INTRODUCTION

The world economy is in the midst of a transformative change. One of the most visible outcomes of this transformation is the rise of a number of dynamic emerging-market countries to the helm of the global economy. It is likely that, by 2025, emerging economiessuch as Brazil, China, India, Indonesia, and the Russian Federationwill be major contributors to global growth, alongside the advanced economies. As they pursue growth opportunities abroad and encouraged by improved policies at home, corporations based in emerging markets are playing an increasingly prominent role in global business and cross border investment. The international monetary system is likely to cease being dominated by a single currency. In this light it is strongly conceded that in the second half of the twentieth century, apart from the international law on the use of armed force, no area of international law has generated as much controversy as the law relating to foreign investment.1 Yet it has emerged as the most important phenomenon in today's economic relations. In general terms foreign investment means the transfer of tangible or intangible assets from one country into another for the purpose of use in that country to generate wealth under the total or partial control of the owner of the assets. There exist various different definitions of the term.2 Despite conflicting opinions of experts,3 the international community led by the World Bank and IMF is continuously encouraging increment of foreign exchange for the developing countries.4

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2

WORLD BANK, LEGAL FRAMEWORK FOR THE TREATMENT OF FOREIGN INVESTMENT (1992). ENCYL. OF PUBLIC INT'L L. 246; I.M.F., BALANCE OF PAYMENTS MANUAL para. 408 (1980). 3 The classical theory on foreign investment is based on the refutable assumption that it is wholly beneficial to the host country whereas the proponents of dependency theory reject it on the ground that it will not bring about meaningful economic development. 4 MULTINATIONAL CORPORATIONS ARE ENTERPRISES WHICH OWN OR CONTROL PRODUCTION OR SERVICE FACILITIES OUTSIDE THE COUNTRY IN WHICH THEY ARE BASED, REPORT OF THE GROUP OF EMINENT PERSONS, U.N.Doc.E/5500/Add. 1 (1974). 1|Page

FOREIGN EXCHANGE
Meaning
The FEMA, 1999 defines the term 'foreign exchange' means "foreign currency and includes:- (i) deposits, credits and balances payable in any foreign currency; (ii) drafts, travellers cheques, letters of credit or bills of exchange, expressed or drawn in Indian currency but payable in any foreign currency; (iii) drafts, travellers cheques, letters of credit or bills of exchange drawn by banks, institutions or persons outside India, but payable in Indian currency".5

Foreign exchange market

The foreign exchange market is global, and it is conducted over-the-counter (OTC) through the use of electronic trading platforms, or by telephone through trading desks. Some shorten the term to forex or FX.6 Trading forex is buying one currency while at the same time selling a different currency. Some companies who do business in other countries use forex markets to convert profits from foreign sales into their domestic currency. Other reasons for trading forex include speculation for profit, or to hedge against currency fluctuations.

Forex Currency
The most crucial component of the foreign exchange market is forex currency, which is bought and sold in the foreign exchange marketplace. The transaction of FX currency involves the exchange of currencies of various nations. Fluctuations in the value of a currency against that of another offer forex traders opportunities to earn profits.7 An international currency serves to invoice imports and exports, to anchor the exchange rate of currencies pegged to it, to effectuate cross-border payments, and to denominate international assets and liabilities (official foreign exchange reserves, private claims, and sovereign debt). In addition, just as domestic money serves as an alternative to bartering, an international currency can serve as a vehicle currency for trading between pairs of currencies for which the liquidity of the bilateral market is limited. Such uses are reinforcing, because currencies used for pricing are also likely to serve as means of payment. The supply of international currencies is influenced by the actions of governments to allow international use and to provide the institutional and policy underpinnings that encourage the development of financial markets and produce macroeconomic stability (Tavlas 1991). Without
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Section 2(n), Foreign Exchange and Management Act, 1999. http://www.pfgbest.com/services/forex/foreignexchangebasics.pdf 7 http://www.economywatch.com/forex/ 2|Page

the existence of markets in various financial instruments and a reasonable amount of investor confidence in accessing them, the currencys usefulness in the international realm is limited. Introducing Indian Currency: The Indian currency is known as the Rupee (International Symbol INR), which is divided into 100 paise. The rupee is fully convertible on the trade front under the liberalized exchange rate management system (LERMS)8. All transactions under the LERMS will take place at market-determined rates. The rupee is fully convertible on current account. On the capital account also the rupee is gradually being made fully convertible with residents permitted to invest abroad subject to the completion of certain formalities and non-residents permitted to invest in most sectors except few sectors like defence etc. Although, holding of foreign currency is permitted, but around the world, the quantity and the amount of such holding is regulated by the respective host country wherein a member holds forex.

Basis traits of the Foreign Exchange Market

Accessibility Its no wonder that the Forex market has the trading volume of 3

trillion a day all anyone needs to take part in the action is a computer with an internet connection.9
24 Hour Market The Forex market is open 24 hours a day, so that one can be

right there trading whenever one hears a financial scoop.

Narrow Focus Unlike the stock market, a smaller market with tens of thousands

of stocks to choose from, the Forex market revolves around more or less eight major currencies. A narrow choice means no rooms for confusion, so even though the market is huge, its quite easy to get a clear picture of whats happening.
Liquidity The foreign exchange market is the largest financial market in the

world with a daily turnover of just over $3 trillion! Now apart from being a really cool statistic, the sheer massive scope of the Forex market is also one of its biggest advantages. The enormous volume of daily trades makes it the most liquid market in the world, which basically means that under normal market conditions you can buy and sell currency as you please.
The Market Cant Be Cornered The colossal size of the Forex market also

makes sure that no one can corner the market. Even banks dont have enough pull to
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really control the market for a long period of time, which makes it a great place for the little guy to make a move.10

INTERNATIONAL GOVERNING AUTHORITIES 5PG

There are few guidelines and norms regulating the foreign investment regime and corporate conduct. Though they don't have any legal binding force, these could be regarded as gentlemen's agreement and expected to be followed by the international community.
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http://www.etoro.com/learn/eToro-Forex-Trading-Guide.pdf 4|Page

International Monetary Fund

Needs small intro that it deals with the regulaton of forex in internatonl arena IMF released the Guidelines for Foreign Exchange Reserve Management in September 2001. The Guidelines for Foreign Exchange Reserve Management have been developed as part of a broader work program undertaken by the Fund to help strengthen the international financial architecture, to promote policies and practices that contribute to stability and transparency in the financial sector and to reduce external vulnerabilities of member countries.11 It high lights the importance of foreign exchange reserve and the objectives that can be attained thereby.12 The guidelines are intended to assist governments in strengthening their policy frameworks for foreign reserve management so as to help increase their country's resilience to shocks that may originate from global financial markets or within the domestic financial system. The aim is to help the authorities to articulate appropriate objectives and principles for reserve management and build adequate institutional and operational foundations for good reserve management practices. IMF has stated that the objective of Reserve management should seek to ensure that: (i) adequate foreign exchange reserves are available for meeting a defined range of objectives; (ii) liquidity, market, and credit risks are controlled in a prudent manner; and (iii) subject to liquidity and other risk constraints, reasonable earnings are generated over the medium to long term on the funds invested. Impact of the guideline, are they binding, indias stand on the guideline.

The World Bank Guidelines on Foreign Investment

The guidelines are based on the philosophy that "the greater flow of foreign exchange brings substantial benefits to bear on the world economy and on the economies of developing countries in particular".13

OECD Guidelines
In 1976, the OECD council of ministers adopted a recommendation entitled "The Declaration On International Investment And Multinational Enterprises."14 As its name suggests, the overriding
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Preface, IMF Guidelines, www.IMF.org What is Reserve Management and Why is it Important?, IMF Guidelines, www.IMF.org 13 WORLD BANK, 2 LEGAL FRAMEWORK FOR THE TREATMENT OF FOREIGN INVESTMENT (1992), reproduced in 31 I.L.M. 1363 (1992). 14 Organization for Economic Cooperation and Development (OECD), OECD Declaration on International Investment and Multinational Enterprises (July 3, 1998) available at http://www.oecd.org/daf/cmis/codes/declarat.htm. The OECD is mainly consisting of industrialized countries of the world. 5|Page

purpose of the declaration was to promote foreign investment, calling on member countries to respect national treatment, minimize conflicting requirements on TNCs by different governments make transparent incentives and disincentives to investment and to enhance foreign exchange.15 It is very interesting to note that the guidelines do not address the issue of compensating on part of TNCs for any damage caused by their activities or for any violations which can have adverse impact on a countrys GDP and thus welfare and development. Even the provision relating to providing adequate education and training among employees16 and contributing to the development of environmentally efficient public policy17 fall short of what is needed in this area. Moreover, these are merely recommendations and do not have binding force.

UNCTAD
The formation of regional economic groups does not contradict the principles underlying multilateralism is evident from the fact that the very first United Nations Conference on Trade and Development (UNCTAD) held in the early 1960's envisaged the role of regional economic cooperation as potential instrument for accelerating economic growth in the developing countries. The final act of the first UNCTAD conference held in 1964 stated: "Regional Economic Groupings, integration or other forms of economic co-operation should be promoted among developing countries as a means of expanding intra-regional and extra-regional trade and encouraging their economic growth and their industrial and agricultural diversification with due regard to the special features of development of the various countries concerned as well as their economic and social systems".18

WTO(TRIMS) 1 pg

15

HUNTER ET AL., INTERNATIONAL ENVIRONMENTAL POLICY 1269 (2d ed. 2002). Art. 7. The OECD Guidelines for Multinational Enterprises (2000), http://www.oecd.org/dataoecd/56/36/1922428.pdf. 17 Art. 8., The OECD Guidelines for Multinational Enterprises (2000), http://www.oecd.org/dataoecd/56/36/1922428.pdf.
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available available

at at

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NATIONAL GOVERNING AUTHORITIES TOTAL 5 PG

RBI GOI(DIPP) SEBI for FII
Illustration of exercising of powers

These governing authorities have been bestowed power under different situations. Like under Section 5 of Foreign Exchange Management Act, 1999, certain rules have been framed for drawal of foreign exchange on current account. According to the said rules, drawal of foreign exchange for certain transactions is prohibited. In respect of certain transactions drawal of foreign exchange is permissible with the prior approval of Central Government. In respect of some of the transaction, prior permission of RBI is sufficient for drawal of foreign exchange.

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For example, (i) in respect of Payment of commission on exports made towards equity investment in wholly owned subsidiary abroad of an Indian Company, is prohibited.(ii) Drawal of foreign exchange for remittance of hiring charges of transponder, can be made with the prior approval of the Central Government. (iii) So far as remittance for use of Trade Mark in India is concerned, the necessary foreign exchange can be obtained with the prior permission of the Reserve Bank of India. In the case of (ii) & (iii) above, approval of concerned authority is not required if the payment is made out of funds held in Resident Foreign Currency (RFC) Account or Exchange Earners Foreign Currency (EEFC) Account of the remitter. Further foreign Exchange can be drawn only from an authorised person19.

LAWS GOVERNING FOREIGN EXCHANGE IN INDIA

There is a German word called zeit-geist which, it can broadly be translated as the spirit of time.20 Nothing better describes the evolution of foreign exchange regulation in India. There are several ancillary laws dealing in foreign exchange and management, in specific there are four which deal with foreign exchange per se: The conservation of Foreign Exchange and Prevention of smuggling Activities Act, 1974; The Foreign Exchange and Management Act, 1999; The Smugglers and Foreign Exchange Manipulators (Forfeiture of Property) Act, 1976 and The Foreign Traade (Development and Regulation) Act, 1992. For the purpose of the present paper, the researcher is focusing only of the FEMA, 1999.

FOREIGN EXCHANGE AND MANAGEMENT ACT, 1999

In India, all transactions that include foreign exchange are regulated by the Foreign Exchange Management Act (FEMA), 1999. It repealed the Foreign Exchange Regulations Act (FERA),1973. FEMA has been enacted to facilitate external trade and payments and to promote the orderly
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development and maintenance of foreign exchange market. It applies to all branches,offices and agencies outside India,owned or controlled by a person resident in India.

