📝 Test yourself with a quick quiz
10 questions · ~5 min · instant score
Graduate Level intermediate External Sector FEMA Exchange Rate Forex Reserves Capital Account
Indian Economy — External Sector, FEMA, Exchange Rates, Forex
Study notes on India's external sector — current account, capital account, FEMA, exchange rate regimes, forex reserves, and capital controls for Kerala PSC.
▶ മലയാളത്തിൽ വായിക്കുക📝
Take a quick quiz
10 Qs · ~5 min
📊
Try a full mock
100 Qs · 75 min · PSC scoring
📋 At a glance
— Study notes on India's external sector — current account, capital account, FEMA, exchange rate regimes, forex reserves, and capital controls for Kerala PSC.
#External Sector
#FEMA
#Exchange Rate
#Forex Reserves
#Capital Account
Sign in to continue reading
You've read 5 free study notes. Sign in to unlock all 270+ notes.
Free forever — no payment needed for study notes.
Or
The external sector covers India’s economic interactions with the rest of the world. Kerala PSC tests FEMA provisions, exchange rate systems, forex reserves, and BOP components. Expect 2-3 questions per paper.
Balance of Payments (BOP) — Structure
| Component | Sub-components | Nature |
|---|---|---|
| Current Account | Trade in goods, Trade in services, Primary income, Secondary income (remittances) | Records regular/recurring transactions |
| Capital Account | FDI, FPI/FII, External Commercial Borrowings (ECB), NRI deposits, Government loans | Records capital/investment flows |
| Errors and Omissions | Statistical discrepancy | Balancing item |
| Overall BOP | Current Account + Capital Account + Errors | Must balance (with forex reserve changes) |
Current Account Components
| Item | Includes |
|---|---|
| Trade balance (Merchandise) | Exports minus Imports of goods |
| Invisibles | Services (IT, tourism, shipping), Primary income (interest, dividends), Secondary income (private transfers including remittances) |
| Current Account Deficit (CAD) | When total outflows exceed total inflows on current account |
| Current Account Surplus | Opposite — inflows exceed outflows |
Capital Account Components
| Item | Details |
|---|---|
| FDI (Foreign Direct Investment) | Long-term investment; investor takes management control (10%+ equity stake) |
| FPI (Foreign Portfolio Investment) | Short-term; stocks, bonds; no management control |
| ECB (External Commercial Borrowings) | Loans from foreign banks/institutions |
| NRI Deposits | FCNR(B), NRE, NRO accounts |
| Government borrowings | Bilateral/multilateral loans |
| Capital Account Convertibility | Freedom to convert domestic currency into foreign currency for capital transactions (India has partial convertibility) |
India’s CAD — Key Facts
| Metric | Approximate (FY 2024-25) |
|---|---|
| India’s CAD | About 1.1% of GDP |
| Largest import item | Crude oil and petroleum products |
| Largest export item | Petroleum products and IT services |
| Remittances received | India is the world’s largest recipient (over $125 billion annually) |
| Kerala’s share of remittances | Significant — Gulf remittances form a major part of Kerala’s economy |
Exchange Rate Regimes
| System | Description | India’s History |
|---|---|---|
| Fixed Exchange Rate | Government fixes currency value against another currency or gold | India followed this from 1947-1975 (pegged to GBP, then USD) |
| Floating Exchange Rate | Market forces of demand and supply determine the rate | Pure float (no government intervention) |
| Managed Float (Dirty Float) | Market-determined, but central bank intervenes to prevent excessive volatility | India follows this since 1993 |
| Crawling Peg | Fixed rate adjusted periodically based on indicators | Some developing countries use this |
India’s Exchange Rate Evolution
| Period | System |
|---|---|
| 1947-1966 | Fixed parity with British Pound |
| 1966 | Rupee devalued by 36.5% (from Rs 4.76 to Rs 7.50 per USD) |
| 1971 | Linked to the dollar after Bretton Woods collapse |
| 1975 | Pegged to a basket of currencies |
| 1991 | Dual exchange rate (LERMS — Liberalized Exchange Rate Management System) during economic crisis |
