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K. Subramaniam

IT WAS the darling of the politicians and business houses. It held sway for two decades. Suddenly, its death has been announced. This is the legacy of the overseas corporate body (OCB).

The OCB cohorts were disturbed when it was caught in the Ketan Parekh scandal and all investigative agencies came swooping on them. Then came the Joint Parliamentary Committee (JPC) Report, heavy with its cargo of adverse findings and strictures.

In November 2001, it was kept on oxygen when the RBI debarred it from making investments under the portfolio investment scheme (PIS). None expected drastic action, though the RBI did inform the JPC in May that it was reviewing the PIS.

The respirator was taken off on September 15 when the RBI made the OCBs ineligible under all NRI schemes. The clarification given the next day does not give it new life. It has to live the life of a foreigner stripped of NRI status. For four decades, the Government and the RBI had abjectly relied on NRIs and paid more attention to them than to other foreign sources for investments and remittances.

Sadly, it is an area where politics and economics cohabit. Politicians need NRI funds for electioneering. The NRIs need political support to enlarge their role and to extract concessions. More than politicians, it suited business houses to have NRI links. They could engage in tax avoidance schemes with NRI companies. It was even fashionable for some businessmen to flaunt NRI status and has even been the theme of many TV serials. How did this situation develop?

In the early 1960s, the Government of India decided to attract remittances from NRIs. It was related to the exodus of Indians from East Africa. Many of them were rich traders owning fortunes. The reasoning was that if special concessions were given, they would prefer to keep their funds in India rather than in the havens such as Switzerland or Bahamas. The idea really was to attract remittances from individuals.

The oil booms added another dimension. Thousands of Indian workers and professionals migrated to the Gulf and, later, to the US. They earned substantial incomes and were committed to making `home remittances'. If suitable incentives were provided, they could be induced to make larger remittances. NRI facilities assumed respectability.

Developments in the global financial market played a major role on the ebb and flow of remittances. Broadly, there are two elements: One is the level of interest rate and the other is the fear of exchange risk. In the late 1970s, global interest rates shot up under the tight monetary policies of the Fed. As Indian rates became unattractive, inward flows declined.

It led to a review in the Finance Ministry in the early 1980s by a committee headed by R. N. Malhotra. The committee made several recommendations to liberalise and attract NRI facilities. One suggestion was that NRI facilities could also be extended to companies owned by NRIs. The rationale was that ordinarily large funds were held by corporate bodies and not by individuals.

The idea of extending NRI facilities to bodies owned by NRIs did not find favour with Mr R. Venkataraman, the then Finance Minister. He felt that they could be abused by non-Indians taking cover behind NRIs. He doubted whether adequate safeguards could be put in place to rein in capital inflows and prevent the adverse effects.

Mr Pranab Mukerjee, who succeeded him, had no hesitation in clearing the package recommended by the Malhotra Committee. These were included with fanfare in the 1982-83 Budget. Under this package, the NRIs were allowed to make investments through stock market, otherwise known as portfolio investment scheme (PIS).

Within months, the drama of Mr Swraj Paul attempting to take over DCM and Escorts through the portfolio route unfolded. His efforts were, however, aborted. Dr Manmohan Singh, who was then the RBI Governor, raised serious questions over the role of NRIs in take-over bids and threatened to resign over the issue. The Finance Ministry resolved the difference by issuing a clarification that the NRI facilities were also open to OCBs.

Though Mr Swraj Paul won the first round, later developments went against him. Ultimately, he decided to quit with compensation from the DCM/Escorts.

The outcome of Paul/Escorts controversy was that OCBs came to be legitimised as players in the stock market. With a shallow market and a low volume of floating shares, the OCBs languished for a while. Even so, a number of Indian companies found it attractive to float OCBs in tax havens and manipulate their own shares through proxies without falling foul of SEBI and its arcane rules.

Their finest hour was when the government decided to permit foreign financial institutions (FIIs) to operate in the stock market as part of post-1991 financial reforms.

By 1994, another door was opened with the government's decision to continue with the Indo-Mauritius Double Taxation Avoidance Agreement (IMDTA), despite evidence of misuse by Indian companies. Tragically, a message was sent that the IMDTA would continue. The virus took life around that time and spread fast very soon. What was the nexus? Why did the OCBs and the FIIs get linked in Mauritius? What was once a detective story lost its mystery with the release of the JPC Report. What is an OCB? The RBI's definition is so broad and vague that one would expect guidelines for proper verification of their status. There were none. Sadly, the RBI left it to be certified by auditors. All that an OCB had to do was to get a certificate in two forms (one for direct ownership and another for indirect) affirming that no less than 60 per cent of ownership/interest was held by NRIs. No other questions were to be asked by banks in India.

In doing this, the Finance Ministry and the RBI abdicated their role and relegated it to auditors in remote havens with no credentials. On that ground, the results were disastrous. The unholy OCB-FII nexus became a black hole.

There were multiple damages. The OCB status itself was not verifiable and depended on certificates by auditors. Any person or company could float an OCB and get it registered with SEBI and banks in India. They could freely operate under PIS. As OCBs, they secured substantial tax concessions vis-a-vis residents. With registration in Mauritius, they avoided the minimal tax burden in India. Furthermore, they had freedom to borrow funds abroad and deploy them in the stock market or with companies.

