In the era of globalisation and finance capitalism, the PSUs with their conservative management emerged as a countervailing force. In his Budget speech this year finance minister Pranab Mukherjee made a statement that left many wondering. While emphasising on the economic success of the previous UPA regime, Mr Mukherjee talked about the 'critical' role played by the public sector banks in insulating the Indian economy from the adverse affects of the global financial crisis. He talked in a manner that justified the nationalisation drive undertaken by the former prime-minister Mrs Indira Gandhi nearly 40 years ago.
The majority of Indians of this generation have grown up in an environment where government owned enterprises dominated our life; be it the slow moving telecom utility, or an airline which would not fly on time, or the local power distributor which could never match the rising demand. The situation was equally worse in the all important banking and financial services sector, where employees never seem to have the time or inclination to serve retail customers.
So when the Indian economy opened up in 1991 and the private sector was allowed entry into sectors earlier reserved for the public sector, it gave an opportunity to Indians to teach a lesson to the state-owned companies they used to deal with. In almost every sphere, PSUs lost market share and customers flocked to the new private sector entrants, who turned out to be much smarter and sleek in serving the customers. It was a new experience for Indians, who were used to standing in queues to buy everything-from a telephone connection to an airline ticket to a domestic gas connection.
Given this, Indians especially the urban middle class is not wrong in viewing PSUs in a certain manner. But it tells only half the story. The consumer's side of the PSUs was always small and has shrunk further in recent years, as private sector has made inroads in one consumer segment after the other. The public sector with their elaborate systems and procedures was never built to be great consumer organisation. Rather they were supposed to provide economic ammunition to the country.
The idea of PSUs was conceptualised at a time when, India hardly had any industrial infrastructure to talk about and it could not have been left to the domestic private sector or foreign companies to provide it. This is because, establishing the infrastructure is a long-drawn process, which may not have yielded profits in the short to near term. Besides, the projects of these kinds are highly capital intensive and was mostly beyond the scope of the fledgling private sector in 1950s and 1960s.
If India today is effortlessly implementing some of the world's largest and most complex industrial and infrastructure projects right from power projects to refineries to dams to mass rapid transit systems, it's because, there is expertise and resources available locally. It was not the case a few decades ago. In the decade following India’s independence, the biggest constraint that India faced was technical know-how and the ability to successfully implement large and nationally important projects. And worse, the technical expertise was either not available in the international market or it was prohibitively expensive. Now that India has successfully nurtured anchor companies across strategic sectors-BHEL (capital goods), SAIL (steel), Indian Oil (oil refining), Bharat Electronics (defence electronics), NTPC (Thermal Power), ONGC (oil exploration) and GAIL (gas) among others, the country has the requisite industrial ecosystems to conceptualise and implement the biggest and the most complex of projects. In fact, the presence of these large domestic companies is now forcing foreign firms to look at the Indian market in favourable terms and this has helped to boost the competition in the domestic market and has thus aided India’s growth story.
The situation was not very different in banking industry either. Though India had a thriving banking industry in 1950s and 60s, its presence was limited to urban areas. But a sustainable economic growth required them to open branches in smaller towns and villages. Not just for equity, but by mid-1960s, the country was facing a food crisis, also called wage-good constraint in development economics. Without cheap food readily available in urban areas, industrialisation was just not possible.
In such as situation a forced industrialisation would have resulted in spiralling wages making entire project economically unviable. Stepping up food production however required investment in new technology and inputs. But given the income levels in rural areas, farmers were not in a condition to invest in fertilisers, modern seeds, pesticides and farm mechanisation on their own. They needed credit and that also at favourable terms. The private sector dominated banking systems was however not geared for it. The agriculture credit was expected to be much less profitable than industrial or consumer loans. So why would a privately owned enterprise take a hit on its profitability?
This had put the government in a Catch 22 situation. So when the push came to shove, the then prime minister Mrs Gandhi did the unconceivable-nationalisation of all large commercial banks in 1969.
The nationalisation led to a massive expansion in the bank branches and farm credit that helped the country to step-up farm productivity and by early 1980s, India was self-sufficient in food. This eliminated the risk of food-price inflation that had weighed heavy on the India’s economic growth in the past. The newly nationalised banks also spread the reach of the formal economy in the farthest corner of the country, which dramatically improved the effectiveness of monetary and fiscal policies. This in itself was a big achievement. Another beneficial impact of a nationwide bank network was a sharp rise in domestic savings, which was now available for investment. In early 1950s, India’s gross saving rate was around 9% of GDP. In next twenty years, it grew at a snail's pace and was 12% on the eve of bank nationalisation. Given India’s long-term capital-output ratio of around 4x, this savings rate would have supported a GDP growth of not more than 3-4% per annum and this was that we were achieving in those days. In the next 20 years country's savings rate rocketed to reach 25% of GDP on the eve of the economic reforms of 1991. Now the Indian economy was ready for the take off.
So in many ways, the current generation is reaping the benefits of the economic plumbing provided by the PSUs. The government-owned companies have proved beneficial in other ways as well. In the post-1991 era, when unfettered globalisation and aggressive finance capitalism acquired the status of a religion, the PSUs with their conservative management style and commitment to the domestic economy emerged as a countervailing force.
While initially this approach was criticised by market men for being anti-growth and typical of PSUs inability to change with times, it proved to be a masterstroke. It saved nation's economic fabric in the aftermath of the global economic crisis. And nowhere was this more visible than the financial market. At the height of the credit crunch in second half of 2008, large PSUs such as State Bank of India and Life Insurance Corporation emerged as the lender of last resort for India Inc. "Many private sector and foreign banks withdrew from the market just when their clients needed them most. In contrast, PSU banks not only honoured their commitments but tried to their best to fill the vacuum," says SBI chairman Mr O P Bhatt. In the stock market LIC emerged as a large investor even as foreign investors were fleeing in hordes putting companies and retail investors in great peril.
A big complaint against PSUs has however been their lacklustre financial performance. But it seems to a case of stereotyping them. PSUs account for nearly half of the combined dividend payout by all listed companies in FY09. The stock market is now also waking up to this reality. In the past, market used to give PSUs a discount. Now companies such as BHEL, SBI, NTPC and Power Grid, among others, rank among one of the most valuable companies in their sectors. (See PSUs lead the way on page 67)
Also while analysing PSUs' past record we must also keep in mind that most of them are much younger than we believe. For instance, BHEL is nearly 20 years younger than its nearest peer L&T, while NTPC was established as late as 1975 compared to its private sector peer Tata Power, which is nearing 100 years of existence. So many of their past investments are still to bear fruit and it may be early to pass a judgement on their finances.
While PSUs are believed to be conservative and slow moving, the last few years have shown that they can be agile in spotting new opportunities and milking them full. Nothing illustrates this better than the MRPL acquisition and swift turnaround under ONGC's management despite stiff bureaucratic opposition. Subir Raha, the then chairman of ONGC still remembers, "The petroleum ministry refused to recognise the public sector status of MRPL for many more months." The deal was however recognised as best M&A deal in Asia in 2003 by Asia Money. The company's total investment in this acquisition was around Rs 1,000 Crore, less than 10% of a Greenfield refinery of same configuration and complexity. The oil major followed it up with large overseas acquisition of Imperial Energy, which it closed at the height of credit crisis last year.
In the banking industry meanwhile, PSUs have learnt their lessons and most of them are investing huge sums in brand building and promotion. (See Today's mega corporations, tomorrow's big brands on page 54). A similar revolution is sweeping through other sectors. For instance, NTPC, which is implementing its 10-year vision plan, has begun the preparatory work on drawing out its corporate plan for next 25 years. Just as last 15 years saw the emergence of a select band of global brands from India’s private sector, the next 20 years may see the emergence of global corporation from the public sector.
****Thanks are due to ET Intelligence Group's Krishna Kant
Showing posts with label Economy. Show all posts
Showing posts with label Economy. Show all posts
Tuesday, 24 November 2009
Red Alert: The Second Wave of The Financial Tsunami
The Wave Is gathering force & could hit between the first & second quarter of 2010
by Matthias Chang
Many of my friends who have been receiving my e-mail alerts over the last two years have lamented that in recent weeks I have not commented on the state of the global economy. I appreciate their anxiety but they forget that I am not a stock market analyst who is paid to write articles to lure investors back into the market. My website is free and I do not sell a financial newsletter so there is no need for me to churn out daily forecasts or analysis.
However, when the data is compelling and supports an inevitable trend, it is time for another review. This Red Alert is to enable visitors to my website to take appropriate actions to safeguard their wealth and welfare of their families in the coming months.
Since the last quarter of 2008, unrelenting currency warfare has been waged by the key global economies and while this competition thus far has been non-antagonistic, it will soon be antagonistic because the inherent differences are irreconcilable. The consequences to the global economy will be devastating and for the ordinary people, massive unemployment and social unrest are assured.
The policy-makers of these countries faced with the total collapse of the international financial architecture have concluded that the solution, the only solution is quantitative easing (i.e. massive injection of liquidity) to salvage the “too big to fail” banks and reflate their depressed economies. This is best reflected in Bernanke’s candid remark that, “the US government has a technology, called the printing press (or today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost”.
This is the crux of the problem!
The Irreconcilable Differences
Some two decades ago, it was decided by the global financial elites that the framework for the global economy shall consist of:
1) A global derivative-based financial system, controlled by the US Federal Reserve Bank and its associate global banks in the developed countries.
2) The re-location from the West to the East in the production of goods, principally to China and India to “feed” the developed economies.
The entire system was built on a simple principle, that of a FED-controlled global reserve currency which will be the engine for growth for the global economy. It is essentially an imperialist economic principle.
Once we grasp this fundamental truth, Bernanke’s boast that the “US can produce as many US dollars as it wishes at no cost” takes on a different dimension.
I have talked to so many economists and when asked what is the crux of the present financial problem, they all respond in unison, “it is the global imbalances... the West consumes too much while the East saves too much and consumes not enough”. This is exemplified by the huge US trade deficits on the one part and China’s massive surpluses on the other.
Incredible wisdom and almost everyone echoes this mantra. The recent concluded APEC Summit was no different. This mantra was repeated as well as the call for freer trade between trading nations.
This is a grand hoax. All the current leaders on the world’s stage are corrupted to the rotten core and as such have no interest to call a spade a spade and expose the inherent contradictions within the existing financial system.
The call for a multi-polar world is meaningless when the entire global financial system is based on the unipolar US dollar reserve currency. This is the inherent contradiction within the present system and the problems associated with it cannot be resolved by another global reserve currency based on the IMF’s Special Drawing Rights as advocated by some countries. It was stillborn, the very moment it was conceived!
The leaders of China, Japan and the oil producing countries of the Middle East are all cursing and pissing about the current situation, but they don’t have the courage of their convictions to spell it out to their countrymen that they have been conned by the financial spin masters from the Fed acting on the instructions from Goldman Sachs.
Tell me which leader would dare admit that they have exchanged the nation’s wealth for toilet papers?
The toilet paper currency pantomime continues.
We have now reached a stalemate in the current currency war, not unlike the situation of the Cold War between the NATO pact countries and the Warsaw pact countries. Both sides were deterred by the MAD (Mutually Assured Destruction) doctrine of nuclear wars. The costs to both sides were horrendous and it was only when the Soviet Union could not continue with the pace and cost of maintaining a nuclear deterrent and was forced into bankruptcy that the balance tilted in favour of the NATO alliance.
But it was a pyrrhic victory for the US and it allies. What kept the ability of the US to maintain its military might and outspend the Soviet Union was the right to print toilet paper currency and the acceptance of the US dollar by her allies as the world’s reserve currency.
But why did the countries allied to the US during the Cold War accepted the status quo?
Simple! They were all conned into believing that without the protection of Big Brother and its military outreach, they would be swallowed up by the communist menace. They agreed to march to the tune of the US Pied-Piper.
The next big question – why did the so-called “liberated” former communist allies of the Soviet bloc jump on the bandwagon?
Simple! They all believed in the illusion that was fostered by the global banks, led by Goldman Sachs that trading and selling their goods and services for the toilet paper US reserve currency would ensure untold wealth and prosperity.