History: From Regulation to Managment

Scenario when FERA was enacted A quarter Century ago, FERA was enacted in 1973 when scenario called for a strict and rigid regulatory regime.
o o

Foreign exchange was scarce. There were instances of misuse of foreign exchange.21

o Indias foreign trade was not substantial compared to what it is today, it was very limited. o The process of globalization had not yet started. In such scenario, there was apprehension that regulations would be circumvented by unscrupulous persons. Such apprehension led to enactment of Foreign Exchange Regulation Act, 1973 as a comprehensive piece of legislation. FERA was administered ruthlessly by overzealous officers of Enforcement.22 Soon after independence, a complex web of controls imposed for all external transactions through a legislation i.e., Foreign Exchange Regulation Act (FERA), 1947.23 The original 1947 version of FERA, enacted under the Defense of India Rules, 1939 and wartime shortage of foreign Exchange, was meant to be temporary. In 1957, when planned economic development failed to eliminate such shortages, FERA permanently entered the statute book. The Foreign Exchange Regulation Act, 1947 was far less draconian than its 1973 incarnation. Foreign Exchange Regulation Act, 1973, consisted of more rigorous framework of control.24 Severe restrictions on current account transactions had continued till mid-1990s when relaxations were made in the operations of the FERA. The control framework was essentially transaction based in terms of which all transactions in foreign exchange including those between residents and non-residents were prohibited, unless specifically permitted.25
21 22

Dilip K. Sheth, TREATISE ON FEMA (Law and Practice), Vol. 1,1st edn. 2002, p. 3. Shyamala Gopinath, Foreign exchange regulatory regimes in India- from control to management, www.bis.org/review/r050217h.pdf (October 20, 2011) 24 Dilip K. Sheth, TREATISE ON FEMA (Law and Practice), Vol. 1,1st edn. 2002, p. 2.
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Unlike other laws where everything is permitted unless specifically prohibited, under Foreign Exchange Regulation Act, 1973 nothing was permitted unless specifically permitted. Hence the tenor and tone of the Act was very drastic. It provided for imprisonment of even a very minor offence. Under Foreign Exchange Regulation Act, 1973, a person was presumed guilty unless he proved himself innocent whereas under other laws, a person is presumed innocent unless he is proven guilty. Scenario 25 years later After passage of 25 years, however the entire Scenario which prevailed in 1973 underwent a change. o Internal economic controls had been progressively relaxed. o Externally, the process of globalization had gained momentum. o Indias foreign trade had substantially increased. Its economy and market had become substantially stronger and vibrant. Time had thus come to take serious re-look at Foreign Exchange Regulation Act, 1973. The government of India took a step towards liberalization by announcing the New Industrial Policy in 1991 to remove obstacles in the inward flow of foreign exchange. 26 Steps were taken to rationalize Foreign Exchange Regulation Act, 1973. While it was necessary to continue to regulate activities of foreign companies or branches of such companies and foreign citizens in India, special restrictions in respect of the companies registered in India were considered no longer necessary, and the regulations on foreign investment needed simplification to attract greater flow of foreign capital and investment. It was considered necessary to empower Reserve Bank to impose penalties on authorized dealers for their lapses with a view to achieve effective monitoring and ensuring compliance of its directions. The government had already indicated its intention in this respect by issuing notifications through the Reserve Bank in exercise of its powers under Foreign Exchange Regulation Act, 1973.27 Along with the said principal objective, a number of other objectives were also taken into account while overhauling Foreign Exchange Regulation Act, 1973. What was done so far through notifications however had left a lurking apprehension in the minds of the foreign investors, particularly from
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Section 73(3), Foreign Exchange Regulation Act, 1973. 10 | P a g e

Japan. Their apprehension was that the piecemeal relaxation in Foreign Exchange Regulation Act, 1973 through notifications may not have the same legal force as the amendment to Foreign Exchange Regulation Act, 1973 itself. To dispel such apprehension expressed by the circumspect foreign investors, the Government eventually decided that Foreign Exchange Regulation Act, 1973 be formally amended so as to give legal shape to the changes, most of which were already made in FERA, 1973 through the notifications issued by the Reserve Bank since the advert of New Industrial Policy in July, 1991. The FERA (Amendment) Bill was slated for discussion in the winter session of Parliament. However, the Ayodhaya muddle28 did not allow the introduction of the Bill. The Government, indeed, meant business and, therefore, it preferred not to wait till the next session of Parliament for passing the FERA (Amendment) Bill. Accordingly an Ordinance was promulgated on 8th January, 1998 by the President, Dr. Shankar Dayal Sharma. The amendment to various provisions of FERA, 1973 came into effect immediately on the promulgation of the Ordinance. Eventually in the Budget session of Parliament in March, 1993, the FERA Amendment Bill (which could not be taken up for consideration in the earlier parliament session) was introduced and passed by both the houses on March 24, 1993. This is how the Foreign Exchange Regulation Act (Amendment) Act, 1993 was enacted with the provisions which were substantially similar to those of the Ordinances.29 Foreign Exchange Regulation Act 1973, was enacted at a time when there was dearth of foreign exchange in India and the main aim behind the enactment was to restrict the outflow of foreign exchange from India. As a result it was made very stringent. With the growth of Foreign trade and commerce the foreign exchange reserve (FOREX) position of our country improved considerably. The provisions of Foreign Exchange Regulation Act, 1973 were becoming draconian, unrealistic and anachronistic. This was accepted by the authorities and Foreign Exchange Management Act, 1999 was enacted. The objective of Foreign Exchange Management Act, 1999, was to consolidate and amend the relating to foreign exchange with the objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India. The law relating to exchange control in India has undergone a substantial change in scope, content and approach by the substitution of the Foreign Exchange Regulation Act, 1973
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( FERA ) by the Foreign Exchange Management Act, 1999 ( FEMA ), which was passed in winter session of the Parliament in 1999. The bill was introduced in the 13th Lok Sabha on 25th Oct'99. The presidential Assent was received on 6th Jan 2000. Finally the Foreign Exchange Management Act, 1999, came into operation w.e.f. 1st June 2000.The most noticeable aspect of Foreign Exchange Management Act, 1999, is that there is no imprisonment prescribed for contraventions of the law, not even as an alternative punishment and for the blatant and deliberate of violations.30 Foreign Exchange Regulation Act, 1973, had a controversial 27 year stint during which many bosses of the Indian Corporate world found themselves at the mercy of the Enforcement Directorate (E.D.). Any offense under Foreign Exchange Regulation Act, 1973, was a criminal offence liable to imprisonment, whereas Foreign Exchange Management Act, 1999, seeks to make offenses relating to foreign exchange civil offenses.31 The provisions of Foreign Exchange Management Act displays so much change that one could almost de link Foreign Exchange Management Act, 1999, from Foreign Exchange Regulation Act, 1973 and concludes that Foreign Exchange Management Act, 1999 is a new law altogether which needs an independent reading and interpretation divorced from the earlier law and decisions rendered there under. The approach has sifted from that of conservation of foreign exchange to one of facilitating trade and payments, as well as developing orderly foreign market. This definitive shift in the objectives of foreign exchange management could be seen in the preamble to the new legislation. 32 Important aspects of transition were: Capital account convertibility, timeframe for convertibility, the recommendations of Tarapore Committee and symptoms of the currency crisis. For a clear perception of implications of the transition from FERA, 1973 to Foreign Exchange Management Act, 1999, these aspects should be reviewed.33 Foreign Exchange Management Act, 1999, which has replaced Foreign Exchange Regulation Act, 1973, had become the need of the hour since Foreign Exchange Regulation Act, 1973 had become incompatible with the pro-liberalization policies of the Government of India. Foreign Exchange Management Act, 1999, has brought a new management regime of Foreign Exchange consistent
30
31

http://www.welcome-nri.com/info/project/femaact1.htm (October 20, 2011).

32

Rama Devi R. Iyer, Compounding of contraventions under Foreign Exchange Management Act, 1999 (FEMA),[2006] 72 SCL(ST.), p. 126.
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with the emerging frame work of the World Trade Organization (WTO). It is another matter that enactment of Foreign Exchange Management Act, 1999, also brought with it Prevention of Money Laundering Act, 2002 which came into effect recently from 1st July, 2005 and the heat of which is yet to be felt as Enforcement Directorate would be investigating the cases under Prevention of Money Laundering Act, 2002, too.34

Regulatory Structure Under Fema, 1999

This is the most significant part of Foreign Exchange Management Act, 1999. All the core sections are contained in this part. It deals with the dealing in foreign exchange, current and capital account transactions, export, realization and reparation of foreign exchange & exemption in certain cases. Objective The objectives of the Foreign Exchange Management Act, 1999 have been to consolidate and amend the law relating to foreign exchange with the following objective: a) a facilitating external trade and payments; and b) for promoting the orderly development and maintenance of foreign exchange market in India. In Foreign Exchange Management Act, 1999, only the specified acts relating to foreign exchange are regulated, while in FERA, 1973 anything and everything that has to do with foreign exchange was controlled. Also the aim of Foreign Exchange Management Act, 1999, is facilitating trade as against that of FERA, which was to prevent misuse.35 Furthermore, the objectives of FERA and FEMA differed in the line that first, in virtually a reverse transition to 1947, criminal remedies have been scrapped and replaced with civil remedies. Second, Foreign Exchange Management Act, 1999, recognizes that foreign exchange is no longer a scarce resource requiring its optimal utilization, thus facilitating current account convertibility and eventual transition to the capital account convertibility. However, since Foreign Exchange Management Act, 1999, is an enabling legislation, the degree of actual liberalism can be judged only from the tenor of the regulations and rules which have been notified. Scope and Applicability FERA, 1973, applied to:
34

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Chinubhai R. Shah and Ms. Komal Parikh, FERA To FEMA: A Journey from forbidden lands to semi-open patures, [2000] Vol. 30 No.5, ICSI Executive Chartered Secretary, p. 590. 13 | P a g e

a) All citizens, outside India. b) Branches and agencies, outside India. - of the companies/bodies corporate registered incorporated in India. Now, FEMA, 1999 applies to36: a) All branches, offices and agencies outside India -owned/ controlled by a person resident in India and b) Any FEMA, 1999 contravention committed outside India -by any person to whom FEMA, 1999 applies. FEMA, 1999 applies to the whole of India and hence, any transaction which takes place in India will be subject to the governance of FEMA, 1999. Thus, any transaction undertaken by nonresident in India would need compliance of FEMA, 1999. FEMA, 1999 also applies to the branches, offices and agencies outside India owned or controlled by a person resident in India. The question whether FEMA, 1999 would apply to the transactions of a resident individual which took place outside India. There are several provisions, which restrict a resident from certain transactions outside India, such as, acquisition of immovable property. Though the branches, etc. of residents himself can carry out transactions abroad which are otherwise not permitted to him in India. However, the word also in section 1(3) seems to suggest that the transactions of a resident person outside India would be subject to FEMA, 1999.37 Definitons The following can be made out from analyzing the definition part of Foreign Exchange Regulation Act, 1973, & Foreign Exchange Management Act, 1999: 1. Authorized dealers and money changers have been clubbed together under the definition of Authorized person. In addition, it also includes a offshore banking unit. 2. Definitions of capital account transaction and current account transaction have been inserted keeping in mind the possibility of introduction of capital account convertibility.
3. Definitions of export and import on similar lines as The Customs Act, 1962 have been

inserted.

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Section 1(3), Foreign Exchange Management Act, 1999. 14 | P a g e

4. Definition of the term service similar to COPRA, 1986 has been inserted. This is

done keeping in mind the export services and infotech sectors.38 5. Definition of person has been inserted and definition of person resident in India has been aligned with the Income tax Act, 1961. This has probably been done considering the difficulties arising due to different definitions and different interpretations. All nonresident accounts with the banks were on the basis of the definition in Foreign Exchange Regulation Act, 1973. Now, according to the Foreign Exchange Management Act, 1999, definition, very few of them will be non-resident accounts. However, the EXIM policy definition still remains different.

Effects due to the change. Under FERA, 1973, all violations were subject to separate investigation and adjudication of the

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Directorate of Enforcement. However, the Foreign Exchange Management Act, 1999, provides for an opportunity for seeking compounding of contraventions. It is pertinent to note that application of law requires that discretionary powers have to be used in a just, fair and reasonable manner and this is expected on the part of the Compounding Authorities while following the provisions of the Foreign Exchange Management Act, 1999, and Rules framed thereunder.39 Provision of Foreign Exchange Management Act, 1999, on dealing in foreign exchange40 provides that no person shall without the general or special permission of Reserve Bank of India, deal in or transfer foreign exchange or foreign security to any person other than an authorized person, make payment outside India or receive payment in any manner otherwise through an authorized person on behalf of person resident outside India or enter into financial transaction in relation to acquisition of assets outside India. FEMA, 1999 has also incorporated the explanation to section 9(1)(b) of the erstwhile FERA, 1973 by covering the possibility of an Indian receiving the payment on behalf of a person resident outside India. In such case the person shall be deemed to have received such payment otherwise through an authorized person. This is retention of explanation to section 991) (b) of the erstwhile FERA, 1973. This provision means that if Mr. X , an Indian claims to have received an amount of USD 1,000 Or INR 1,000 ( both foreign and/or domestic currencies) on behalf of MrY a non resident through Mr. Z, an authorized person, there should be present an actual inward remittance of USD 1,00 or INR 1,000 to back the transaction. Otherwise, it smells collusion between the authorised person and the resident Indian.41 Goods and Services The provision of FEMA, 1999, dealing with export goods and services 42 appears highly simplified compared to similar provision of FERA, 1973,43 It requires the exporter to furnish to the Reserve bank of India correct particulars including the export value of the goods/payment for services, and where it is not ascertainable, value which the exporter expects to receive, other information as the Reserve Bank of India may require. While similar provision of the erstwhile FERA, 1973 attached

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Section 3, Foreign Exchange Management Act, 1999. Section 7, Foreign Exchange Management Act, 1999. Section 18, Foreign Exchange Regulation Act, 1973. 16 | P a g e

a lot of anti under invoicing conditions to export and cover as many deeming provisions on the part of both the Reserve Bank of India and the exporter and even then, it did not cover services.44 Holding Foreign Exchnage In India, the realized foreign exchange should be sold to an authorized person in India in exchange for rupees.45 It also includes the holding of realised amount in an account with an authorised person in India to the extent notified by the Reserve Bank and includes use of the realised amount for discharge of a debts or liability denominated in foreign exchange. Exemption from holding/repatriation: Section 4 of the FEMA, 1999 prohibits holding of foreign exchange by a resident in India. Section 8 requires that foreign exchange earned by a resident in India is realised and repatriated to India. However, in the following cases, the foreign exchange can be held or need not be repatriated to India:1. Possession of foreign currency possession of foreign currency or foreign coins upto limit prescribed by RBI is permitted (section 9(a)) 2. Foreign currency account Foreign currency account can be held and operated by such persons and within such limits as specified by RBI (Section 9(b)) 3. 3 Foreign currency acquired before July 1947 Foreign exchange acquired or received before 8th July 1947 or income arising or accruing thereon can be held outside India (section 9(c)) 4. Gift or inheritance If such foreign exchange is acquired as a gift or inheritance, that exchange and income arising therefrom can be held as foreign exchange in India or held abroad and need not be repatriated (Section 9(d)). 5. Foreign exchange acquired abroad Foreign exchange acquired from employment, business, trade, vocation, services honorarium, gifts, inheritance, or any other legitimate means can be held as foreign exchange in India or it need not be repatriated to India subject to limits specified by RBI (Section 9(e)) 6. Any other receipts specified by RBI (Section 9(f)).

