Published on July 15, 2009
CAPAC Recommendations Economics and Social Sciences Title: Recommendations on capital control policies for India Advisor: Dr Vivek Moorthy Name: Kaushik Rana Email: email@example.com Roll No: 2005128 Post Graduate in Software Enterprise Management INDIAN INSTITUTE OF MANAGEMENT BANGALORE, Bannerghatta Road, Bangalore, India. IIMB-PGSEM Page 1 of 51
CAPAC Recommendations Economics and Social Sciences Copyright © 2007 by Indian Institute of Management Bangalore & Kaushik Rana Declaration: As guided by my advisor Dr Vivek Moorthy I have investigated into various capital account convertibility (CAPAC) policies of India in comparison with East Asian Economies. Since the scope of CAPAC is very wide I have restricted the study to understanding the regulations allowing outflows for resident individuals especially with regard to real estate investment in foreign land. Firstly I have critiqued the gaps in the Fuller Capital Account Convertibility report (2006) prepared by honorable Economists and chaired by Dr Tarapore and argued the need to increase the ceiling for capital outflow for resident individuals in India. I have also investigated into the recommendations of Economic Outlook report (2007-08) chaired by Dr Rangarajan. Next after extensive search on the various Central Bank websites of Thailand, Malaysia, South Korea, Philippines and Taiwan, I have brought out the relevant sections/circulars that mention about capital control policies for residents. These have been referred extensively in the report and also provided sections in the Appendix. Have analyzed these regulations with respect to the present economic condition in that country like GDP growth, inflation, net increase in international reserves and movement of currency in the last one year and compared that with India. The Economic indicators for each country are detailed in the Exhibits. Further, I have investigated into various rules and regulations in USA, Canada and UK on foreigners (Indians) acquiring immovable property there. I had read up many papers to understand the economic implications and also referred many websites to get a full context. Based on my understanding have prepared the report using Harvard style of referencing. I hereby declare that the work is an original contribution and not a reproduction of any available papers or reports. I would like to especially thank Dr Vivek Moorthy for his guidance and timely feedback. Also grateful to Dr Shyamal Roy and Dr Rupa Chanda for providing helpful suggestions. IIMB-PGSEM Page 2 of 51
CAPAC Recommendations Economics and Social Sciences With Best Regards, Table of Contents Declaration:..........................................................................................................................2 Table of Contents.................................................................................................................3 Introduction:.........................................................................................................................4 Review of the FCAC:...........................................................................................................5 Allowing outflows for foreign real estate investment:........................................................7 CAPAC for Resident Individuals in East Asian Economies: .............................................9 Thailand:..........................................................................................................................9 Malaysia: .......................................................................................................................10 South Korea: .................................................................................................................11 Philippines:....................................................................................................................13 Taiwan:..........................................................................................................................14 Real estate investment in Developed Countries:...............................................................16 United States of America: .............................................................................................17 Canada:..........................................................................................................................19 United Kingdom:...........................................................................................................21 Conclusion:........................................................................................................................23 Appendices:........................................................................................................................25 Appendix 1: Circular issued by Bank of Thailand on 24th July, 2007......................25 Appendix 2: Circular issued by Central Bank of Malaysia (1-Apr-2007).................27 Appendix 3: Summary of Credit Facilities allowed in Malaysia ..............................29 Appendix 4: Forex Liberalization Plan in South Korea (19 May 2006) ...................31 Appendix 5: Foreign Exchange Regulations in Philippines (Mar-2007)...................32 Appendix 6: Excerpts from Foreign Exchange Control Act in Taiwan.....................34 Exhibits:.............................................................................................................................37 Exhibit 1: Key Economic Indicators in Thailand......................................................37 Exhibit 2: Key Economic Indicators in Malaysia......................................................38 Exhibit 3: Key Economic Indicators in South Korea.................................................40 Exhibit 4: Key Economic Indicators in Philippines...................................................42 Exhibit 5: Key Economic Indicators in Taiwan.........................................................44 Exhibit 6: Key Economic Indicators in India............................................................46 References:.........................................................................................................................48 IIMB-PGSEM Page 3 of 51