But the biggest game in town was the Asia gambit. Japan, after a decade of recession following the burst of her property bubble did not have the means and the capacity to bring the game to the next level as envisaged by the financial architects in Goldman Sachs.
And China was the biggest beneficiary. The senior management of Goldman Sachs brokered a secret pact with China’s leaders that in exchange for orchestrating the most massive injection of US dollar capital and wholesale re-location of manufacturing capacity in the history of the global economy, China would recycle their hard-earned US toilet paper reserve currency wealth into US treasuries and other US debt instruments.
This was the necessary condition precedent for the global financial casino to rise to the next level of play.
Why?
The New Game
The financial architects at Goldman Sachs had a master plan – to dominate the global financial system. The means to achieve this financial power was the Shadow Banking System, the lynchpin being the derivative market and the securitization of assets, real and synthetic. The stakes would be huge, in the hundreds of US$ trillions and the way to transform the market was through massive leverage at all levels of the financial game.
But there was an inherent weakness in the overall scheme – the threat of inflation, more precisely hyperinflation. Such huge amounts of liquidity in the system would invariably trigger the depreciation of the reserve currency and the confidence in the system.
Hence the need for a system to keep in check price inflation and the illusion that the purchasing power of the toilet paper reserve currency could be maintained.
This is where China came in. Once China became the world’s factory, the problem would be resolved. When a suit which previously cost US$600 could be had for less than US$100, and a pair of shoes for less than US$5, the scam masterminds concluded that there would be no foreseeable threat to the largest casino operation in history.
China agreed to the exchange as it has over a billion mouths to feed and jobs for hundreds of millions needed to be secured, without which the system could not be maintained. But China was pragmatic enough to have two “economic systems” – a Yuan based domestic economy and a US$ based export economy, in the hope that the profits and benefits of the export economy would enable China to transform and establish a viable and dynamic domestic market which in time would replace the export dependent economy. It was a deal made with the devil, but there were no viable alternative options at the material time, more so after the collapse of the Soviet Union.
The Next Level of the Game
The next level of the game was reached when the toilet paper reserve currency literally went virtual – through the simple operation of a click of the mouse in the computers of the global banks.
The big boys at Goldman Sachs and other global banks were more than content to leave Las Vegas for the mafia and their miserable billions in turnover. The profits were considered dimes when compared to the hundreds of trillions generated by the virtual casino. It was a financial conquest beyond their wildest dreams. They even called themselves, “Master of the Universe”. Creating massive debts was the new game, and the big boys could even leverage more than 40 times capital! Asset values soared with so much liquidity chasing so few good assets.
However, the financial wizards failed to appreciate and or underestimate the amount of financial products that were needed to keep the game in play. They resorted to financial engineering – the securitization of assets. And when real assets were insufficient for securitization, synthetic assets were created. Soon enough, toxic waste was even considered as legitimate instruments for the game so long as it could be unloaded to greedy suckers with no recourse to the originators of these so-called investments.
For a time, it looked as if the financial wizards have solved the problem of how to feed the global casino monster.
Unfortunately, the music stopped and the bubble burst! And as they say the rest is history.
The Goldman Sachs Remedy
When losses are in the US$ trillions and whatever assets / capital remaining are in the US$ billions, we have a huge problem – a financial black-hole.
The preferred remedy by the financial masterminds at Goldman Sachs was to create another hoax – that if the big global banks were to fail triggering a systemic collapse, there would be Armageddon. These “too big to fail” banks must be injected with massive amount of virtual monies to recapitalize and get rid of the toxic assets on their balance sheet. The major central banks in the developed countries in cahoots with Goldman Sachs sang the same tune. All sorts of schemes were conjured to legitimize this bailout.
In essence, what transpired was the mere transfer of monies from the left pocket to the right pocket, with the twist that the banks were in fact helping the Government to overcome the financial crisis.
The Fed and key central banks agreed to lend “virtual monies” to the “too big to fail” global banks at zero or near zero interest rate and these banks in turn would “deposit” these monies with the Fed and other central banks at agreed interest rates. These transactions are all mere book entries. Other “loans” from the Fed and central banks (again at zero or near zero interest rates) are used to purchase government debts, these debts being the stimulus monies needed to revive the real economy and create jobs for the growing unemployed. So in essence, these banks are given “free money” to lend to the government at prior agreed interest rates with no risks at all. It is a hoax!
These “monies” are not even the dollar bills, but mere book entries created out of thin air.
So when the Fed injects US$ trillions into the banking system, it merely credits the amount in the accounts of the “too big to fail” banks at the Fed.
When the system is applied to international trade, the same modus operandi is used to pay for the goods imported from China, Japan etc.
For the rest of world, when buying goods denominated in US$, these countries must produce goods and services, sell them for dollars in order to purchase goods needed in their country. Simply put, they have to earn an income to purchase whatever goods and services needed. In contrast, all that the US needs to do is to create monies out of thin air and use them to pay for their imports!
The US can get away with this scam because it has the military muscle to compel and enforce this hoax. As stated earlier, this status quo was accepted especially during the Cold War and with some reluctance post the collapse of the Soviet Union, but with a proviso – that the US agrees to be the consumer of last resort. This arrangement provided some comfort because countries which have sold their goods to the US, can now use the dollars to buy goods from other countries as more than 80 per cent of world trade is denominated in dollars especially crude oil, the lifeline of the global economy.
But with the US in full bankruptcy and its citizens (the largest consumers in the world) being unable to borrow further monies to buy fancy goods from China, Japan and the rest of the world, the demand for dollar has evaporated. The dollar status as a reserve currency and its usefulness is being questioned more vocally.
The End Game
The present fallout can be summarized in simple terms:
Should a bankrupt country (the US) be allowed to use money created out of thin air to pay for goods produced with the sweat and tears of hardworking citizens of exporting countries? Adding insult to injury, the same dollars are now purchasing a lot less than before. So what is the use of being paid in a currency that is losing rapidly its value?
On the other hand, the US is telling the whole world, especially the Chinese that if they are not happy with the status quo, there is nothing to stop them from selling to the other countries and accepting their currencies. But if they want to sell to the mighty USA, they must accept US toilet paper reserve currency and its right to create monies out of thin air!
This is the ultimate poker game and whosoever blinks first loses and will suffer irreparable financial consequences. But who has the winning hand?
The US does not have the winning hand. Neither has China the winning hand.
This state of affairs cannot continue for long, for whatever cards the US or China may be contemplating to throw at the table to gain strategic advantage, any short term gains will be pyrrhic, for it will not be able to address the underlying antagonistic contradictions.
When the survival of the system is dependent on the availability of credit (i.e. accumulating more debts) it is only a matter of time before both the debtor and creditor come to the inevitable conclusion that the debt will never be paid. And unless the creditor is willing to write off the debt, resorting to drastic means to collect the outstanding debt is inevitable.
It would be naïve to think that the US would quietly allow itself to be foreclosed! When we reach that stage, war will be inevitable. It will be the US-UK-Israel Axis against the rest of the world.
The Prelude to the End Game
The US economy will be spiraling out of control in the coming months and will reach critical point by the end of the 1st quarter 2010 and implode by the 2nd quarter.
The massive US$ trillions of dollars stimulus has failed to turn the economy around. The massive blood transfusion may have kept the patient alive, but there are numerous signs of multi-organ failure.
There will be another wave of foreclosures of residential and more importantly commercial properties by end December and early 2010. And the foreclosed properties in 2009 will lead to depressed prices once they come through the pipeline. Home and commercial property values will plunge. Banks’ balance sheets will turn ugly and whatever “record profits” in the last two quarters of 2009 will not cover the additional red ink.
Given the above situation, will the Fed continue to buy mortgage-backed securities to prop up the markets? The Fed has already spent trillions buying Fannie Mae and Freddie Mac mortgages with no potential substitute buyer in sight. Therefore, the Fed’s balance sheet is as toxic as the “too big to fail” banks that it rescued.
In the circumstances, it makes no sense for anyone to assert that the worst is over and that the global economy is on the road to recovery.
And the surest sign that all is not well with the big banks is the recent speech by the President of the Federal Reserve Bank of New York, William Dudley at Princeton, New Jersey when he said that the Fed would curtail the risk of future liquidity crisis by providing a “backstop” to solvent firms with sufficient collateral.
This warning and assurance deserves further consideration. Firstly, it is a contradiction to state that a solvent firm with sufficient collateral would in fact encounter a liquidity crisis to warrant the need for a fall back on the Fed. It is in fact an admission that banks are not sufficiently capitalized and when the second wave of the tsunami hits them again, confidence will be sorely lacking.
Dudley actually said that, “the central bank could commit to being the lender of last resort... [and this would reduce] the risk of panics sparked by uncertainty among lenders about what other creditors think”.
To put it bluntly what he is saying is that the Fed will endeavour to avoid the repeat of the collapse of Bear Stearns, Lehman Bros and AIG. It is also an indication that the remaining big banks are in trouble.
It is interesting to note that a Bloomberg report in early November revealed that Citigroup Inc and JP Morgan Chase have been hoarding cash. The former has almost doubled its cash holdings to US$244.2 billion. In the case of the latter, the cash hoard amounted to US$453.6 billion. Yet, given this hoarding by the leading banks, the New York Federal Reserve Bank had to reassure the financial community that it is ready to inject massive liquidity to prop up the system.
It should come as no surprise that the value of the dollar is heading south.
When currencies are being debased, volatility in the stock market increases. But the gains are not worth the risks and if anyone is still in the market, they will be wiped out by the 1st quarter of 2010. The S&P may have shot up since the beginning of the year by over 25 per cent but it has been out-performed by gold. The gains have also lagged behind the official US inflation rate. It has in fact delivered a total return after inflation of approximately minus 25 per cent. When Meredith Whitney remarked that, “I don’t know what’s going on in the market right now, because it makes no sense to me”, it is time to get out of the market fast.
In a report to its clients, Société Générale warned that public debt would be massive in the next two years – 105 per cent of GDP in the UK, 125 per cent in the US and in Europe and 270 per cent in Japan. Global debt would reach US$45 trillion.
At some point in time, all these debts must be repaid. How will these debts be repaid?
If we go by what Bernanke has been preaching and practising, it means more toilet paper currency will be created to repay the debts.
As a result, debasement of currencies will continue and this will further aggravate existing tensions between the competing economies. And when creditors have enough of this toilet paper scam, expect violent reactions!
by Matthias Chang
Many of my friends who have been receiving my e-mail alerts over the last two years have lamented that in recent weeks I have not commented on the state of the global economy. I appreciate their anxiety but they forget that I am not a stock market analyst who is paid to write articles to lure investors back into the market. My website is free and I do not sell a financial newsletter so there is no need for me to churn out daily forecasts or analysis.
However, when the data is compelling and supports an inevitable trend, it is time for another review. This Red Alert is to enable visitors to my website to take appropriate actions to safeguard their wealth and welfare of their families in the coming months.
Since the last quarter of 2008, unrelenting currency warfare has been waged by the key global economies and while this competition thus far has been non-antagonistic, it will soon be antagonistic because the inherent differences are irreconcilable. The consequences to the global economy will be devastating and for the ordinary people, massive unemployment and social unrest are assured.
The policy-makers of these countries faced with the total collapse of the international financial architecture have concluded that the solution, the only solution is quantitative easing (i.e. massive injection of liquidity) to salvage the “too big to fail” banks and reflate their depressed economies. This is best reflected in Bernanke’s candid remark that, “the US government has a technology, called the printing press (or today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost”.
This is the crux of the problem!
The Irreconcilable Differences
Some two decades ago, it was decided by the global financial elites that the framework for the global economy shall consist of:
1) A global derivative-based financial system, controlled by the US Federal Reserve Bank and its associate global banks in the developed countries.
2) The re-location from the West to the East in the production of goods, principally to China and India to “feed” the developed economies.
The entire system was built on a simple principle, that of a FED-controlled global reserve currency which will be the engine for growth for the global economy. It is essentially an imperialist economic principle.
Once we grasp this fundamental truth, Bernanke’s boast that the “US can produce as many US dollars as it wishes at no cost” takes on a different dimension.
