India’s External Sector: Policies, Practices and Implications

India’s External Sector: Policies, Practices and Implications

• Gold

• Special drawing rights (SDRS)

• Reserve tranche position (RTP)

• Foreign currency assets (FCA)

• Government securities

• Gold= $36 Billion

• RTP= $4.68 Billion

• SDRs= $1.4 Billion

• Gold= $36 Billion

• Value of the SDR is based on a basket of five currencies- Dollar, Euro, Renminbi, Yen, and Pound Sterling.

• It is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members.

No role of authority

In crisis, central banks may intervene to stabilize the exchange rate

Captures inflation differentials between country and its major trading partners and reflects the degree of external competitiveness

• Union Budget for 1992-93, introduced it on current account under Liberalized Exchange Rate Management System (LERMS)

• Also known as Dual exchange system.

• Presently partial convertibility still operational on capital account.

• Dual exchange rate system got automatically abolished and LERMS was now based upon the open market exchange.

• In 1994, the Government of India declared full convertibility of Rupee on Current account.

• India delinked its currency from the fixed currency system and moved into the era of floating exchange-rate system under it.

• Invisible
• Visible
• Goods(+)
• Services [+)
• Income
• 1. Dividend
• 2. Interest
• 3. Profit
• Transfer [+]
• 1. Gift
• 2. Donation
• 3. Remittance

• Investment [+]
• 1.Sovereign 2.Commercial
• NRI account [+]
• 1. Gift
• 2.Donation 3.Remittance
• Loan (+)
• 1 FDI 2. FII/FPI

• Short term implication transactions

• Covers only earnings and spending.

• Excludes any borrowings and lending.

• Long term implication transactions

• Only includes borrowings and lending by a country

• Invisible trade(Export and Import of services)

• Unilateral transactions

• Portfolio Investment (FPI)

• Loans / External commercial borrowing (ECB)

• Non-resident investment in Bank, Insurance, Pension schemes.

• RBI’s foreign exchange reserve

• Current Account deficit = Trade gap(export – import) + Net current transfers (foreign aid) + Net factor income (Interest, Dividend)

• UAE

• China

• Hong Kong

• Singapore

• USA

• UAE

• Saudi Arabia

• Pearls, precious and semi-Precious stones

• Drug formulations, biologicals

• Gold and other precious metal jewellery

• Iron and steel

• Mineral fuels including oil

• Gems, precious metals

• Machinery including computers, Organic, Electrical machinery

• Pharmaceuticals products.

• Value of its currency increases

• Value of its currency decreases.

• Supply of currency = Decreases

• Supply of currency = Increases

• Imports become cheaper.

• Value of the remittances decreases

• Overall Inflation decreases

• Imports become expensive

• Increase in aggregate demand

• Increase in inflation

• International currency which has the highest faith, strongest currency of the world and highest level of liquidity.
• Ex: US Dollar, The Euro

• It is just the opposite of Hard currency.
• Ex: Indian Rupee is the Soft currency in the Indian Forex market.

• It is the term for the Forex market and is the temporary name for any Hard currency.
• If any Hard currency is exiting any economy at a fast pace for the time, the Hard currency is said to be hot currency.

Heated currency:

• Domestic currency which is under pressure (heat) of depreciation due to any hard currency’s high tendency of exiting the economy.
• Also known as currency under Heat or under Hammering.
• In the case of the SE Asian crisis (1997), the US Dollar became hot.

• When a government starts re-purchasing its bonds before their maturities and at full maturity prices, there is an increase in supply of money which is called cheap money.

• It is just the opposite of cheap money.
• Government issues bonds, the flow of money increases from public to the government hence supply of money in the market decreases, which is dear currency.

External Sector Stability and Economic Resilience

• Helps countries in economic crisis to overcome the Balance of Payment (BoP) problems.

Flexible Credit Line (FCL):

• For countries with very strong track records of policy implementation.
• No ongoing conditions and no caps on the size of the credit line.

• PLL provides financing to meet actual or potential balance of payments needs of countries with sound policies
• Serve as insurance and help resolve crises.

• It is a service provided by the IMF to its member countries which authorizes them to raise any amount of foreign exchange from it to fulfill their BoP crisis, but on the conditions of structural reforms in the economy.
• Established to provide assistance to countries:

• • Experiencing serious payment imbalances because of structural impediments.
  • Characterized by slow growth and an inherently weak balance of payments position.

• Allows the IMF to provide loans under one of its facilities to a developing country whose balance of payments is suffering because of multilateral trade liberalization.

Countervailing Duties

(CVD)

• This includes investing funds in any investment/insurance so that the net amount earned is less and the taxpayer has to pay only a reduced amount as tax. Tax avoidance is completely legal.

• This includes fraudulent practices such as dishonest tax reporting, declaration of less income or profits than the amount actually earned, and also overstating their deductions.

• Objective = To codify the doctrine of ‘substance over form’ where the real intention of the parties and purpose of an arrangement is taken into account for determining the tax consequences, irrespective of the legal structure of the concerned transaction or arrangement.

• Targeted at aggressive tax planning arrangements or transactions made specifically to avoid taxes

• Introduced in India because of the VODAFONE case ruling by the Supreme Court.

• Helps to assess if companies are setting up shell subsidiaries abroad to evade taxes.

• It means a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance, made.

• Tackles tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations.

• India has recently ratified the Multilateral Convention to implement tax treaty related measures.

