Foreign Exchange Market in India operates under the Central Government of India and executes wide powers to control transactions in foreign exchange. The Foreign Exchange Management Act, 1999 or FEMA regulates the whole Foreign Exchange Market in India. Before the introduction of this act, the foreign exchange market in India was regulated by the Reserve Bank of India through the Exchange Control Department, by the Foreign Exchange Regulation Act or FERA, 1947. After independence, FERA was introduced as a temporary measure to regulate the inflow of the foreign capital. But with the Economic and Industrial development, the need for conservation of foreign currency was urgently felt and on the recommendation of the Public Accounts Committee, the Indian government passed the Foreign Exchange Regulation Act, 1973 and gradually, this act became famous as FEMA.
Indian forex market since independence can be grouped in three distinct phases.
1947 to1977:
During 1947 to 1971, India exchange rate system followed the par value system. RBI fixed rupee’s external par value at 4.15 grains of fine gold. 15.432grains of gold is equivalent to 1 gram of gold. RBI allowed the par value to fluctuate within the permitted margin of ±1 percent. With the breakdown of the Bretton Woods System in 1971 and the floatation of major currencies, the rupee was linked with Pound-Sterling. Since Pound-Sterling was fixed in terms of US dollar under the Smithsonian Agreement of 1971, the rupee also remained stable against dollar.
1978-1992:
During this period, exchange rate of the rupee was officially determined in terms of a weighted basket of currencies of India’s major trading partners. During this period, RBI set the rate by daily announcing the buying and selling rates to authorized dealers. In other words, RBI instructed authorized dealers to buy and sell foreign currency at the rate given by the RBI on daily basis. Hence exchange rate fluctuated but within a certain range. RBI managed the exchange rate in such a manner so that it primarily facilitates imports to India. As mentioned in Section 5.1, the FERA Act was part of the exchange rate regulation practices followed by RBI.
India’s perennial trade deficit widened during this period. By the beginning of 1991, Indian foreign exchange reserve had dwindled down to such a level that it could barely be sufficient for three-week’s worth of imports. During June 1991, India airlifted 67 tonnes of gold, pledged these with Union Bank of Switzerland and Bank of England, and raised US$ 605 millions to shore up its precarious forex reserve. At the height of the crisis, between 2nd and 4th June 1991, rupee was officially devalued by 19.5% from 20.5 to 24.5 to 1 US$. This crisis paved the path to the famed “liberalization program” of government of India to make rules and regulations pertaining to foreign trade, investment, public finance and exchange rate encompassing a broad gamut of economic activities more market oriented.
1992 onwards:
1992 marked a watershed in India’s economic condition. During this period, it was felt that India needs to have an integrated policy combining various aspects of trade, industry, foreign investment, exchange rate, public finance and the financial sector to create a market-oriented environment. Many policy changes were brought in covering different aspects of import-export, FDI, Foreign Portfolio Investment etc. One important policy changes pertinent to India’s forex exchange system was brought in -- rupees was made convertible in current account. This paved to the path of foreign exchange payments/receipts to be converted at market-determined exchange rate. However, it is worthwhile to mention here that changes brought in by government of India to make the exchange rate market oriented have not happened in one big bang. This process has been gradual.
FEMA FEATURES
- Activities such as payments made to any person outside India or receipts from them, along with the deals in foreign exchange and foreign security is restricted. It is FEMA that gives the central government the power to impose the restrictions.
- Restrictions are imposed on residents of India who carry out transactions in foreign exchange, foreign security or who own or hold immovable property abroad.
- Without general or specific permission of the MA restricts the transactions involving foreign exchange or foreign security and payments from outside the country to India – the transactions should be made only through an authorised person.
- Deals in foreign exchange under the current account by an authorised person can be restricted by the Central Government, based on public interest generally.
- Although selling or drawing of foreign exchange is done through an authorized person, the RBI is empowered by this Act to subject the capital account transactions to a number of restrictions.
- Residents of India will be permitted to carry out transactions in foreign exchange, foreign security or to own or hold immovable property abroad if the currency, security or property was owned or acquired when he/she was living outside India, or when it was inherited by him/her from someone living outside India.
- Exporters are needed to furnish their export details to RBI. To ensure that the transactions are carried out properly, RBI may ask the exporters to comply to its necessary requirements.