I have talked to so many economists and when asked what is the crux of the present financial problem, they all respond in unison, “it is the global imbalances... the West consumes too much while the East saves too much and consumes not enough”. This is exemplified by the huge US trade deficits on the one part and China’s massive surpluses on the other.
Incredible wisdom and almost everyone echoes this mantra. The recent concluded APEC Summit was no different. This mantra was repeated as well as the call for freer trade between trading nations.
This is a grand hoax. All the current leaders on the world’s stage are corrupted to the rotten core and as such have no interest to call a spade a spade and expose the inherent contradictions within the existing financial system.
The call for a multi-polar world is meaningless when the entire global financial system is based on the unipolar US dollar reserve currency. This is the inherent contradiction within the present system and the problems associated with it cannot be resolved by another global reserve currency based on the IMF’s Special Drawing Rights as advocated by some countries. It was stillborn, the very moment it was conceived!
The leaders of China, Japan and the oil producing countries of the Middle East are all cursing and pissing about the current situation, but they don’t have the courage of their convictions to spell it out to their countrymen that they have been conned by the financial spin masters from the Fed acting on the instructions from Goldman Sachs.
Tell me which leader would dare admit that they have exchanged the nation’s wealth for toilet papers?
The toilet paper currency pantomime continues.
We have now reached a stalemate in the current currency war, not unlike the situation of the Cold War between the NATO pact countries and the Warsaw pact countries. Both sides were deterred by the MAD (Mutually Assured Destruction) doctrine of nuclear wars. The costs to both sides were horrendous and it was only when the Soviet Union could not continue with the pace and cost of maintaining a nuclear deterrent and was forced into bankruptcy that the balance tilted in favour of the NATO alliance.
But it was a pyrrhic victory for the US and it allies. What kept the ability of the US to maintain its military might and outspend the Soviet Union was the right to print toilet paper currency and the acceptance of the US dollar by her allies as the world’s reserve currency.
But why did the countries allied to the US during the Cold War accepted the status quo?
Simple! They were all conned into believing that without the protection of Big Brother and its military outreach, they would be swallowed up by the communist menace. They agreed to march to the tune of the US Pied-Piper.
The next big question – why did the so-called “liberated” former communist allies of the Soviet bloc jump on the bandwagon?
Simple! They all believed in the illusion that was fostered by the global banks, led by Goldman Sachs that trading and selling their goods and services for the toilet paper US reserve currency would ensure untold wealth and prosperity.
But the biggest game in town was the Asia gambit. Japan, after a decade of recession following the burst of her property bubble did not have the means and the capacity to bring the game to the next level as envisaged by the financial architects in Goldman Sachs.
And China was the biggest beneficiary. The senior management of Goldman Sachs brokered a secret pact with China’s leaders that in exchange for orchestrating the most massive injection of US dollar capital and wholesale re-location of manufacturing capacity in the history of the global economy, China would recycle their hard-earned US toilet paper reserve currency wealth into US treasuries and other US debt instruments.
This was the necessary condition precedent for the global financial casino to rise to the next level of play.
Why?
The New Game
The financial architects at Goldman Sachs had a master plan – to dominate the global financial system. The means to achieve this financial power was the Shadow Banking System, the lynchpin being the derivative market and the securitization of assets, real and synthetic. The stakes would be huge, in the hundreds of US$ trillions and the way to transform the market was through massive leverage at all levels of the financial game.
But there was an inherent weakness in the overall scheme – the threat of inflation, more precisely hyperinflation. Such huge amounts of liquidity in the system would invariably trigger the depreciation of the reserve currency and the confidence in the system.
Hence the need for a system to keep in check price inflation and the illusion that the purchasing power of the toilet paper reserve currency could be maintained.
This is where China came in. Once China became the world’s factory, the problem would be resolved. When a suit which previously cost US$600 could be had for less than US$100, and a pair of shoes for less than US$5, the scam masterminds concluded that there would be no foreseeable threat to the largest casino operation in history.
China agreed to the exchange as it has over a billion mouths to feed and jobs for hundreds of millions needed to be secured, without which the system could not be maintained. But China was pragmatic enough to have two “economic systems” – a Yuan based domestic economy and a US$ based export economy, in the hope that the profits and benefits of the export economy would enable China to transform and establish a viable and dynamic domestic market which in time would replace the export dependent economy. It was a deal made with the devil, but there were no viable alternative options at the material time, more so after the collapse of the Soviet Union.
The Next Level of the Game
The next level of the game was reached when the toilet paper reserve currency literally went virtual – through the simple operation of a click of the mouse in the computers of the global banks.
The big boys at Goldman Sachs and other global banks were more than content to leave Las Vegas for the mafia and their miserable billions in turnover. The profits were considered dimes when compared to the hundreds of trillions generated by the virtual casino. It was a financial conquest beyond their wildest dreams. They even called themselves, “Master of the Universe”. Creating massive debts was the new game, and the big boys could even leverage more than 40 times capital! Asset values soared with so much liquidity chasing so few good assets.
However, the financial wizards failed to appreciate and or underestimate the amount of financial products that were needed to keep the game in play. They resorted to financial engineering – the securitization of assets. And when real assets were insufficient for securitization, synthetic assets were created. Soon enough, toxic waste was even considered as legitimate instruments for the game so long as it could be unloaded to greedy suckers with no recourse to the originators of these so-called investments.
For a time, it looked as if the financial wizards have solved the problem of how to feed the global casino monster.
Unfortunately, the music stopped and the bubble burst! And as they say the rest is history.
The Goldman Sachs Remedy
When losses are in the US$ trillions and whatever assets / capital remaining are in the US$ billions, we have a huge problem – a financial black-hole.
The preferred remedy by the financial masterminds at Goldman Sachs was to create another hoax – that if the big global banks were to fail triggering a systemic collapse, there would be Armageddon. These “too big to fail” banks must be injected with massive amount of virtual monies to recapitalize and get rid of the toxic assets on their balance sheet. The major central banks in the developed countries in cahoots with Goldman Sachs sang the same tune. All sorts of schemes were conjured to legitimize this bailout.
In essence, what transpired was the mere transfer of monies from the left pocket to the right pocket, with the twist that the banks were in fact helping the Government to overcome the financial crisis.
The Fed and key central banks agreed to lend “virtual monies” to the “too big to fail” global banks at zero or near zero interest rate and these banks in turn would “deposit” these monies with the Fed and other central banks at agreed interest rates. These transactions are all mere book entries. Other “loans” from the Fed and central banks (again at zero or near zero interest rates) are used to purchase government debts, these debts being the stimulus monies needed to revive the real economy and create jobs for the growing unemployed. So in essence, these banks are given “free money” to lend to the government at prior agreed interest rates with no risks at all. It is a hoax!
These “monies” are not even the dollar bills, but mere book entries created out of thin air.
So when the Fed injects US$ trillions into the banking system, it merely credits the amount in the accounts of the “too big to fail” banks at the Fed.
When the system is applied to international trade, the same modus operandi is used to pay for the goods imported from China, Japan etc.
For the rest of world, when buying goods denominated in US$, these countries must produce goods and services, sell them for dollars in order to purchase goods needed in their country. Simply put, they have to earn an income to purchase whatever goods and services needed. In contrast, all that the US needs to do is to create monies out of thin air and use them to pay for their imports!
The US can get away with this scam because it has the military muscle to compel and enforce this hoax. As stated earlier, this status quo was accepted especially during the Cold War and with some reluctance post the collapse of the Soviet Union, but with a proviso – that the US agrees to be the consumer of last resort. This arrangement provided some comfort because countries which have sold their goods to the US, can now use the dollars to buy goods from other countries as more than 80 per cent of world trade is denominated in dollars especially crude oil, the lifeline of the global economy.
But with the US in full bankruptcy and its citizens (the largest consumers in the world) being unable to borrow further monies to buy fancy goods from China, Japan and the rest of the world, the demand for dollar has evaporated. The dollar status as a reserve currency and its usefulness is being questioned more vocally.
The End Game
The present fallout can be summarized in simple terms:
Should a bankrupt country (the US) be allowed to use money created out of thin air to pay for goods produced with the sweat and tears of hardworking citizens of exporting countries? Adding insult to injury, the same dollars are now purchasing a lot less than before. So what is the use of being paid in a currency that is losing rapidly its value?
On the other hand, the US is telling the whole world, especially the Chinese that if they are not happy with the status quo, there is nothing to stop them from selling to the other countries and accepting their currencies. But if they want to sell to the mighty USA, they must accept US toilet paper reserve currency and its right to create monies out of thin air!
This is the ultimate poker game and whosoever blinks first loses and will suffer irreparable financial consequences. But who has the winning hand?
The US does not have the winning hand. Neither has China the winning hand.
This state of affairs cannot continue for long, for whatever cards the US or China may be contemplating to throw at the table to gain strategic advantage, any short term gains will be pyrrhic, for it will not be able to address the underlying antagonistic contradictions.
When the survival of the system is dependent on the availability of credit (i.e. accumulating more debts) it is only a matter of time before both the debtor and creditor come to the inevitable conclusion that the debt will never be paid. And unless the creditor is willing to write off the debt, resorting to drastic means to collect the outstanding debt is inevitable.
It would be naïve to think that the US would quietly allow itself to be foreclosed! When we reach that stage, war will be inevitable. It will be the US-UK-Israel Axis against the rest of the world.
The Prelude to the End Game
The US economy will be spiraling out of control in the coming months and will reach critical point by the end of the 1st quarter 2010 and implode by the 2nd quarter.
The massive US$ trillions of dollars stimulus has failed to turn the economy around. The massive blood transfusion may have kept the patient alive, but there are numerous signs of multi-organ failure.
There will be another wave of foreclosures of residential and more importantly commercial properties by end December and early 2010. And the foreclosed properties in 2009 will lead to depressed prices once they come through the pipeline. Home and commercial property values will plunge. Banks’ balance sheets will turn ugly and whatever “record profits” in the last two quarters of 2009 will not cover the additional red ink.
Given the above situation, will the Fed continue to buy mortgage-backed securities to prop up the markets? The Fed has already spent trillions buying Fannie Mae and Freddie Mac mortgages with no potential substitute buyer in sight. Therefore, the Fed’s balance sheet is as toxic as the “too big to fail” banks that it rescued.
In the circumstances, it makes no sense for anyone to assert that the worst is over and that the global economy is on the road to recovery.
And the surest sign that all is not well with the big banks is the recent speech by the President of the Federal Reserve Bank of New York, William Dudley at Princeton, New Jersey when he said that the Fed would curtail the risk of future liquidity crisis by providing a “backstop” to solvent firms with sufficient collateral.
This warning and assurance deserves further consideration. Firstly, it is a contradiction to state that a solvent firm with sufficient collateral would in fact encounter a liquidity crisis to warrant the need for a fall back on the Fed. It is in fact an admission that banks are not sufficiently capitalized and when the second wave of the tsunami hits them again, confidence will be sorely lacking.
Dudley actually said that, “the central bank could commit to being the lender of last resort... [and this would reduce] the risk of panics sparked by uncertainty among lenders about what other creditors think”.
To put it bluntly what he is saying is that the Fed will endeavour to avoid the repeat of the collapse of Bear Stearns, Lehman Bros and AIG. It is also an indication that the remaining big banks are in trouble.
It is interesting to note that a Bloomberg report in early November revealed that Citigroup Inc and JP Morgan Chase have been hoarding cash. The former has almost doubled its cash holdings to US$244.2 billion. In the case of the latter, the cash hoard amounted to US$453.6 billion. Yet, given this hoarding by the leading banks, the New York Federal Reserve Bank had to reassure the financial community that it is ready to inject massive liquidity to prop up the system.
It should come as no surprise that the value of the dollar is heading south.
When currencies are being debased, volatility in the stock market increases. But the gains are not worth the risks and if anyone is still in the market, they will be wiped out by the 1st quarter of 2010. The S&P may have shot up since the beginning of the year by over 25 per cent but it has been out-performed by gold. The gains have also lagged behind the official US inflation rate. It has in fact delivered a total return after inflation of approximately minus 25 per cent. When Meredith Whitney remarked that, “I don’t know what’s going on in the market right now, because it makes no sense to me”, it is time to get out of the market fast.
