IFM

Importance, Challenges, and

Financial Sector Reforms
CS Rakesh Chawla
9873302122
Importance of IFM
 Better allocation of capital - International
investment has been improvement in the
global allocation of capital and an enhanced
ability to diversify investment portfolios.
 Increased prosperity - The major gain of

international trade is that it has brought

about increased prosperity by allowing
nations to specialize in producing those
goods and services at which they are
relatively efficient.
 Economic trends : The modern economic trends
are revealing that International Trade is helping
the growth of Developing Nations. The openness
to international trade has been lucrative to the
developing countries for rapid economic growth
 Growth and Development: International trade is
one of the most crucial elements in the
economic growth of a developing country.
 Confidence and Energy: The present economic
slowdown in trade would be harmful for the
developing economies. New trade relations
would help induce extra energy and confidence
into the financial markets, and support economic
growth and opportunity, in the short run.
 Opening of Agriculture Market: International
trade and new trade relations would lead to the
liberalization of the global market of agriculture.
As agriculture plays an important part in many of
the developing countries, opening of the
agricultural market would be a major
contribution to wards the elimination of poverty.
 Uruguay Round: After this the potential for more

global trade in developing countries increased.

The market accessibility pertaining to agricultural
sector, manufacturing sector, and services sector
was enhanced. It also established new and
improved rules pertaining to the trading system,
and agriculture.
 Opening Markets is opening opportunities: The
open markets of the developing countries would
be the assurance of long-term economic growth
for the same. The developing countries need to
participate in the trading system and global
economy. The new global trade negotiations
would be helped by the new WTO global trading
system, which puts the developing nations
parallel to the developed nations
 Consumer Benefits: With the open market policy

the consumers have more and better options to

choose from the market.
Challenges of IFM or Related issues of concern:

 International diversification and risk reduction

 Local Government taxation
◦ Taxable income derived from non-
domestic operations through a
branch or division is taxed under
Local Tax System.
◦ Foreign subsidiaries are taxed under
foreign tax codes until dividends are
received by the parent Co from the
foreign subsidiary.
Foreign Taxation
◦ Tax codes and policies differ from country
to country, but all countries impose
income taxes on foreign companies.
◦ The Indian government provides a tax
credit to companies to avoid the double
taxation problem.
◦ A credit is provided up to the amount of
the foreign tax, but not to exceed the
same proportion of taxable earnings from
the foreign country.
◦ Excess tax credits can be carried forward.
Political Risk
 Expropriation is the ultimate political risk.
 Developing countries may provide financial
incentives to enhance foreign investment.
 Bottom line: Forecasting political instability.
 Protect the firm by hiring local nationals,
acting responsibly in the eyes of the host
government, entering joint ventures, making
the subsidiary reliant on the parent company,
and/or purchasing political risk insurance.
Financial Sector Reforms in India
Since Globalisation
 Broad based reforms touching every sector
 Financial Sector
 Monetary and Fiscal Policy
 Capital Market
 Foreign Exchange Market
 Money and Government Securities Market 
In early 1990s
 Financial Repression
 Extensive Regulations
 Administered Interest rates
 Directed Credit Programmes
 Weak Banking Structure
 Lack of Proper Accounting & Risk

management systems
 Lack of transparency in operations
 Pre-emption of resources from the banking
system by the Pre- government to finance its
fiscal deficit
 Excessive structural and micro regulation that

inhibited financial innovation and increased

transaction costs
 Relatively inadequate level of prudential

regulation in the financial sector

 Poorly developed debt and money markets
 Outdated (often primitive) technological and

institutional structures that made the capital

markets and the rest of the financial system
highly inefficient.
Resulting into …
 Government regulated the price at which firms
could issue equity, the rate of interest which they
could offer on their bonds, and the debt equity ratio
that was permissible in different Industries
 Working capital management was even more
constrained with detailed regulations on how much
inventory the firms could carry or how much credit
they could give to their customers.
 Working capital was financed almost entirely by
banks at interest rates laid down by the central bank
 Working capital finance was related more to the
credit need of the borrower than to creditworthiness
 The balance of payments crisis that
threatened the international credibility of the
country and pushed it to the brink of default

 The grave threat of insolvency confronting

the banking system which had for years
concealed its problems with the help of
defective accounting policies.
 Hindered efficient allocation of resources
Banking Sector Reforms
 Reduction in public ownership of public sector
banks – Can raise capital from equity market up to
49% of paid up capital
 Transparent Norms related to entry, mergers
/amalgamation and governance issues for Indian
private sector, foreign and joint-venture joint-
banks, NBFC’s and insurance companies
 Permission for foreign investment in the financial
sector in the form of Foreign Direct Investment (FDI)
 Permission to banks to diversify product portfolio
and business activities
 Measures Enhancing Role of Market Forces
 Sharp reduction in pre-emption through

reserve requirement
 Market determined pricing for government

securities
 Disbanding of administered interest rates
 Introduction of pure inter-bank call money

market and developing inter- markets for

securitized assets
 Auction-based repos-reverse repos for

short-term liquidity
  Introduction and phased implementation of
international best practices and norms
related to:- CRAR, Income recognition,
Provisioning and Exposure
 Strengthen risk management :-

