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Foreign Exchange Management ( Permissible capital account transactions) Regulations, 2000 Notification No.

FEMA 1 /2000-RB dated 3rd May 2000 [G.S.R. 384 (E)] In exercise of the powers conferred by sub-section (2) of Section 6, sub-section (2) of Section 47 of the Foreign Exchange Management Act 1999 (42 of 1999), the Reserve Bank of India makes, in consultation with the Central Government following regulations relating to capital account transactions namely :1Short title and commencement. (i)These Regulations may be called the "Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000". (ii)They shall come into force on the 1st day of June, 2000. 2.Definitions. In these Regulations, unless the context requires otherwise, (a)'Act' means, the Foreign Exchange Management Act, 1999 (42 of 1999); (b)"Drawal" means drawal of foreign exchange from an authorised person and includes opening of Letter of Credit or use of International Credit Card or International Debit Card or ATM card or any other thing by whatever name called which has the effect of creating foreign exchange liability; (c)'Schedule' means a schedule to these Regulations; (d)'Transferable Development Rights' means certificates issued in respect of category of land acquired for public purpose either by Central or State Government in consideration of surrender of land by the owner without monetary compensation, which are transferable in part or whole; (e)The words and expressions used but not defined in these Regulations shall have the same meanings respectively assigned to them in the Act. 3.Permissible Capital Account Transactions. (1)Capital account transactions of a person may be classified under the following heads, namely :(A)transactions, specified in Schedule I, of a person resident In India; (B)transactions, specified in Schedule II, of a person resident outside India. (2)Subject to the provisions of the Act or the rules or regulations or direction or orders made or issued thereunder, any person may sell or draw foreign exchange to or from an authorised person for a capital account transaction specified in the Schedules: Provided that the transaction is within the limit , if any, specified in the regulations relevant to the transaction. 4.Prohibition. Save as otherwise provided in the Act, rules or regulations made thereunder,

a) no person shall undertake or sell or draw foreign exchange to or from an authorised person for any capital account transaction, Provided that (a) subject to the provisions of the Act or the rules or regulations or directions or orders made or issued thereunder, a resident individual may, draw from an authorized person foreign exchange not exceeding USD 50,000 per financial year with effect from December 20, 2006, USD 100,000 per financial year with effect from May 8, 2007 and USD 2,00,000 per financial year with effect from September 26, 2007, for a capital account transaction specified in Schedule I. Explanation: (a) subject to the provisions of the Act or the rules or regulations or directions or orders made or issued thereunder, a resident individual may, draw from an authorized person foreign exchange not exceeding USD 50,000 per financial year with effect from December 20, 2006, USD 100,000 per financial year with effect from May 8, 2007 and USD 2,00,000 per financial year with effect from September 26, 2007, for a capital account transaction specified in Schedule I. Explanation: Drawal of foreign exchange by resident individuals towards remittances of gift or donations as per item Nos. 3 and 4 of Schedule III to Foreign Exchange Management (Current Account Transactions) Rules, 2000 dated 3rd May, 2000 as amended from time to time, shall be subsumed within the limit under proviso (a) above ;

(b) where the drawal of foreign exchange by a resident individual for any capital account transaction specified in Schedule I exceeds USD 50,000 or USD 100,000 or USD 200,000, as the case may be, per financial year, the limit specified in the regulations relevant to the transaction shall apply with respect to such drawal : Provided further that no part of the foreign exchange of USD 50,000 or USD 100,000 or USD 200,000, as the case may be, drawn under proviso (a) shall be used for remittance directly or indirectly to countries notified as non-co-operative countries and territories by Financial Action Task Force (FATF) from time to time and communicated by the Reserve Bank of India to all concerned. b)no person resident outside India shall make investment in India, in any form, in any company or partnership firm or proprietary concern or any entity, whether incorporated or not, which is engaged or proposes to engage(i)in the business of chit fund, or (ii)as Nidhi Company , or (iii)in agricultural or plantation activities or (iv)in real estate business, or construction of farm houses or (v)in trading in Transferable Development Rights (TDRs).

Explanation: For the purpose of this regulation, "real estate business" shall not include development of townships, construction of residential/commercial premises, roads or bridges. 5.Method of payment for investment. The payment for investment shall be made by remittance from abroad through normal banking channels or by debit to an account of the investor maintained with an authorised person in India in accordance with the regulations made by the Reserve Bank under the Act. 6.Declaration to be furnished. Every person selling or drawing foreign exchange to or from an authorised person for a capital account transaction shall furnish to the Reserve Bank, a declaration in the form and within the time specified in the regulations relevant to the transaction.