In a report to its clients, Société Générale warned that public debt would be massive in the next two years – 105 per cent of GDP in the UK, 125 per cent in the US and in Europe and 270 per cent in Japan. Global debt would reach US$45 trillion.
At some point in time, all these debts must be repaid. How will these debts be repaid?
If we go by what Bernanke has been preaching and practising, it means more toilet paper currency will be created to repay the debts.
As a result, debasement of currencies will continue and this will further aggravate existing tensions between the competing economies. And when creditors have enough of this toilet paper scam, expect violent reactions!
Wednesday, 14 October 2009
What Determines Oil Prices?
What Determines Oil Prices?
by Paul Kosakowski
With each passing year, oil seems to play an even greater role in the global economy. In the early days, finding oil during a drill was considered somewhat of a nuisance as the intended treasures were normally water or salt. It wasn't until 1857 that the first commercial oil well was drilled in Romania. The U.S. petroleum industry was born two years later with an intentional drilling in Titusville, Pa.
While much of the early demand for oil was for kerosene and oil lamps, it wasn't until 1901 that the first commercial well capable of mass production was drilled at a site known as Spindletop in southeastern Texas. This site produced more than 10,000 barrels of oil per day, more than all the other oil-producing wells in the U.S. combined. Many would argue that the modern oil era was born that day in 1901, as oil was soon to replace coal as the world's primary fuel source. Oil's use in fuels continues to be the primary factor in making it a high-demand commodity around the globe, but how are prices determined? Read on to find out. (For more, read Oil And Gas Industry Primer.)
The Determinants of Oil Prices
With oil's stature as a high-demand global commodity comes the possibility that major fluctuations in price can have a significant economic impact. The two primary factors that impact the price of oil are:
supply and demand
market sentiment
The concept of supply and demand is fairly straightforward. As demand increases (or supply decreases) the price should go up. As demand decreases (or supply increases) the price should go down. Sound simple? (For background reading, see Economics Basics: Demand And Supply.)
Not quite. The price of oil as we know it is actually set in the oil futures market. An oil futures contract is a binding agreement that gives one the right to purchase oil by the barrel at a predefined price on a predefined date in the future. Under a futures contract, both the buyer and the seller are obligated to fulfill their side of the transaction on the specified date.
The following are two types of futures traders:
hedgers
speculators
An example of a hedger would be an airline buying oil futures to guard against potential rising prices. An example of a speculator would be someone who is just guessing the price direction and has no intention of actually buying the product. According to the Chicago Mercantile Exchange (CME), the majority of futures trading is done by speculators as less than 3% of transactions actually result in the purchaser of a futures contract taking possession of the commodity being traded.
The other key factor in determining oil prices is sentiment. The mere belief that oil demand will increase dramatically at some point in the future can result in a dramatic increase in oil prices in the present as speculators and hedgers alike snap up oil futures contracts. Of course, the opposite is also true. The mere belief that oil demand will decrease at some point in the future can result in a dramatic decrease in prices in the present as oil futures contracts are sold (possibly sold short as well).
Additionally, from a historical perspective, there appears to be a possible 29-year (plus or minus one or two years) cycle that governs the behavior of commodity prices in general. Since the beginning of oil's rise as a high-demand commodity in the early 1900s, major peaks in the commodities index have occurred in 1920, 1951 and 1980. Oil peaked with the commodities index in both 1920 and 1980. (Note: there was no real peak in oil in 1951 because it had been moving in a sideways trend since 1948 and continued to do so through 1968.) If this cycle remains valid, many commodities, including oil, may exhibit some downward price pressure during the period 2008 through 2010 , with the next potential top thereafter occurring during the period 2037 thru 2039. It is important to note that supply, demand and sentiment take precedence over cycles because cycles are just guidelines, not rules. (Find out how to invest and protect your investments in this slippery sector in Peak Oil: What To Do When The Well Runs Dry.)
If one wishes to pursue his or her education of oil beyond this brief introduction, recommended educational material on oil can be obtained directly from OPEC. Information on the oil futures market can be obtained through the CME.
Conclusion
Unlike most products, oil prices are not determined entirely by supply, demand and market sentiment toward the physical product. Rather, supply, demand and sentiment toward oil futures contracts, which are traded heavily by speculators, play a dominant role in price determination. Cyclical trends in the commodities market may also play a role. Regardless of how the price is ultimately determined, based on it's use in fuels and countless consumer goods, it appears that oil will continue to be in high demand for the foreseeable future.
by Paul Kosakowski
With each passing year, oil seems to play an even greater role in the global economy. In the early days, finding oil during a drill was considered somewhat of a nuisance as the intended treasures were normally water or salt. It wasn't until 1857 that the first commercial oil well was drilled in Romania. The U.S. petroleum industry was born two years later with an intentional drilling in Titusville, Pa.
While much of the early demand for oil was for kerosene and oil lamps, it wasn't until 1901 that the first commercial well capable of mass production was drilled at a site known as Spindletop in southeastern Texas. This site produced more than 10,000 barrels of oil per day, more than all the other oil-producing wells in the U.S. combined. Many would argue that the modern oil era was born that day in 1901, as oil was soon to replace coal as the world's primary fuel source. Oil's use in fuels continues to be the primary factor in making it a high-demand commodity around the globe, but how are prices determined? Read on to find out. (For more, read Oil And Gas Industry Primer.)
The Determinants of Oil Prices
With oil's stature as a high-demand global commodity comes the possibility that major fluctuations in price can have a significant economic impact. The two primary factors that impact the price of oil are:
supply and demand
market sentiment
The concept of supply and demand is fairly straightforward. As demand increases (or supply decreases) the price should go up. As demand decreases (or supply increases) the price should go down. Sound simple? (For background reading, see Economics Basics: Demand And Supply.)
Not quite. The price of oil as we know it is actually set in the oil futures market. An oil futures contract is a binding agreement that gives one the right to purchase oil by the barrel at a predefined price on a predefined date in the future. Under a futures contract, both the buyer and the seller are obligated to fulfill their side of the transaction on the specified date.
The following are two types of futures traders:
hedgers
speculators
An example of a hedger would be an airline buying oil futures to guard against potential rising prices. An example of a speculator would be someone who is just guessing the price direction and has no intention of actually buying the product. According to the Chicago Mercantile Exchange (CME), the majority of futures trading is done by speculators as less than 3% of transactions actually result in the purchaser of a futures contract taking possession of the commodity being traded.
The other key factor in determining oil prices is sentiment. The mere belief that oil demand will increase dramatically at some point in the future can result in a dramatic increase in oil prices in the present as speculators and hedgers alike snap up oil futures contracts. Of course, the opposite is also true. The mere belief that oil demand will decrease at some point in the future can result in a dramatic decrease in prices in the present as oil futures contracts are sold (possibly sold short as well).
Additionally, from a historical perspective, there appears to be a possible 29-year (plus or minus one or two years) cycle that governs the behavior of commodity prices in general. Since the beginning of oil's rise as a high-demand commodity in the early 1900s, major peaks in the commodities index have occurred in 1920, 1951 and 1980. Oil peaked with the commodities index in both 1920 and 1980. (Note: there was no real peak in oil in 1951 because it had been moving in a sideways trend since 1948 and continued to do so through 1968.) If this cycle remains valid, many commodities, including oil, may exhibit some downward price pressure during the period 2008 through 2010 , with the next potential top thereafter occurring during the period 2037 thru 2039. It is important to note that supply, demand and sentiment take precedence over cycles because cycles are just guidelines, not rules. (Find out how to invest and protect your investments in this slippery sector in Peak Oil: What To Do When The Well Runs Dry.)
If one wishes to pursue his or her education of oil beyond this brief introduction, recommended educational material on oil can be obtained directly from OPEC. Information on the oil futures market can be obtained through the CME.
Conclusion
Unlike most products, oil prices are not determined entirely by supply, demand and market sentiment toward the physical product. Rather, supply, demand and sentiment toward oil futures contracts, which are traded heavily by speculators, play a dominant role in price determination. Cyclical trends in the commodities market may also play a role. Regardless of how the price is ultimately determined, based on it's use in fuels and countless consumer goods, it appears that oil will continue to be in high demand for the foreseeable future.
Tuesday, 8 July 2008
Banking: Why India's different from the US
One of the points made about the US sub-prime crisis is that its roots lie in the enhanced efforts towards financial inclusion in the form of bringing sub-prime borrowers within the ambit of the financial services industry.
While there is extensive literature to show the crisis was triggered by the combination of under-pricing risk, complex financial engineering and a poor regulatory framework, the key to financial inclusion lies in adopting a two-pronged strategy:
First, fostering institution building, product and policy innovation capable of handling the "informationally opaque" borrowers, especially small businesses and farmers - borrowers without long credit histories suitable for credit-scoring; secondly, promoting of financial literacy and education to reduce information asymmetry itself to enable an expansion of mainstream credit markets with increasing participation by the excluded.
The Indian banking sector has acquired a greater degree of resilience due, inter alia, to the financial reforms implemented in a gradual and sequential manner within a participative process aimed at reduction in statutory preemptions, while stepping up prudential regulations and adopting international best practices taking into account the India-specific conditions at the same time.
An assessment of the banking sector performance shows that banks in India have experienced strong balance sheet growth in the post-reform period in an environment of operational flexibility. Improvement in the financial health of banks, reflected in significant improvement in capital adequacy and improved asset quality, is distinctly visible.
These significant gains have been achieved even while renewing our goals of social banking viz, maintaining the wide reach of the banking system and directing credit towards important but disadvantaged sectors of society. Thus, financial inclusion has been an integral part of the overall economic thinking, though this emphasis has acquired enhanced visibility in the recent years.
The financial inclusion model followed in India is aimed at providing access to formal banking to a large section of socially and economically excluded segment of population and improving its social/economic status.
The amounts involved are very small and spread over large geographical areas over large number of banks/financial institutions and do not involve any complex financial instruments. Thus, the argument that financial inclusion is fraught with the danger of jeopardising the financial system is not true in the Indian context, as is enumerated below:
The evolving Indian paradigm for financial inclusion, though not having any statutory backing, embodies various novel ingredients enumerated above. Making affordable financial services available to the un/under-served has been the cornerstone of the evolution underlying institutional development, product and policy innovation in India.
The Indian banking system is multilayered, comprising 82 scheduled commercial banks (SCBs), 92 regional rural banks (RRBs), 4 local area banks (LABs), 1,813 urban co-operative banks (UCBs) and 107,497 rural co-operative credit institutions.
The self-help-group bank linkage programme, adoption of Business Correspondent Model leveraging the post offices and setting up the Banking Codes and Standards Board of India (BCSBI) are illustrations of institutional creativity crafted to Indian conditions. The branch licensing policy followed by the RBI has an inclusive bias, while taking care of the viability aspects.
The involvement of the State Level Bankers' Committee (SLBC), simplification of know-your-customer (KYC) norms, introduction of the Banking Ombudsman Scheme and no-frills accounts (number of such accounts, which was less than half a million in March-end 2006 and rose to 7 million a year later, jumped to about 13 million by the end of December 2007), and Financial Sector Plan for North Eastern Region are the manifestation of inclusive centric-policy initiatives.
Yet, only 27 per cent of farm households are indebted to formal sources (of which one-third also borrow from informal sources). Thus, there is a huge unfinished agenda. However, India has the advantage of suitable infrastructure (institutions, products and policies) for scaling up efforts for financial inclusion in a big way.
The most effective catalyst for financial exclusion is economic development. Finance follows economics. Hence, there is a need for the financially excluded districts to catch up with the rest.
Nevertheless, in a wider canvas, micro finance, micro insurance, new delivery channels, and credit counselling would have to be integrated. For better outcomes, there has to be joint and concerted efforts on the part of the Government, the formal financial sector, voluntary organisations and SHGs. More focused attention on various fronts is called for.
