Trade policy reforms over since 1991 have aimed at creating an environment for achieving rapid increase in exports,

raising Indias share in world exports and making exports an engine for achieving higher economic growth.

The focus of these reforms have been on liberalization, openness, transparency and globalization with a basic thrust on outward orientation focusing on export promotion activity, moving away from quantitative restrictions and improving competitiveness of Indian industry to meet global market requirements.

Reforms in industrial and trade policy were a central focus of much of Indias reform effort in the early stages. Industrial policy prior to the reforms was characterized by multiple controls over private investment which limited the areas in which private investors were allowed to operate, and often also determined the scale of operations, the location of new investment, and even the technology to be used

Trade policy reform has made progress, though the pace has been slower than in industrial liberalization. Before the reforms, trade policy was characterized by high tariffs and pervasive import restrictions. Imports of manufactured consumer goods were completely banned.

For capital goods, raw materials and intermediates, certain lists of goods were freely importable, but for most items where domestic substitutes were being produced, imports were only possible with import licenses. The criteria for issue of licenses were nontransparent, delays were endemic and corruption unavoidable. The economic reforms sought to phase out import licensing and also to reduce import duties.

Import licensing was abolished relatively early for capital goods and intermediates which became freely importable in 1993, simultaneously with the switch to a flexible exchange rate regime. Import licensing had been traditionally defended on the grounds that it was necessary to manage the balance of payments, but the shift to a flexible exchange rate enabled the government to argue that any balance of payments impact would be effectively dealt with through exchange rate flexibility.

Removing quantitative restrictions on imports of capital goods and intermediates was relatively easy, because the number of domestic producers was small and Indian industry welcomed the move as making it more competitive.

Tariff protection Progress in reducing tariff protection, the second element in the trade strategy, has also taken place. The peak duty rate was reduced and a number of duty rates at the higher end of the existing structure were lowered, while many low end duties were raised to 5 percent.

Although Indias tariff levels are significantly lower than in 1991, they remain on the higher side because most other developing countries have also reduced tariffs in this period. The weighted average import duty in China and southeast Asia is currently about half the Indian level.

Foreign Direct Investment Liberalizing foreign direct investment was another important part of Indias reforms, driven by the belief that this would increase the total volume of investment in the economy, improve production technology, and increase access to world markets. Now100 percent foreign ownership in a large number of industries and majority ownership in all except banks, insurance companies, telecommunications and airlines is allowed.

Procedures for obtaining permission were greatly simplified by listing industries that are eligible for automatic approval up to specified levels of foreign equity (100 percent, 74 percent and 51 percent). Potential foreign investors investing within these limits only need to register with the RBI. For investments in other industries, or for a higher share of equity than is automatically permitted in listed industries, applications are considered by a Foreign Investment Promotion Board that has established a track record of speedy decisions.

These reforms have created a very different competitive environment for Indias industry than existed in 1991, which has led to significant changes. Indian companies have upgraded their technology and expanded to more efficient scales of production. They have also restructured through mergers and acquisitions and refocused their activities to concentrate on areas of competence. The presence of foreign-owned firms and their products in the domestic market is evident and has added greatly to the pressure to improve quality.

FERA TO FEMA

Why was it necessary to replace FERA by FEMA? How different is FEMA from FERA? Is it merely change of one word, from "Regulation" to "Management"? How does the change from FERA to FEMA affect common citizens such as you, who are Indian residents not engaged in imports or exports?

To understand the difference, one needs to understand the underlying principles of FERA. FERA was introduced at a time when foreign exchange (forex) reserves of the country were low, forex being a scarce commodity.

FERA therefore proceeded on the presumption that all foreign exchange earned by Indian residents rightfully belonged to the Government of India and had to be collected and surrendered to the Reserve bank of India (RBI) expeditiously. It regulated not only transactions in forex, but also all financial transactions with nonresidents. FERA primarily prohibited all transactions, except to the extent permitted by general or specific permission by RBI.

Violation of FERA was a criminal offence. If you had ever visited a relative abroad, or had nonresident relatives visiting you, the chances are high that you had also violated FERA. In such cases, it is highly likely that your relatives may have given you or your visiting family members some small gift in forex, which you spent on buying some small article which you wanted to bring back. Or you may have spent some money on hospitality towards your non-resident relatives visiting you. Strictly, speaking, till the 1990's, these were FERA violations.

Fortunately, with the winds of liberalization blowing in the early 1990's, the Government relaxed many of the rigours of FERA by issuing notifications. Forex reserves swelled, the rupee was made convertible on current account.