◦ Assignment of risk-weights to various asset classes

◦ Norms on connected lending, risk concentration
◦ Application of marked-to-market principle for
investment portfolio and limits on deployment of
fund in sensitive activities
◦ 'Know Your Customer‘ norms
◦ 'Anti Money Laundering' guidelines
◦ Graded provisioning for NPA’s
 Setting up of Lok Adalats (people’s courts), debt
recovery tribunals, asset reconstruction
companies, settlement advisory committees,
corporate debt restructuring mechanism, etc.
 Promulgation of Securitization and
Reconstruction of Financial Assets and
Enforcement of Securities Interest (SARFAESI)
Act, 2002 and its subsequent amendment to
ensure creditor rights
 Setting up of Credit Information Bureau of India
Limited (CIBIL) for information sharing on
defaulters as also other borrowers
 Setting up of Clearing Corporation of India
Limited (CCIL) to act as central counter party.
Monitory Policy Reforms
 Discontinuation of automatic monetization through
an agreement between the Government and the
Reserve Bank
 Amendment of Securities Contracts Regulation Act
(SCRA), to create the regulatory framework
 Introduction of automated screen-based trading in
government securities
 Phased introduction of Real Time Gross Settlement
(RTGS) System
 Deepening of government securities market by
making the interest rates on such securities market
related
Capital Market Reforms
 Abolition of capital issues control and the introduction
of free pricing of equity issues (CCI)
 Securities and Exchange Board of India (SEBI) was set

up as the apex regulator of the Indian capital markets.

 Primary market regulations:

◦ Entry norms for capital issues were tightened

◦ Disclosure requirements were improved
◦ Regulations were framed and code of conduct laid down for
merchant bankers
◦ Underwriters, mutual funds, bankers to the issue and other
intermediaries
◦ Regulations were framed for insider trading
 Secondary market regulations: – Capital
adequacy and prudential regulations were
introduced for brokers, and other
intermediaries
 Dematerialization of scrips was initiated with

the creation of a legislative framework and

the setting up of the first depository
 Settlement period was reduced to one week
 Carry forward trading was banned
 Tentative moves were made towards a rolling

settlement system.
 Government Securities Market :
◦ Increase in Instruments
◦ Market Stabilization Scheme (MSS) has been
introduced, which has expanded the instruments
available to the Reserve Bank for managing the
enduring surplus liquidity in the system
◦ 91-day Treasury bill was introduced for
benchmarking
◦ Zero Coupon Bonds, Floating Rate Bonds, Capital
Indexed Bonds were issued
◦ Exchange traded interest rate futures were
introduced
Reforms in Foreign Exchange Market
 Exchange Rate Regime
 Finance Mobilization
 Institutional Framework
 Increase in Instruments in the Foreign

Exchange Market
 Liberalization Measures
Exchange Rate Regime
 Evolution of exchange rate regime from a single-
currency fixed- exchange rate system to fixing the
value of rupee against a basket of currencies and
further to market-determined floating exchange
rate regime
 Adoption of convertibility of rupee for current
account transactions with acceptance of Article VIII
of the Articles of Agreement of the IMF
 Full capital account convertibility for non residents
 Calibrated liberalization of transactions undertaken
for capital account purposes in the case of residents
Finance Mobilization
 Indian companies were allowed to raise equity in
international markets subject to various restrictions.
 Indian companies were allowed to borrow in
international markets subject to a minimum
maturity, a ceiling on the maximum interest rate,
and annual caps on aggregate external commercial
borrowings by all entities put together.
 Indian mutual funds were allowed to invest a small
portion of their assets abroad.
 Indian companies were given access to long dated
forward contracts and to cross currency options
Institutional Framework
 Replacement of the earlier Foreign Exchange Regulation
Act (FERA), 1973 by the market friendly Foreign Exchange
Management Act, 1999 (FEMA)
 Delegation of considerable powers by RBI to Authorized
Dealers to release foreign exchange for a variety of
purposes
  Increase in Instruments
 Introduction of additional hedging instruments, such as,
foreign currency-rupee options
 Permission to use innovative products like cross-currency
options, interest rate swaps (IRS) and currency swaps,
caps/collars and forward rate agreements (FRAs) in the
international forex market. 
Conclusion
 The multi-pronged approach towards managing
capital account in conjunction with prudential and
cautious approach to financial liberalisation has
ensured financial stability in contrast to the
experience of many developing and emerging
economies
 Monetary policy and financial sector reforms in India
had to be fine tuned to meet the challenges
emanating from all global and domestic shocks.
 Viewed in this light, the success in maintaining price
and financial stability is all the more creditworthy.