There has been a measured streamlining of the banking architecture over the years, including refocusing the SCBs, consolidating RRBs and revamping the co-operatives. However, the LABs are not able to make significant headway in terms of redeeming their mandate.
The Rangarajan Committee on Financial Inclusion has recommended that the RBI may consider revisiting the LABs, in view of their inherent potential for ushering in financial institution. Thus, any blueprint for restructuring LABs needs to mitigate their inherent weaknesses such as meagre capital, restrictions on geographical jurisdiction, etc.
Recognising the fact that only 27 per cent of the eligible rural farming population has access to the formal banking system, the RBI has instructed banks to open a no frills account with zero or very low minimum balance.
Such a basic bank account should be supplemented by an account which has the potential for generating income, maybe linking up with SHGs. The role of SLBCs in furthering financial inclusion may be augmented by extending its coverage to all districts (from the current stipulation of one district) in a timebound manner.
The scope of collaboration of public, private and non-profit organisations for designing and conducting the financial education programmes could be explored. Leveraging IT for scaling up has to be top priority.
A National Rural Financial Inclusion Plan (NRFIP) may be launched with a clear target to provide access to comprehensive financial services, including credit, to at least 50 per cent of financially excluded households, say, 55.77 million, by 2012 through rural/semi-urban branches of commercial banks and regional rural banks.
The remaining households, with such shifts as may occur in the rural/urban population, have to be covered by 2015.
The latest Budget has announced certain measures incorporating some of these suggestions. As regards supporting funding costs in the initial stages, the Rangarajan Committee recommended two funds with Nabard namely, the Financial Inclusion Promotion & Development Fund and the Financial Inclusion Technology Fund with an initial corpus of Rs 500 crore (Rs 5 billion) each to be contributed in equal proportion by the central government/RBI /Nabard (these funds have since been set up).
To sum up, the evolving paradigm for financial inclusion in India does not have any resemblance to the US sub-prime crisis and efforts directed to achieve financial inclusion India do not possess the adverse potential for jeopardising the Indian financial/banking system. On the contrary, financial inclusion will enhance the viability of the banking sector through a process of deepening.
(Adopted from Web)
Wednesday, 25 July 2007
How do foreign companies invest in India?
What is foreign investment? How does a foreign company invest in India? What are the rules applicable to Resident and Non-Resident Indians when it comes to foreign investment? If you have doubts on any of these or more questions, read on:
I - Foreign Direct Investment
1. What are the forms in which business can be conducted by a foreign company in India?
A foreign company planning to set up business operations in India has the following options:
• As an incorporated entity by incorporating a company under the Companies Act, 1956 through
• Joint ventures; or
• Wholly owned subsidiaries
• As an office of a foreign entity through
• Liaison Office / Representative Office
• Project Office
• Branch Office
Such offices can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office or other place of business) Regulations, 2000.
2. How does a foreign company invest in India? What are the regulations pertaining to issue of shares by Indian companies to foreign collaborators/investors?
Automatic Route
FDI up to 100% is allowed under the automatic route in all activities/sectors except the following which require prior approval of the government:
• i) where provisions of Press Note 1 (2005 Series) issued by the Government of India are attracted.
• ii) where more than 24% foreign equity is proposed to be inducted for manufacture of items reserved for the Small Scale sector.
• iii) FDI in sectors/activities to the extent permitted under Automatic Route does not require any prior approval either by the government or the Reserve Bank of India].
• iv) The investors are only required to notify the Regional Office concerned of the Reserve Bank of India within 30 days of receipt of inward remittances and file the required documents along with form FC-GPR with that Office within 30 days of issue of shares to the non-resident investors.
Government Route
FDI in activities not covered under the automatic route requires prior Government approval and are considered by the Foreign Investment Promotion Board (FIPB), Ministry of Finance. Application can be made in Form FC-IL, which can be downloaded from www.dipp.gov.in. Plain paper applications carrying all relevant details are also accepted. No fee is payable.
General permission of RBI under FEMA
Indian companies having foreign investment approval through FIPB route do not require any further clearance from the Reserve Bank of India for receiving inward remittance and issue of shares to the non-resident investors. The companies are required to notify the concerned regional office of the Reserve Bank of India of receipt of inward remittances within 30 days of such receipt and submit form FC-GPR within 30 days of issue of shares to the non-resident investors.
3. Which are the sectors where FDI is not allowed in India, under the Automatic Route as well as Government Route?
FDI is prohibited under Government as well as Automatic Route for the following sectors:
• i) Retail Trading (except single brand product retailing)
• ii) Atomic Energy
• iii) Lottery Business
• iv) Gambling and Betting
• v) Business of Chit Fund
• vi) Nidhi Company
• vii) Agricultural or plantation activities (cf Notification No. FEMA 94/2003-RB dated June 18, 2003).
• viii) Housing and real estate business (except development of townships, construction of residential/commercial premises, roads or bridges to the extent specified in Notification No. FEMA 136/2005-RB dated July 19, 2005 )
• ix) Trading in Transferable Development Rights (TDRs).
4. What should be done after investment is made under the Automatic Route or with Government approval?
A two-stage reporting procedure has been introduced for this purpose.
• On receipt of money for investment:
• Within 30 days of receipt of money from the non-resident investor, the Indian company will report to the regional office of the Reserve Bank of India, under whose jurisdiction its registered office is located, containing details such as:
• Name and address of the foreign investor/s
• Date of receipt of funds and their rupee equivalent
• Name and address of the authorised dealer through whom the funds have been received, and
• Details of the Government approval, if any.
• Upon issue of shares to non-resident investors:
• Within 30 days from the date of issue of shares, a report in Form FC-GPR, PART A together with the following documents should be filed with the concerned regional office of the Reserve Bank of India.
• Certificate from the company secretary of the company accepting investment from persons resident outside India certifying that;
• The company has complied with the procedure for issue of shares as laid down under the FDI scheme as indicated in the notification no. FEMA 20/2000-RB dated 3rd May 2000 as amended from time to time
• The proposal is within the sectoral policy / cap permissible under the automatic route of RBI and it fulfills all the conditions laid down for investments under the Automatic approval route namely
a) Non-resident entity/ies (other than individuals) to whom it has issued shares does / do not have any existing joint venture or technology transfer or trade mark agreement in India in the same field.
b) The company is not investing in an SSI unit & the investment limit of 24 % has been observed/ requisite approvals have been obtained.
c) Shares have been issued on rights basis and the shares are issued to non-residents at a price that is not lower than that at which shares are/were issued to residents.
OR
d) Shares issued are bonus shares.
OR
e) Shares have been issued under a scheme of merger and amalgamation of two or more Indian companies or reconstruction by way of demerger or otherwise of an Indian company, duly approved by a court in India.
• Shares have been issued in terms of SIA/FIPB approval No. --------------------- dated --------------------
• Certificate from statutory auditors or chartered accountant indicating the manner of arriving at the price of the shares issued to the persons resident outside India.
5. What are the guidelines for transfer of existing shares from non-residents to residents or residents to non-residents?
Transfer from Non-Resident to Resident:
The term 'transfer' is defined under FEMA as including "sale, purchase, acquisition, mortgage, pledge, gift, loan or any other form of transfer of right, possession or lien."
The FEMA Regulations give specific permission covering the following forms of transfer i.e. transfer by way of sale and gift. These permissions are discussed below:
A: Transfer by way of sale:
A person resident outside India can freely transfer share/convertible debenture by way of sale to a person resident in India as under:
• Any person resident outside India (other than NRIs/OCBs) can transfer by way of sale the shares/convertible debentures to any person resident outside India; subject to the condition that the acquirer or transferee does not have any previous venture or tie up in India in the same field or sector.
• A non-resident Indian (NRI) or an erstwhile Overseas Corporate Body may transfer by way of sale, the shares/convertible debentures held by him to another NRI only.
• Any person resident outside India may sell share/convertible debenture acquired in accordance with FEMA Regulations, on a recognized Stock Exchange in India through a registered broker.
B: Transfer by way of Gift:
A person resident outside India can freely transfer share/convertible debenture by way of gift to a person resident in India as under:
• Any person resident outside India, (not being a non-resident Indian or an erstwhile overseas corporate body), can transfer by way of gift the shares/convertible debentures to any person resident outside India; subject to the condition that the acquirer or transferee does not have any previous venture or tie up in India in the same field or sector.
• A non-resident Indian (NRI) may transfer by way of gift, the shares/convertible debentures held by him to another NRI only.
• Any person resident outside India may transfer share/convertible debenture to a person resident in India by way of gift.
Transfer from Resident to Non-Resident:
A: Transfer by way of sale - General Permission under Regulation 10 of Notification No. FEMA 20/2000-RB dated May 3, 2000.
• A person resident in India may transfer to a person resident outside India any share/convertible debenture of an Indian company whose activities fall under the Automatic Route for FDI subject to the sectoral limits, by way of sale subject to complying with pricing guidelines, documentation and reporting requirements for such transfers, as may be specified by the Reserve Bank of India, from time to time.
This general permission is not available where:
• Indian company whose shares or convertible debentures are proposed to be transferred is in financial service sector (financial services sector means service rendered by banking and non-banking companies regulated by the Reserve Bank, insurance companies regulated by Insurance Regulatory and Development Authority (IRDA) and other companies regulated by any other financial regulator, as the case may be).
• The transfer falls within the provisions of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.
B: Transfer by way of gift:
• A person resident in India can transfer by way of gift shares to a person resident outside India in the following ways:
A person resident in India who proposes to transfer to a person resident outside India [other than erstwhile OCBs] any security, by way of gift, shall make an application to the central office of the foreign exchange department, Reserve Bank of India furnishing the following information, namely:
• Name and address of the transferor and the proposed transferee
• Relationship between the transferor and the proposed transferee
• Reasons for making the gift. The gifts are permissible up to a limit of:
(i) 5% of the paid up capital of the company per donee, and
(ii) Amount does not exceed $25,000 per calendar year for each donor. The valuation of these shares shall be in accordance with pricing guidelines prescribed.
6. What if the transfer from resident to non-resident does not fall under the above facility?
In case the transfer does not fit into any of the above, either the transferor (resident) or the transferee (non-resident) can make an application for the Reserve Bank's permission for the transfer. The application has to be accompanied with the following documents:
• A copy of FIPB approval (if required).
• Consent letter from transferor and transferee clearly indicating the number of shares, name of the investee company and the price at which the transfer is proposed to be effected.
• The present/post transfer shareholding pattern of the Indian investee company showing the equity participation by residents and non-residents category-wise.
• Copies of the Reserve Bank of India's approvals/acknowledged copies of FC-GPR evidencing the existing holdings of the non-residents.
• If the sellers/transferors are NRIs / OCBs, the copies of the Reserve Bank of India's approvals evidencing the shares held by them on repatriation / non-repatriation basis.
• Open Offer document filed with SEBI if the acquisition of shares by non-resident is under SEBI Takeover Regulations.
• Fair valuation certificate from chartered accountant indicating the value of shares as per the following guideline.
• In the case of unlisted shares the fair value is worked out as per the erstwhile Controller of Capital Issue/s.
• For listed shares, the price worked out is not less than the higher of average weekly high and low quotations for 6 months and average of daily high and low quotation or two weeks preceding 30 days prior to the date of making application to FIPB.
7. Are the investments and profits earned in India repatriable?
All foreign investments are freely repatriable except for the cases where NRIs choose to invest specifically under non-repatriable schemes. Dividends declared on foreign investments can be remitted freely through an Authorised Dealer.
8. What are the guidelines on issue and valuation of shares in case of existing companies?
• Allotment of shares on preferential basis shall be as per the requirements of the Companies Act, 1956, which will require special resolution in case of a public limited company.
• In case of listed companies, valuation shall be as per the Reserve Bank of India /SEBI guidelines as follows:
• The issue price shall be either at:
i) The average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the six months preceding the relevant date or
ii) The average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the two weeks preceding the relevant date.
• In case of unlisted companies, valuation shall be done in accordance with the guidelines issued by the erstwhile Controller of Capital Issues.