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Section 18, Foreign Exchange Regulation Act, 1973. Known as Repatriate to India defined under section 2(y) of the FEMA, Act 1999. 17 | P a g e

According to Section 5 of FEMA, 1999 any citizen may sell or draw foreign exchange to or from an authorised person if such sale or drawl is a current account transaction46. Provided that the Central Government may in public interest and in consultation with the Reserve Bank, impose such reasonable restrictions for current account transactions as may be prescribed. Further, any person may sell or draw foreign exchange to or from an authorised person 47 for a capital account transaction48 subject to the provisions of section 6(2). Under Section 5 of Foreign Exchange Management Act, 1999, certain rules have been framed for drawal of foreign exchange on current account. According to the said rules, drawal of foreign exchange for certain transactions is prohibited. In respect of certain transactions drawal of foreign exchange is permissible with the prior approval of Central Government. In respect of some of the transaction, prior permission of RBI is sufficient for drawal of foreign exchange. i. In respect of item No.1 i.e. Payment of Commission on exports made towards equity investment in wholly owned subsidiary abroad of an Indian company is prohibited. ii. Drawal of foreign exchange for remittance of hiring charges of transponder, can be made with the prior approval of the Central Government. iii. So far as remittance for use of Trade Mark in India is concerned, the necessary foreign exchange can be obtained with the prior permission of the Reserve Bank of India. In the case of (ii) & (iii) above, approval of concerned authority is not required if the payment is made out of funds held in Resident Foreign Currency (RFC) Account or Exchange Earners Foreign Currency (EEFC) Account of the remitter. Further foreign Exchange can be drawn only from an authorised person. Contraventions and Penalties: Under this chapter, penalty for any kind of contravention has been specified as thrice the amount involved, where it is quantifiable, and otherwise, up to Rs 2lakhs + Rs. 5000 per day for
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continuing contravention. The provision is in total contrast to the provision of the erstwhile FERA, 1973 which provided for imprisonment and no limit on fine.49 Also, one question which arises here is that where the alleged person is an authorized person, whether this fine will be in addition to the one under section 11(3), of FEMA, 1999. However, if the person does not pay the fine within 90 days from the date of notice, then after formalities of show cause notice and personal hearing, he can be subjected to civil detention. If he does not respond to the notice their can be warrant of arrest. The civil detention is on the following lines where the amount involved exceeds there can be warrant of arrest. The civil detention is on the following lines where the amount involved exceeds Rs. 1 crore, detention for three years. Otherwise, six months. However, it is clearly civil detention and not imprisonment.50 This is a major diversion from FERA, 1973 which contained provisions that would lead to imprisonment even in trivial cases. Perhaps the government is of the opinion that there should be pecuniary punishment for economic offences, where that punishment is not complied with, then, civil detention and if that is also not complied with, then a warrant of arrest. Under the Foreign Exchange (Compounding Proceedings) Rules 2000, the Central Government may appoint Compounding Authority an officer either from Enforcement Directorate or Reserve Bank of India for any person contravening any provisions of the FEMA. The Compounding Authorities are authorized to compound the amount involved in the contravention to the Act made by the person. No contravention shall be compounded unless the amount involved in such contravention is quantifiable. Any second or subsequent contravention committed after the expiry of a period of three years from the date on which the contravention was previously compounded shall be deemed to be a first contravention. The Compounding Authority may call for any information, record or any other documents relevant to the compounding proceedings. The Compounding Authority shall pass an order of compounding after affording an opportunity of being heard to all the concerns as expeditiously and not later than 180 days from the date of application made to the Compounding Authority. Compounding Authority shall issue order specifying the provisions of the Act or of the rules, directions, requisitions or orders made there under in respect of which contravention has taken place along with details of the alleged contraventions.

49 50

Section 56, Foreign Exchange Regulation Act, 1973. Section 14, Foreign exchange Management Act, 1999. 19 | P a g e

For example, Mr. X, an Indian national has failed to realise and repatriate foreign exchange worth more than Rs.2 crores. Mr. X having realised that he had committed a contravention of the provisions of the Foreign Exchange Management Act, 1999, desires to compound the said offence. Because of his failure to realise and repatriate foreign exchange, Mr. X has contravened the provisions of section 8 of FEMA and he is liable to the penalties leviable under Section 13, followed by adjudication proceedings. Section 15 of FEMA permits the offending party to Director of Enforcement or such other officers of the Directorate of Enforcement and officers of the Reserve Bank of India as may be authorised in this behalf by the Central Government in such manner as may be prescribed. No contravention shall be compounded unless the amount involved in such contravention is quantifiable. Where a contravention has been compounded, no proceeding can continue or be initiated against the person in respect of the contravention so compounded. Adjudication and Appeals: The following are the provisions which differ from FERA, 1973 and are incorporated in FEMA, 1999:
1. The Appellate Tribunal for Foreign Exchange has been granted powers to hear appeals

against the orders of both the adjudicating authorities as also the Special Director (Appeals).51 There is no provision like other laws which requires following the hierarchy or qualification of a case as fit for hearing by the appellate tribunal. This means the aggrieved person can choose to appeal directly to the appellate tribunal against the order of the adjudicating authorities. The objective behind the introduction of an intermediary authority like the Special Director (Appeals) is not clear.
2. The Chairperson of the Appellate Tribunal is empowered to transfer cases from one bench

to another, but only on the application of any of the parties and after notice to them.52
3. Civil court will not have any jurisdiction to entertain any suit or proceeding which an

Adjudicating authority, Special Director (Appeals) or the Appellate tribunal are empowered to determine under this act.53 Directorate of Enforcement54:
51 52

Section 19, Foreign Exchange Management Act, 1999. Section 30, Foreign Exchange Management Act, 1999. 53 Section 34, Foreign Exchange Management Act, 1999 54 Chapter IV, Sections 36-38, Foreign Exchange Management Act, 1999 20 | P a g e

This chapter envisages the appointment of all officers included under the erstwhile FERA, 1973.55 The powers of search and seizure conferred by FEMA, 199956 are limited only to contraventions mentioned in FEMA, 1999.57 Also, many other strict provisions relating to searches and seizures, which were similar to Customs Act, 1962 have been withdrawn. This will relieve the industry, trade and commerce from the autocracy of the office of Director of Enforcement, which had been alleged to be the dwelling place of corruption due to unlimited powers granted to it.58 Miscellaneous: The not so normal provision in this area is that any right, obligation, liability, proceeding or appeal arising in relation to penalty59 will not abate with the death or insolvency of the person, but will be shifted to the legal representative, official receiver or official assignee. But the terms winding up or liquidation and official liquidator are nowhere to be found although the term person includes a Company.60 In totality, following can be made out:
1.

FEMA, 1999 is much smaller enactment- 49 sections, as against 81 sections of The theme of FERA, 1973 was : everything that is specified is under control.

FERA, 1973.
2.

While the theme of FEMA, 1999, is: everything other than what is expressly covered is not controlled. Thus there is a lot of deregulation.
3.

In many process of simplification, many of the laid downs of the erstwhile Many provisions of FERA, 1973 like the ones relating to blocked accounts, Indians

FERA, 1973 have been withdrawn.

4.

taking up employment abroad, employment of foreign technicians in India, contract in evasion of the act, vexatious search, culpable mental state etc. have no appearance in FEMA, 1999.61

55 56

Section 3, Foreign Exchange Regulation Act, 1973 Section 37, Foreign Exchange Management Act, 1999. 57 section 13, Foreign Exchange management Act, 1999. 58 Foreign Exchange Management Manual, 2007 59 Section 13, Foreign Exchange Management Act, 1999.
60 61

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Obligations of the Exporter

With the governing authorities in place, there also exists simultaneous obligation and responsibility on the exporter himself to ensure compliance of the laws. Thus, the duties of every exporter of goods and services under FEMA, 1999 are: (i) Furnishing of Information:- Every exporter of goods is required the furnish to RBI or other prescribed authority a declaration containing true and correct material particulars, including the amount representing full export value. If full exportable value is not ascertainable at the time of export due to prevailing market conditions, the exporter shall indicate the amount he expects to share indicate the amount he expects to receive on sale of goods in a market outside India. The exporter of goods shall also furnish to RBI such other information as may be required by RBI for the purpose of ensuring realization of export proceeds by such exporter [section 7(i)]. RBI can direct any exporter to comply with prescribed requirements to ensure that full export value of the goods or such reduced value of the goods as RBI determines, is received without delay [section 7(2)]. Every exporter of services shall furnish to RBI or other prescribed authority a declaration containing true and correct material particulars in relation to payment of such services [section 7(3)]. (ii) Realisation and repatriation of foreign exchange: Where any amount of foreign exchange is due or has accrued to any resident in India, such person shall take all reasonable steps to realize and repatriate to India the foreign exchange within such period and in such manner as may be specified by RBI (section 8). Exporter of goods and services must comply with the requirements of section 7 and 8 of FEMA, 1999 and also with the requirements under Foreign Exchange Management (Export of Goods and Services) Regulations, 2000. Change in the Economy. Globalization has many meanings depending on the context and on the person who is talking about. Though the precise definition of globalisation is still unavailable a few definitions are worth viewing, Guy Brainbant62: says that the process of globalisation not only includes opening up of world trade, development of advanced means of communication, internationalisation of financial
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markets, growing importance of MNCs, population migrations and more generally increased mobility of persons, goods, capital, data and ideas but also infections, diseases and pollution.63 The term globalization refers to the integration of economies of the world through uninhibited trade and financial flows, as also through mutual exchange of technology and knowledge. Ideally, it also contains free inter-country movement of labour. In context to India, this implies opening up the economy to foreign direct investment by providing facilities to foreign companies to invest in different fields of economic activity in India, removing constraints and obstacles to the entry of MNCs in India, allowing Indian companies to enter into foreign collaborations and also encouraging them to set up joint ventures abroad; carrying out massive import liberalisation programs by switching over from quantitative restrictions to tariffs and import duties, therefore globalization has been identified with the policy reforms of 1991 in India. Major measures initiated as a part of the liberalisation and globalisation strategy in the early nineties included Allowing Foreign Direct Investment (FDI) across a wide spectrum of industries and encouraging non-debt flows. The Department has put in place a liberal and transparent foreign investment regime where most activities are opened to foreign investment on automatic route without any limit on the extent of foreign ownership. Some of the recent initiatives taken to further liberalise the FDI regime, inter alias, include opening up of sectors such as Insurance (upto 26%); development of integrated townships (upto 100%); defence industry (upto 26%); tea plantation (upto 100% subject to divestment of 26% within five years to FDI); enhancement of FDI limits in private sector banking, allowing FDI up to 100% under the automatic route for most manufacturing activities in SEZs; opening up B2B e-commerce; Internet Service Providers (ISPs) without Gateways; electronic mail and voice mail to 100% foreign investment subject to 26% divestment condition; etc. The Department has also strengthened investment facilitation measures through Foreign Investment Implementation Authority (FIIA).

Foreign Exchange leading to Integration with International Economy: Globalization, Welfare and Sustenance
Integration of financial markets is a process of unifying markets and enabling convergence of risk adjusted returns on the assets of similar maturity across the markets. The process of integration is facilitated by an unimpeded access of participants to various market segments. Financial markets
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all over the world have witnessed growing integration within as well as across boundaries, spurred by deregulation, globalisation and advances in information technology. Central banks in various parts of the world have made concerted efforts to develop financial markets, especially after the experience of several financial crises in the 1990s. As may be expected, financial markets tend to be better integrated in developed countries. At the same time, deregulation in emerging market economies (EMEs) has led to removal of restrictions on pricing of various financial assets, which is one of the pre-requisites for market integration. Capital has become more mobile across national boundaries as nations are increasingly relying on savings of other nations to supplement the domestic savings.64 Harmonization of prudential regulations in line with international best practices, by enabling competitive pricing of products, has also strengthened the market integration process. Integrated financial markets assume vital importance for several reasons. First, integrated markets serve as a conduit for authorities to transmit important price signals (Reddy, 2003). Second, efficient and integrated financial markets constitute an important vehicle for promoting domestic savings, investment and consequently economic growth (Mohan, 2005). Third, financial market integration fosters the necessary condition for a countrys financial sector to emerge as an international or a regional financial centre (Reddy, 2003). Fourth, financial market integration, by enhancing competition and efficiency of intermediaries in their operations and allocation of resources, contributes to financial stability (Trichet, 2005). Fifth, integrated markets lead to innovations and cost effective intermediation, thereby improving access to financial services for members of the public, institutions and companies alike (Giannetti et al., 2002). Sixth, integrated financial markets induce market discipline and informational efficiency. Seventh, market integration promotes the adoption of modern technology and payment systems to achieve cost effective financial intermediation services. An important objective of reforms in India has been to integrate the various segments of the financial market for bringing about a transformation in the structure of markets, reducing arbitrage opportunities, achieving higher level of efficiency in market operation of intermediaries and increasing efficacy of monetary policy in the economy (Reddy, 1999, 2005d). Efficient allocation of funds across the financial sector and uniformity in the pricing of various financial products through greater inter-linkages of financial markets has been the basic emphasis of monetary policy
64

http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/77579.pdf 24 | P a g e

(Mohan, 2005). In the domestic sphere, integration of markets has been pursued through strengthening competition, financial deepening with innovative instruments, easing of restrictions on flows or transactions, lowering of transaction costs and enhancing liquidity. Financial markets in India have also increasingly integrated with the global financial system as a result of calibrated and gradual capital account liberalisation in keeping with the underlying macroeconomic developments, the state of readiness of the domestic financial system and the dynamics of international financial markets (Reddy, 2005a).65 Worldwide, foreign direct investment (FDI) represents a major source of funding for capital intensive projects. This is more so for emerging economies including India. As a result of persistent tapping of this source of fund by emerging economies in the last two decades, the FDI level as of now stands at approximately 35 percent of global FDI in emerging economies.66 In 1991, India adopted a massive liberalization program and since then FDI inflow has been increasing tremendously in India. The main objective of the liberalization program was to bring stability, economic growth and development via the liberalization, privatization and globalization (LPG) program. The liberalization policy of Indian Government of 1991 emphasized undertaking regulatory measures such as deregulations, tax reforms, initiation of privatization and opening Indian economy to investments from abroad. Implicitly, it resulted in restructuring of its previous trade regime to ensure greater integration of the Indian economy with other international economies.67 Since 1991, Indian economy has made rapid strides towards integration with world economies and has been able to establish a mutually beneficial inter-linkage with them. In a way, the major structural changes under the economic liberalization program continued till 1995. As India moved from policies of import substitution to export promotion, it was able to attract more and more FDI. In addition, several other factors favoured Indian economy such as economic growth above global average, fast growing population with ever increasing young population and consumers, lower interests rates and relatively stable financial systems, lower wages and production costs, low inflation rate and increasingly reformed exchange rate system, etc. These factors ensured that India
65 66

67

Monica Singhania and Akshay Gupta, Determinants of foreign direct investment in India, J.I.T.L. & P. 2011, 10(1), 64-82 25 | P a g e

continued to attract an increasingly large chunk of FDI and as of now, India has become the second favorite destination for FDI inflows for next three years (Ernst & Young, 2010).68 STRENGTHENING DOMESTIC REGULATIONS Perhaps the most realistic recommendation is to strengthen the domestic environmental regulation of developing countries. Again, a human rights approach to address environmental degradation issues caused by foreign invest-ment must be incorporated in the domestic legislation. Governments will be bound to create pressure on corpora-tions if they are under public scrutiny. If we look at the statistics of foreign investment,69 developed coun-tries are on both ends of exporting and receiving foreign investment. The reason they praise the notion of foreign investment is partly the strict environmental regulations that prevent them from endangering their eco-system. However, a question may arise about how this would solve the problem of corrupt governments ignoring pub-lic opinion as in many developing countries. F. EXTRATERRITORIALITY OF JURISDICTION The mandatory provision of home country jurisdiction over corporations in the absence of adequate remedy from other forums could prove to be fruitful in this area of law. The idea is to propose the flipside of foreign direct in-vestment--foreign direct liability. Powerful nations have, however, invented processes to avoid that kind of jurisdic-tion.70 The bilateral investment agreements or multilateral agreement on investment can include detailed provisions to this effect.