CAPAC Recommendations Economics and Social Sciences Introduction: Capital Account Convertibility (CAPAC) refers to the freedom to convert local financial assets into foreign financial assets and vice versa. It is associated with changes of ownership in foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by, the rest of the world. CAPAC can be, and is, coexistent with restrictions other than on external payments. (Tarapore et al. 2006, 5) While the benefits of CAPAC are quite obvious like greater capital mobility allows foreign fund inflows easier into the country increasing the availability of large capital stock for long term investments. CAPAC allows residents to hold internationally diversified portfolios thereby reducing the vulnerability of income streams to shocks in the domestic market. Capital account liberalization also provides effective financial intermediation allowing the domestic and foreign players more choice of financial products, and raises the bar to international levels. In short move towards CAPAC is regarded as a mark of a developing country graduating into a developed country. In 1997, the RBI appointed a Committee on Capital Account Convertibility headed by Mr S. S. Tarapore, the then Deputy Governor of RBI, to examine the issue in all its ramifications and provide a road map for the economy to move towards full convertibility. The Tarapore Committee recommended that the capital account convertibility be done in a phase manner from 1997 to 2000 and only after certain preconditions were satisfied. However, nothing much happened during the recommended phase (1997-2000) mostly because of political pressures that did not allow Government to take many drastic steps and the onset of financial crisis in Southeast Asia barely two months after the report was published. But, after 2000, there was a phenomenal increase in the foreign exchange reserves (there was a quantum jump of $21.3 billion in 2002/03 alone). This embarrassingly high level of reserves forced the policy makers to compulsorily liberalize both the current and capital account exchange control regime. Again at the behest of our PM Manmohan Singh on 18 th March, 2006 to come up with a transparent framework to move towards fuller capital account convertibility, the RBI IIMB-PGSEM Page 4 of 51
CAPAC Recommendations Economics and Social Sciences constituted the Fuller Capital Account Convertibility (FCAC) committee in March 20, 2006. For the purpose of this paper we shall be primarily reviewing the FCAC report in light of the recent developments in India. We shall also be referring to the Economic Advisory Council (EAC) recommendations for this year and recommendations of others over the years on the path to be taken for CAPAC liberalization. A comparison of India's policies with respect other East Asian Countries like Thailand, Malaysia, South Korea, Philippines and Taiwan will hopefully support our arguments for India. As we may note, the FCAC report which is built upon the 1997 Tarapore Committee report has different policy regulations for various entities which are as segmented below: ● Corporate/Business Residents ● Corporates – Non Residents (including OCBs) ● Banks – Residents ● Banks – Non Residents ● Non-banks – Financial Residents ● Non-banks Non-residents – FIIs ● Individuals – Residents ● Individuals – Non-Residents For the purpose of this paper we will consider the capital control measures primarily on Resident Indian Individuals (RII) who we think has been successively left out (Moorthy 1997, Part 1). Review of the FCAC: The FCAC report had acknowledged the fact while there has been reasonable amount of convertibility for non-resident corporate and NRI, there is near-zero convertibility for IIMB-PGSEM Page 5 of 51
CAPAC Recommendations Economics and Social Sciences non-resident individuals (Tarapore et al. 2006, 10). Again, resident individuals face a virtual ban on capital outflow (Tarapore et al. 2006, 11). While the very definition of CAPAC calls for freedom of converting local assets into foreign and vice-versa, the RBI seems to have taken a step-motherly approach towards capital control measures for resident Indians for fears of waves of outflows that requires to be calibrated (Tarapore et al. 2006, 11). While the 1997 committee Report called for implementing a plan to allow RIIs to remit upto USD 100,000 per annum by 2000, it was only in this fiscal (2007-08 to 2008-09) that this got implemented (Tarapore et al. 2006, 109). Ironically, RBI was forced to hike the limit to USD 200,000 through Circular No. 9 dated 26-Sep-2007 to ease the pressure on the rupee on account of the strong FII inflows. As per the FCAC report, this hike would have come into effect only in the 2009-10 to 2010-11 time-frames. Hence, one may be forced to raise the question of delay of the 