9. What are the regulations pertaining to issue of ADRs/GDRs by Indian companies?
• Indian companies are allowed to raise capital in the international market through the issue of ADRs/GDRs. They can issue ADRs/GDRs without obtaining prior approval from RBI if it is eligible to issue ADRs/GDRs in terms of the Scheme for Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 and subsequent guidelines issued by ministry of finance, government of India.
• After the issue of ADRs/GDRs, the company has to file a return in the proforma given in Annexure 'C' to the RBI Notification No.FEMA.20/ 2000-RB dated May 3, 2000. The company is also required to file a quarterly return in a form specified in Annexure 'D' of the same regulations.
• There are no end-use restrictions on GDR/ADR issue proceeds, except for an express ban on investment in real estate and stock markets.
10. What is meant by Sponsored ADR & Two-way fungibility Scheme of ADR/GDR?
• Sponsored ADR/GDR: An Indian company may sponsor an issue of ADR/GDR with an overseas depository against shares held by its shareholders at a price to be determined by the Lead Manager. The Operative guidelines for the same have been issued vide A.P. (DIR Series) Circular No.52 dated November 23, 2002.
• Two-way fungibility Scheme: Under the limited Two-way fungibility Scheme, a registered broker in India can purchase shares of an Indian company on behalf of a person resident outside India for the purpose of converting the shares so purchased into ADRs/GDRs. The operative guidelines for the same have been issued vide A.P. (DIR Series) Circular No.21 dated February 13, 2002. The Scheme provides for purchase and re-conversion of only as many shares into ADRs/GDRs which are equal to or less than the number of shares emerging on surrender of ADRs/GDRs which have been actually sold in the market. Thus, it is only a limited two-way fungibility wherein the headroom available for fresh purchase of shares from domestic market is restricted to the number of converted shares sold in the domestic market by non-resident investors. So long ADRs/GDRs are quoted at discounts to the value of shares in domestic market, an investor will gain by converting the ADRs/GDRs into underlying shares and selling them in the domestic market. In case of ADRs/GDRs being quoted at premium, there will be demand for reverse fungibility, i.e. purchase of shares in domestic market for re-conversion into ADRs/GDRs. The scheme is operationalised through the Custodians of securities and stockbrokers under SEBI.
11. Can Indian companies issue Foreign Currency Convertible Bonds (FCCBs)?
• FCCBs can be issued by Indian companies in the overseas market in accordance with Scheme for Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993.
• The FCCB issue needs to conform to External Commercial Borrowing Guidelines, issued by RBI vide Notification No. FEMA 3/2000-RB dated May 3, 2000 as amended from time to time.
12. Can I invest through Preference Shares? What are the regulations applicable in case of such investments?
• Foreign investment through preference shares is treated as foreign direct investment. Foreign investment in preference share is considered as part of share capital and fall outside the external commercial borrowing (ECB) guidelines/cap.
• Preference shares to be treated as foreign direct equity for purpose of sectoral caps on foreign equity, where such caps are prescribed, provided they carry a conversion option. If the preference shares are structured without such conversion option, they would fall outside the foreign direct equity cap.
13. Can shares be issued against Lumpsum Fee, Royalty and ECB?
Issue of equity shares against lump sum fee, royalty and external commercial borrowings (ECBs) in convertible foreign currency are permitted, subject to meeting all applicable tax liabilities and sector specific guidelines.
14. Other than issue of shares under Automatic /Government Route, what other general permissions are available under RBI Notification No.FEMA 20 dt.3-5-2000?
• Issue of shares under ESOP by Indian companies to its employees or employees of its joint venture or wholly owned subsidiary abroad who are resident outside India directly or through a Trust up to 5% of the paid up capital of the company.
• Issue and acquisition of shares by non-residents after merger or de-merger or amalgamation of Indian companies.
• Issue shares or preference shares or convertible debentures on rights basis by an Indian company to a person resident outside India.
15. Can I invest in unlisted shares issued by a company in India?
Yes. As per the regulations/guidelines issued by the Reserve Bank of India/Government of India, investment can be made in unlisted shares of Indian companies.
16. Can a foreigner set up a partnership/proprietorship concern in India?
No. Only NRIs/PIOs are allowed to set up partnership/proprietorship concerns in India. Even for NRIs/PIOs investment is allowed only on non-repatriation basis.
17. Can I invest in Rights shares issued by an Indian company at a discount?
There are no restrictions under FEMA for investment in Rights shares at a discount, provided the rights shares so issued are being offered at the same price to residents and non-residents.
II - Foreign Technical Collaboration
1. What are the payment parameters for foreign technology transfer under the Automatic Route of Reserve Bank of India? How should royalty be calculated?
• Payment for foreign technology collaboration by Indian companies are allowed under the automatic route subject to the following limits:
• Lump sum payments not exceeding US$ 2 million.
• Royalty payable being limited to 5 per cent for domestic sales and 8 per cent for exports, without any restriction on the duration of the royalty payments.
• The royalty limits are net of taxes and are calculated according to standard conditions.
• The royalty will be calculated on the basis of the net ex-factory sale price of the product, exclusive of excise duties, minus the cost of the standard bought-out components and the landed cost of imported components, irrespective of the source of procurement, including ocean freight, insurance, custom duties, etc.
• RBI has delegated the powers to ADs to make payment of royalty under such agreements. The requirement of registration of the agreement with the Regional Office of Reserve Bank of India has been done away with.
2. What should be done, if Automatic Route of Reserve Bank of India for technology transfer is not available?
Proposals, which do not satisfy the parameters prescribed for automatic route of RBI, require clearance from Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India.
III -- Foreign Portfolio Investment
1. What are the regulations regarding Portfolio Investments by Foreign Institutional Investors (FIIs)?
• Investment by FIIs is regulated under SEBI (FII) Regulations, 1995 and Regulation 5(2) of FEMA Notification No.20 dated May 3, 2000. FIIs include asset management companies, pension funds, mutual funds, and investment trusts as nominee companies, incorporated / institutional portfolio managers or their power of attorney holders, university funds, endowment foundations, charitable trusts and charitable societies.
• SEBI acts as the nodal point in the registration of FIIs. The Reserve Bank of India has granted general permission to SEBI-registered FIIs to invest in India under the Portfolio Investment Scheme (PIS).
• Investment by individual FIIs cannot exceed 10% of paid up capital. Investment by foreign registered as sub accounts of FII cannot exceed 5% of paid up capital. All FIIs and their sub-accounts taken together cannot acquire more than 24% of the paid up capital of an Indian company. An Indian company can raise the 24% ceiling to the sectoral cap / statutory ceiling, as applicable, by passing a resolution by its board of directors followed by passing a special resolution to that effect by their general body.
2. What are the regulations regarding Portfolio Investments by NRIs/PIOs?
• Non Resident Indian (NRIs) and Persons of Indian Origin (PIOs) can purchase/sell shares/convertible debentures of Indian companies on stock exchanges under Portfolio Investment Scheme. For this purpose, the NRI/PIO has to apply to a designated branch of a bank, which deals in Portfolio Investment. All sale/purchase transactions are to be routed through the designated branch.
• An NRI or a PIO can purchase shares up to 5% of the paid up capital of an Indian company. All NRIs/PIOs taken together cannot purchase more than 10% of the paid up value of the company. (This limit can be increased by the Indian company to 24% by passing a General Body resolution).
• The sale proceeds of the repatriable investments can be credited to the NRE/NRO etc. accounts of the NRI/PIO whereas the sale proceeds of non-repatriable investment can be credited only to NRO accounts.
• The sale of shares will be subject to payment of applicable taxes.
IV - Investment in Government Securities and Corporate debt
1. Can a Non-resident Indian invest in Government Securities/Treasury bills and Corporate debt?
Under the FEMA Regulations only NRIs and SEBI registered FIIs are permitted to purchase Government Securities/Treasury bills and Corporate debt. The details are as under;
A. A Non-resident Indian can purchase,
(1) i) Government dated securities (other than bearer securities) or treasury bills or
units of domestic mutual funds;
ii) bonds issued by a public sector undertaking(PSU) in India;
iii) shares in Public Sector Enterprises being disinvested by the Government of India.
(2) They can also invest, on non-repatriation basis, in dated Government securities (other than bearer securities), treasury bills, units of domestic mutual funds, units of Money Market Mutual Funds in India, or National Plan/Savings Certificates on non-repatriation basis. The guidelines for these schemes are framed by the concerned Government agencies.
B. A SEBI registered Foreign Institutional Investor may purchase, on repatriation basis, dated Government securities/treasury bills, non-convertible debentures/bonds issued by an Indian company and units of domestic mutual funds either directly from the issuer of such securities or through a registered stock broker on a recognised stock exchange in India. The FIIs is required to ensure that;
i) the FII allocation of its total investment between equity and debt instruments (including dated Government Securities and Treasury Bills in the Indian capital market) should not exceed the ratio of 70:30.
ii) In case the FII is set-up as a 100% debt FII, it can invest the entire corpus in dated Government Securities including Treasury Bills, non-convertible debentures/bonds issued by an Indian company subject to limits, if any, stipulated by SEBI in this regard.
The Investment in Government Securities/Treasury bills and Corporate debt is subject to a ceiling decided in consultation with the Government of India. Investment limit for the FIIs as a group in Government securities currently is USD 3.2 Billion. The limit for investment in Corporate debt is USD 1.5 billion. At present, the FIIs can also invest in Innovative instruments such as Upper Tier-II capital upto a limit of USD 500 million.
V - Foreign Venture Capital Investment
1. What are the regulations for Foreign Venture Capital Investment?
A SEBI registered Foreign Venture Capital Investor with general permission from the Reserve Bank of India can invest in a Venture Capital Fund or an Indian Venture Capital Undertaking, in the manner and subject to the terms and conditions specified in Schedule 6 of RBI Notification No. FEMA 20/2000-RB dated May 3, 2000 as amended from time to time.
VI - Procedure for opening Branch/Project/Liaison Office
1. How can foreign companies open Liaison/Project/Branch office in India?
Foreign company can set up Liaison/Branch Offices in India after obtaining approval from Reserve Bank of India. Reserve Bank of India has given general permission to foreign companies to establish Project Offices in India subject to certain conditions.
2. What is the procedure to be followed for obtaining Reserve Bank's approval for opening Liaison Office/Representative Office?
• A Liaison office can carry on only liaison activities, i.e. it can act as a channel of communication between Head Office abroad and parties in India. It is not allowed to undertake any business activity in India and cannot earn any income in India. Expenses of such offices are to be met entirely through inward remittances of foreign exchange from the Head Office abroad. The role of such offices is, therefore, limited to collecting information about possible market opportunities and providing information about the company and its products to the prospective Indian customers.
• The companies desirous of opening a liaison office in India may make an application in form FNC-1 along with the documents mentioned therein to Foreign Investment Division, Foreign Exchange Department, Reserve Bank of India, Central Office, Mumbai. This form is available at www.rbi.org.in
• Permission to set up such offices is initially granted for a period of 3 years and this may be extended from time to time by the Regional Office in whose jurisdiction the office is set up. Liaison/Representative offices have to file an Activity Certificate on annual basis from a Chartered Accountant to the concerned Regional Office of the Reserve Bank of India , stating that the Liaison Office has undertaken only those activities permitted by Reserve Bank of India .
3. What is the procedure for setting up Project Office?
• Foreign companies are granted projects in India by Indian entities. General Permission has been granted by Reserve Bank of India vide Notification No. FEMA 95/2003-RB dated July 2, 2003 to foreign companies to open Project Office/s in India provided they have secured from an Indian company, a contract to execute a project in India, and the project is funded directly by inward remittance from abroad; or
• the project is funded by a bilateral or multilateral International Financing Agency; or
• the project has been cleared by an appropriate authority; or
• a company or entity in India awarding the contract has been granted Term Loan by a Public Financial Institution or a bank in India for the project.
• However, if the above criteria are not met, or if the parent entity is established in Pakistan, Bangladesh, Sri Lanka, Afghanistan, Iran or China, such applications have to be forwarded to Central Office of the Foreign Exchange Department of the Reserve Bank at Mumbai for approval.