Schedule I [See Regulation 3 (1) (A)] Classes of capital account transactions of Persons resident in India a)Investment by a person resident in India in foreign securities b)Foreign currency loans raised in India and abroad by a person resident in India c)Transfer of immovable property outside India by a person resident in India d)Guarantees issued by a person resident in India in favour of a person resident outside India e)Export, import and holding of currency/currency notes f)Loans and overdrafts (borrowings) by a person resident in India from a person resident outside India g)Maintenance of foreign currency accounts in India and outside India by a person resident in India h)Taking out of insurance policy by a person resident in India from an insurance company outside India i)Loans and overdrafts by a person resident in India to a person resident outside India j)Remittance outside India of capital assets of a person resident in India k)Sale and purchase of foreign exchange derivatives in India and abroad and commodity derivatives abroad by a person resident in India.

Schedule II [See Regulation 3 (1) (B)] Classes of capital account transactions of persons resident outside India a)Investment in India by a person resident outside India, that is to say,

i)issue of security by a body corporate or an entity in India and investment therein by a person resident outside India; and ii)investment by way of contribution by a person resident outside India to the capital of a firm or a proprietorship concern or an association of persons in India. b)Acquisition and transfer of immovable property in India by a person resident outside India. c)Guarantee by a person resident outside India in favour of, or on behalf of, a person resident in India. d)Import and export of currency/currency notes into/from India by a person resident outside India. e)Deposits between a person resident in India and a person resident outside India. f)Foreign currency accounts in India of a person resident outside India. g)Remittance outside India of capital assets in India of a person resident outside India.

Capital account transaction is defined as a transaction which:-

Alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India. In other words, it includes those transactions which are undertaken by a resident of India such that his/her assets or liabilities outside India are altered ( either increased or decreased). For example:- (i) a resident of India acquires an immovable property outside India or acquires shares of a foreign company. This way his/her overseas assets are increased; or (ii) a resident of India borrows from a non-resident through External commercial Borrowings (ECBs). This way he/she has created a liability outside India.

Alters the assets or liabilities in India of persons resident outside the India. In other words, it includes those transactions which are undertaken by a non-resident such that his/her assets or liabilities in India are altered (either increased or decreased). For example, (i) a non-resident acquires immovable property in India or acquires shares of an Indian company or invest in a Wholly Owned Subsidiary or a Joint Venture with a resident of India. This way his/her assets in India are increased; or (ii) a non-resident borrows from Indian housing finance institute for acquiring a house in India. This way he/she has created a liability in India.

Capital account transactions permitted under the Liberalised Remittance scheme.

Provide an illustrative list of capital account transactions permitted under the Liberalised Remittance scheme? Reply With Quote

The remittance under the Scheme is available to the resident individuals for any permitted current or capital account transactions combination of both. Under the Scheme, resident individuals can acquire and hold immovable property or shares or debt instruments or any other assets outside India, without prior approval of the Reserve Bank. Individuals can also open, maintain and hold foreign currency accounts with banks outside India. However, it is clarified that remittance from India for margins or margin calls to overseas exchanges / overseas counterparty are not allowed under the Scheme. The remittance facility under the Scheme is also not available for the following: i) Remittance for any purpose specifically prohibited under Schedule-I (like purchase of lottery/sweep

stakes, tickets, proscribed magazines, etc.) or any item restricted under Schedule II of Foreign Exchange Management (Current Account Transactions) Rules, 2000. ii) Remittances made directly or indirectly to Bhutan, Nepal, Mauritius or Pakistan. iii) Remittances made directly or indirectly to countries identified by the Financial Action Task Force (FATF) as countries and territories from time to time. iv) Remittances directly or indirectly to those individuals and entities identified as posing significant risk of committing acts of terrorism as advised separately by the Reserve Bank to the banks.

FEMA stands for Foreign Exchange Management Act. Residential status and nature of transaction i.e. capital account transaction (e.g. purchase/ sale of shares, property) or current account transaction (e.g. remittance of income on shares, property) are the cornerstones of FEMA. The golden rule of FEMA is, All capital account transactions other than those permitted are prohibited while all current account transactions other than those prohibited are permitted. Under FEMA, certain types of transactions do not require RBI permission while others either require prior approval of RBI/ Government or it is mandatory to inform RBI of the same. Although total capital account convertibility does not exist under FEMA, there is full convertibility to the extent of USD 1 million per calendar year for NRIs- See Repatriation for details.

