CORPORATE LAW

ASSIGNMENT ON: CAPITAL ACCOUNT TRANSACTIONS

SUBMITTED BY: SHRIKANT R. BHOSALE

ROLL NO: 07

SUBMITTED TO : PROF. PUNJWANI

Introduction In India, Foreign exchange transactions in dollars, pounds or any other currency are broadly classified into two accounts: 1. Current account transactions 2. Capital account transactions

Current Account Transactions: Current account includes all transactions, which give rise to or use of our National Income. Transactions relating to: - Exchange of goods and services - Money transfers - Transactions that are classified in the Current Accounts. Examples of Current Account Transactions - All imports and exports of merchandise. - Invisible Exports and Imports (sale/purchase of services) - Inward private remittances (to & fro) - Pension payments (to & fro) - Government Grants (both ways) Presently in India the current account convertibility is fully allowed that means Indian Rupee can be fully converted into foreign currency. There is full freedom of conversion while making transactions for both residents as well as non-residents.

Capital Account Transactions It consists of short term or Long term capital transactions. Examples include Inflows and Outflows of capital. Borrowing from or Lending to aboard. Sales and Purchase of securities aboard

Capital Account Transactions Classification Portfolio Investment .

Stocks, Bonds, Bank Loans, Derivatives.

Direct Investment. Real estate Production facilities Equity investment.

Other investment.

Holdings in loans Bank accounts Currencies

Capital account transactions are under the restrictions of the Reserve Bank Of India and are regulated by FEMA(Foreign Exchange Management Act) 2000.

Capital account transaction is defined as a transaction which:

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

liability outside India.

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

The Act also contains a list of some of the most common capital account transactions:

Transfer or issue of any foreign security by a person resident in India; Transfer or issue of any security by a person resident outside India; Transfer or issue of any security or foreign security by any branch, office or agency in India of a person resident outside India; Any borrowing or lending in rupees in whatever form or by whatever name called; Any borrowing or lending in rupees in whatever form or by whatever name called between a person resident in India and a person resident outside India; Deposits between persons resident in India and persons resident outside India; Export, import or holding of currency or currency notes; Transfer of immovable property outside India, other than a lease not exceeding five years, by a person resident in India; Acquisition or transfer of immovable property in India, other than a lease not exceeding five years, by a person resident outside India;

Giving of a guarantee or surety in respect of any debt,obligation or other liability incurred(i) By a person resident in India and owed to a person resident outside India; or (ii) By a person resident outside India.

The Act has empowered the Reserve Bank of India (RBI) to specify, in consultation with the Central Government, the permissible capital account transactions and the limits upto which foreign exchange may be drawn for these such transactions. But it shall not impose any restriction on the drawal of foreign exchange for payments due on account of amortization of loans or for depreciation of direct investments in the ordinary course of business.

Accordingly, the RBI has issued notifications governing capital account transaction. The FEMA Notification No. 1/2000 dated 3-5-2000 contains the list of permissible capital account transactions as well as list of prohibited capital account transactions. The permitted capital account transactions have been classified into two categories:

Capital account transactions by persons resident in India includes,

Investment in foreign securities; Foreign currency loans raised in India and abroad; Acquisition and transfer of immovable property outside India; Guarantees issued in favour of a person resident outside India; Export, import and holding of currency or currency notes; Loans and overdrafts (borrowings) from a person resident outside India; Maintenance of foreign currency accounts in India and outside India; Taking out the insurance policy from an insurance company outside India; Remittance outside India of capital assets of a person resident in India; Sale and purchase of foreign exchange derivatives in India and abroad and commodity derivatives abroad.

Capital account transactions by non- residents includes,

Investment in India such as (i) issue of security by a body corporate or an entity in India and investment therein by a non-resident and (ii) investment by way of contribution to the capital of a firm or a proprietary concern or an association of persons in India; Acquisition and transfer of immovable property in India; Guarantee in favour of, or on behalf of, a person resident in India; Import and export of currency/currency notes into/from India; Deposits between a person resident in India and a person resident outside India; Foreign currency accounts in India of a non-resident; Remittance of the assets in India held by a non-resident.

There are generally two types of prohibitions on capital account transactions :

General Prohibition:- A person shall not undertake or sell or draw foreign exchange to or from an authorized person for any capital account transaction. This prohibition is subjected to the conditions specified by Reserve Bank in its circulars and notifications. For example, Reserve Bank of India has issued an AP (DIR) Circular, wherein a resident individual can draw from an authorized person foreign exchange up to US$ 25,000 per calendar year for a capital account transaction specified in Schedule I to the

Notification.