1997 recommendations and this ad hoc measure in 2007. To this point, we are in agreement to Mr S.S. Bhalla's (Committee Member of FCAC report) dissent note stating that FCAC report has failed to deliver the benefits of CAPAC to resident Indians and that he is being allowed to remit about 30% less in real terms than he was recommended in 1999/00 (Tarapore et al. 2006, 151). FCAC has argued that remittance from resident individuals is but a trickle – US$ 28.3 million for portfolio investments and additional US$ 1.9 million for immovable property in 2004 and 2005 (Tarapore et al. 2006, 19). While one may not be very sure whether its an issue with data collection or procedural impediments, the report mentions that RBI has liberalized CAPAC on an ad hoc basis and the basic framework of control system has remain unchanged (Tarapore et al. 2006, 20). Mr A.V. Rajwade (Committee member of FCAC report) is however against liberalizing capital account for individuals for fear of large capital outflows from resident individuals through herd mentality that happened during the Asian crisis (Tarapore et al. 2006, 148). Consider this, since March 2007, the increase in foreign currency assets in India is USD 62.7 billion (an increase of 32%) while it has increased by about 58.79.84% since October 2006 while the rupee has appreciated by about 15.075% against the dollar in the last one year (See Exhibit 6). Hence, most of the above currency asset is because of RBI's intervention in the foreign IIMB-PGSEM Page 6 of 51
CAPAC Recommendations Economics and Social Sciences exchange market to prevent the rupee from appreciating quickly. As Dr Vivek Moorthy had argued in response to the 1997 report that the goal of RBI is to get the rupee to gradually fall in line with India's higher inflation, so that the competitiveness of the external sector is not adversely affected (Moorthy 1997, Part-3). He recommends that allowing RIIs to hold some foreign currency assets is likely to facilitate this goal as the ongoing demand by Indians to invest overseas is likely to continue to put downward pressure on the absolute value of the rupee. Hence, we respectfully disagree with Mr. Rajwade's views. The Economic Outlook report 2007-08 chaired by Dr C. Rangarajan mentions that accumulation of foreign currency assets with the RBI has the direct monetary consequence of increasing the stock of reserve money which in turn may fuel inflation in the economy. Further, it mentions that the order of magnitude of capital inflows can have serious repercussions for domestic businesses in both the domestic and export markets (Rangarajan et al. 2007, 58). So, the report suggests various channels for 'orderly conditions' through RBI intervention – one by neutralizing through issue of MSBs, increasing the CRR and by limiting the conversion of ECB proceeds into rupees (Rangarajan et al. 2007, 59). As restrictions on capital inflows may be seen as a regressive step, the report suggests liberalizing outflows by removing administrative and procedural impediments. However, it does not specify how or anything specifically related to RII. This is where we think there is a gap and an opportunity for RBI to bridge. Allowing outflows for foreign real estate investment: We also think that the FCAC report has probably missed the point regarding short term outflows versus long term outflows. While outflow controls are used to limit the downward pressure on their currencies. Such controls should mainly be applied to short- term capital transactions to counter speculative outflows that threaten to undermine the stability of the exchange rate and deplete foreign exchange reserves. But the same cannot be said for long term outflows like investment in real estate in a foreign country by RIIs. A foreign investment in real estate by a RII can be a good way to help one diversify one's IIMB-PGSEM Page 7 of 51
CAPAC Recommendations Economics and Social Sciences portfolio, help one make a provision of better living conditions in developed countries and also most importantly make a progressive move towards fuller CAPAC. However, as Dr Vivek Moorthy rightly points out that such a scheme should not be allowed to be used to convert black money into white (Moorthy 1997, Part 3). Guidelines can be given to allow buy of foreign assets only by selling of well-documented financial assets and ensuring record through PAN and annual tax returns. We would hence focus our analysis on the possibility of allowing real estate investments abroad referring to countries like Thailand, Malaysia, South Korea, Philippines and Taiwan. We would also consider some other measures being taken by the Central Banks in these economies to enable fuller capital account convertibility for residents and ease the pressure of an appreciating currency. We would also touch upon some other measures taken by the Central banks in these economies for Resident individuals. Interestingly, the FCAC report has recommended remittance up to US$ 1 million, per calendar year, for NRIs out of balances held in NRO accounts or sale proceeds of assets in India acquired by way of inheritance or sale proceeds of house bought 10 years ago (Tarapore et al. 2006, 108). However, the same law does not apply for resident individuals. Today, in spite of the increase of allowed capital outflow to US$ 200,000 per calendar year for resident individual, it is not much to acquire an immovable property in a foreign land. While the RBI has been continuously taking different measures to ease the pressure on rupee through controls in the ECB route, allowing increased portfolio investments abroad by corporate, exchange earner's foreign currency account liberalization, market stabilization schemes, it is yet to consider allowing individual residents to invest in real estate abroad. While short term capital outflow can lead to exchange rate volatility, allowing RIIs to invest in long term foreign assets like real estate can surely be beneficial. According to Dr Moorthy (1997, Part-3), there is opportunity cost of keeping huge reserves of dollars idle or in low yielding assets. Cultural affinity of Indians makes then invest in gold which is in general a poor investment with no cash dividends. Instead they can invest in high yielding foreign assets to enhance their returns and have better quality IIMB-PGSEM Page 8 of 51