• Investment in physical asset

• Aim to increase enterprise capacity or productivity or change management control

• Leads to technology transfer, access to markets and management inputs

• FDI flows into primary market

• Entry and exit is relatively difficult

• Eligible for profits of company

• Does not tends to be speculative

• Investment in financial asset

• Aim to increase capital availability

• FPI results in only capital inflows

• FPI flows into secondary market

• Entry and exit is relatively easy

• Eligible for capital gains

• Tends to be speculative

Financial Action Task Force (FATF)

• Objectives: To set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system.

• Secretariat: OECD headquarters in Paris.

• FATF has two list:

• Grey List: Countries that are considered safe haven for supporting terror funding and money laundering are put in the FATF grey list. EX: Pakistan
• Black List: Countries known as Non-Cooperative Countries or Territories (NCCTs) are put in the blacklist. These countries support terror funding and money laundering activities. The FATF revises the blacklist regularly, adding or deleting entries. EX: Iran, North Korea.

• Treaties impose conditions on the regulatory behavior of the host state and limit interference with the rights of the foreign investor.

• According to the FDI policy guideline, “Marketplace model of e-commerce means providing an information technology platform by an e-commerce entity on a digital and electronic network to act as a facilitator between buyer and seller.”
• Marketplaces are platforms that enable a large, fragmented base of buyers and sellers to discover prices and transact with one another in an environment that is efficient, transparent and trusted.
• Amazon and Flipkart in India have a marketplace model.

• According to the FDI policy, “Inventory model of ecommerce means an ecommerce activity where inventory of goods and services is owned by e-commerce entity and is sold to the consumers directly.”
• The main feature of the inventory model is that the customer buys the product from the ecommerce firm. He manages an inventory (stock of products), interfaces with customers, runs logistics and is involved in every aspect of the business.
• Alibaba of China is following the inventory model.

• Possible downgrade by rating agencies which eventually might increase the cost of debt.

• Exposes the company to interest and currency fluctuations.

• Longer maturity

• Capital gains

• It is Export Credit Insurance Scheme (ECIS)

• To enhance loan availability and ease the lending process.

• The WTO compliant scheme will reimburse all taxes and duties paid on inputs consumed in exports.

• End to end digitised

• Rewards (duty credit scrips) to exports of services.

• Scripts are transferable and can be used to pay certain central duties & taxes.

• Aim: develop expert hubs to promote growth and development

• Can be set up by either central or state government or even by private sector

• India had set up Asia’s first ‘export processing zone’ (EPZ) in Kandla in 1965 itself.

• Recent steps (till March 2020) taken by the Government to strengthen SEZs in the country are:

• Minimum Land Area requirement = reduced to 50 per cent for multi-product and sector-specific SEZs.
• A new sector ‘agro-based food processing’ sector has been introduced
• Dual use of facilities like Social and Commercial infrastructure by SEZs and non-SEZs entities has been allowed in order to make SEZ operations more viable.
• Sectoral broad-banding has been introduced to encompass similar and related areas under the same sector.
• ‘SEZ India’ mobile app launched to help the SEZs to track their transactions.

• Provides financial assistance in the form of grant-in-aid to Central/State Government owned agencies for setting up or for up-gradation of export infrastructure.

• To double agricultural exports from present US$ 30 Billion to US$ 60 Billion by 2022

• To strive to double India’s share in world agri exports.

• Scheme focus is on agriculture export oriented production, export promotion, better farmer realization

• Done by reducing tariffs but not by abolishing them completely.

• It requires the lowest level of commitment to reducing trade barriers

• Ex: Mercosur preferential trade agreement, Asia pacific trade agreement

• It involves reduced Most Favored Nations (MFN) Tariffs or duty-free entry of eligible products exported by beneficiary countries to the markets of donor countries.

• Recently the US government has withdrawn its GSP benefits to India.

• EX: SAFTA (South Asian PTA to FTA), ASEAN FTA

• CEPA has a bit wider scope than CECA. While CECA comes first with elimination of tariffs, CEPA comes later including trade in services and investments.

• EX: India: CEPA with Japan and CECA with Singapore .

• EX: Gulf Cooperation Council (GCC), East African Community (EAC).

• Members eliminate trade barriers among themselves, adopt common external barriers, allow free import and export of resources, adopt a set of economic policies, and use one currency.

• EX: European union

To make it easier for products and services of each of these countries to be available across this region. Largest economic bloc. Recently India opted to stay out of RCEP.

Evolved from the Trans-Pacific Partnership (TPP), which never entered into force due to the withdrawal of the United States.

• Exim policy or Foreign Trade Policy for the years 2015-20, aims at doubling the overseas sales to $900 billion by 2019-20 and making India global, while integrating the foreign trade with “Make in India” and “Digital India Programme”.
• To support both the manufacturing and services sectors, with a special emphasis on improving the ‘ease of doing business’.

• Incentives are to be provided in the form of duty scrips as % of FOB (free on board) value of exports.
• Service Exports from India Scheme (SEIS) will be only for India based service providers and will be based on net foreign exchange earned.
• Both SEIS and MEIS schemes are applicable to SEZ units.
• Paperless Trade and Online filling of forms
• Provision for Export oriented units, Export hardware technology park and software technology park.
• The Duty free scrips (form of credit) are provided to the exporters under various export promotion schemes of the government.
• Government has extended foreign trade policy for one year till March 2021 amid the outbreak of the coronavirus pandemic outbreak.