18 August 2013

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Decoding capital controls :: Business Line

Last week, the RBI announced additional measures to halt the steep fall in the rupee which now trades at below 60 to the US dollar. The central bank imposed restrictions on the amount individuals and businesses can remit or invest overseas. Now, as an individual, you can remit overseas a maximum of $75,000 (or equivalent) in a year. Earlier, you could remit $200,000 a year. Also now, you are not allowed to invest in immovable property.
So, say goodbye to plans of buying a house in Singapore or Dubai. The RBI has also reduced the amount Indian companies can invest abroad. From four times its net worth, an Indian company can now invest only up to an amount equal to its net worth, under the automatic route.
These measures are aimed at stemming foreign currency outflows from the country and shoring up the rupee. But market observers are terming these moves as ‘a return to capital control’. What does this mean?

CURRENT AND CAPITAL

Transactions using foreign currency fall under two categories -current account and capital account.
Capital account transactions involve changes in assets or liabilities abroad. For instance, when an Indian buys a business or property in a foreign country, it is considered a capital account transaction. Likewise, when a foreign company buys stake in an Indian company, the transaction is capital in nature. Current account transactions on the other hand are all those transactions which are not capital in nature. So, payment for imports, interest payment on loans, gifts, expenditure on travel, education and medical treatment abroad come under the current account.
When a country makes its currency convertible, it allows its residents the freedom to convert the home currency into an internationally accepted currency such as the dollar and vice versa.
In India, there is full convertibility for current account transactions. Most current account transactions are permitted except for a few prohibited ones. There may be limits though, beyond which approval from the RBI is required.
But on the capital account, the rupee is only partially convertible. Purchase or sale of foreign exchange on the capital account is permitted only for those transactions that have been specifically mentioned under the rules.
Beginning the early 1990s, as part of the liberalisation process, India began easing restrictions on, the till then tightly controlled capital account transactions. Over the years, there was a gradual relaxation on the amount of foreign exchange Indians could remit or invest abroad. In 2004, the RBI introduced the Liberalized Remittance Scheme. Under this, $25,000 could be remitted abroad by Indian individuals (without RBI approval).
This was later increased to $75,000 , and by end 2007, the limit was increased to $200,000 This amount can be used for both capital and current account transactions. Indians were also allowed to invest in property abroad.
To enable Indian companies to acquire assets abroad, the RBI in 2007 increased the foreign currency investment limit to up to four times their net worth , under the automatic route (without RBI approval). Investments by companies above this limit required RBI approval.

A STEP BACK

Now, with the RBI in rupee salvage mode, there has been a reversal in the liberalisation moves. In a bid to conserve dollars, the central bank has reduced the amount individuals and companies can remit or invest abroad without prior approval. Property purchases in foreign countries have also been disallowed.
The new reduced investment limit for companies (one time of net worth) will however not apply to Navratna public sector companies, ONGC Videsh and Oil India for their overseas investments in the oil sector. This is to ensure that the country’s attempts at securing its energy supplies are not hampered.

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Gold costlier
Tempted to buy gold, silver or platinum now? Well, you might need deeper pockets. To help the falling rupee and plug a part of the current account deficit, the government hiked import duty on these precious metals earlier this week. From 8 per cent, the duty on gold has increased to 10 per cent now. This is the fifth round of duty hikes for gold since January 2012. With the latest round of hikes, the import duty on platinum and silver has also inched up to 10 per cent.
This was not the only measure to wean interest away from gold. Additional customs duty and excise duties on gold and silver bars were also raised. Besides, the Reserve Bank (RBI) banned the import of gold coins as well. But close on the heels of these measures, strong demand from stockists ahead of the festival season due to fear of tightened supply made gold prices shoot higher. On Friday, the price per 10 gm crossed the Rs 30,000 mark. In New Delhi, it moved to just over Rs 31,000, a level last seen in November 2012.
Lower overseas remittances
To restrict dollar demand, the RBI has reduced the limit on remittances abroad by resident individuals. The limit, given under the ‘Liberalised Remittance Scheme’ has been brought down from $200,000 to $75,000 per financial year.
This scheme is available for acquiring shares, debt instruments or any other assets outside India. Individuals can also hold foreign currency accounts in banks outside India.
Besides reduction in the sum allowed, the only new restriction that has been imposed right now is that resident individuals cannot use this scheme to directly or indirectly acquire immovable property. Other restrictions such as prohibition for use in margin trading, lottery, etc., would continue.
Fixed deposit rates move up
Given the volatility in the equity and bond markets, are you looking for safe investment options? Bank fixed deposits may not be a bad idea, especially if you have shorter timeframes in mind. Thanks to the RBI measures to curb liquidity, several banks are raising deposits rates right now to muster funds.
While private banks such as HDFC Bank, Axis Bank and Yes Bank were the early birds, many others, be it PSU, private or foreign banks, have followed suit.
ICICI Bank has raised interest rates by 0.25-0.75 per cent across various maturities.
The hikes are the maximum for shorter timeframes of up to one year. Karnataka Bank is offering 25 to 50 basis points more on its fixed deposits. IDBI Bank will now offer 8.5 per cent for deposits of 46-200 days, compared with 7-7.25 per cent earlier. Deutsche Bank and Oriental Bank of Commerce too have raised interest rates by up to 1.5 per cent. Punjab National Bank has raised NRI deposit rates by 1 per cent.
NSEL woes deepen
As if the battering at the stock markets was not enough, more bad news came from the spot markets. To settle its Rs 5,574 crore dues to investors, the NSEL (National Spot Exchange) sought seven months, instead of the five months asked for earlier. While the first pay-in happened on August 16, the first pay-out will be done on August 20.
Bond yields surge
The uninviting macro economic situation — record lows by the rupee despite measures to curb the current account deficit, coupled with higher inflation numbers — saw 10-year bond yields jump this week. They moved up by 40-50 basis points on Friday, ending the week at around 8.9 per cent. This is closer to the levels seen towards the end of 2011. The surge is good news for those invested in funds which, in turn, have holdings in securities with a shorter-term duration of 12-18 months.

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