68

Monica Singhania and Akshay Gupta, Determinants of foreign direct investment in India, J.I.T.L. & P. 2011, 10(1), 64-82 69 "Top five outward investors countries are USA (24%), UK (14%), Germany (11%), France (7%) and Japan (6%); investment recipients are USA (24%), China (10%), UK (8%), France (6%) and Belgium (4%);" DUNOFF ET AL., INTERNATIONAL LAW: NORMS, ACTORS, PROCESS: A PROBLEM ORIENTED APPROACH (2000). 70 The use of the forum non conveniens doctrine by United States courts in cases like In re Union Carbide Corp. Gas Plant Disaster at Bhopal India in Dec. 1984, 634 F. Supp. 842 (S.D.N.Y. 1986) and Dow Chemical Co. v. Alfaro, 786 S.W.2d 674 (1990); and the Law of Comity doctrine in cases like Sequihua v. Texaco, 847 F. Supp. 61 (S.D. Tex. 1994) and Aquinda v. Texaco, 945 F. Supp. 625 (S.D.N.Y 1996); and the various restrictions on availing the Alien Torts Claims Act before the 1980s can be considered in this context. The Alien Tort Claims Act provides that district courts shall have jurisdiction over civil actions "by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States." Alien Tort Claims Act, 28 U.S.C. 1350 (1988). 26 | P a g e

It is important to note that the preference should be given to the victim's choice of forum and it should not pose any threat to sovereignty of the affected state. Impacts Of Globalization Indian economy had experienced major policy changes in early 1990s. The new economic reform, popularly known as, Liberalization, Privatization and Globalization (LPG model) aimed at making the Indian economy as fastest growing economy and globally competitive. The series of reforms undertaken with respect to industrial sector, trade as well as financial sector aimed at making the economy more efficient.71 "(G)lobalization must mean more than creating bigger markets. To survive and thrive, a global economy must have a more solid foundation in shared values and institutional practices."72 Positive Impact Globalization is the new catchphrase in the world economy, dominating the globe since the nineties of the last century. People relied more on the market economy, had more faith in private capital and resources, international organizations started playing a vital role in the development of developing countries. The impact of globalization has been fair enough on the developing economies to a certain extent. It brought along with it varied opportunities for the developing countries. It gave a fillip for better access to the developed markets. The technology transfer promised better productivity and thus improved standard of living. Negative Impact Globalization has also thrown open varied challenges such as inequality across and within different nations, volatility in financial market spurt open and there were worsening in the environmental situation. Another negative aspect of globalization was that a majority of third world countries stayed away from the entire limelight. Till the nineties, the process of globalization in the Indian economy had been guarded by trade, investment and financial barriers. Due to this, the liberalization process took time to hasten up. The pace of globalization did not start that smoothly. Economic integration by 'globalization' enabled the cross country free flow of information, ideas, technologies, goods, services, capital, finance and people. This cross border integration had
71

Dr. C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister, RESPONDING TO GLOBALIZATION: INDIAS ANSWER, at 4th Ramanbhai Patel Memorial Lecture on Excellence in Education, February 25, 2006 available at www.eac.gov.in 72 Kofi Annan's Millennium Declaration obtained from www.un.org. 27 | P a g e

different dimensions - cultural, social, political and economic. More or less the economic integration happened through four channels o Trade in goods and services o Movement of capital o Flow of finance o Movement of people Advantages of globalization The gains from globalization can be cited in the context of economic globalization: Trade in Goods and Services - From the theoretical aspect, international trade ensures allocating different resources and that has to be consistent. This specialization in the processes leads to better productivity. We all know from the economic perspective that restrictive trade barriers in emerging economies only impede growth. Emerging economies can reap the benefits of international trade if only all the resources are utilized in full potential. This is where the importance of reducing the tariff and non-tariff barriers crop up. Movement of Capital - The production base of a developing economy gets enhanced due to capital flows across countries. It was very much true in the 19th and 20th centuries. The mobility of capital only enabled savings for the entire globe and exhibited high investment potential. A country's economic growth doesn't, however, get barred by domestic savings. Foreign capital inflow does play an important role in the development of an economy. To be specific, capital flows either can take the form of foreign direct investment or portfolio investment. Developing countries would definitely prefer foreign direct investment because portfolio investment doesn't have a direct impact on the productive capacity expansion. Financial Flows - The capital market development is one of the major features of the process of globalization. We all know that the growth in capital and mobility of the foreign
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exchange markets enabled better transfer of resources cross borders and by large the global foreign exchange markets improved. It is mandatory to go in for the expansion of foreign exchange markets and thus facilitate international transfer of capital. The major example of such international transfer of funds led to the financial crisis - which has by now become a worrying phenomenon. Thus, globalization has the fair and rough share of its impacts and thus we can surely hope for more advancement in the global economy due to this process. Foreign exchange leading to welfare: In theory: A financial system consists of financial institutionse.g., commercial banksand financial marketse.g., stock and bond markets. At a broader level, a robust and efficient financial system promotes growth by channeling resources to their most productive uses and fostering a more efficient allocation of resources. A stronger and better financial system can also lift growth by boosting the aggregate savings rate and investment rate, speeding up the accumulation of physical capital. Financial development also promotes growth by strengthening competition and stimulating innovative activities that foster dynamic efficiency. According to Demirg-Kunt and Levine (2008), the overall function of a financial system is to reduce information and transactions costs impeding economic activity, and its five core functions are to (i) produce ex ante information about possible investments and allocate capital; (ii) monitor investments and provide corporate governance after providing finance; (iii) facilitate the trading, diversification and management of risk; (iv) mobilize and pool savings; and (v) ease the exchange of goods and services. In evidence: Economic theory and intuition suggest a number of plausible channels through which financial development can have a positive effect on economic growth. Predictably, a large and growing empirical literature has sprung up to examine the relationship between finance and growth. At a broader level, the literature looks at the impact on gross domestic product (GDP) growth of (i) the depth of the financial system, as measured by indicators such as the ratio of total liquid liabilities to GDP, the ratio of bank credit to GDP, or the ratio of stock market capitalization to GDP; and (ii) the structure of the financial system, as measured by indicators such as the ratio of bank credit to
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stock market capitalization. The balance of evidence from the empirical literature strongly indicates that financial depth has a significant positive effect on growth whereas financial structure (the relative weight of banks versus capital markets) does not have any appreciable effect Financial Development and Economic Growth in Developing Asia on growth. More specifically, bank development and stock market development exerts a significant positive effect on growth, as does overall financial development. Although a shift from banks to capital markets is often viewed as evidence of financial development, countries with market-based financial systems do not perform better than those with bank-based systems. Conclusively, Critics of economic globalization have identified that the competition between countries for investment may result in a neglect of environmental concerns; that national governments are gradually losing their influence over important domestic issues; and that globalization undermines the traditional balance of power between rich and poor.73 In the Brundtland Report, the commission recognized two key concepts of sustainable development. One of them is the concept of needs, in particular the essential needs of the world's poor, to which overriding priority should be given. The other is the idea of limitations imposed by the state of technology and social organization on the envi-ronment's ability to meet present and future. Thus, foreign investment could be called an effective tool of achieving sustainable development if it meets the criteria. However, the reality remains far from satisfying. Whereas the positive role of foreign investment in alleviating poverty is facing uncertainty from various economists, many times they can be seen as contradictory forces against sustainable development. Globalization of market economy and the growth of multinational corporations present a conflict with the goal of sustainable development which requires local participation and control over development choices.74 Environmental disasters, such as the 1984 isocyanate gas leak in Bhopal, India that killed several thousand people, highlight the problems that occur when foreign investment brings

73

Jan McDonald, The Multilateral Agreement on Investment: Heyday or MAI-Day for Ecologically Sustainable Development? 22 MELBOURNE UNIV. L.R. 617, 620 (1998). 74 HUNTER ET AL., INTERNATIONAL ENVIRONMENTAL POLICY 1269 (2d ed. 2002). 30 | P a g e

environmentally hazardous technologies to coun-tries with neither the environmental law framework nor the technical infrastructure to address the resulting the envi-ronmental problems.75 might argue that foreign investment also brings in opportunities for environmental protection and sustainable development. However the tendency to offer lowest possible environmental protection laws to attract foreign in-vestment can prove fatal to the interest of developing countries. In a recent study,76 researchers concluded that FDI-led integration has done little to promote sustainable industrial development in a developing country. Be-sides the most alarming effect of foreign investment is trying to get corporations to comply with host country laws, let alone ensuring adequate compensation after an environmental wrong has been done. International Commitments. Regulation in Practice Governing Bodies under FEMA, 1999: Constitution Functions Powers Obligations Outcome of Foreign Exchange: Investment Aspect Indian economy has experienced major policy changes in early 1990. Adoption of Liberalization, privatization and Globalization (LPG) model made it an attractive avenue of investment for whole world. This opened boundaries and sent an invitation to outsiders that we are more open to work together. Apart from relaxed regulatory control of the government, the availability of affluent resources has lured the entrepreneur and the government of various countries to make it a hub of their operation.77 Investment is usually understood as financial contribution to the capital of an enterprise or purchase of shares in the enterprise. Foreign investment is investment in an enterprise by a Non75

HUNTER ET AL., INTERNATIONAL ENVIRONMENTAL POLICY 1269 (2d ed. 2002). KEVIN GALLAGHER ET AL., SUSTAINABLE INDUSTRIAL DEVELOPMENT? THE PERFORMANCE OF MEXICO'S FDI-LED INTEGRATION STRATEGY (2003). 77 Doing Business in India, Professional Development Committee The Institute of Chartered Accountants of India (Set up by an Act of Parliament) New Delhi, The Institute Of Chartered Accountants of India, February 3, 2009.
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Resident irrespective of whether this involves new capital or re-investment of earnings. Foreign investment is of two kinds (i) Foreign Direct Investment (FDI)78 and (ii) Foreign Portfolio Investment (includes Foreign Institutional Investors79).80 BILATERAL INVESTMENT REGULATIONS In the absence of any multilateral instruments regulating foreign investment, the regime is currently operated through bilateral investment treaties. Though a recent phenomenon,81 these treaties embody the principle rules in this area. There exist a large number of bilateral investment treaties between industrialized capital exporting countries and developing countries that have, as one of their objectives,82 increasing the legal protection of the private bodies investing under the treaties. It doesn't come as a surprise that the bilateral treaties include in themselves encouragement and protection of foreign investment as their statement of purpose and mostly deal with treatment of foreign investment, repatriation of profit, nationalization and compensation, compensation in cases of emergency situations, protection of commitments, dispute resolution, etc.83 How investment brings forex? Process of investment bringing forex: A person resident outside India other than NRIs/PIO may make an application and seek prior approval of Reserve Bank for making investment by way of contribution to the capital of a firm or a proprietorship concern or any association of persons in India. The application will be decided in consultation with the Government of India.84 Thus, it is apparent that the foreign exchange in any form or way does not go unregulated. This however, has to be qualified by reasonable regulation
78

2.1.12 of CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India. 79 2.1.15 of CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India. 80 CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India. 81 "According to a list of treaties that appears in (1989) 4 ICSID Rev 189, the first bilateral investment treaty was the one concluded between Germany and Pakistan in 1959." M. SORNARAJAH, THE INTERNATIONAL LAW ON FOREIGN INVESTMENT (1994). 82 Some critics argue that to be the sole objective of BITs. 83 M. SORNARAJAH, THE INTERNATIONAL LAW ON FOREIGN INVESTMENT (1994). 84 CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India. 32 | P a g e

and supervision, for excess would lead to repetition of the history of a closed economy which will only make sustenance highly unsustainable. Foreign exchange through FDI can be by various mechanism like issuance of ADR, GDR, FVC investing into IVCU, ECB, FCCB, through partner ship firms / proprietary concerns. This is regulated by RBI, FEMA, GOI through DIPP, SEBI for conversion and regularization of shares and debentures and notifications and rules thereunder and is annually or bi-annually accompanied by the FDI circulars which provide for the procedural and substantive aspects of these concepts. For the purpose of computation of indirect Foreign investment, Foreign Investment in Indian company shall include all types of foreign investments i.e. FDI; investment by FIIs(holding as on March 31); NRIs; ADRs; GDRs; Foreign Currency Convertible Bonds (FCCB); fully, compulsorily and mandatorily convertible preference shares and fully,compulsorily and mandatorily convertible Debentures regardless of whether the said investments have been made under Schedule 1, 2, 3 and 6 of FEM (Transfer or Issue of Security by Persons Resident Outside India) Regulations, 2000.85 The Leaders welcomed the signing of the SAARC Agreement on Trade in Services and expressed that this will open up new vistas of trade cooperation and further deepen the integration of the regional economies.86 Realization of the importance of development of communication system and transport infrastructure and transit facilities specially for the landlocked countries to promote intra- SAARC trade.87 The Leaders called for collaborative efforts to achieve greater intra-regional connectivity and endorsed the recommendation to declare 2010-2020 as the Decade of Intra-regional Connectivity in SAARC.88
85

CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 1, 2011), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India. 86 SIXTEENTH SAARC SUMMIT, 28-29 April 2010, Thimphu Silver Jubilee Declaration Towards a Green and Happy South Asia, SAARC/SUMMIT.16/15 87 SIXTEENTH SAARC SUMMIT, 28-29 April 2010, Thimphu Silver Jubilee Declaration Towards a Green and Happy South Asia, SAARC/SUMMIT.16/15 88 SIXTEENTH SAARC SUMMIT, 28-29 April 2010, Thimphu Silver Jubilee Declaration Towards a Green and Happy South Asia, SAARC/SUMMIT.16/15 33 | P a g e

Developing Asias financial systems have largely escaped the paralysis experienced by their counterparts in the European Union (EU) and the US during the global financial crisis. Even during the climax of the crisis, credit flowed more or less normally from the financial system to the real economy. In particular, commercial banks, the bedrock of the regions financial system, continue to provide financing for the regions firms and households. The region was not completely free from financial instability but the bouts of instability were intermittent and sporadic rather than systematic and persistent.89 In fact, the primary impact of the global financial crisis on developing Asia was not financial at all but transmitted through the trade channel, as the recession in the industrialized countries dulled their appetite for the regions exports. A major explanation for why the regions financial systems were largely unscathed by the momentous upheaval in the global financial markets was that the regions financial institutions had very low levels of direct and indirect exposure to subprime assets such as mortgage backed securities and collateralized debt obligations. The lack of exposure to toxic assets, in turn, is widely believed to have been due to the relative lack of financial sophistication.90 For those with floating exchange rate regimes, a critical element would be the development of the necessary institutional policy frameworks, market microstructure, and financial institutions that can ensure the smooth functioning of foreign exchange markets Security Aspect The Leaders strongly condemned terrorism in all its forms and manifestations and expressed deep concern over the threat which terrorism continue s to pose to peace, security and economic stability of the South Asian region. They reiterated their firm resolve to root out terrorism and recalled the Ministerial Declaration on Cooperation in Combating Terrorism adopted by the Thirty-first Session of the Council of Ministers in Colombo. They emphasized that the linkages between the terrorism, illegal trafficking in drugs and psychotropic substance, illegal trafficking of persons and firearms all continue to remain a matter of serious concern and reiterated their
89

Gemma Estrada, Donghyun Park, and Arief Ramayandi, Financial Development and Economic Growth in Developing Asia, ADB Economics Working Paper Series, No. 233 | November 2010, Asian Development Bank. 90 Gemma Estrada, Donghyun Park, and Arief Ramayandi, Financial Development and Economic Growth in Developing Asia, ADB Economics Working Paper Series, No. 233 | November 2010, Asian Development Bank. 34 | P a g e

commitment to address these problems in a comprehensive manner. The Leaders emphasized the need to strengthen regional cooperation to fight terrorism and transnational organized crimes. They reaffirmed their commitment to implement the SAARC Regional Convention on Suppression of Terrorism and its Additional Protocol and SAARC Convention on Narcotic Drugs and Psychotropic Substances. They re-emphasized the importance of coordinated and concerted response to combat terrorism. The Leaders also recognized in this regard the value of the proposed UN Comprehensive Convention on International Terrorism and noted the progress made during the recent rounds of negotiations and called for an early conclusion of the Convention. Further Integration with World Economies? European Union Foreign Exchange Regulatory Structure. As Europe has followed a trajectory of ever-increasing economic integration, the euro has come to represent a growing proportion of international transactions and foreign exchange reserve holdings

India and its relation with its neighbors. (The neighbouring countries in the north are China, Nepal and Bhutan, in the east, Bangladesh and Myanmar, and in the west, Pakistan and Afghanistan.) India and China

India and China are the two great giants of Asia. Besides being the most populous countries, they are also two of the most ancient civilisations of the world. Historically, several historians have successfully traced the cultural linkages dating back to 2nd century BC. As a result of the communist revolution in 1949, China became the Peoples Republic of China (PRC), under the leadership of Mao Tse Tung. Nehru regarded India as Chinas rival for the leadership of the non-white people of the world. India, on the other hand, tried India and the World its best to come close to China. It was the first non-communist country to recognize communist China in 1949. India fully supported Chinas claim for membership in the United Nations. It also acknowledged Chinas claim over Formosa (Taiwan). It refused to be a party to peace treaty with Japan without China. In the Korean crisis too, India refused to brand China as aggressor when China intervened on behalf of North Korea. In fact, India supported China even though the Western bloc especially USA was displeased with it. Nehrus China policy received the first jolt in 1950, when China occupied Tibet in 1950. It is important to remember in this context that India had long term interests in Tibet because it was a
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buffer lying between India and China. India even enjoyed certain special privileges in Tibet. Therefore direct Chinese control over Tibet was likely to endanger these, and Indias security. Indias suggestions for a peaceful settlement of the Tibet problem were treated as interference by the communist regime. Gradually the Tibetans grew restless under Chinas yoke and rose in revolt in 1959. China ruthlessly suppressed the movement and declared Tibet as an integral part of China. The head of Tibet, Dalai Lama took shelter in India while Tibet lost whatever autonomy it still enjoyed. The granting of political shelter to Dalai Lama by India added to Chinas distrust. China appreciated Indias neutral and mediatory role in easing the Korean problem (1950- 53). Thus, began a period of friendship between the two countries, with the signing of the Sino-Indian Treaty of friendship in 1954. This treaty put a seal of approval upon Chinese suzerainty over Tibet. The Preamble of the treaty embodies the famous Panchsheel Principles about which you have studied (lesson number 26). This agreement initiated a period of relaxed relationship, marked by the slogan of Hindi Chini Bhai Bhai. It is interesting to note that at the Bandung Conference (1955), Nehru actively brought China into the hold of the Afro-Asian solidarity. Boundary Dispute between India and China The 1950s were marked by the boundary dispute between India and China, the flash point of which unfortunately caused a war between the two countries in 1962. China first started to claim large parts of Indian territory in North East Frontier Agency (NEFA, now Arunachal Pradesh) and Ladakh by publishing maps in which these were shown as included in China. China continued extending its borders and also constructed a 110 mile long road across Aksai China area (Ladakh) of India in 1956-57. In 1959, China put claim to some 50, appa sq. miles of Indian territory and also denied the validity of McMahon Line. By this time Tibet had been fully integrated into China; it was in a strong position at the IndiaChina border with Chinese troops posted all along. While the two countries were in dispute over the McMahon line issue, China launched a massive attack on India in October 1962, in the NEFA as well as the Ladakh sector. After overrunning large areas of Indian territory, China announced a unilateral ceasefire after occuping huge territory of India 200 sq. miles in the North Eastern sector and 15,000 sq. miles in Ladakh. A futile attempt to work out a peaceful settlement between the two countries was made by Sri Lanka. The Colombo Proposals failed because China refused to agree on conditions contained in them. For long in the years following the war, ChinaIndia relations did not show any
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improvement. In fact, China went out of the way to make friends with Pakistan, just to isolate and contain India. Normalisation of Relations Although the two countries resumed diplomatic relations in 1976 by exchanging ambassadors. The efforts of normalisation of Sino-Indian relations received a boost when the then Prime Minister Rajiv Gandhi paid a successful five day visit to China in 1988. The two countries pledged to settle the border dispute through dialogue. Several high level visits followed including visit by Ex-Prime Minister Atal Bihari Vajpayee in 2003. The two countries agreed to keep the border dispute apart, and develop friendly relations in other fields. Until the border dispute is resolved, both countries agreed to maintain peace and tranquility on the Line of Actual Control (LAC). One could see a clear shift in the Chinese attitude towards India. The fact that erstwhile USSR had mended fences with China, there were no more apprehensions from the South. Moreover, Chinas post-1979 economic transformation demanded big markets for its massive production under economic liberalisation. President Jiang Zemins visit to India in 1996 witnessed a major consolidation of this progress. This was first ever visit of Chinas head of State to India. Chinas withdrawal of support to Naga and Mizo rebels; meaningful silence on the status of Sikkim (China considered Sikkims status as that of an independent state) and a neutral stand on Kashmir issue could be seen as positive shift in Chinese attitude towards India. Nevertheless, there was suddenly a brief setback in the mutual ties of the two after the nuclear explosions by India during 1998. These were followed by sharp Chinese reaction and its leading role in getting the resolutions condemning the tests in UN and similar fora, passed. These tests by India were seen as neutralising Chinese prominence in the region. But the Chinese posture of neutrality during the Indo-Pak military showdown in Kashmir, Kargil sector in 1999 exhibited Chinas inclination to toe a softer and friendly line with India. In fact, Chinese refusal to interfere in the conflict forced Pakistan for cessation of hostilities with India. However, Ex-Prime Minister Atal Bihari Vajpayees 2003 visit to China is a renewed effort in the promotion of close and cordial ties between the two neighbours. The border agreement has recognised the Nathula Pass in Sikkim as a border pass, implying that China no more considers Sikkim as an independent state. Another positive breakthrough was the Joint Declaration that underlined the need to explore a framework of a boundary settlement at political level of bilateral
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relations. This is an acknowledgement that the key issue in resolving the dispute is political. This is seen as Beijings readiness to give up its policy of delaying dialogue. Indias National Security Advisor and Chinese Vice Minister have been appointed for holding the tasks. The developments at the diplomatic and political levels have been supplemented by fresh initiatives at the economic level to strengthen bilateral relations. The border trade between India and China has crossed $ 10 billion quickly. India and Pakistan

No two countries in the world have so much in common as India and Pakistan. Yet they have perpetually been in a state of undeclared war with varying degree of intensity. Pakistans aggression in Kargil (1999) brought the two countries even on the verge of a nuclear confrontation. The legacy of suspicion and mistrust predates the partition of India in 1947. During the freedom struggle the Muslim League, under the leadership of Mohammad Ali Jinnah propounded the two-nation theory, in support of a separate Muslim state. Jinnah insisted that since Hindus and Muslims were two communities, two separate states must be constituted for the two communities. The Indian National Congress (INC)s long rejection of and reluctant acceptance of partition gave room for suspicion in Pakistan that India would try to undo the partition and divide Pakistan. Moreover, Pakistan was concerned at the possibility of Indias domination in the region and its inability to match Indias power all by itself. Pakistan developed a perception that it is an incomplete state without Kashmir being incorporated into it. On the other hand, India perceives Kashmirs accession and integration into India as an essential element of its secular and federal democratic structure. The Kashmir Issue At the time of partition Jammu and Kashmir (J&K) was one of those several princely states, the fate of which was left uncertain in 1947. Pakistan desired that Kashmir with Muslim majority population should join Muslim country, Pakistan. But the popular leader of National Congress opposed Pakistans ideology. Maharaja Hari Singh did not take a decision until Pakistan sent armed intruders into the Kashmir valley in October 1947. Seeking Indian help to repulse the Pakistani intruders Maharaja signed the Instrument of Accession making Jammu and Kashmir a part of Indian Union. On this occasion, as true democrat, Prime Minister Nehru assured that after Pakistani aggression was cleared, the future status of the state would be decided on the basis of
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wishes of the people of Kashmir. Since India did not want an open clash with Pakistan, it referred the matter to the United Nations. Indian forces saved Srinagar from the invaders, pushed back the Pakistanis from the Kashmir Valley. But the whole of Kashmir could not be recaptured, at it would have meant direct and difficult war between the two new nations. India sought United Nations help in 1948. A ceasefire came to be implemented on January 1, 1949. It left a large part of Jammu and Kashmir (nearly 2/5 of the State) under Pakistans possession, which we call Pakistan Occupied Kashmir (POK). In 1950s the UN mediators put forward several plans to resolve the dispute, but they failed to bridge the differences between the two conuntries. The problem of Kashmir is still pending. Plebiscite was to be conducted only after Pakistan withdrew its forces from the occupied territory, as per the UN resolution of 1948, which Pakistan refused to comply. Hence India pleaded that the wishes of the people were ascertained in 1954 in the form the direct election to the Constituent Assembly which satisfied the accession of Jammu and Kashmir to India. The mediation come to an end. Pakistan was desperate to capture Kashmir. Thinking that Indias army was weak after defeat in the war with China in 1962, Pakistan tried through a war to take Kashmir in 1965. But Indian forces defeated the Pakistani designs. Moreover, Pakistan suffered another humiliation, when its eastern wing, 1000 miles away from West Pakistan successfully waged independence struggle in 1971. India played a key role in the war to liberate Bangladesh. The birth of Bangladesh proved to be the final burial of two-nation theory on the basis of which Pakistan put a claim to Kashmir. Pakistan was reduced to one fourth of the size of India. This altered the power equation in South Asia in Indias favour. In order to normalise relations India invited Pakistan for an agreement, the result of which was the Shimla Pact of 1972. This Shimla agreement however bears important significance as the two countries agreed to seek the settlement of all bilateral problems, including Kashmir, mutually without the intervention of any third party. Thus under the Shimla Pact, the Kashmir issue cannot be raised in international or any other forum, although Pakistan has not hesitated to ignore the sprit of the agreement. The agreement also talked about the return of Prisoners of War (POW). Though Pakistans territory in Indias possession was returned, a new cease-fire line (in place of the old cease-fire line of 194849) was drawn, which is known as the LoC, Pakistan found ways other than open war to destabilise India by encouraging and assisting terrorism in Punjab, and the State39 | P a g e