By "Capital Account Convertibility" (or CAC in short), we mean "the freedom to convert the local financial assets into foreign financial assets and vice-versa at market determined rates of exchange. It is associated with the changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by the rest of the world. " (Report of the Committee on Capital Account Convertibility, RBI, 1997) Thus, in simpler terms, it means that irrespective of whether one is a resident or non-resident of India one's assets and liabilities can be freely (i.e. without permission of any regulatory authority) denominated (or cashed) in any currency and easily interchanged between that currency and the Rupee.

CAPITAL ACCOUNT CONVERTIBILITY

What is currency convertibility?

Currency convertibility means the freedom to convert one currency into other internationally accepted currencies. There are two popular categories of currency convertibility, namely : Convertibility for current international transactions; and Convertibility for international capital movements.

Currency convertibility implies the absence of exchange controls or restrictions on foreign exchange transactions.

What is meant by Current Account Convertibility: Current account convertibility is popularly defined as the freedom to buy or sell foreign exchange for :a. The international transactions consisting of payments due in connection with foreign trade, other current businesses including services and normal short-term banking and credit facilities

b. Payments due as interest on loans and as net income from other investments c. Payment of moderate amounts of amortisation of loans for depreciation of direct investments

d. Moderate remittances for family living expenses e. Authorised Dealers may also provide exchange facilities to their customers without prior approval of the RBI beyond specified indicative limits, provided, they are satisfied about the bonafides of the application such as, business travel, participation in overseas conferences/seminars, studies/ study tours abroad, medical treatment/check-up and specialised apprenticeship training.

What is meant by Capital Account Convertibility? Tarapore Committee on Capital Account Convertibility appointed in February, 1997 defines Capital Account Convertibility as the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. In other terms we can say Capital Account Convertibility (CAC) means that the home currency can be freely converted into foreign currencies for acquisition of capital assets abroad and vice versa.

Background of Capital Account Convertibility :

Foreign exchange transactions are broadly classified into two types: current account transactions and capital account transactions. In the early nineties, Indias foreign exchange reserves were so low that these were hardly enough to pay for a few weeks of imports. To overcome this crisis situation, Indian Government had to pledge a part of its gold reserves to the Bank of England to obtain foreign exchange. However, after reforms were initiated and there was some improvement on FOREX front in 1994, transactions on the current account were made fully convertible and foreign exchange was made freely available for such transactions. But capital account transactions were not fully convertible. The rationale behind this was clear.that India wanted to conserve precious foreign exchange and protect the rupee from volatile fluctuations. By late nineties situation further improved, a committee on capital account convertibility was setup in February, 1997 by the Reserve Bank of India (RBI) under the chairmanship of former RBI deputy governor S.S. Tarapore to "lay the road map" to capital account convertibility. The committee recommended that full capital account convertibility be brought in only after certain preconditions were satisfied. These included low inflation, financial sector reforms, a flexible exchange rate policy and a stringent fiscal policy. However, the report was not accepted due to Asian Crisis. The five-member committee has recommended a three-year time frame for complete convertibility by 1999-2000. The highlights of the report including the preconditions to be achieved for the full float of money are as follows:Pre-Conditions Set By Tarapore Committee : Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5 per cent in 199798 to 3.5% in 1999-2000. A consolidated sinking fund has to be set up to meet government's debt repayment needs; to be financed by increased in RBI's profit transfer to the govt. and disinvestment proceeds. Inflation rate should remain between an average 3-5 per cent for the 3-year period 19972000 Gross NPAs of the public sector banking system needs to be brought down from the present 13.7% to 5% by 2000. At the same time, average effective CRR needs to be brought down from the current 9.3% to 3%. RBI should have a Monitoring Exchange Rate Band of plus minus 5% around a neutral Real Effective Exchange Rate RBI should be transparent about the changes in REER. External sector policies should be designed to increase current receipts to GDP ratio and bring down the debt servicing ratio from 25% to 20%. Four indicators should be used for evaluating adequacy of foreign exchange reserves to safeguard against any contingency. Plus, a minimum net foreign asset to currency ratio of 40 per cent should be prescribed by law in the RBI Act.

