Government of India Volume I: Analysis and Recommendations

CAPITAL CONTROLS
requirements are fulfilled, there should be full national treatment of foreign entities, i.e.
full symmetry when compared with resident entities. For instance, net worth, capital adequacy
norms or investment restrictions should not be different for a foreign entity when
compared to a resident entity performing similar functions or investments in India.
8.2. Current framework
The Foreign Exchange Management Act, 1999, codifies the existing approach to capital
controls. It differentiates between current account transactions and capital account
transactions. The Central Government makes rules in consultation with RBI for current
account transactions, and the RBI in consultation with the Central Government makes
regulations in relation to capital account transactions. This approach has led to a complex
web of rules and regulations on capital controls spread across laws. It has also led to
the absence of a clear and consistent framework of policy and translation of policy into
law. In studying the current framework, the Commission notes that the deficiencies can
be broadly be classified into two categories:
1. Difficulties of multiplicity: These arise due to multiple laws, multiple regulators and multiple artificial
investment vehicles created by the regulations; and
2. Difficulties of absence: These arise due to absence of legal process and judicial review, and absence
of clear and consistent drafting.
8.2.1. Difficulties of multiplicity
The difficulties of multiplicity involve the following elements:
1. Multiple laws: The current framework of controls involves a myriad and complex web of regulations
issued by multiple regulators regulating multiple market participants. Regulations are also
organised by asset classes such as equity, quasi-equity instruments (such as convertible debentures)
and debt instruments, issued by both listed and unlisted entities.
2. Multiple regulators: The institutional bodies regulating capital flows include the RBI, SEBI, FMC,
IRDA, and the interim PFRDA. Within the Central Government, the Ministry of Finance houses the
Department of Revenue, the Department of Economic Affairs, and the Department of Financial
Services. The Department of Economic Affairs hosts the Foreign Investment Promotion Board
which approves Foreign Direct Investment (FDI) into the country, on a case by case basis for those
investments which require prior approval under the regulatory framework. The Ministry of Commerce
and Industry hosts the Department of Industrial Policy and Promotion which is responsible
for promulgating policy on FDI into the country.
3. Multiple investment vehicles and unequal treatment: Various artificial investment vehicles
have been created in India to regulate capital inflows. These investment vehicles include the Foreign
Institutional Investors (FIIs), the Foreign Venture Capital Investors (FVCIs) and the Qualified
Foreign Investors (QFIs). Varied levels of controls are exercised on these vehicles, in accordance
with policy considerations. In addition to the artificial vehicles, non-resident Indians and persons
of Indian origin are treated differently from other foreign investors, effectively creating a separate
‘investment vehicle’.
Additionally, there is also a problem of unequal treatment, as foreign investors are not treated at
par with Indian investors.
8.2.2. Difficulties of absence
The difficulties of absence in the field of capital controls comprise the following:
1. Absence of legal process: The rule making process in relation to capital controls is devoid of any
public consultation. In addition, policy pronouncements and regulations are rarely accompanied
by statements of policy and purpose, making it difficult for stake-holders to deduce a regulator’s
intention.
82 FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION