[This guest post is by Pratik Datta and Shefali Malhotra, who are Consultants at the National Institute of Public Finance and Policy (NIPFP). They can be reached at email@example.com and firstname.lastname@example.org respectively.]
This blog had earlier explained the policy backdrop leading up to the Reserve Bank of India's (RBI's) draft framework for External Commercial Borrowing (ECB). Recently, the RBI released two circulars and one amending regulation in its effort to "liberalise" the ECB regime:
- AP (DIR Series) Circular No. 17 dated September 29, 2015: Provides a framework for the issuance of Rupee denominated bonds overseas
- AP (DIR Series) Circular No. 32 dated November 30, 2015: Provides a revised framework for the ECB Policy, comprising medium term foreign currency denominated ECB with minimum average maturity (MAM) of 3-5 years, long term foreign currency denominated ECB with MAM of 10 years and Indian Rupee denominated ECB with MAM of 3-5 years.
- Notification No.FEMA.358/2015-RB dated December 2, 2015: Amends the Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000 allowing the RBI, in consultation with the Central Government, to prescribe certain changes to the regulations for foreign exchange (FX) and Indian rupee (INR) borrowing under approval and automatic routes.
In this post, we show the policy inconsistencies and drafting errors across these circulars and regulation.
Briefly revisiting the policy backdrop
The current ECB reforms are based on a detailed report of the Sahoo Committee. The Committee argued that the purpose of any financial regulation is to address market failure. With regards to ECB, the only potential market failure arises from currency exposure. This nudged the policy-makers to rethink the policy behind INR denominated borrowings, where the currency risk is completely borne by the lender thereby alleviating the systemic risk concerns on the Indian borrowers’ side. Therefore, from a policy perspective, there is no difference between INR denominated bonds and INR denominated borrowings that justifies different regulations for these.
The RBI has issued two circulars: One is on INR bonds (Circular 17) and the other is on INR borrowings (Track III of Circular 32). The framework for the issuance of INR bonds and INR borrowings provides different conditions for eligible borrowers, recognised investors, end use restrictions, etc. The framework for issuance of INR borrowings is more restrictive than for INR bonds.
For example, while any investor from FATF jurisdiction can invest in INR bonds, only nine investor classes are recognised for investment in INR borrowings. Similarly, there is no end use restriction (except a negative list) in the case of INR bonds. On the other hand, the framework for INR borrowings provides a list of permitted end use for different sectors.
As suggested by the Sahoo Committee, the objective of regulating ECBs is to address the potential market failure that can arise from currency exposure alone. In the case of INR bonds as well as INR borrowings, there is no currency exposure. Hence, the reason for the variance between these two frameworks is unclear and does not stem from the recommendations of the Sahoo Committee. Unfortunately, unlike SEBI, the RBI has not yet voluntarily started issuing discussion papers regularly before making regulations as is required under the FSLRC Handbook. This makes it even more difficult to discern what regulatory concern could have prompted the RBI to digress from Sahoo Committee's recommendations.
Can the RBI regulate trade credit or short term credit facilities for working capital?
Post liberalisation, India decided to comply with Art. VIII of the IMF Articles of Agreement. Consequently, one of the crucial policy reforms introduced in the Foreign Exchange Management Act (FEMA) in 1999 was full current account convertibility through statute. Full capital account convertibility could not be enshrined in the statute since in the aftermath of the East Asian crisis of 1997 there were scepticisms about the idea. Accordingly, section 5 of FEMA provides for full current account convertibility by default except to the extent that the Central Government may impose restrictions through rules. On the other hand, section 6 of FEMA provides restricted capital account convertibility and the RBI was given wide powers to regulate such transactions. This arrangement was agreed upon since it enables opening up of capital account through regulations in the future without having to amend the statute itself.
With this legislative intent, section 2(j) of FEMA defines `current account transaction' to include payments due in connection with foreign trade, other current business, services, and short-term banking and credit facilities in the ordinary course of business. Essentially, it means that trade credits as well as short term foreign currency borrowings for working capital are current account transactions. Since these are not capital account transactions, the RBI does not have jurisdiction to regulate them in the first place. Instead, it is the Central Government which has power to issue rules on these transactions. However, in practice, Central Government does not regulate them -- instead the RBI has been regulating trade credit and ECB for working capital under the FEMA (Borrowing or Lending in Foreign Exchange) Regulations, 2000 as if these were capital account transactions. The new ECB framework continues with the same mistakes, contradicting the basic policy behind FEMA -- full current account convertibility.
Penal (criminal) action for violating ECB guidelines?
Circular No. 32 states that:
The primary responsibility for ensuring that the ECB is in compliance with the applicable guidelines is that of the borrower concerned. Any contravention of the applicable provisions of ECB guidelines will invite penal action under the Foreign Exchange Management Act 1999 (FEMA).
If `penal action' is intended to mean `criminal action', then this statement is legally incorrect with respect to Track III INR borrowings.
One of the primary policy objectives of the FEMA was to move away from the philosophy of the Foreign Exchange Regulation Act, 1973 (FERA) of criminalising contraventions of foreign exchange regulations. Accordingly, FEMA was originally a civil statute and did not impose any criminal sanction for any contravention. However, in a political effort to pacify black money related grievances, the Finance Act, 2015, for the first time introduced criminal provisions under FEMA, with the objective of addressing the menace of black money. From September 9, 2015, section 13 of FEMA stood amended. Therefore, as of now, section 13(1C) read with sections 37A and 4 of FEMA criminalises acquisition of foreign exchange, foreign security or immovable property, situated outside India, in violation of FEMA.
It is important to note that in case of INR borrowings or INR bonds, the borrower is not acquiring any foreign exchange. Therefore, this criminal provision under the current FEMA does not extend to any such borrower. To this extent, the usage of the words penal in Circular No. 32 is incorrect.
A superfluous amendment or institutionalising ad hocism?
The Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) (Amendment) Regulations, 2015 adds Paragraph 4 in Schedule 1 of the Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000, which states:
Provided that under these Regulations, the Reserve Bank may, in consultation with the Government of India, prescribe for the automatic route, any provision or proviso regarding various parameters listed in paragraphs 1 to 3 above of this Schedule or any other parameter as prescribed by the Reserve Bank and also prescribe the date from which any or all of the existing proviso will cease to exist, in respect of borrowings from overseas, whether in foreign currency or Indian Rupees, such as addition / deletion of borrowers eligible to raise such borrowings, overseas lenders / investors, purposes of such borrowings, change in amount, maturity and all-in-cost, norms regarding security, pre-payment, parking of ECB proceeds, reporting and drawal of loan, refinancing, debt servicing, etc.
Section 2(x) of FEMA 1999 states that `prescribed' means prescribed by rules made under this Act, while 2(zd) states that `specify' means to specify by regulations made under this Act and the expression "specified" shall be construed accordingly. The statute empowers the RBI to issue regulations (section 47) while the Central Government is empowered to issue rules (section 46). The RBI is not empowered to `prescribe' rules, but can only `specify' regulations. Therefore, the amending regulation has wrongly used the word `prescribe' instead of `specify'. This drafting error although seemingly innocuous needs to be treated with caution since section 139 (yet to be notified) of the Finance Act, 2015, has shifted some of the RBI's regulation making powers within the Central Government's rule making zone.
It seems that this amendment was intended to empower the RBI, in consultation with the Central Government, to insert or remove provisions in the Schedules. But the RBI always had this power under section 47. It could always have amended its own regulation to insert or delete provisions or provisos therein. So what was the need for this additional provision? Is it merely superfluous?
It is hard to imagine that an entire amendment to a FEMA regulation would be completely superfluous. In that case, the only explanation could be that the RBI intends to use this provision to exempt the application of some provisions or impose certain additional obligations on transactions under these regulations on a case-to-case basis after consultation with the Central Government. This may have been necessitated due to the Tata-Docomo debacle where the RBI had initially intended to exempt the Japanese investors from the application of the pricing norms but was then reportedly instructed by the Central Government to follow its own rules and not exempt transactions on a case to case basis. If this is indeed the intention behind this amendment, it would institutionalise regulatory ad hocism -- the antithesis of rule of law.
Any major policy shift is bound to have implementation issues. However, administrative convenience should not be an excuse for diluting the policy intent. The RBI's new initiative to revamp the ECB framework is indeed a welcome step. However, there still remains much (watch M.S. Sahoo's interview and read Mukesh Butani's piece) to expect from the Central Bank.
- Pratik Datta & Shefali Malhotra
 There is some confusion on this issue. However, Clause 6(iii) of the Annex of Circular 32 at page 8 of 16 states: These limits are separate from the limits allowed under the framework for issuance of Rupee denominated bonds overseas. Clause 6(i) applies to all the three tracks including INR borrowings in Track III. Therefore, it is submitted that the circular treats INR borrowings and INR bonds differently.
 Financial Action Task Force.
 Penal action need not necessarily mean criminal action. See Ritesh Agarwal v. SEBI, (2008) 8 SCC 205.
 A similarly worded paragraph 6 has been inserted in Schedule II for approval route.