Evolution of the Foreign Exchange: FERA to FEMA

Written by: Pulkeshwar Rajpurohit and Lilian Thomas, Christ University, Bangalore


The Foreign Exchange Regulation Act (FERA) was a legislation passed by the Indian Parliament in 1973 and came into force with effect from January 1, 1974. The laws were enacted for the management and regulation of foreign exchange and payments in India. It was a temporary arrangement to control the flow of investment at the time of Independence. It also imposed stringent regulations on certain kinds of payments, foreign exchange, securities, and transactions which had an indirect impact on the import and export of currency.

Features and Objectives of FERA

FERA was applicable to all citizens residing in and outside India, branches and agencies outside India, as well as companies or corporate bodies, registered or incorporated in India. The principle rule that governed such bodies was that all branches of foreign companies that operated in India were made to convert themselves into Indian companies with at least 60 per cent local equity participation. Moreover, all subsidiaries of foreign companies were ordered to bring down their foreign equity share to 40% or less.

The preamble to the Act describes it as ‘An Act to consolidate and amend the law regulating certain payments, dealings in foreign exchange and securities, transactions indirectly affecting foreign exchange and the import and export of currency and bullion, for the conservation of foreign exchange resources of the country and the proper utilisation thereof in the interests of the economic development of the country”. On the face of it, the objective is the conservation of foreign exchange and its proper utilisation, and not towards the regulation of foreign companies.

During the post-Independence period, the objective of the Act was limited i.e., it was mainly to regulate the inflow of foreign capital and concerns with the substantial non-resident interest, and the employment of foreigners. Owing to the preserving and consolidating attitude of the Government, so as to avoid any sort of foreign domination, the initial approach towards foreign investment was unenthusiastic. However, due to rapid industrialisation in the country, there was an essential need to conserve foreign exchange. There was a severe imbalance between trade and payments.

In this background, the Ministry of Finance pointed out before the Joint Parliamentary Committee[1] on the Foreign Exchange Regulation Bill that it was necessary to replace the previous Foreign Exchange Regulation Act of 1947 in order to deal effectively with the following:

1. regulation of foreign capital in India

2. regulation of employment of foreigners in India

3. making enforcement of provisions regarding foreign exchange leakages more rigorous.

The Foreign Exchange Regulation Act, 1973 was drafted with the major changes in the abovementioned areas. It worked towards the effective implementation of the Government policy and the removal of the previous inconsistencies.

Challenges that led from Foreign Regulation Act, 1973 (FERA) to Foreign Exchange Management Act, 1999 (FEMA)

The FERA in its original form became ineffective and increasingly incompatible with the change in the economic policy and the opening up of the country to liberalization in the early 1990s. The need for a sustained foreign exchange husbandry was required along with a less stringent and supportive enactment. Therefore, the Foreign Exchange Management Act, 1999 (FEMA) was adopted.

The FERA system provided for the approval of the Reserve Bank whether it was special or general, in accordance with many of the laws thereunder. General permits have been granted by the State Bank under these provisions in respect of various matters by issuing several notices from time to time since the Act came into effect on 1 January 1974. Special permits were granted to applicants who applied for the purpose. Therefore, in order to understand part of the operation of the regulations one must refer to the Exchange Control Manual and the various notices issued by the RBI and the Central Government.

FEMA has brought about a change in and out of phase 3, which deals with foreign exchange transactions, etc. There are no other FEMA provisions that specify obtaining RBI approval. It looks like this is a change from the time of the permit to the regulation. FEMA's emphasis on the RBI is to lay down regulations rather than granting warrants. This change also removed the concept of "exchange control" and ushered in the era of "exchange management". As a result of this change, the legal title has rightly been changed to FEMA.

The preamble of FEMA stipulates that the Act shall incorporate and amend the law relating to foreign exchange in order to facilitate foreign exchange and payment and to promote the systematic development and maintenance of the foreign exchange market in India. Regarding the facilitating of foreign exchange, Section 5 of the Act removes restrictions on foreign currency deductions for the purpose of current account transactions. Since foreign trade i.e. import and export of goods and services, involves transactions in the current account, there will be no need to seek RBI permits in respect of remittances involving foreign trade. The need to remove restrictions on account sales currently became necessary as the country had submitted to the IMF in August 1994 that it had secured Article VIII. This notice states that no restrictions will be placed on remittances due to the current account transaction.

The Need for FEMA

The need for a new law was addressed to two main figures.

FERA was introduced in 1974 when India's financial position was unsatisfactory. It required strong controls to save foreign currency and to use it for the benefit of the country. The strongest limits have exceeded their use in the current changed environment.

Secondly there was a need to scrap FERA provisions and there was a forward-looking law on foreign exchange issues.

Repeal of draconian conditions under FERA

The strict regulations under FERA relate to the unregulated power of the Enforcement Directorate. This power empowers the Enforcement Directorate to arrest any person, search any location, seize documents, and initiate proceedings against any person in violation of FERA or in breach of FERA violations. Violations under FERA were considered a criminal offense and the burden of proof lay with the perpetrator.

Conclusion

It was seen that there were several inconsistencies and gaps between the declared object and the actual impact of the Act in India. But what made FERA stand out was that foreign companies were gaining by implementing the various provisions of the Act. The Indian economy was at an all-time low of foreign exchange reserves, which continued to drop even with FERA in place. Thus, in order for the vision of FERA to come into place, it was replaced by FEMA, 1999, which proved to be more fruitful in the long run.


References:

1. www.academia.edu

2. www.jagaranjosh.com

3. www.bankexamstoday.com

4. Report of the Joint Committee on the Foreign Exchange Regulation Bill, 1972.

5. https://www.rbi.org.in/


[1] Report of the Joint Committee on the Foreign Exchange Regulation Bill, 1972.

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