sponsored militancy in Jammu and Kashmir since the mid 1980s. Pakistan still continues to encourage terrorist and separatist tendencies in Kashmir, operating mainly from terrorist training camps situated in POK. The sanctity of the LoC that came to be agreed upon between India and Pakistan under the Shimla Agreement of 1972, was violated by Pakistan in May 1999 as a part of a big plan. This was done when the Pakistani forces infiltrated into India, after crossing the line of control in Kargil, Drass and Batelik sectors of J &K. Indian army once again gave a befitting defeat in a war that continued for about 60 days. The purpose of Pakistani operation in Kargil was to create a crisis with a threat of nuclear war, which would in turn ensure intervention by the United States in its favour on Kashmir dispute. Neither United States nor China came to Pakistans help. In fact, Pakistan had a diplomatic and military defeat. Nuclear Tests and Efforts Towards Improvement of Relations Indo-Pakistan relations acquired an entirely new dimension in the context of nuclear tests by both India and Pakistan in May 1998. The relations between the two neighbours hit a India and the World new low. India has been facing a nuclear threat arising out of Chinas clandestine support to build up of the nuclear weapon capability of Pakistan since the mid-seventies. No doubt, Pakistans nuclear policy is targeted against India The extreme bitterness and tension between India and Pakistan in the aftermath of the nuclear tests of May 1998 did bring with it an increasing realisation on both sides that things could not continue in the same manner indefinitely. That, some meeting ground between the two neighbours has to be found. Thus, foreign secretary level talks started, and a direct bus service between Delhi and Lahore was proposed. Prime Minister Vajpayees Bus Diplomacy in 1999 marked a tremendous goodwill between the two countries. The Lahore Declaration signed at the time underlined the need for resolving all outstanding issues, including that of Kashmir, through peaceful means. While India agreed to bring Kashmir onto the agreed agenda along with other areas of mutual benefits, Pakistan conceded to bilateralism. The reference to the composite and integrated dialogue process implied that the two would not be a hostage to any single issue. Despite the rupture caused by the Kargil war and the terrorist attack against our Parliament (December 2001) the unconditional dialogue has been resumed. The emphasis in these talks is to promote people to people contacts across LoC, and also improve
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economic ties between India and Pakistan Change of government in India has not meant any deviation from our commitment to peaceful and prosperous co-existence with Pakistan. India and Srilanka

Sri Lanka, earlier known as Ceylon (until 1972), is a small island country situated in the Indian Ocean to the south of India. Its total area is 25,332 sq. miles. Of all countries, it has geographical proximity to India. Only 18 miles wide shallow water in the Palk Straits separates Jaffna in northern Sri Lanka from the Southernmost tip of the Indian state of Tamil Nadu. Its geostrategic location in the Indian Ocean (at the centre of commercial and strategic sea and air routes) and its closeness to US naval base in Deigo Garcia indicates its importance far beyond its size, population and resources. The history of cultural relations between India and Sri Lanka dates back to the ancient times. Out of the total population of Sri Lanka, about 64 percent believe in Buddhism and about 15 percent believe in Hinduism. Sri Lanka became a British colony in early 19th century. It was granted independence on February 4, 1948. India-Sri Lanka relations have generally been cordial, though there have been occasions of tense relations due to the ethnic conflict between Tamils and the Sinhalese. Despite ethnic problems, India has never sought to impose its will on Sri Lanka and has always based its foreign policy towards this southern neighbour on mutual understanding and friendship. An important area of common interest between the two neighbours is the foreign policy of non alignment. Sri Lanka has generally stood neutral in Sino-Indian disputes. In fact, it made efforts to mediate between India and China after the war of 1962. Sri Lanka also showed understanding when India become nuclear. Recently in 2005, India extended valuable help to Sri Lanka after Tsunami devastated the coastal areas of that country. Problem of Indian Tamils Jaffna province of Sri Lanka has large concentration of Tamil population. The problem became serious when Tamilians began demanding a national homeland or Eelam in northern Sri Lanka. It is important to understand that there are essentially two categories of Tamilians in Sri Lanka: The Ceylon Tamils whose forefathers had migrated to Sri Lanka centuries ago. They are estimated to be one million. The second category is of Indian Tamils whose forefathers were taken by the Britishers as plantation workers in the 19th century. They are another one million, many of them without citizenship. The problem of their status dominated early India-Sri Lanka relations. The
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conflict with Ceylon Tamils came later. The Sinhalese fear Tamil domination, which is the principal reason behind the ethnic conflict. The difference between the two communities was exploited by British rulers in order to check the growing Sinhalese nationalism. The Tamils were allowed to enter the administration structure and thus gradually took control of the trade and profession. Scarce economic resources and opportunities plus the majority pressure from its own people forced the Government of Sri Lanka to pass series of steps to reducing the importance of Tamils- Indian and the Ceylonese. The representation of Tamilians in public service in 1948 was 30 percent, but by 1975 it had fallen to mere 5 percent. The Sinhalese were encouraged to settle down in Tamil dominated areas in large numbers. The citizenship law of 1948 and 1949 had deprived about 10 lakh Indian Tamils of political rights. The Tamil youth who had lost faith in non-violence organised themselves into Liberation Tigers. The aim of these Tigers is a sovereign Tamil State of Eelam. The issue of Tamilians, and the policy pursued by government cast a dark shadow on Indo-Sri Lanka relations. India from time to time complained against the discriminatory policy of the Ceylon government. The agreement of 1964 sought to solve the problem of stateless persons (Indian Tamils) in Sri Lanka. About 3 lakhs of these people were to be granted Sri Lankan citizenship and about 5 lakh 25 thousand persons were to be given citizenship of India. These people were given 15 years time to shift to India in instalments. Later in 1974, the fate of the rest 1 lakh 50 thousand stateless persons was decided. It was agreed between the two countries that half of them were to be given citizenship of Sri Lanka and rest would become Indian nationals. Thus, the issue of stateless persons was sorted out peacefully between the two countries. A territorial dispute arose between India and Sri Lanka over the ownership of one mile India and the World long and only 300 yard wide small island known as Kacchativu, in 1968. In 1974 under the agreement signed between the two countries, India accepted Sri Lankan ownership of the island. Tamil Separatism The ethnic problem between Tamils and Sinhalese had a long history. It assumed serious proportions in 1983. As the gulf between the communities developed, militancy, separatist organisations became active. Tamil United Liberation Front (TULF) demanded separate homeland for Tamils in 1988 Tamil Eelam. A reign of terror was unleashed against the agitating Tamils in 1983. During 1983 86, about 2 lakh Tamils were rendered homeless. The worst racial riots in the history of the country made thousands of Tamils refugees in India.
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India offered to help resolve the crisis but it was interpreted as Indian intervention in Sri Lanka on behalf of the Tamils. When the situation became grim, India and Sri Lanka signed an agreement in 1987. India offered military assistance under the Accord. Indian Peace Keeping Force (IPKF) was sent to Sri Lanka to help restore normalcy in the country. The deployment of IPKF was also an extension of Indias policy of reminding Sri Lanka and outside powers that if their involvement inside the region were to have an anti- Indian orientation, New Delhi would not remain a mute spectator. Though the accord of 1987 was a triumph of Indian diplomacy, it proved to be costly for India. India lost about 1200 soldiers and it costed Rs. 2 crore a day on IPKF in the height of its involvement. The worst part was that the Tamils turned against IPKF and a fighting broke out between the two. Rajiv Gandhi, the architect of India-Sri Lanka Accord of 1987 was assassinated in 1991 at the behest of LTTE (Liberation Tigers of Tamil Eelam) leader,Velupillai Prabhakaran. Areas of Mutual Cooperation Systematic efforts at strengthening economic ties have been taken by India and Sri Lanka since the 1990s, especially after the withdrawal of Indian troops. In 1998, the two countries set up an Indo Sri Lankan Foundation for increasing bilateral exchanges in various fields. They have agreed on a free trade area to facilitate trade, which has gone up greatly. India encouraged Sri Lanka to invite the peace process between the Tamils and the Sinhalese. In 1998 Sri Lanka invited Norway to work out a peaceful solution to the ethnic problem. India stands for unity of Sri Lanka The greatest milestone of this process was the cease-fire agreement of 2002 between LTTE and Sri Lanka and the revival of the dialogue between the two. From Indias long term point of view, Norway recognized Indias legitimate interests in Sri Lanka and stated that it has no desire to come in the way of any Indian initiative to end the conflict in the region.

Does SAARC or ACU have the potential to be next monetary union in the lines of EU? Regional economic integration is one of the most important trends in th contemporary world economy. Over the past decade and a half, the worl economy has seen the emergence of many strong regional trading blocs I different parts of the world. These include EU (European Union), NAFTA (Nort American Free Trade Area), CIS (Commonwealth of Independent States), LAl
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(Latin American Integration Association), ASEAN (Association of South Ea: Asian Nations), and DECD (Organisation for Economic Co-operation an Development), among others. Countries have responded by forming region trading blocs to mobilize their resources to strengthen their competitiveness in tl world market.91 The term 'Regional Economic Co-operation' means, the collaboration of a group of nations comprising the region on economic matters to exploit the greater benefits than what would be possible in the course of normal economic relationships without co-operation. Regional Economic Co-operation can be in different forms. In a very simple form, the extent of co operation among nations may be confined to specific or selected economic issues such as mutual trade agreements and preferential tariff In a very broad form, It can cover a wide range of economic issues like trade tariffs, technology, investment, joint ventures, fiscal and monetary policies.92 SAARC: Over the past 20 years, world trade has grown twice as fast as real GDP deepening economic integration and raising living standards.93 The role of foreign trade in economic development is considerable and both are intimately connected. Trade can stimulate growth if exports are tending to increase faster than imports or be a brake on growth if imports are tending to increase faster than exports. The dramatic growth of cross-border investment and international trade over the past two decades combined with explosive growth in global communications and technology. However, it is generally accepted that the gains to a nation from free international trade may more than outweigh the losses to particular domestic firms and workers. Although free trade is often strongly advocated, many countries believe that the expansion in trade is best accomplished through the establishment of Regional Economic Association (REA) / Integration (REI). However, the emerging WTO regime has in no way undermined the process of regionalism. It has wide ranging implications for the global economy.

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VENKATESH M, A STUDY ON INDIA'S TRADE RELATIONSHIP WITH SAARC COUNTRIES WITH SPECIAL REFERENCE TO SAPTA, School Of Management Studies Cochin University Of Science And Technology, Kerala, 2006 92 Bhagavati Jagadish, "Regionalism and Multilateralism: An Overview" in "The New Regionalism in Trade Policy". The World Bank. 93 Adam Smith, " An inquiry into the nature and causes of the Wealth ofNations", Oxford Clarendon Press 1970. 44 | P a g e

The South Asian Association for Regional Co-operation (SAARC) comprises the seven countries of South Asia. i.e., Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. SAARC is a manifestation of the determination of the people of South Asia to work together towards finding solutions to their common problems in a spirit of friendship, trust and understanding and to create an order based on mutual respect, equity and shared benefits.94 The primary objective of the Association is the acceleration of the process of economic and social development in member states, through collective action in agreed areas of co-operation The region suffers from massive balance of payments burden, mass unemployment, high population growth rate, large concentration of poverty, low rate of economic growth, constant food shortage, worsening terms of trade, largely illiterate, considerable malnourished, and also the least gender sensitive region of the globe.95 SAPTA: In December 1991, the Sixth Summit held in Colombo approved the establishment of an Inter-Governmental Group (IGG) to formulate an agreement to establish a SAARC Preferential Trading Arrangement (SAPTA) by 1997. Given the consensus within the SAARC, the framework Agreement on SAPTA was finalized in 1993, and formally came into operation in December 1995, well in advance of the date stipulated by the Colombo Summit.96 The Agreement reflected the desire of the SAARC countries to promote and sustain mutual trade and economic co-operation within the SAARC region through exchange of concessions. Since 1997, attempts have been made to clear the duck for the smooth transition of region from SAPTA to SAFTA. Owing to geo-political situation in the region, the ambitioustarget of SAFTA implementation had been deferred to 2003, recently in-principle agreement has been reached to implement SAFTA. The present study reveals that there are enormous opportunities for forging closer economic relations among SAARC countries. These opportunities could be fully utilized through the twin processes of trade liberalization and industrial restructuring which are complementary io each other. The SAARC Preferential Trade Arrangement (SAPTA) is the first step in trade liberalization. However, the scope of SAPTA has
94

ESCAP, "Economic and Social Survey of Asia and the Pacific" 2003 IGSAC 11, "SAARC: Moving Towards Core Areas of Coopertion"(A Report of the Independent Group on South Asian Co-operation), Colombo, 1992 96 Bhuyan A.R, "Regional Co-operation in South Asia: Outlook and Prospects under SAPTA". South Asia Survey Vol.3 1996
95

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to be sufficiently widened in order to derive substantial benefits

from preferential trading

arrangements. It is suggested that the SAARC countries adopt a combined approach for tariff elimination, tariff reduction and preferential or concessional tariffs. This process will help in moving quickly towards the creation of a Free Trade Area in the SAARC region. It is necessary to emphasise that, in any regional organization, smaller countries may feel that greater trade co-operation with their larger neighbors may result in larger countries taking over their economies. India occupies seventy percent of the SAARC region, both geographically and economically, and the remaining six nations of SAARC have borders only with India and not with each other. As thebiggest, and the most industrialized trading partner among the SAARC countries, India has to recognize that a special responsibility devolves on her and take a lead in making the Regional Economic Co-operation a reality in South Asia. It is time that the member countries come still closer to achieve economic development through increased regional self-reliance. What is needed is the will and a powerful leadership to bring the countries together as partners in mutual progress. Here lies India's role... !!! Other associated aspects: time, government control, economy, sustenance etc. Conclusion Provisions of FERA are in consonance with the present trend of globalisation and liberalisation adopted by the Indian Government to encourage India's foreign trade. FEMA is an improvement over FERA. Domestic financial market integration in India has been largely facilitated by wide-ranging financial sector reforms introduced since the early 1990s. Financial markets in India have acquired greater depth and liquidity. In the process, various market segments have also become better integrated over the years. A high degree of correlation between the long-term government bond yield and the short-term Treasury Bills rate indicates the significance of the termstructure of interest rates in financial markets. Integration of the foreign exchange market with the money and the government securities markets has facilitated liquidity management by the Reserve Bank. However, the equity market has relatively low correlation with other market segments. A sharp improvement in correlation

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between the reverse repo rate and money market rates in recent years implies enhanced effectiveness of the monetary policy transmission mechanism. A key feature of global financial integration during the past three decades has reflected in the shift in the composition of capital flows to developing and emerging market economies, especially from official to private flows. Regional integration has served as a major catalyst to the global integration process during the past two decades. East and South East Asian economies, in particular, have achieved substantial integration. Apart from Asias growing integration with the rest of the world, increasing integration within Asia also reflects the growing intraregional trade and financial flows. Evidence from price-based measures suggests that financial market integration in Asia has been increasing. The stock markets in Asia are more integrated than the money and the bond markets. In the region, Japan, Hong Kong and Singapore serve as the nodal centres for other stock markets. There is evidence of Indias growing international integration through trade and cross border capital flows. Indias trade and financial links with Asia are also growing amidst recent initiatives taken to promote regional cooperation. Emerging Asia has become the growth centre of the world due to shifting of production base to the region. This is likely to stimulate greater financial integration in the region. Indias financial integration within the region and with the international financial markets is likely to increase in future in view of its robust growth prospects. However, if benefits are to be maximized from a more integrated economy, the need is to pursue efforts towards a greater sophistication of financial markets and financial market instruments that allow risks to be shared more broadly and capital to flow into the most productive sectors. There would also be a need to constantly review the risk management practices so that financial institutions and financial markets continue to remain resilient to adverse external developments.