There was total chaos. The RBI, SEBI or any other agency had no control over them. When confronted by the JPC, the RBI was unable to provide even data on OCBs such as their capital, ownership, etc. However, the data collected by the RBI for the JPC showed that 664 OCBs were registered in the country. Nearly 80 per cent of them were registered in Mauritius. Curiously, 60 companies shared the same postbox number as their address. Their capital base varied from $1-10,000. The fund flow statement prepared for the JPC revealed a total outflow of Rs 3,491 crore for six OCB accounts.

The OCBs, in league with foreign banks and FIIs, were able to exploit the porous the system. The bubble reached unsustainable levels. The findings of the JPC and its preliminary report led to the RBI debarring the OCBs under the PIS in November 2001.

Curiously, in its final report released in December 2002, the JPC took the view that barring OCBs from PIS may not be a permanent solution! It directed the Finance Ministry to lay down clear guidelines and establish an elaborate system of regulation, supervision and enforcement to regulate the OCBs.

In its action taken report (May 2002), the RBI informed the JPC that it was carrying out an internal study on the PIS. The study seems to have resulted in the decision to debar OCBs from all NRI facilities. There should have been other macro compulsions leading to it.

An embarrassing episode attached to State Bank operations in the US related to NRI accounts. Late in 2001, the Federal Reserve Bank and New York Stock Exchange imposed a fine of $7.5 million for failure to maintain proper accounts and to exercise `due diligence' in customer relations. Much of these related to NRI/OCB operations, including the handling of RIBs. In its 26-page order, the Fed imposed humiliating conditions on the premier bank. The SBI had no choice but to pay the fine and revamp its systems. What happened in the US could happen in other western countries.

Globally, there is greater awareness of money laundering practices and OECD has evolved a code for bank operations under "40-principles" evolved by its Financial Action Task Force (FATF). It is taking action to `black list' countries which do not conform to the guidelines. NRI accounts and operations are suspect tested against FATF code. In fact, in June 2002, an RBI panel, headed by (then) Deputy Governor, Mr Y. V. Reddy, recommended a relook at all NRI schemes in the background of OECD and FTAF guidelines.

Mauritius was initially in the `black list' of FATF as a country which was not `cooperative'. However, since 2002, it has signalled its willingness to cooperate. However, there is not much improvement. In its latest Annual Report, FATF regards Mauritius as its jurisdiction with a lax supervisory system. When the GoI held talks with Mauritius, it was evident that they were unwilling to cooperate and said they would not "allow a fishing expedition". If, for any reason, the IMDTA cannot be rescinded, a better course would be to ban the operations of OCBs whether from Mauritius or elsewhere.

After the September 11 attack, there were concerted efforts to curb terrorist finances and fierce steps have been taken to supervise the banking system. There is a UN Code on curbing terrorist finance, which was unanimously adopted by all members.

Interpol, in its report on terrorist finance, has highlighted how some countries are lax in controlling inward remittances in their eagerness to earn foreign exchange. A person or group wishing to route funds for such activities can easily avail of NRI facilities through OCBs. In the Gulf, there are charitable foundations engaged in this and which have come under US attack.

More than such non-economic ramifications, it is realised that the conventional rationale to attract remittance has lost its validity in the changed global financial system. An attempt to maintain differential rates for any class of persons such as NRIs results in large volume arbitraging of money. There is evidence that a good part of NRI inflow is either from "round tripping" or on arbitrage. Foreign banks, in league with OCBs, lend money that is covered by back-to-back guarantees.

There is jubilation in some quarters over the increase in the forex reserves. There are many who worry over the unexplained rise in reserves. Presently, it is estimated at $87 billion. The rise in reserves or `surplus' is unmatched by any surplus on trade and service accounts. In 2001-02 alone, the net private transfers were $12.1 billion and has been in the rise since then. On the positive side, the inflow is because of confidence in the strength and stability of the rupee rate and the higher interest on deposits. On the negative side, it could suggest inflows of `hot money" or suspicious money fleeing from the surveillance of the western (US) banks.

A direct consequence of the rise in reserves is the problem it creates for monetary management. There is a high fiscal cost to maintaining forex reserves. The interest on NRE deposits is higher than the rates prevailing abroad. Our own reserves earn very low rates leading to high fiscal cost. Monetary policies and restraints on banks are defeated by the excessive liquidity brought in by NRIs/OCBs.

A major decision seems to have been taken to rely less on NRI inflows. A pointer to this is the RBI's decision of September 15 to reduce interest on NRE deposits from 250 basis points to 100 basis points above the LIBOR/SWAP rates for the US dollar of corresponding maturity. The next day, the RBI came up with it decision to derecognise OCBs. Both signal a policy shift.

There is a sideshow to the drama. In 1994, the Government floated Resurgent India Bonds (RIBs) through the State Bank of India. It was indeed a high-cost, government guaranteed bond with many tax concessions. These bonds, valued at $4.23 billion, fell due for redemption on October 1.

On September 18, the RBI notified that banks would be free to mobilise the RIB redemption proceeds strictly through the existing schemes available to non-resident Indians for bank deposits or any other investments.

By debarring the OCBs from the ambit of NRI facilities, the RBI has outwitted benami RIB holders. Robbed of their NRI status, they will have to worry about their deployment in other havens!

The recent policy decisions of the RBI are courageous and constructive. They were long overdue. They are not targeted against genuine NRIs, but against those who siphon away recourses.

(The author, a former Finance Ministry official, has extensive experience in international, financial and trade issues.)

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