4. What is the procedure for setting up branch office?
• Reserve Bank permits companies engaged in manufacturing and trading activities abroad to set up Branch Offices in India for the following purposes:
• To represent the parent company/other foreign companies in various matters in India e.g. acting as buying/selling agents in India
• To conduct research work in the area in which the parent company is engaged
• To undertake export and import activities and trading on wholesale basis
• To promote possible technical and financial collaborations between the Indian companies and overseas companies.
• Rendering professional or consultancy services
• Rendering services in Information technology and development of software in India
• Rendering technical support to the products supplied by the parent/Group companies.
• A branch office is not allowed to carry out manufacturing, processing activities directly/indirectly. A Branch Office is also not allowed to undertake Retail Trading activities of any nature in India. Branch Offices have to submit Activity Certificate from a Chartered Accountant on an annual basis to the Central Office of FED. For annual remittance of profit Branch Office may submit required documents to an authorised dealer.
• Permission for setting up branch offices is granted by the Reserve Bank of India. Reserve Bank of India considers the track record of the Applicant Company, existing trade relations with India, the activity of the company proposing to set up office in India as well as the financial position of the company while scrutinising the application.
Source: Reserve Bank of India
What is foreign investment? How does a foreign company invest in India? What are the rules applicable to Resident and Non-Resident Indians when it comes to foreign investment? If you have doubts on any of these or more questions, read on:
I - Foreign Direct Investment
1. What are the forms in which business can be conducted by a foreign company in India?
A foreign company planning to set up business operations in India has the following options:
• As an incorporated entity by incorporating a company under the Companies Act, 1956 through
• Joint ventures; or
• Wholly owned subsidiaries
• As an office of a foreign entity through
• Liaison Office / Representative Office
• Project Office
• Branch Office
Such offices can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office or other place of business) Regulations, 2000.
2. How does a foreign company invest in India? What are the regulations pertaining to issue of shares by Indian companies to foreign collaborators/investors?
Automatic Route
FDI up to 100% is allowed under the automatic route in all activities/sectors except the following which require prior approval of the government:
• i) where provisions of Press Note 1 (2005 Series) issued by the Government of India are attracted.
• ii) where more than 24% foreign equity is proposed to be inducted for manufacture of items reserved for the Small Scale sector.
• iii) FDI in sectors/activities to the extent permitted under Automatic Route does not require any prior approval either by the government or the Reserve Bank of India].
• iv) The investors are only required to notify the Regional Office concerned of the Reserve Bank of India within 30 days of receipt of inward remittances and file the required documents along with form FC-GPR with that Office within 30 days of issue of shares to the non-resident investors.
Government Route
FDI in activities not covered under the automatic route requires prior Government approval and are considered by the Foreign Investment Promotion Board (FIPB), Ministry of Finance. Application can be made in Form FC-IL, which can be downloaded from www.dipp.gov.in. Plain paper applications carrying all relevant details are also accepted. No fee is payable.
General permission of RBI under FEMA
Indian companies having foreign investment approval through FIPB route do not require any further clearance from the Reserve Bank of India for receiving inward remittance and issue of shares to the non-resident investors. The companies are required to notify the concerned regional office of the Reserve Bank of India of receipt of inward remittances within 30 days of such receipt and submit form FC-GPR within 30 days of issue of shares to the non-resident investors.
3. Which are the sectors where FDI is not allowed in India, under the Automatic Route as well as Government Route?
FDI is prohibited under Government as well as Automatic Route for the following sectors:
• i) Retail Trading (except single brand product retailing)
• ii) Atomic Energy
• iii) Lottery Business
• iv) Gambling and Betting
• v) Business of Chit Fund
• vi) Nidhi Company
• vii) Agricultural or plantation activities (cf Notification No. FEMA 94/2003-RB dated June 18, 2003).
• viii) Housing and real estate business (except development of townships, construction of residential/commercial premises, roads or bridges to the extent specified in Notification No. FEMA 136/2005-RB dated July 19, 2005 )
• ix) Trading in Transferable Development Rights (TDRs).
4. What should be done after investment is made under the Automatic Route or with Government approval?
A two-stage reporting procedure has been introduced for this purpose.
• On receipt of money for investment:
• Within 30 days of receipt of money from the non-resident investor, the Indian company will report to the regional office of the Reserve Bank of India, under whose jurisdiction its registered office is located, containing details such as:
• Name and address of the foreign investor/s
• Date of receipt of funds and their rupee equivalent
• Name and address of the authorised dealer through whom the funds have been received, and
• Details of the Government approval, if any.
• Upon issue of shares to non-resident investors:
• Within 30 days from the date of issue of shares, a report in Form FC-GPR, PART A together with the following documents should be filed with the concerned regional office of the Reserve Bank of India.
• Certificate from the company secretary of the company accepting investment from persons resident outside India certifying that;
• The company has complied with the procedure for issue of shares as laid down under the FDI scheme as indicated in the notification no. FEMA 20/2000-RB dated 3rd May 2000 as amended from time to time
• The proposal is within the sectoral policy / cap permissible under the automatic route of RBI and it fulfills all the conditions laid down for investments under the Automatic approval route namely
a) Non-resident entity/ies (other than individuals) to whom it has issued shares does / do not have any existing joint venture or technology transfer or trade mark agreement in India in the same field.
b) The company is not investing in an SSI unit & the investment limit of 24 % has been observed/ requisite approvals have been obtained.
c) Shares have been issued on rights basis and the shares are issued to non-residents at a price that is not lower than that at which shares are/were issued to residents.
OR
d) Shares issued are bonus shares.
OR
e) Shares have been issued under a scheme of merger and amalgamation of two or more Indian companies or reconstruction by way of demerger or otherwise of an Indian company, duly approved by a court in India.
• Shares have been issued in terms of SIA/FIPB approval No. --------------------- dated --------------------
• Certificate from statutory auditors or chartered accountant indicating the manner of arriving at the price of the shares issued to the persons resident outside India.
5. What are the guidelines for transfer of existing shares from non-residents to residents or residents to non-residents?
Transfer from Non-Resident to Resident:
The term 'transfer' is defined under FEMA as including "sale, purchase, acquisition, mortgage, pledge, gift, loan or any other form of transfer of right, possession or lien."
The FEMA Regulations give specific permission covering the following forms of transfer i.e. transfer by way of sale and gift. These permissions are discussed below:
A: Transfer by way of sale:
A person resident outside India can freely transfer share/convertible debenture by way of sale to a person resident in India as under:
• Any person resident outside India (other than NRIs/OCBs) can transfer by way of sale the shares/convertible debentures to any person resident outside India; subject to the condition that the acquirer or transferee does not have any previous venture or tie up in India in the same field or sector.
• A non-resident Indian (NRI) or an erstwhile Overseas Corporate Body may transfer by way of sale, the shares/convertible debentures held by him to another NRI only.
• Any person resident outside India may sell share/convertible debenture acquired in accordance with FEMA Regulations, on a recognized Stock Exchange in India through a registered broker.
B: Transfer by way of Gift:
A person resident outside India can freely transfer share/convertible debenture by way of gift to a person resident in India as under:
• Any person resident outside India, (not being a non-resident Indian or an erstwhile overseas corporate body), can transfer by way of gift the shares/convertible debentures to any person resident outside India; subject to the condition that the acquirer or transferee does not have any previous venture or tie up in India in the same field or sector.
• A non-resident Indian (NRI) may transfer by way of gift, the shares/convertible debentures held by him to another NRI only.
• Any person resident outside India may transfer share/convertible debenture to a person resident in India by way of gift.
Transfer from Resident to Non-Resident:
A: Transfer by way of sale - General Permission under Regulation 10 of Notification No. FEMA 20/2000-RB dated May 3, 2000.
• A person resident in India may transfer to a person resident outside India any share/convertible debenture of an Indian company whose activities fall under the Automatic Route for FDI subject to the sectoral limits, by way of sale subject to complying with pricing guidelines, documentation and reporting requirements for such transfers, as may be specified by the Reserve Bank of India, from time to time.
This general permission is not available where:
• Indian company whose shares or convertible debentures are proposed to be transferred is in financial service sector (financial services sector means service rendered by banking and non-banking companies regulated by the Reserve Bank, insurance companies regulated by Insurance Regulatory and Development Authority (IRDA) and other companies regulated by any other financial regulator, as the case may be).
• The transfer falls within the provisions of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.
B: Transfer by way of gift:
• A person resident in India can transfer by way of gift shares to a person resident outside India in the following ways:
A person resident in India who proposes to transfer to a person resident outside India [other than erstwhile OCBs] any security, by way of gift, shall make an application to the central office of the foreign exchange department, Reserve Bank of India furnishing the following information, namely:
• Name and address of the transferor and the proposed transferee
• Relationship between the transferor and the proposed transferee
• Reasons for making the gift. The gifts are permissible up to a limit of:
(i) 5% of the paid up capital of the company per donee, and
(ii) Amount does not exceed $25,000 per calendar year for each donor. The valuation of these shares shall be in accordance with pricing guidelines prescribed.
6. What if the transfer from resident to non-resident does not fall under the above facility?
In case the transfer does not fit into any of the above, either the transferor (resident) or the transferee (non-resident) can make an application for the Reserve Bank's permission for the transfer. The application has to be accompanied with the following documents:
• A copy of FIPB approval (if required).
• Consent letter from transferor and transferee clearly indicating the number of shares, name of the investee company and the price at which the transfer is proposed to be effected.
• The present/post transfer shareholding pattern of the Indian investee company showing the equity participation by residents and non-residents category-wise.
• Copies of the Reserve Bank of India's approvals/acknowledged copies of FC-GPR evidencing the existing holdings of the non-residents.
• If the sellers/transferors are NRIs / OCBs, the copies of the Reserve Bank of India's approvals evidencing the shares held by them on repatriation / non-repatriation basis.
• Open Offer document filed with SEBI if the acquisition of shares by non-resident is under SEBI Takeover Regulations.
• Fair valuation certificate from chartered accountant indicating the value of shares as per the following guideline.
• In the case of unlisted shares the fair value is worked out as per the erstwhile Controller of Capital Issue/s.
• For listed shares, the price worked out is not less than the higher of average weekly high and low quotations for 6 months and average of daily high and low quotation or two weeks preceding 30 days prior to the date of making application to FIPB.
7. Are the investments and profits earned in India repatriable?
All foreign investments are freely repatriable except for the cases where NRIs choose to invest specifically under non-repatriable schemes. Dividends declared on foreign investments can be remitted freely through an Authorised Dealer.
8. What are the guidelines on issue and valuation of shares in case of existing companies?
• Allotment of shares on preferential basis shall be as per the requirements of the Companies Act, 1956, which will require special resolution in case of a public limited company.
• In case of listed companies, valuation shall be as per the Reserve Bank of India /SEBI guidelines as follows:
• The issue price shall be either at:
i) The average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the six months preceding the relevant date or
ii) The average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the two weeks preceding the relevant date.
• In case of unlisted companies, valuation shall be done in accordance with the guidelines issued by the erstwhile Controller of Capital Issues.
9. What are the regulations pertaining to issue of ADRs/GDRs by Indian companies?
• Indian companies are allowed to raise capital in the international market through the issue of ADRs/GDRs. They can issue ADRs/GDRs without obtaining prior approval from RBI if it is eligible to issue ADRs/GDRs in terms of the Scheme for Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 and subsequent guidelines issued by ministry of finance, government of India.
• After the issue of ADRs/GDRs, the company has to file a return in the proforma given in Annexure 'C' to the RBI Notification No.FEMA.20/ 2000-RB dated May 3, 2000. The company is also required to file a quarterly return in a form specified in Annexure 'D' of the same regulations.
• There are no end-use restrictions on GDR/ADR issue proceeds, except for an express ban on investment in real estate and stock markets.
10. What is meant by Sponsored ADR & Two-way fungibility Scheme of ADR/GDR?
• Sponsored ADR/GDR: An Indian company may sponsor an issue of ADR/GDR with an overseas depository against shares held by its shareholders at a price to be determined by the Lead Manager. The Operative guidelines for the same have been issued vide A.P. (DIR Series) Circular No.52 dated November 23, 2002.