Phased liberalisation of capital controls The Committee's recommendations for a phased liberalization of controls on capital outflows over the three year period which have been set out in detail in a tabular form in Chapter 4 of the Report, inter alia, include:(i) Indian Joint Venture/Wholly Owned Subsidiaries (JVs/WOSs) should be allowed to invest up to US $ 50 million in ventures abroad at the level of the Authorised Dealers (ADs) in phase 1 with transparent and comprehensive guidelines set out by the RBI. The existing requirement of repatriation of the amount of investment by way of dividend etc., within a period of 5 years may be removed. Furthermore, JVs/WOs could be allowed to be set up by any party and not be restricted to only exporters/exchange earners. ii) Exporters/exchange earners may be allowed 100 per cent retention of earnings in Exchange Earners Foreign Currency (EEFC) accounts with complete flexibility in operation of these accounts including cheque writing facility in Phase I. iii) Individual residents may be allowed to invest in assets in financial market abroad up to $ 25,000 in Phase I with progressive increase to US $ 50,000 in Phase II and US$ 100,000 in Phase III. Similar limits may be allowed for non-residents out of their nonrepatriable assets in India. iv) SEBI registered Indian investors may be allowed to set funds for investments abroad subject to overall limits of $ 500 million in Phase I, $ 1 billion in Phase II and $ 2 billion in Phase III. v) Banks may be allowed much more liberal limits in regard to borrowings from abroad and deployment of funds outside India. Borrowings (short and long term) may be subject to an overall limit of 50 per cent of unimpaired Tier 1 capital in Phase 1, 75 per cent in Phase II and 100 per cent in Phase III with a sub-limit for short term borrowing. in case of deployment of funds abroad, the requirement of section 25 of Banking Regulation Act and the prudential norms for open position and gap limits would apply. vi) Foreign direct and portfolio investment and disinvestment should be governed by comprehensive and transparent guidelines, and prior RBI approval at various stages may be dispensed with subject to reporting by ADs. All non-residents may be treated on part purposes of such investments. vii) In order to develop and enable the integration of forex, money and securities market, all participants on the spot market should be permitted to operate in the forward markets; FIIs, non-residents and non-resident banks may be allowed forward cover to the extent of their assets in India; all India Financial Institutions (FIs) fulfilling requisite criteria should be allowed to become full-fledged ADs; currency futures may be introduced with screen based trading and efficient settlement system; participation in money markets may be widened, market segmentation removed and interest rates deregulated; the RBI should withdraw from the primary market in Government securities; the role of primary and

satellite dealers should be increased; fiscal incentives should be provided for individuals investing in Government securities; the Government should set up its own office of public debt. viii) There is a strong case for liberalising the overall policy regime on gold; Banks and FIs fulfilling well defined criteria may be allowed to participate in gold markets in India and abroad and deal in gold products. The assumption of the committee was that these pre-conditions would take care of possible problems created by unseen flight of capital. Given a sound fiscal and financial set-up, the flight of capital was unlikely to be large, particularly in the short run, as capital would be invested and not all of it would be in a liquid form.

Present Status :
Major Pre-Conditions by Tarapore Committee 1 Reduction in gross fiscal deficit to 3.5% by 1999-2000 2. The inflation rate for 3 years should be an average 3% to 5% 3. Forex reserves should at least be enough to cover 6 months import cover 4. Gross NPAs to be brought down to 5% by 1999-2000 5. CRR to be reduced to 3% by 1999-2000 6. Interest Rate to be fully deregulated Status as on March 2006 The present fiscal deficit is still at 4.1% (above the level of 3.5%). However, estimates for the next fiscal year are pegged at 3.8% Inflation at present is around 4.00%. The present forex reserves are enough to cover more than one years imports. Gross NPA for the banking sector is still marginally higher than 5% CRR is still at 5.00% All interest rates, except Saving Fund interest rates, have already been deregulated.

The process of opening up the Indian economy has proceeded in steady steps. First, the exchange rate regime was allowed to be determined by market forces as against the fixed exchange rate linked to a basket of currencies. Second, this was followed by the convertibility of the Indian rupee for current account transactions with India accepting the obligations under Article VIII of the IMF in August 1994. Third, capital account convertibility has proceeded at a steady pace. RBI views capital account convertibility as a process rather than as an event. Fourth, the distinct improvement in the external sector has enabled a progressive liberalisation of the exchange and payments regime in India. Reflecting the changed approach to foreign exchange restrictions, the restrictive Foreign Exchange Regulation Act (FERA), 1973 has been replaced by the Foreign Exchange Management Act, 1999.