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Introduction97 The Indian attitude to foreign investment has been ambiguous. As a hangover of the colonial past, there has been caution as to what types of foreign firms have operated in India and many foreign firms fled India. Whether this psyche has diffused or not, *40 in present times India had barely managed a few billion dollars a year as foreign direct investment (FDI) inflows. The sums hovered around the $1 billion mark for several years, and in 2004 the sums were $3.7 billion out of annual global FDI flows of over $650 billion. By the beginning of the twenty first century, the share of foreign direct investment in the capital stock of India had been one of the lowest in the world. Also, in relation to the size of the economy, the share of foreign direct investment was less than one percent of the national income. Nevertheless, recent growth in inflows has been substantial compared to the extremely low values of around $150 million at the time of economic liberalization in 1991. A tracking of the values of the foreign direct investment inflows over the period from 1991-1992 to 2003-2004, as given in Fig. 1, shows that the values increased from $155 million to over $3.7 billion, and the trend, if exponentially estimated, is very clearly upward sloping.1 The decline in the role of foreign firms in the Indian economy was particularly exacerbated by the introduction of the Foreign Exchange Regulation Act (FERA) legislation in 1973. The legislation incorporated within the framework of FERA was the instrument used to implement changes in property rights regimes that would put foreign firms at a disadvantage in India. These legal regime changes operated via the legal framework of the Indian Companies Act, 1956. While the FERA legislation was promulgated after the hike in oil prices to save foreign exchange needed to pay for critical imports such as food and petroleum, at the same time the maximum shareholding by foreign firms in Indian companies was limited to 40%. Other than this rule, several other rules put into operation by FERA involved the usage of foreign exchange within the Indian economy. This was so that outflows repatriated abroad, say to foreign owners, would be minimized. Nevertheless, the consequences were dysfunctional. The incentives that normally
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SUMIT K. MAJUMDAR, FOREIGN EXCHANGE LEGISLATION TRANSFORMATION AND ENTERPRISE DEMOGRAPHY IN INDIA, E.J.L. & E. 2008, 25(1), 39-56. 48 | P a g e

percolate down to businesses when rights are guaranteed disappeared. The FERA provisions relating to ownership limits continued till 1991, but the other provisions of FERA were changed in 1999. A change of government in 1977 had brought together a coalition of political partners which had ambiguous attitudes towards foreign firms. Firms such as IBM and Coca-Cola were given marching orders out of India. Firms such as Siemens and Bechtel were welcomed with open arms. The rules limiting foreign ownership to 40% continued for almost two decades and were only eliminated in 1991 after the reforms were introduced. There has been a resurgence of entrepreneurial activity in India after that date. Not only has domestic entrepreneurship expanded substantially, but foreign firms have started to make investments in India again. Approvals were made automatic for foreign ownership levels of 51% in 1991 in Indian companies, and for ownership levels of up to 74% in 1997, save for a few sectors thought to be critical such as the media sector. Tabular or graphic material set at this point is not displayable. *41 In 1999 FERA was transformed into the Foreign Exchange Management Act (FEMA). The FEMA legislation simplifies the maze of controls, procedures and bureaucratic minutiae that have to be observed by all those undertaking to set up and operate a business in India. The changes in the legislative regimes as well as removal of administrative lacunae make India an attractive investment destination for foreign firms, inducing them to set up operations in India. The transformation of FERA to FEMA can be considered a considerable step forward in the institutional evolution of India after over two decades of the backward steps taken in 1973. The legislative change embodied in FEMA modernizes the legal framework and brings it in line with best practice in developed countries. FEMA takes current account convertibility as a base and allows for progressive liberalization of the capital account. It is more transparent than FERA and, unlike FERA, is a civil law. Thus, the psychological change that FEMA has brought in is that it is a civil law, whereas FERA was a criminal law, operated, in effect, by a country that was economically a police state. Nor does FEMA embody the FERA presumption of mens rea, which placed the burden of proving innocence on the citizen. As an institutional change, it signals that
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India is taking a positive attitude to business and will welcome foreign transactions on the current and capital account. Thus, traders and investors from abroad are now welcome in India. 1.1 Contours of the present study Using a unique data base that was put together for the purposes of this analysis from the records of the Department of Company Affairs (DCA) of the Government of India, and using time series regression techniques, I evaluated the extent to which *42 the introduction of FERA and the transformation to from FERA to FEMA had made an impact on the presence of foreign firms in India's corporate sector. The DCA data are organized as a time-series for the period 1957-1958 to 2001-2002, and contains details on: (1) the number of foreign companies in India; (2) the number of domestic private companies in India; (3) the number of government companies in India; and (4) the total number of companies in India. The data cover the entire population of enterprises making up the corporate sector in India and provide a full picture of the evolution of India's corporate economy for almost five decades. These have been the critical post-war and post-independence decades when the basic structure of India's economy was being developed. The evolution of an economy is a historical phenomenon contingent on several policies. What organizations come into existence and how they evolve are fundamentally influenced by the institutional framework (North 1991). An assessment of the evidence shows how the growth of foreign firms in the Indian economy has been influenced by the prevailing institutional rules. From the data, it was possible to calculate: (i) the proportion of foreign companies to the total number of companies in the corporate sector as a whole; (ii) the proportion of domestic private companies to the total number of companies in the corporate sector as a whole; and (iii) the proportion of government companies to the total number of companies in the corporate sector as a whole. The structural constraints that were endangered by the institutions in place in India will have had positive or negative effects on the diffusion of different types of firms within the Indian economy. In fact, a constellation of constraints were put in place. The constraints would have reduced the set
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of opportunities available to each type of firm and, thereby, led to a withdrawal of that type of firm from the economy. These statistics calculated provide the overall picture on the evolution of the industrial structure of India for over a 45 year period. I then evaluated how far the foreign exchange legislation that the Indian government had adopted retarded or promoted the presence of foreign firms within the economy. This study of foreign firms' presence in the Indian economy is cast in a unique corporate demography framework. A corporate demography framework focuses on the life events of firms, such as entry or exit, and bases itself on a population perspective. Corporate demography abstracts from the individual firm and focuses on population characteristics such as count of the number of firms in the population. The corporate demography framework is evolutionary, putting stress on natural selection of firms by events among which several can be important institutional or regulatory events which alter the environment for conducting business (Frech 2002). In addition, the study also contributes to the evolving literature on FDI in India. A substantial literature has described the contours of evolving FDI in India, primarily tracking the flows of FDI, the sectors into which FDI flows and the regional flows of FDI. The early works are by Kidron (1965) and Kurian (1966). The contemporary analyses are by the Asian Development Bank (2004), Athreye and Kapur (2001), Bajpai and Sachs (2000), Balasubramanyam and Mahambare (2003), Chhibber and Majumdar (2005), Gakhar (2006), Gupta (2005), Majumdar (2007), Sen and Pan (2007) and UNCTAD (2006). *43 A parallel literature, by, inter-alia, Agarwal (2001), Agrawal (2005), Bhat et al. (2004), Chakraborty and Basu (2002), Chhibber and Majumdar (1999), Dua and Rashid (1998), Feinberg and Majumdar (2001), Kathuria (2002), Kumar and Aggarwal (2005), Kumar and Pradhan (2005), Majumdar (2007), Nunnenkamp (2004), Pradhan (2002) and Sahoo and Mathiyazhagan (2003), has evaluated the consequences of FDI on various aspects of economic and industrial performance. The current study looks specifically at the impact of one critical legislative change, that relating to foreign exchange transactions in India, and evaluates its impact on the population of foreign firms within India's economy.

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2 Analysis 2.1 The framework The model evaluated in this article is as follows: Tabular or graphic material set at this point is not displayable. where FOREIGN is the log of the proportion of foreign firms in India's corporate sector over each of the years t (t = 1, 2, 345) for the 45 year period evaluated. Of the explanatory variables, the variable FERA is a dummy variable capturing the periods before FERA was promulgated and the period after the non-ownership provisions were dispensed with in 1999 after the withdrawal of FERA and the promulgation of FEMA; the variable FEMA is a dummy variable capturing the periods after the promulgation of FEMA; the variable GOVERNMENT captures the proportional extent of government firms participating in India's corporate economy in each time period t and the variable PRIVATE captures the proportional extent of domestic private sector firms participation in India's corporate economy in each time period t. A number of macro-economic time-series control variables are also introduced. These are FOODGRAINS which is the natural log of foodgrains production capturing agricultural growth within the economy, EXCHANGE which is the natural log of foreign exchange reserves, GNP which is the growth in gross national product at factor cost and INVISIBLES, which measures in mean-deviation terms the earnings made within the economy on the invisibles account, and the residual error term is ##. 2.2 Foreign exchange policies affecting foreign firms in India 2.2.1 The Foreign Exchange Regulation Act The first of the policies that directly affected foreign firms have revolved around the, now notorious, 1973 FERA, based on an earlier Foreign Exchange Regulation Act promulgated in 1947, and later repealed, the provisions of which would ensure that *44 India was quite willing to
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wave foreign firms goodbye from its shores. The basic policy that was put into place by FERA in 1973 was the inability of the majority of foreign companies to hold more than 40% shares in their Indian companies. Thereby, foreign firms lost control of their Indian operations. Other than that, there were several restrictions on the use of foreign exchange. By and large, other than the ownership constraints, FERA was not transformed into FEMA until 1999. Severe restrictions on current account transactions continued till the mid-1990s when relaxations were made in the operations of the FERA. The framework was essentially transaction-oriented based in terms of which all transactions in foreign exchange including those between residents and nonresidents were prohibited, unless specifically permitted. 2.2.2 The transformation of FERA to FEMA A major institutional change that has taken place in 1999 has been the translation of FERA to FEMA. The FERA variable in the regression equation is a dummy variable with 1 signifying the existence of the FERA in its manifestations other than for ownership which as been separately controlled for. Thus, the years preceding 1973 and after 1999 are coded 0 while the other intervening years are coded as 1. The FERA legislation was promulgated during a period of economic crisis, when a left wing mind set was in place among India's policy makers and the principal objective of the FERA legislation was to stop the unnecessary flow of foreign exchange out of the country. The change to FEMA reflects more than a legislative re-write of rules and procedures. There has been a change of mind set, with the realization that globalization is irreversible, and the statutes have been re-written to make the participation of Indian firms in the global economy much easier. The specifics of the legislation apply towards making current transactions with firms based in India and those abroad easier, paperwork has been simplified and the role of the government is less intrusive. In addition, regulatory structures, that monitor compliance, have been re-designed so as to be compatible with regulatory structures elsewhere in the world. Other than making foreign currency transactions easier, and providing positive incentives to do so, versus the negative control mentality that characterized FERA, the new FEMA legislation simplifies the maze of controls,
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procedures and bureaucratic minutiae that have to be observed by all those undertaking to set up and operate a business in India. These processes slow down considerably the pace of activity and make Indian items uncompetitive, especially in today's context where time compression is a source of critical competitive advantage. Removal of these administrative lacunae makes India potentially attractive as a destination for foreign firms wishing to make investments. 2.2.3 The history behind and logic of FEMA Consistent with the philosophy of economic reforms in the 1990s changes in the broad approach to reform in the external sector took place. The 1993 Report of a *45 High Level Committee on the Balance of Payments, chaired by Dr. C. Rangarajan, set the agenda. The Committee recommended the introduction of a marketdetermined exchange rate regime within limits, liberalization of current account transactions leading to current account convertibility, shifts in capital flows away from debt to non debt creating flows, regulation of external commercial borrowings especially short-term debt, discouraging volatile elements of flows from non-resident Indians, full freedom for outflows associated with inflows and gradual liberalization of other outflows, and the disassociation of Government in the intermediation of flow of external assistance (Gopinath 2005). In 1997, a Committee on Capital Account Convertibility (CAC), constituted by the Reserve Bank of India and chaired by S. S. Tarapore, indicated the preconditions for Capital Account Convertibility. The Tarapore Committee had also recommended change in the legislative framework governing foreign exchange transactions. Accordingly, FERA which formed the statutory basis for exchange control in India was repealed and replaced by FEMA. The philosophical approach shifted from that of conservation of foreign exchange to one of facilitating trade and payments as well as developing orderly foreign exchange markets, and from a negative attitude of control to a positive attitude of management (Gopinath 2005). 2.2.4 Definitional and intellectual changes brought about by FEMA Several changes have been brought by FEMA. The procedural changes include reduction of complexity. FERA consisted of 81 sections and was a considerably complex piece of legislation
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while FEMA is much simpler and consists of 49 sections. A presumption of negative intent and joining hands to commit an offence existed in FERA while these presumptions abatement have been excluded in FEMA. Standard terms in international trade and finance such as capital account transaction, current account transaction, person, service etc. were not defined in FERA but have been defined in detail in FEMA. The definition of authorized person in FERA was narrow while it has been widened to include banks, money changes and off shore banking units, among others, in FEMA. Also, there was a substantial difference in the definition of resident under FERA and tax legislation, while the provisions of FEMA are now consistent with the Indian tax legislation. Any offence under FERA was a criminal offence, punishable with imprisonment as per the code of criminal procedure extant in India. In FEMA, offences are considered to be civil offences only punishable with a monetary fine as a penalty with imprisonment prescribed only for failure to pay the penalty. The monetary penalty under FERA was five times the amount involved while under FEMA the quantum of penalty has been decreased to three times the amount involved. FERA conferred wide powers on police officers to conduct searches while the scope and power of search and seizure has been curtailed in FEMA. FEMA is no longer, psychologically, legislation that is enforced by an economic police state. The Directorate of Enforcement is no longer a commercial Gestapo. *46 2.2.5 Procedural changes brought about by FEMA The Act of 1999 (FEMA) contains the substantive and procedural aspects of Foreign Exchange Regulations. The detailed provisions in regard to various aspects connected with foreign exchange regulations are found in the rules, regulations and notifications under FEMA issued or promulgated by the Government of India or the Reserve Bank of India. The Government of India, in exercise of the powers conferred on it under Section 46 of FEMA, has made various sets of rules, namely the Foreign Exchange Management (Current Transactions) Rules, 2000, the Foreign Exchange (Compounding Proceedings) Rules, 2000, the Foreign Exchange Management (Adjudication Proceedings and Appeal), Rules, 2000, the Foreign Exchange (Authentication of Documents) Rules, 2000 and the Foreign Exchange Management (Encashment of Draft, Cheque, Instrument and Payment of Interest) Rules, 2000. These govern the implementation of FEMA.
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Additionally, the implementation process for enforcement and appeals has been made transparent and independent. In the FERA regime, appeals against the actions of the Directorate of Enforcement, housed in the Department of Economic Affairs in the Ministry of Finance, which operated like a commercial Gestapo, would first be decided by an Adjuticating Office, and appeals against the decisions of this authority would go before a Foreign Exchange Regulation Appellate Board, a nonindependent operational unit of the Ministry of Law. Appeals against the decisions of the Foreign Exchange Regulation Appellate Board would be decided by a High Court of Judicature. Thus, an independent judicial authority would only enter the adjudicating process at the last stage. Within the FEMA framework, appeals against the actions of the Directorate of Enforcement are first decided by an Adjuticating Authority, and appeals against the decisions of this authority go before the Special Director (Appeals), an independent position equivalent to the Director of Enforcement. Appeals against the decisions of the Special Director (Appeals) lie before a completely independent Appellate Tribunal for Foreign Exchange. Appeals against the decisions of the Appellate Tribunal for Foreign Exchange are then decided by a High Court of Judicature. Thus, additional competencies have been included to deal with disputes and independent judicial processes enter the adjudicating process at an earlier stage. These changes enhance the reliability of the system in the eyes of entrepreneurs and investors. 2.2.6 Crowding out by government and private firms There are two allied institutional concerns. These have been captured by two variables, GOVERNMENT capturing the proportion of government firms participating in India, and the variable PRIVATE capturing the proportion of domestic private sector firms. An ownership issue that has predated FERA has been the role accorded to state-owned firms in the Indian economy. The core presumption underlying the promotion of government companies was that it was better for firms *47 owned by the government to drive forward and enjoy the fruits of industrial development in India.