In this liberal atmosphere, the government realized that possession of forex could no longer be regarded as a crime, but was an economic offence, for which the more appropriate punishment was a penaly. Thus, the need of FEMA was felt. The primary difference between FERA and FEMA therefore lies in the fact that offences under FEMA are not regarded as criminal offences and only invite penalties, not prosecution and imprisonment.

FEMA now codifies in the legislation and rules itself various transactions, which had been permitted by notification under FERA. Under FEMA, all current account transactions in forex (such as expenses, which are not for capital purposes) are permitted to the extent that the Central Government notifies. However, so far as capital account transactions are concerned, all capital account transactions in forex are prohibited, except to the extent as may be notified by RBI.

FEMA now codifies in the legislation and rules itself various transactions, which had been permitted by notification under FERA. Under FEMA, all current account transactions in forex (such as expenses, which are not for capital purposes) are permitted, except to the extent that the Central Government notifies. However, so far as capital account transactions are concerned, all capital account transactions in forex are prohibited, except to the extent as may be notified by RBI.

CAPITAL AND CURRENT ACCOUNT CONVERTIBILITY (CAC)

Capital account convertibility is a feature of a nation's financial regime that centers on the ability to conduct transactions of local financial assets into foreign financial assets freely and at market determined exchange rates. It is sometimes referred to as CAC.

CAC was first coined as a theory by the RBI in 1997 by the Tarapore Committee, in an effort to find fiscal and economic policies that would enable developing Third World countries transition to globalized market economies. However, it had been practiced, although without formal thought or organization of policy or restriction, since the very early 90's. Article VIII of the IMFs Articles of Agreement is agreed by most economists to have been the basis for CAC, although it notably failed to anticipate problems with the concept in regard to outflows of currency.

WHAT IS CURRENT AND CAPITAL ACCOUNT?

In an open economy, we buy from abroad (Import) and we sell to abroad. (export) Similarly Indians invest abroad, foreigners invest in India. So lot of money incoming and outgoing. Current and Capital accounts are nothing but method of classifying that incoming and outgoing money.

As you know, Balance of Payment (bop) = Import Export. This BoP is calculated under two heads: Current Account and Capital Account.

CURRENT AND CAPITAL ACCOUNT CONVERTIBILITY

Convertibility = converting one currency into another. Like rupee to dollar, yen to poundanything. Since money is incoming and outgoing. People will need to convert the money into different currencies based on their requirements. We classified the incoming and outgoing money into Current and Capital account. Similarly we classify the procedure involved in converting that money. In brief

Which account is permanent & which is reversible & why?

Current account =Money sent and received during import and export You sold something (exported) and received the money, so that money is yours forever (until you spend it on something else!) So Current account is permanent and irreversible.

Capital account = Money sent and received during investment and borrowing. Suppose Japanese guy buys factory in India (capital account), sells it after 5 years and takes back the money. So Capital account inflow is NOT PERMANENT and hence reversible (because he took back the money he invested in India).

FULL CAPITAL ACCOUNT CONVERTIBILITY PRO AND CONS

ARGUMENT IN FAVOR OF FULL CAPITAL ACCOUNT CONVERTIBILITY It facilitates foreign investments and borrowing. So competition is increased = more factories = more jobs = more product choices for consumers = good for economy.

ARGUMENTS AGAINST OF FULL CAPITAL ACCOUNT CONVERTIBILITY Local producers have to compete with International giants. So they lose market and customers

Counter-argument#1: Business is about survival of the fittest, so perform or perish, no need to get sentimental about Swadeshi. Why should consumer pay for not-so-good yet expensive domestic quality, if a foreigner is offering better stuff at cheaper price?

Counter argument#2: If a few Indians lose the customers, many more Indians get jobs in those new factories started by foreigners.

What if foreigners buy lot of factories in India and suddenly they find that investing money in France is better than in India. So they immediately sell all those factories, get their Rupees converted into Euro and run away! Thatll lead to huge job loss and collapse in Indian economy

(Counter argument#1: Its a two way street: if Foreigners can do that, Indians can also do it while investing abroad. (Counter argument#2: Sudden outflow of money happens only when governing institutions have weak foundations and policies. [e.g. when Govt. is busy firefighting Sugar-Onion prices without any long-term vision, it makes cronies get involved in speculative business.If every country has sound economic policies, then itll be attractive to invest in every country.

Then there will be no sudden outflow or inflow of money in any country and hence no-one will be misusing the full capital account convertibility.

On which account does the government need to keep close eye?

There is no this or that answer. Government needs to keep an eye on both accounts to make changes in trade policies, tax rates etc. But since Capital account inflows come with a risk (of sudden outflow collapsing the economy), so Government should keep a closer eye on Capital account.