Thus, at present in India we have a restricted capital account convertibility. Indian entities (i.e. individuals, companies or otherwise) are allowed to invest or acquire assets outside India or a foreign entity remit funds for investment or acquisition of assets with specified cap on such investments and for specific purpose. A full convertibility will allow free movement of funds in and out of India without any restrictions on purpose and amount. Thus, after full convertibility is allowed, residents in India will be able to transfer money abroad and receive from other entities across the world. However, government will certainly make rules and regulations to ensure these do not lead to money laundering or funding for illegal activities. Prime Minister Manmohan Singh on 18th March 2006 said that the country's economic position internally and externally had become 'far more comfortable' and it was worth looking into greater capital account convertibility. In a speech at the Reserve Bank of India (RBI) in the country's financial hub Mumbai, Prime Minister Manmohan Singh said he would ask the Finance Minister and RBI to come out with a roadmap to greater convertibility 'based on current realities'. PM also said "Given the changes that have taken place over the last two decades, there is merit in moving towards fuller capital account convertibility within a transparent framework," Singh said. RBI in its circular issued in March, 2006 has laid down that economic reforms in India have accelerated growth, enhanced stability and strengthened both external and financial sectors. Our trade as well as financial sector is already considerably integrated with the global economy. India's cautious approach towards opening of the capital account and viewing capital account liberalisation as a process contingent upon certain preconditions has stood India in good stead. Given the changes that have taken place over the last two decades, however, there is merit in moving towards fuller capital account convertibility within a transparent framework. There is, thus, a need to revisit the subject and come out with a roadmap towards fuller Capital Account Convertibility based on current realities. In consultation with the Government of India, the Reserve Bank of India has appointed a committee to set out the framework for fuller Capital Account Convertibility. The Committee consists of the following: i. Shri S.S Tarapore Chairman ii. Dr. Surjit S. Bhalla Member iii. Shri M.G Bhide Member iv. Dr. R.H. Patil Member v. Shri A.V Rajwade Member vi. Dr. Ajit Ranade Member The terms of reference of the Committee will be: i. To review the experience of various measures of capital account liberalisation in India, ii. To examine implications of fuller capital account convertibility on monetary and exchange rate management, financial markets and financial system, iii. To study the implications of dollarisation in India of domestic assets and liabilities and internationalisation of the Indian rupee, iv. To provide a comprehensive medium-term operational framework, with sequencing and timing, for fuller capital account convertibility taking into account the above implications and progress in revenue and fiscal deficit of both centre and states,

v. To survey regulatory framework in countries which have advanced towards fuller capital account convertibility, vi. To suggest appropriate policy measures and prudential safe- guards to ensure monetary and financial stability, and vii. To make such other recommendations as the Committee may deem relevant to the subject. Technical work is being initiated in the Reserve Bank of India. The Committee will commence its work from May 1, 2006 and it is expected to submit its report by July 31, 2006. The Committee will adopt its own procedures and meet as often as necessary. The Reserve Bank of India will provide Secretariat to the Committee.

FACTORS WHICH ARE CRITICAL / OF CONCERN IN ADOPTING CAPITAL ACCOUNT CONVERTIBILITY: There are number of issues which are of concern for adopting capital account convertibility. The impact of allowing unlimited access to short-term external commercial borrowing for meeting working capital and other domestic requirements. In respect of short-term external commercial borrowings, there is already a strong international consensus that emerging markets should keep such borrowings relatively small in relation to their total external debt or reserves. Many of the financial crises in the 1990s occurred because the short-term debt was excessive. When times were good, such debt was easily accessible. The position, however, changed dramatically in times of external pressure. All creditors who could redeem the debt did so within a very short period, causing extreme domestic financial vulnerability. The occurrence of such a possibility has to be avoided, and we would do well to continue with our policy of keeping access to short-term debt limited as a conscious policy at all times good and bad.