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The underlying theoretical premise was that private firms, whether domestic or foreign, would not have either the best interests of a nascent Indian economy at heart or the capabilities to drive forward the process of industrial development. For example, the profit motive would predominate and the necessary basic items required by the mass of India's population would not be on the product development agenda of such firms. The first impact of such a policy would be that the growth of state-owned enterprises would have crowded out foreign firms. In an economy, growing at a finite rate, if one type of firm grows at a faster pace than others the other types of firms are surely likely to lose their relative standing in the overall corporate economy. Crowding out by private and government enterprises of foreign firms is the reduction of opportunities by one group of firms, in the sense described by Elster (1979), for another so that the relative position of the first group can be enhanced. From the mid-1950s, the thrust on the stateowned sector as an instrument of industrial progress ensured that growth of this sector made the growth of domestic private and foreign firms that much more difficult. Other than the growth of government owned firms, the second related phenomenon that would impact on foreign firms' growth would be the growth of domestic private firms, given that domestic entrepreneurship in India had been somewhat limited in the past and there was a clamor for catch-up. Thus, an autarkic mind set, the growth in the number of government firms and in the growth of private firms will have crowded out foreign firms from the Indian corporate landscape. 3 Results and evidence 3.1 The corporate demography of India The approach that I initially take is to highlight the demography of India's corporate sector, in a relatively straightforward way, and first describe the different patterns of growth displayed by three types of firms that are important within the context being evaluated: foreign firms, private domestic firms and government firms. Table 1 provides details of the basic statistics. Table 1 shows the average number of foreign, domestic private and government firms within India's corporate sector for the overall period 1957-1958 to 2001-2002. The average numbers in
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total, for each category, may not provide as much insights as the proportions that each category bears to the whole. The proportion of foreign firms in India is less than 1% of India's firms but their share has ranged from a high of 1.94% of all firms in India in the period between 1957-1958 to 1972-1973, to a low of 0.186% of all firms in India in the period from 1991-1992 to 2001-2002. This is shown in panel C. Clearly, there has been a substantial rise and fall in the proportion of foreign firms within India's corporate economy. facie evidence shows that the 1973 measure, which created a draconian 40% maximum ownership limit for foreign firms operating in India, has had a substantially negative and significant effect in retarding the entry of foreign firms into India. The growth in the number of foreign firms is also counter balanced by the crowding out that the presence of government firms and domestic firms has on the presence of foreign firms. Whenever there has been a growth in the presence of government firms in the economy, there has been a decline in the proportion of foreign firms. Similarly, whenever there has been a growth in the proportion of domestic private firms there has been a decline in the proportion of foreign firms. The estimates for model (B) where the FEMA variable is included show that FEMA is positive and significant (t statistic: 3.53; p < 0.01) at the conventional levels. The GOVERNMENT and PRIVATE variables are again both highly significant (t statistics are 3.45 and 88.70 respectively with the value of p < 0.001). The evidence now shows that the 1999 measure, which has now eliminated the draconian FERA policies, relating to maximum ownership limit for foreign firms operating in India as well as transforming the transactions landscape, has had a substantially significant effect in promoting the entry of foreign firms into India. In model (C) where the FERA and FEMA variables are both included, the FERA variable is negative but non-significant while FEMA is positive and significant (t statistic: 3.57; p < 0.01) at the conventional levels. The GOVERNMENT and PRIVATE variables are once again both highly significant (t statistics are 3.08 and 79.66 respectively with the value of p < 0.001). *52 4 Discussion A first finding established is that the transition in 1973 from an ownership regime where holdings of 51% were allowed to one where the maximum limit was 40% had a large negative impact on foreign firms' willingness to participate in the Indian economy. The negative coefficient for the FERA variable versus the positive sign for the FEMA variable, which implicitly also captures the ownership transition, shows this to be the case. Since this policy has been reversed foreign firms'
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presence in India has significantly increased. Clearly, the 51% ownership limit is crucial as an incentive for foreign firms to make investments. Following the guidelines of the International Monetary Fund, the Reserve Bank of India classifies equity ownership of more than 25% as enabling control. Below that level, foreign firms are assumed to be relatively passive investors. At just over a 25% level of shareholding, foreign firms have the ability to block members' special resolutions which are necessary to make significant strategic changes. The passage of special resolutions, under the Indian Companies Act of 1956, requires that those holding 75% of the shares vote in favor. The government, in reducing the maximum permissible foreign ownership limit to 40% in 1973, had thought that foreign firms with 40% shareholding would have effective control. Nevertheless, the ability to block a special resolution has not been adequate as a means of obtaining control. The role of foreign firms would be reduced to that of a minority shareholder because those shareholders owning the residual 60% of the shares could pass the necessary ordinary resolutions which required that 51% vote in favor. An argument could be made that a 51% holding was not critical if the holdings of the other shareholders were widely dispersed. Where several small stake holders have only a small resultant benefit from engaging in collective action then the motivation to engage in collective action becomes low. Thus, with only a 40% stake, a foreign firm would be able to execute its plans. Nevertheless, this would mean only a negative ability to achieve its objectives by blocking a special resolution that went against its interests. Indian corporate law, however, requires that 51% of the votes be cast in favor if an ordinary resolution is to be passed. The ability to exercise its abilities in a positive way would mean that a foreign firm would have to engage in proxy contests so as to acquire the necessary majority. These would add layers of costs and uncertainties to the decision making process. The second important finding is that the transition from FERA to FEMA has had significant impact in attracting foreign firms to India. Attitudinal as well as transactional transformations in the management of the Indian economy have taken place, as shown by the several legislative changes that were put through in the new FEMA. From being an economic police state, where the Directorate of Enforcement once operated like a commercial Gestapo, the transaction environment has been transformed to reflect India's increasingly enhanced role in the global economy and participation therein will be on globally accepted terms. Both the simplification of transactions, clarification of rules and the provision of independent appellate authorities serve to reduce the
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uncertainties that foreign participants will feel, and the reduction of such uncertainties, via the legislation and implementation of FEMA, have served to attract foreign firms into India. *53 The presence of foreign firms matters for overall productivity within an economy. Capital is the source of productivity and national wealth (de Soto 2000). Productive efficiency is the most significant measure of economic performance, since a continuing high level of productivity eventually provides the financial outcomes from undertaking economic activity and the funds to make further capital investments. A literature (for instance, Dunning 1993; Grossman and Helpman 1991; Helpman 1984; Hymer 1976 [1960]) shows that foreign firms' performance is superior relative to that of other firms within an economy, and a key view is that foreign firms have superior capabilities and intangible capital which lead them to become international players in the first place (Caves 1996). Such firms possess international marketing capabilities, location advantages in other countries, a global operations network, in-depth knowledge of foreign markets (de la Torre 1974) and the ability to manage the international political economy dimension (Helleiner 1988). Such capabilities help foreign firms become productive relative to domestic firms within an economy, and the foreign firms within an economy have been shown to be better in performance relative to domestic firms (Balasubramanyam et al. 1996; Majumdar 1998). In addition, whether for comparative advantage reasons (Ricardo 1817), to exploit India's current cost advantage, factor endowments reasons (Hecksher 1950; Ohlin 1933), or demand similarities with the foreign firms' countries of origin (Lindner 1961), foreign firms, too, may find India an attractive investment destination. The international mobility of capital has ensured that availability of capital is no longer an issue for economic development to take place. A comparison is made with China. India's share of world trade is less than one percent while China's is six times as large. Companies that do invest in the Indian economy also make investments one hundred times larger in China (Jalan 2005). The attitude that India has displayed towards foreign investment, from the early 1970s onwards, has been replaced by a change of spirit. This change can have eventual significant productivity consequences. The first policy change was the automatic approval for foreign firms to hold 51% ownership. The second change has been the extension of automatic approvals for having ownership stakes of up to
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74% in all but a few sectors such as media and telecommunications. This took place in 1997. The third important change has been the transformation of FERA to FEMA. The transformation of the transactions environment and the creation of independent adjudication bodies ensure that Indian institutional practices converge to best practices observed elsewhere and make India as attractive an investment destination of choice as any developed country. Nevertheless, a guarantee that these rules will not be changed again is important otherwise the country's ability to make credible commitments is in doubt. 5 Conclusion Using a data base on India's corporate sector, I evaluated the extent to which institutional changes that have taken place in India have made an impact on the presence of foreign firms in the economy. The data are organized as a time-series for *54 the period 1957-1958 to 2001-2002, and cover the entire population of enterprises making up the corporate sector in India. The data provide a comprehensive picture of the evolution of India's corporate economy for almost five decades, and while there are limitations of aggregative data sets in capturing the nuances of relational problems there is the necessity to evaluate phenomena and generalize for the sake of reaching useful policy conclusions. In the period after reforms commenced in 1991, the number of foreign firms in India has increased very substantially. The growth in numbers averages 8.5% for the period from 1991-1992 to 20012002 and since 1995-1996 has averaged 10% per year. While the proportion for foreign firms to the total number of firms as a whole has dropped, because of the unleashing of domestic private entrepreneurial activity in India, this statistic shows a positive growth from 1997 to 1998 onwards. The growth portends a significant interest in India by the suppliers of foreign capital. Thus, foreign firms are interested in becoming an increasing presence in the Indian economy, with positive performance consequences expected. The control rights regime changes have had significant effects on providing incentives for foreign firms to operate in India. The automatic availability of such rights, permitting ownership of 51% after 1991 and 74% in some sectors after 1997, has been a major factor affecting the motivation of foreign firms to operate in India. In addition, the transformation of FERA to FEMA in 1999 has had a positive effect in inducing foreign firms to enter India. The new FEMA legislation simplifies the controls to be observed by those undertaking to set up and operate a business in India. Removal of the lacunae, the transformation of the transactions environment and the creation of
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independent adjudication bodies ensure that Indian institutional practices are as good as any elsewhere and make India an attractive investment destination of choice.

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