Special Prohibition:- A non resident person shall not make investment in India in any form, in any company or partnership firm or proprietary concern or any entity, whether incorporated or not, which is engaged or proposes to engage:- (i) in the business of chit fund, or (ii) as Nidhi Company, or (iii) in agricultural or plantation activities or (iv) in real estate business, or construction of farm houses or (v) in trading in Transferable Development Rights (TDRs). Capital Account Convertibility(CAC) It is also known as floating exchange rate. It means the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates. It refers to the removal of restraints on international flows on a country's capital account, enabling full currency convertibility and opening of the financial system. A capital account refers to capital transfers and acquisition or disposal of non-produced, non-financial assets, and is one of the two standard components of a nation's balance of payments. The other being the current account, which refers to goods and services, income, and current transfers. Advantages:1. It is a major feature of developed economy. 2. It offers foreign investors a lot of comfort as they can re-convert local currency into foreign currency anytime they want to and take their money away. 3.It makes easier for domestic companies to tap foreign markets At the moment, India has current account convertibility. This means one can import and export goods or receive or make payments for services rendered. However, investments and borrowings are restricted. 4. Fear of economic crisis just like East Asian economic crisis is suggested by economist if India embraces capital account convertibility without adequate preparation. Steps: - The Reserve Bank of India has appointed a committee to set out the framework for fuller Capital Account Convertibility.

Reasons favoring Financial Openness and CAC Diversification: Unrestricted investment in foreign assets would result in the domestic households diversifying their income sources into foreign economies and industries. This would enhance the returns while reducing risk as a direct consequence of the diversification. The resultant overall economy will be more robust and stable. NRI Remittances: The NRI Diaspora will benefit tremendously if and when Capital Account Convertibility becomes a reality. The reason is on account of current restrictions imposed on movement of their funds. As the remittances made by NRIs are subject to numerous restrictions, which will be eased considerably once Capital Account Convertibility is incorporated. It also opens the gate for international savings to be invested in India. It is good for India if foreigners invest in Indian assets this makes more capital available for Indias development. That is, it reduces the cost of capital. When steel imports are made easier, steel becomes cheaper in India. Similarly, when inflows of capital into India are made easier, capital becomes cheaper in India. The main benefits of financial globalization may not be through the direct channel of providing more financing. Rather, the main benefits may be in terms of catalyzing financial market and institutional development, stimulating gains in efficiency through competition and access to new technologies, and disciplining macroeconomic policies. Controls on the capital account are rather easy to evade through unscrupulous means. Huge amounts of capital are moving across the border anyway. It is better for India if these transactions happen in white money. Convertibility would reduce the size of the black economy, and improve law and order, tax compliance and corporate governance. Most importantly convertibility induces competition against Indian finance. Currently, finance is a monopoly in mobilizing the savings of Indian households for the investment plans of Indian firms. No matter how inefficient Indian finance is, households and firms do not have an alternative, thanks to capital controls. Exactly as we saw with trade liberalization, which consequently led to lower prices and superior quality of goods produced in India, capital account liberalization will improve the quality and drop the price of financial intermediation in India.

Reasons favoring Restrictions During the good years of the economy, it might experience huge inflows of foreign capital, but during the bad times there will be an enormous outflow of capital under herd behavior (refers to a phenomenon where investors acts as herds, i.e. if one moves out, others follow immediately). For example, the South East Asian countries received US$ 94 billion in 1996 and another US$ 70 billion in the first half of 1997. However, under the threat of the crisis, US$ 102 billion flowed out from the region in the second half of 1997, thereby accentuating the crisis. This has serious impact on the economy as a whole, and can even lead to an economic crisis as in South-East Asia. There arises the possibility of misallocation of capital inflows. Such capital inflows may fund low-quality domestic investments, like investments in the stock markets or real estates, and desist from investing in building up industries and factories, which leads to more capacity creation and utilization, and increased level of employment. This also reduces the potential of the country to increase exports and thus creates external imbalances. An open capital account can lead to the export of domestic savings (the rich can convert their savings into dollars or pounds in foreign banks or even assets in foreign countries), which for capital scarce developing countries would curb domestic investment. Moreover, under the threat of a crisis, the domestic savings too might leave the country along with the foreign investments, thereby rendering the government helpless to counter the threat. Entry of foreign banks can create an unequal playing field, whereby foreign banks cherrypick the most creditworthy borrowers and depositors. This aggravates the problem of the farmers and the small-scale industrialists, who are not considered to be credit-worthy by these banks. In order to remain competitive, the domestic banks too refuse to lend to these sectors, or demand to raise interest rates to more competitive levels from the subsidized rates usually followed. International finance capital today is highly volatile, i.e. it shifts from country to country in search of higher speculative returns. In this process, it has led to economic crisis in numerous developing countries. Such finance capital is referred to as hot money in todays context. Full capital account convertibility exposes an economy to extreme volatility on account of hot money flows.

Conclusion Unlike other developed countries India has some restrictions on Capital Account Transactions. These restrictions are imposed by RBI and regulated by FEMA act 2000. Today India is able to capitalize on its foreign reserves and FDI because of its healthy capitalization rate and the restrictions imposed by RBI on investments in India by foreign countries or outside India by Indians which leaves India less affected by Global slowdown. The restrictions and regulations secures the investors interest so this is not good time to open up Capital Account Transactions as there is shadow of global slowdown in European countries.