| 1993 onwards | Unified market-determined exchange rate (managed float) |
FERA vs FEMA
| Feature | FERA (1973) | FEMA (1999) |
|---|---|---|
| Full form | Foreign Exchange Regulation Act | Foreign Exchange Management Act |
| Year | 1973 | 1999 (effective June 2000) |
| Approach | Regulatory (conservation of forex) | Facilitating (management of forex) |
| Violation | Criminal offence (imprisonment) | Civil offence (penalties/fines) |
| Philosophy | Restrictive; forex was scarce | Liberal; promote external trade and payments |
| Replaced | — | Replaced FERA |
| Administered by | RBI and Enforcement Directorate | RBI (primarily) |
| Context | License Raj era | Post-liberalization era |
| Presumption | Guilty until proven innocent | Innocent until proven guilty |
Key FEMA Provisions
| Provision | Details |
|---|---|
| Current account transactions | Fully convertible — free for trade, travel, education, medical purposes |
| Capital account transactions | Partially convertible — regulated by RBI (FDI limits, ECB guidelines) |
| Enforcement | Enforcement Directorate investigates FEMA violations |
| Penalties | Civil penalties (up to 3 times the sum involved) |
| Appellate Tribunal | FEMA Appellate Tribunal handles appeals |
| Authorized dealers | Banks and entities authorized by RBI to deal in foreign exchange |
Foreign Exchange Reserves
| Component | Details |
|---|---|
| Foreign Currency Assets (FCA) | Largest component; includes USD, Euro, GBP, Yen holdings |
| Gold | Physical gold held by RBI |
| SDR (Special Drawing Rights) | Allocated by IMF |
| Reserve Tranche Position | India’s quota position in IMF |
India’s Forex Reserve Milestones
| Year | Milestone |
|---|---|
| 1991 | Forex reserves fell to just $1.2 billion (triggered liberalization) |
| 2004 | Crossed $100 billion |
| 2021 | Crossed $600 billion (peaked around $642 billion in September 2021) |
| 2024 | Rose above $680 billion (4th largest globally after China, Japan, Switzerland) |
| Country | Forex Reserves (Approx.) |
|---|---|
| China | Over $3.2 trillion |
| Japan | Over $1.2 trillion |
| Switzerland | Over $800 billion |
| India | Over $680 billion |
Convertibility
| Type | Status in India | Meaning |
|---|---|---|
| Current Account Convertibility | Full (since August 1994) | Freedom to buy/sell forex for trade, travel, remittances |
| Capital Account Convertibility | Partial | Restrictions on capital flows (FDI limits, ECB rules, overseas investment caps) |
| Tarapore Committee I (1997) | Recommended full capital account convertibility with preconditions | Preconditions: fiscal deficit below 3.5%, inflation 3-5%, NPA reduction |
| Tarapore Committee II (2006) | Recommended phased convertibility by 2011 | Not fully implemented due to global financial crisis |
| Fuller Capital Account Convertibility | India moving gradually toward it | RBI liberalizes limits periodically |
Important Committees on External Sector
| Committee | Year | Subject |
|---|---|---|
| Rangarajan Committee | 1993 | BOP reform; recommended market-determined exchange rate |
| Tarapore Committee I | 1997 | Capital account convertibility |
| Tarapore Committee II | 2006 | Fuller capital account convertibility |
| Arvind Mayaram Committee | 2014 | Definition of FDI and FPI |
PSC Quick Recall
| Question | Answer |
|---|---|
| FEMA replaced which act? | FERA (1973) |
| FEMA came into force | June 2000 |
| FEMA violation is a | Civil offence (not criminal) |
| India’s exchange rate system | Managed float (since 1993) |
| Current account convertibility achieved | August 1994 |
| Full capital account convertibility? | No, only partial |
| Tarapore Committee relates to | Capital account convertibility |
| India’s forex reserves rank | 4th globally |
| 1991 forex crisis — reserves fell to | About $1.2 billion |
| Largest component of forex reserves | Foreign Currency Assets (FCA) |
| Largest recipient of remittances globally | India |
| FDI vs FPI — which is long-term? | FDI |
Found an error or have a suggestion?
Thank you! Your feedback has been submitted.