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There is a very good case for re-looking the principle governing capital account transactions and aligning the regulatory approaches for the same, according to Reserve Bank of India Deputy Governor HR Khan.
“Unlike in the case of current account transactions, where the principle is that everything that is not specifically forbidden is allowed, in the case of capital account transactions the principle is that only anything that is not allowed is forbidden.
“This makes a great demand on the framers of regulations, lest the investment and business is subject to the limitations of their perceptions. The way business is done is forever evolving and it is a difficult job for the regulators to keep pace with it,” said Khan in his recent address at the 11{+t}{+h} Annual Conference of the Foreign Exchange Dealers Association of India in Hong Kong.
Khan observed that most of the details of the structures in the foreign direct investment regime come from the concern that FDI should not be used as a camouflage for debt. But, in the process, the structures become complex.
“In a manner of speaking, every investment is an act of speculation. Every investor must have an expectation about the future state of affairs and the cash flows or return that will accrue to him. Every act of investment is subject to the usual information asymmetry.
“Therefore, every investment contract must provide for the probable states of affairs and how the investor will protect himself against the uncertainties and the information problems. Straitjacketing investment contracts, thus, often results in disputes, or worse, much-needed investment shying away from socially useful sectors,” he said.
Referring to cases where hybrid instruments (such as optionally convertible preference shares) are issued with the option of exiting linked to predetermined milestones, the RBI Deputy Governor felt this becomes imperative as the investment strategy of many investors (private equity, for instance) is often different and there is need for a reasonable exit option under certain circumstances without any assured return.
This problem is aggravated by the way the Foreign Exchange Management Act (FEMA) is structured.
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