Awaiting FEMA

HOW OFTEN does one come across the word ``draconian'' in everyday life? Most of us would answer that question with ``rarely". Yet when journalists look for an adjective to describe the Foreign Exchange Regulation Act, which one affectionately calls FERA, more often than not, they choose "draconian". The good news is that FERA is on the way out and will soon be replaced by the Foreign Exchange Management Act, which people will refer to, with even greater affection, as FEMA.

The impending change has caught the imagination of a lot of people, including those who do not have much of an imagination. Some believe that the exchange control is on the way out and that one of these days we will wake up and find ourselves living in a country where we can buy foreign exchange as easily as we buy vegetables. Some optimists think that the FEMA will instantly transform the rupee into a convertible currency. Some slightly shady individuals are hoping that the Directorate of Enforcement will suddenly vanish into thin air. They will hope in vain. A quick reading of the preamble to the new Act makes it clear that the objectives of FEMA are different from those of FERA. The stated objective of the new Act is to facilitate external trade and payments and promote the orderly development and maintenance of the foreign exchange market in India. The preamble to FERA grimly talks about regulating payments, dealings and transactions with the objective of conservation of foreign exchange and its proper utilisation for economic development. A development oriented and outward looking act is replacing a control oriented and inward looking enactment.

Exchange Control had crept into India through the Defence of India Rules long before FERA was thought of. FERA was enacted just after India became free, originally for a period of five years, at a time when the country faced an acute foreign exchange shortage. As the shortage stubbornly refused to go away, FERA became permanent. The foreign currency earnings of resident companies and individuals were required to be surrendered to a central pool, from which the regulators would release foreign exchange to those who wanted it for purposes that were in the interests of economic development.

As conservation was one of the objectives, the Reserve Bank of India had sometimes to be as generous as Scrooge when it came to releasing foreign exchange. The central bank had to decide what was necessary and what was not. It had to prioritise the purposes for which the public could spend foreign exchange. Companies and individuals had to go to the RBI for permission every time they needed to incur any expenditure in foreign exchange. To establish the bona fides of each transaction, they had to submit documents and furnish clarifications. Often applicants and the exchange control department differed on what was a valid purpose. The resultant refusals and delays were a source of great irritation to the public.

There were so many rules that it was difficult to know all of them. Many people, in the normal course of life, found themselves violating exchange control rules that they did not know existed. Some others shivered with fear imagining that they had violated rules that did not exist. Businessmen found themselves hard pressed to reconcile the needs of business and the requirements of exchange control. If sometimes they considered violating a rule in the interests of commerce, they also had to think of the unpleasant possibility of being hauled off by the Enforcement Directorate.As time went on, and the foreign exchange reserves began looking more and more healthy, the RBI began to dilute the rules and delegate its authority to the banking system. Though things became comparatively easy for the public, it was still a system that focused on control. That is what the new Act is widely expected to change.

In FERA, a number of the sections include the words ``without the general or special permission of the RBI, no person shall..." All foreign exchange transactions, except those permitted by the RBI, were prohibited.

The FEMA differentiates between capital account and current account transactions. On the capital account, the forex outflow is allowed only for transactions that are permitted, while the foreign exchange can be drawn for all current account transactions, except those prohibited. Capital account transactions can be allowed by the RBI in consultation with the Central Government, while current account transactions can be restricted by the Central Government in consultation with the RBI. By eliminating, decreasing, or increasing the restrictions, the authorities can bring about real convertibility on the current account or have stringent exchange control.

Ultimately it all depends on what the authorities decide to prohibit. If they continue to have a control orientation, the exchange control under FEMA can be as restrictive as under FERA. The mere introduction of FEMA will not necessarily create a system that focuses on developing the market and encouraging external trade. The key is whether the regulators will retain or change their mindset.

P. Yesuthasen

Former Deputy Controller,

Reserve Bank of India.

* * *

The stated objective of the new Act is to facilitate external trade and payments.

It seeks to promote the orderly development and maintenance of the foreign exchange market.

On the capital account, the forex outflow is allowed only for transactions that are permitted.

Current account transactions can be restricted by the Centre in consultation with the RBI.

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