• Two-way fungibility Scheme: Under the limited Two-way fungibility Scheme, a registered broker in India can purchase shares of an Indian company on behalf of a person resident outside India for the purpose of converting the shares so purchased into ADRs/GDRs. The operative guidelines for the same have been issued vide A.P. (DIR Series) Circular No.21 dated February 13, 2002. The Scheme provides for purchase and re-conversion of only as many shares into ADRs/GDRs which are equal to or less than the number of shares emerging on surrender of ADRs/GDRs which have been actually sold in the market. Thus, it is only a limited two-way fungibility wherein the headroom available for fresh purchase of shares from domestic market is restricted to the number of converted shares sold in the domestic market by non-resident investors. So long ADRs/GDRs are quoted at discounts to the value of shares in domestic market, an investor will gain by converting the ADRs/GDRs into underlying shares and selling them in the domestic market. In case of ADRs/GDRs being quoted at premium, there will be demand for reverse fungibility, i.e. purchase of shares in domestic market for re-conversion into ADRs/GDRs. The scheme is operationalised through the Custodians of securities and stockbrokers under SEBI.
11. Can Indian companies issue Foreign Currency Convertible Bonds (FCCBs)?
• FCCBs can be issued by Indian companies in the overseas market in accordance with Scheme for Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993.
• The FCCB issue needs to conform to External Commercial Borrowing Guidelines, issued by RBI vide Notification No. FEMA 3/2000-RB dated May 3, 2000 as amended from time to time.
12. Can I invest through Preference Shares? What are the regulations applicable in case of such investments?
• Foreign investment through preference shares is treated as foreign direct investment. Foreign investment in preference share is considered as part of share capital and fall outside the external commercial borrowing (ECB) guidelines/cap.
• Preference shares to be treated as foreign direct equity for purpose of sectoral caps on foreign equity, where such caps are prescribed, provided they carry a conversion option. If the preference shares are structured without such conversion option, they would fall outside the foreign direct equity cap.
13. Can shares be issued against Lumpsum Fee, Royalty and ECB?
Issue of equity shares against lump sum fee, royalty and external commercial borrowings (ECBs) in convertible foreign currency are permitted, subject to meeting all applicable tax liabilities and sector specific guidelines.
14. Other than issue of shares under Automatic /Government Route, what other general permissions are available under RBI Notification No.FEMA 20 dt.3-5-2000?
• Issue of shares under ESOP by Indian companies to its employees or employees of its joint venture or wholly owned subsidiary abroad who are resident outside India directly or through a Trust up to 5% of the paid up capital of the company.
• Issue and acquisition of shares by non-residents after merger or de-merger or amalgamation of Indian companies.
• Issue shares or preference shares or convertible debentures on rights basis by an Indian company to a person resident outside India.
15. Can I invest in unlisted shares issued by a company in India?
Yes. As per the regulations/guidelines issued by the Reserve Bank of India/Government of India, investment can be made in unlisted shares of Indian companies.
16. Can a foreigner set up a partnership/proprietorship concern in India?
No. Only NRIs/PIOs are allowed to set up partnership/proprietorship concerns in India. Even for NRIs/PIOs investment is allowed only on non-repatriation basis.
17. Can I invest in Rights shares issued by an Indian company at a discount?
There are no restrictions under FEMA for investment in Rights shares at a discount, provided the rights shares so issued are being offered at the same price to residents and non-residents.
II - Foreign Technical Collaboration
1. What are the payment parameters for foreign technology transfer under the Automatic Route of Reserve Bank of India? How should royalty be calculated?
• Payment for foreign technology collaboration by Indian companies are allowed under the automatic route subject to the following limits:
• Lump sum payments not exceeding US$ 2 million.
• Royalty payable being limited to 5 per cent for domestic sales and 8 per cent for exports, without any restriction on the duration of the royalty payments.
• The royalty limits are net of taxes and are calculated according to standard conditions.
• The royalty will be calculated on the basis of the net ex-factory sale price of the product, exclusive of excise duties, minus the cost of the standard bought-out components and the landed cost of imported components, irrespective of the source of procurement, including ocean freight, insurance, custom duties, etc.
• RBI has delegated the powers to ADs to make payment of royalty under such agreements. The requirement of registration of the agreement with the Regional Office of Reserve Bank of India has been done away with.
2. What should be done, if Automatic Route of Reserve Bank of India for technology transfer is not available?
Proposals, which do not satisfy the parameters prescribed for automatic route of RBI, require clearance from Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India.
III -- Foreign Portfolio Investment
1. What are the regulations regarding Portfolio Investments by Foreign Institutional Investors (FIIs)?
• Investment by FIIs is regulated under SEBI (FII) Regulations, 1995 and Regulation 5(2) of FEMA Notification No.20 dated May 3, 2000. FIIs include asset management companies, pension funds, mutual funds, and investment trusts as nominee companies, incorporated / institutional portfolio managers or their power of attorney holders, university funds, endowment foundations, charitable trusts and charitable societies.
• SEBI acts as the nodal point in the registration of FIIs. The Reserve Bank of India has granted general permission to SEBI-registered FIIs to invest in India under the Portfolio Investment Scheme (PIS).
• Investment by individual FIIs cannot exceed 10% of paid up capital. Investment by foreign registered as sub accounts of FII cannot exceed 5% of paid up capital. All FIIs and their sub-accounts taken together cannot acquire more than 24% of the paid up capital of an Indian company. An Indian company can raise the 24% ceiling to the sectoral cap / statutory ceiling, as applicable, by passing a resolution by its board of directors followed by passing a special resolution to that effect by their general body.
2. What are the regulations regarding Portfolio Investments by NRIs/PIOs?
• Non Resident Indian (NRIs) and Persons of Indian Origin (PIOs) can purchase/sell shares/convertible debentures of Indian companies on stock exchanges under Portfolio Investment Scheme. For this purpose, the NRI/PIO has to apply to a designated branch of a bank, which deals in Portfolio Investment. All sale/purchase transactions are to be routed through the designated branch.
• An NRI or a PIO can purchase shares up to 5% of the paid up capital of an Indian company. All NRIs/PIOs taken together cannot purchase more than 10% of the paid up value of the company. (This limit can be increased by the Indian company to 24% by passing a General Body resolution).
• The sale proceeds of the repatriable investments can be credited to the NRE/NRO etc. accounts of the NRI/PIO whereas the sale proceeds of non-repatriable investment can be credited only to NRO accounts.
• The sale of shares will be subject to payment of applicable taxes.
IV - Investment in Government Securities and Corporate debt
1. Can a Non-resident Indian invest in Government Securities/Treasury bills and Corporate debt?
Under the FEMA Regulations only NRIs and SEBI registered FIIs are permitted to purchase Government Securities/Treasury bills and Corporate debt. The details are as under;
A. A Non-resident Indian can purchase,
(1) i) Government dated securities (other than bearer securities) or treasury bills or
units of domestic mutual funds;
ii) bonds issued by a public sector undertaking(PSU) in India;
iii) shares in Public Sector Enterprises being disinvested by the Government of India.
(2) They can also invest, on non-repatriation basis, in dated Government securities (other than bearer securities), treasury bills, units of domestic mutual funds, units of Money Market Mutual Funds in India, or National Plan/Savings Certificates on non-repatriation basis. The guidelines for these schemes are framed by the concerned Government agencies.
B. A SEBI registered Foreign Institutional Investor may purchase, on repatriation basis, dated Government securities/treasury bills, non-convertible debentures/bonds issued by an Indian company and units of domestic mutual funds either directly from the issuer of such securities or through a registered stock broker on a recognised stock exchange in India. The FIIs is required to ensure that;
i) the FII allocation of its total investment between equity and debt instruments (including dated Government Securities and Treasury Bills in the Indian capital market) should not exceed the ratio of 70:30.
ii) In case the FII is set-up as a 100% debt FII, it can invest the entire corpus in dated Government Securities including Treasury Bills, non-convertible debentures/bonds issued by an Indian company subject to limits, if any, stipulated by SEBI in this regard.
The Investment in Government Securities/Treasury bills and Corporate debt is subject to a ceiling decided in consultation with the Government of India. Investment limit for the FIIs as a group in Government securities currently is USD 3.2 Billion. The limit for investment in Corporate debt is USD 1.5 billion. At present, the FIIs can also invest in Innovative instruments such as Upper Tier-II capital upto a limit of USD 500 million.
V - Foreign Venture Capital Investment
1. What are the regulations for Foreign Venture Capital Investment?
A SEBI registered Foreign Venture Capital Investor with general permission from the Reserve Bank of India can invest in a Venture Capital Fund or an Indian Venture Capital Undertaking, in the manner and subject to the terms and conditions specified in Schedule 6 of RBI Notification No. FEMA 20/2000-RB dated May 3, 2000 as amended from time to time.
VI - Procedure for opening Branch/Project/Liaison Office
1. How can foreign companies open Liaison/Project/Branch office in India?
Foreign company can set up Liaison/Branch Offices in India after obtaining approval from Reserve Bank of India. Reserve Bank of India has given general permission to foreign companies to establish Project Offices in India subject to certain conditions.
2. What is the procedure to be followed for obtaining Reserve Bank's approval for opening Liaison Office/Representative Office?
• A Liaison office can carry on only liaison activities, i.e. it can act as a channel of communication between Head Office abroad and parties in India. It is not allowed to undertake any business activity in India and cannot earn any income in India. Expenses of such offices are to be met entirely through inward remittances of foreign exchange from the Head Office abroad. The role of such offices is, therefore, limited to collecting information about possible market opportunities and providing information about the company and its products to the prospective Indian customers.
• The companies desirous of opening a liaison office in India may make an application in form FNC-1 along with the documents mentioned therein to Foreign Investment Division, Foreign Exchange Department, Reserve Bank of India, Central Office, Mumbai. This form is available at www.rbi.org.in
• Permission to set up such offices is initially granted for a period of 3 years and this may be extended from time to time by the Regional Office in whose jurisdiction the office is set up. Liaison/Representative offices have to file an Activity Certificate on annual basis from a Chartered Accountant to the concerned Regional Office of the Reserve Bank of India , stating that the Liaison Office has undertaken only those activities permitted by Reserve Bank of India .
3. What is the procedure for setting up Project Office?
• Foreign companies are granted projects in India by Indian entities. General Permission has been granted by Reserve Bank of India vide Notification No. FEMA 95/2003-RB dated July 2, 2003 to foreign companies to open Project Office/s in India provided they have secured from an Indian company, a contract to execute a project in India, and the project is funded directly by inward remittance from abroad; or
• the project is funded by a bilateral or multilateral International Financing Agency; or
• the project has been cleared by an appropriate authority; or
• a company or entity in India awarding the contract has been granted Term Loan by a Public Financial Institution or a bank in India for the project.
• However, if the above criteria are not met, or if the parent entity is established in Pakistan, Bangladesh, Sri Lanka, Afghanistan, Iran or China, such applications have to be forwarded to Central Office of the Foreign Exchange Department of the Reserve Bank at Mumbai for approval.
4. What is the procedure for setting up branch office?
• Reserve Bank permits companies engaged in manufacturing and trading activities abroad to set up Branch Offices in India for the following purposes:
• To represent the parent company/other foreign companies in various matters in India e.g. acting as buying/selling agents in India
• To conduct research work in the area in which the parent company is engaged
• To undertake export and import activities and trading on wholesale basis
• To promote possible technical and financial collaborations between the Indian companies and overseas companies.
• Rendering professional or consultancy services
• Rendering services in Information technology and development of software in India
• Rendering technical support to the products supplied by the parent/Group companies.
• A branch office is not allowed to carry out manufacturing, processing activities directly/indirectly. A Branch Office is also not allowed to undertake Retail Trading activities of any nature in India. Branch Offices have to submit Activity Certificate from a Chartered Accountant on an annual basis to the Central Office of FED. For annual remittance of profit Branch Office may submit required documents to an authorised dealer.
• Permission for setting up branch offices is granted by the Reserve Bank of India. Reserve Bank of India considers the track record of the Applicant Company, existing trade relations with India, the activity of the company proposing to set up office in India as well as the financial position of the company while scrutinising the application.
Source: Reserve Bank of India
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