
rupee makes
infrastructure
1.3 If rate of rupee is constant @
Rs.36 per $
projects unviable.
interest rate is 17% p.a., total payments
Rs.10,026 mn.
1.4 If rate of rupee keeps falling
@10% every
year and rate of interest is 7% p.a. total
payments
Rs.15,728 mn.
1.5 Assume that the investor is expecting
a 10% net profit after
payment of all costs, interest and taxes.
In a depreciating currency every soon the Debt Service
payments will exceed its net profits, will cause huge losses
and bring entire cash flow to a grinding halt.
2.1 Continuously falling rupee makes
debt servicing impossible
and causes the company serious difficulties. Some companies
have gone insolvent because of this reason.
2.2 To say that the investor can build
in a 10% depreciation of
rupee in his cost of capital - cannot work in many cases. It
may work for portfolio investor; or for consumer goods with
low payback period. It may not work for infrastructure
&nb