Providing unrestricted freedom to domestic residents to convert their domestic bank deposits and idle assets (such as, real estate), in response to market developments or exchange rate expectations. The day-to-day movement in exchange rates is determined by "flows" of funds, i.e. by demand and supply of spot or forward transactions in the market. Now, suppose the exchange rate is depreciating unduly sharply (for whatever reasons) and is expected to continue to do so for the near future. Now, further suppose that domestic residents, therefore, that they should convert a part or whole of their stock of domestic assets from domestic currency to foreign currency. This will be financially desirable as the domestic value of their converted assets is expected to increase because of anticipated depreciation. And, if a large number of residents so decide simultaneously within a short period of time, as they may, this expectation would become self-fulfilling. A severe external crisis is then unavoidable. Although at present our reserves are high and exchange rate movements are, by and large, orderly. However, there can be events like Kargil ware or Pokhran Test, which creates external uncertainty, Domestic stock of bank deposits in rupees in India is presently close to US $ 290 billion, nearly three and a half times our total reserves. At the time of Kargil or Pokhran or the oil crises, the multiple of domestic deposits over

reserves was in fact several times higher than now. One can imagine what would have had happened to our external situation, if within a very short period, domestic residents decided to rush to their neighbourhood banks and convert a significant part of these deposits into sterling, euro or dollar. No emerging market exchange rate system can cope with this kind of contingency. This may be an unlikely possibility today, but it must be factored in while deciding on a long term policy of free convertibility of "stock" of domestic assets. Incidentally, this kind of eventuality is less likely to occur in respect of industrial countries with international currencies such as Euro or Dollar, which are held by banks, corporates, and other entities as part of their long-term global asset portfolio (as distinguished from emerging market currencies in which banks and other intermediaries normally take a daily long or short position for purposes of currency trade).

Impact of Capital Account Convertibility After full convertibility is adopted by India, it will lead to acceptance of Indian Rupee currency all over the world. In case of two convertible currencies, Forward Exchange Rates reflect interest rate differentials between these two currencies. Thus, we can say that the Forward Exchange Rate for the higher interest rate currency would depreciate so as to neutralize the interest rate difference. However, sometimes there can be opportunities when forward rates do not fully neutralize interest rate differentials. In such situations, arbitrageurs get into the act and forward exchange rates quickly adjust to eliminate the possibility of risk-less profits. Capital account convertibility is likely to bring depth and large volumes in long-term INR currency swap markets. Thus for a better market determination of INR exchange rates, the INR should be convertible.

The automatic route connotes no requirement of any prior regulatory approval but only post facto filing / intimation with the RBI as under:

Filing of an intimation with the RBI, in the prescribed format, within 30 days of receipt of investment money in India Filing of prescribed documents and particulars of issue of shares within 30 days of issue of shares to foreign investors

FDI by a Foreign Company/Investor in an Indian Company in most of the business/commercial sectors now falls under the Automatic Route and very few cases/transactions require prior Government/FIPB approval. If the FDI exceeds the ceiling (cap) fixed by the Government of India, then, the application for foreign Investment Approval needs to be submitted to Foreign Investment Promotion Board (FIPB). For information about sector caps, please: Sectoral caps

Prior approval route

FDI in sectors/transactions requiring prior Government Approval is categorized as that falling under the Prior Approval Route. Such approval is granted by the Government of India, Ministry of Finance, the Foreign Investment Promotion Board (FIPB). FDI in the following activities/sectors generally requires prior approval of the Government:

Where more than 24 percent foreign equity is proposed to be inducted for manufacture of items reserved for the Small Scale sector Proposals in which the foreign collaborator has an existing financial/technical collaboration in India in the same field as per the Press Notes 1 and 3 of 2005 All proposals falling outside notified sectoral caps or under sectors in which FDI is not permitted under the Automatic Route FDI policy is reviewed on an ongoing basis and changes in sectoral policy/sectoral equity caps are notified through Press Notes.

Portfolio investment in India

Foreign Institutional Investors (FII) registered with SEBI and Non-resident Indians are eligible to invest in India under the Portfolio Investment Scheme within prescribed guidelines and parameters. Investment by FIIs are primarily governed by the Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995, (SEBI Regulations). Eligible Institutional Investors that can register as FIIs include Asset Management Companies, Pension Funds, Mutual Funds, Banks, Investment Trusts, Insurance Companies, Re-insurance Companies, Incorporated/Institutional Portfolio Managers, Investment Manager/Advisor, International or Multilateral organisation, University Funds, Endowment Foundations, Charitable Trusts and Charitable Societies, Foreign Government Agencies, Sovereign Wealth funds, Foreign Central Bank, Broad based Fund, Trustee of a Trust. Sub-account means any person resident outside India, on whose behalf investments are proposed to be made in India by a foreign institutional investor and who is registered as a sub-account under these regulations. Entities eligible to register as sub-account are braid based funds, portfolio which is broad based, proprietary funds of the FII, foreign corporate and foreign individuals satisfying the prescribed conditions, etc. Conceptually, an application for registration as an FII can be made in two capacities, namely as an investor or for investing on behalf of its subaccounts. SEBI grants registration as FII based on certain criteria, namely constitution and incorporation of FII, being regulated in home country, track record, previous registration with any Securities Commission, legal permissibility to invest in securities as per the norms of the country of its incorporation, fit and proper person, etc. SEBI grants registration to the FII and sub-account which is permanent unless suspended or cancelled by SEBI, subject to payment of fees and filing information every three years. The approval of the sub-account is co-terminus with that of the FII. FIIs / sub-accounts can invest in Indian equities, units, exchange traded derivatives, commercial papers and debt. FIIs can also invest in security receipts of Asset Reconstruction Companies on its own behalf.

A FII can invest any portion of its portfolio in debt instruments as the requirement to maintain 70:30 (equity: debt) investment limit by pure equity FIIs has been removed by SEBI subject to limits being sanctioned by SEBI. The entry level guidelines / conditions for FDI in an Indian Company have been expressly clarified to extend to downstream investments as well. Further, prior Government approval followed by notification has been stipulated for Foreign Investments in an Indian Company which is an Investment Company or which does not have any operation. Prior Government approval has also been stipulated for transfer of ownership or control of Indian Companies in specified / controlled sectors from resident Indian citizens / entities to Non-resident entities. For downstream Investment by an operating-cum-holding company with foreign investment as stipulated, a notification to the Government is stipulated within the prescribed timeframe / parameters.

Foreign Currency Convertible Bond (FCCB)


What it is FCCB? A Foreign Currency Convertible Bond (FCCB) is a type of convertible bond issued in a currency that is different from the domestic currency of the issuer. This means that the money being raised by the issuing company is in the form of a foreign currency. It offers two options: to receive regular interest along with the principal, and to convert the bond into equities. It is a mix between a bond and a stock. Why opt for FCCB? Governments, companies and banks issue bonds in foreign currencies because they are apparently more stable and predictable than their respective domestic currencies. Such bonds also provide issuers the opportunity to access investment capital that is available in markets overseas. Further, companies can use the bonds to foray into foreign markets. An FCCB not only performs the dual functions of a debt and equity instrument to make regular equity and principal payments, but also gives the holder the option to convert it into stock. Because of its equity component, an FCCB is a low-cost debt and the interest rates charged are usually 30-50% lower than the market rate. Company stocks have lower dilution because the conversion price is fixed when the bond is issued. The regulatory process for FCCBs is also less cumbersome compared to other types of bonds. Individual investors, too, can enjoy the benefits of an FCCB as payments on the bond are guaranteed and relatively safer. They can also take advantage of any significant price appreciation in the companys stock. An FCCB is redeemable at maturity if not converted and is easily marketable because it offers the option of converting it into equity that would lead to an appreciation in capital. Disadvantages As with all financial instruments, FCCBs have their disadvantages as well. Some FCCBs, for instance, include exchange risk, which is higher in FCCBs because of the fact that interest is required to be paid in foreign currency. Consequently, only companies with low debt equity ratios and large forex earnings potential opt for FCCBs. They also mean creating more debt and the giving out of interest in foreign exchange. Although convertible bonds have rates of interest around 3-4% that is relatively low, the exchange risk on both the interest as well as the principal is high if the bonds are not converted in to equity. Furthermore, if stock prices go down drastically, investors would opt for redemption and not for conversion. This means that companies would have to refinance to fulfill the redemption promise and this could affect their earnings adversely. FCCBs will remain as debt in the balance sheets unless they are converted. FCCBs: a potential mode of investment FCCBs have the potential for higher rates while providing investors with income on a regular basis. They offer regular interest payments like regular bonds. The disadvantages in this investment category have not been as drastic as in other investment categories. If a bond's underlying stock does decline in value, the minimum value of ones investment will be equal to the value of a high-yield bond making the risk much less than directly investing in the common stock. Nonetheless, investors who purchase after a significant price appreciation must keep in mind that the bond is no longer valued like a bond but rather like a stock. Therefore, the price could fluctuate significantly. As a bonds value is derived from the value of the underlying stock, a decline in the value of the stock will also cause the bond to decline in value until it touches a level equal to the value of a traditional bond but without the conversion option.

In India, convertible bonds have generated superior returns compared to traditional bonds. This is derived from the fact that many companies have improved their financial performances and have had their stocks appreciated in value over the past few years. FCCBs can also play a key role in a well-diversified investment portfolio for both conservative and aggressive investors. Many mutual funds invest a portion of their investments in convertible bonds, but no fund invests solely in convertible bonds. Investors intending to invest directly may consider an FCCB from some of the largest companies in the world. FCCB Policy in India Indias Ministry of Finance defines FCCBs as bonds issued and subscribed by a non-resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments. Criteria for issuing FCCBs Companies intending to raise foreign funds by issuing FCCBs must receive the approval of the Department of Economic Affairs of the Union Finance Ministry. Such firms should have a consistent track record of at least three years. FCCBs can be denominated in any freely convertible foreign currency while the ordinary shares of an issuing company shall be denominated in Indian rupees. Companies issuing FCCBs should deliver ordinary shares or bonds to a domestic custodian bank as required while the latter hand instructs the overseas depositary bank to issue a global depositary receipt or certificate to nonresident investors against the shares or bonds held by the domestic custodian bank. Limits of foreign investment The ordinary shares and FCCBs issued against the global depository receipts are treated at par with foreign direct investment (FDI). But total foreign investment, whether direct or indirect, must not exceed 51% of the issued and subscribed capital of the issuing company. Taxation on FCCBs As long as the conversion option is not exercised, all interest payments on FCCBs are subject to deduction of tax at source at the rate of 10%. Taxes levied on dividends on the converted portion of the bonds are subject to tax deducted at source at the rate of 10%. If FCCBs are converted into shares, they will not lead to gains in capital that is liable to income tax. Further, if FCCBs are transferred by a non-resident investor to another non-resident investor, they cannot yield capital gains liable to taxation. Default If companies default, the bondholders can exercise a legal claim to those assets. This is because FCCBs are unique from other bonds or debt instruments as the bondholder has the right, but not the obligation, to convert the bond into a predetermined number of shares of the issuing company. This means that if the stock price of the firm goes up, the bondholder makes profit that is considerably more than what a traditional bondholder does. On the other hand, if the stock price remains constant or declines, they receive interest payments and their principal payment, unlike stock investors who lose money. FCCBs in India

FCCBs have gained popularity among Indian companies for raising foreign exchange at competitive rates. Besides, Government of India has liberalized guidelines for them periodically to give impetus to infrastructure development and expansion plans of corporate houses in India. FCCBs can be raised in two ways --- approval route and automatic route. Significantly, the Reserve Bank of India issued comprehensive guidelines on FCCBs or External Commercial Borrowings (ECBs) on August 1, 2005. Under the Automatic route, the real sector such as the industrial sector, in particular the infrastructure sector can avail of FCCBs. They include financial institutions dealing exclusively with infrastructure or export finance such as IDFC, IL&FS, Power Finance Corporation, Power Trading Corporation, IRCON and EXIM Bank. The list also includes Banks and financial institutions which had participated in the textile or steel sector restructuring package as approved by the government. The FCCB market in India is basically a limited market consisting of foreign institutional investors (FIIs), banks, mutual funds and high net-worth individuals (HNIs). In 2005, a study conducted by the India Brand Equity Foundation found that India emerged as the biggest issuer of FCCBs in the Asia-Pacific region. The total FCCBs issued from India added to a total of US$1.4 billion, accounting for 32.7% share, while Taiwanese companies ranked second and raised US$1billion. Further, out of about 30 FCCB issues in the Asia-Pacific region, 15 were from India while six were from Taiwan. Some Indian corporations which raised FCCBs from the market include Tata Chemicals, Jaiprakash Associates, Glenmark, Tata Power, Bharat Forge, Amtek Auto Ballarpur Industries, Reliance Energy, Indian Hotels, Bharti Tele and Ashok Leyland. Pitfalls The RBI has said that since companies can prepay their FCCB loans, overseas investors could exit as soon as there is a downturn in the economy and the interest rates in overseas economy increase, even though the maturity period is for five years. This could also lead to an increase in the quantity of short-term debt in the country. Furthermore, while the RBI policies are aimed at liberalizing fund-raising avenues in the country, the excessive limit of forex reserves in the Indian economy is also known to have adversely affected the earnings of IT and export companies in the country. Conclusion Nevertheless, in spite of some notable drawbacks, the upsides tip the balance in favor of FCCBs and India has been using them as a major tool for raising finance to meet its capital expenditure requirements at competitive rates. The countrys regulatory regime has completely endorsed the industrys efforts to meet its financing needs. The quality of Indian bonds has also gained widespread International acceptability and is expected to gain further momentum in the future.

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