CAPAC Recommendations Economics and Social Sciences of life. CAPAC for Resident Individuals in East Asian Economies: Thailand: Consider the case of Thailand – the economy has grown at around 4.4% in the last one year while inflation has been falling steadily and stood at 1.9% in May'07 (See Exhibit 1). On the other hand, international reserves increased by 32.5% to USD 80.2 billion (Oct'07) since Oct'06 while the baht appreciated by 6.43% in the same period (See Exhibit 1). However, to prevent this rapid appreciation of the baht hurting the exporters, the Central bank introduced some capital controls on Dec 18, 2006 which read as follows: “Anyone selling more than $20,000-worth of foreign currency, other than for the purposes of trade, would have had to deposit 30% of it with the central bank—at zero interest—for one year, or forfeit one-third of the deposit.” (Bizasia.com 2007) On December 19, 2006, Thailand’s stock market plunged 15%, a degree greater than anything experienced during the 1997 Asian Financial Crisis in response to the above regulation!! (WSJ.com 2007) Thus, recently on 24th July, 2007 the Ministry of Finance issued notification allowing relaxation of Exchange Control Regulations to benefit Thai business and individuals in their investments abroad (see Appendix 1). For a Thai resident the limit to which he may remit abroad has been raised to USD 1 million or its equivalent per person per year. This remittance can be for a family or relative who is a permanent resident abroad, remittance for donation to public, remittance to purchase immovable properties abroad and remittance to purchase securities of an affiliated business abroad according to an IIMB-PGSEM Page 9 of 51
CAPAC Recommendations Economics and Social Sciences employee's benefits plan. The remittance limit is same for inheritance to a person who is a Thai emigrant resident abroad. One may argue that Thailand has a fairly comprehensive liberalized capital account as permanent Thai residents can buy, exchange or borrow foreign currencies from authorized person and deposit that with obligation up to USD 500,000 or its equivalent for a natural person and USD 50 million or its equivalent for a juristic person. Compare this with India where foreign reserves have increased by 58% and rupee appreciated by about 15% compared to 32% and 6.5 for Thailand. So, while India has similar policy with Thailand related to remittance for non-resident individuals, the policies differ grossly when it comes to resident individuals. Hence, to prevent any further misbalance to economy, RBI may do good to relax the capital controls for RIIs as Thailand has done. Malaysia: Another East Asian economy is Malaysia which has achieved remarkable growth with the GDP above 4% in the last 5 years and grew by 5.5% in the last 6 months of this year (See Exhibit 2). This growth has been achieved amidst low inflation - Headline inflation, as measured by the annual change in the Consumer Price Index (CPI), increased to 1.9% in August 2007 (See Exhibit 2). The ringgit appreciated against the dollar by 3.3% between Dec'06 to Sep'07 while net international reserves stood at USD 97 billion (approximately 21.25% increase since Dec'06). The Central Bank of Malaysia (Bank Negara Malaysia) in the circular dated 1st April, 2007 overhauled the investment abroad policies in Malaysia (See Appendix 2). Accordingly, a resident Malay individual with domestic ringgit credit facilities is allowed to convert ringgit into foreign currency up to RM 1 million (equivalent to approximately USD 30,000) per calendar year for investment in foreign currency assets while there is no restriction on the amount for a resident without domestic ringgit credit facilities. While this amount may be small and also they have not specified if FCA can include real estate, IIMB-PGSEM Page 10 of 51
CAPAC Recommendations Economics and Social Sciences they have made separate provisions for resident individuals to invest in offshore and onshore foreign currency assets. Resident Malays wishing to invest more than RM 50 million (apprx USD 1.5 million) per year in offshore foreign currency accounts without domestic ringgit facility may need to register (See Appendix 2) while no registration is required for placement in onshore FCA or foreign currency financial products marketed by licensed onshore banks or any residents permitted by the Controller. This is again a step forward in liberalizing current account convertibility and helps the central bank manage capital flows. In the same circular (1st April, 2007), the Central Bank has made extensive provisions for providing credit facilities for non-residents. So, a resident corporation without domestic ringgit credit facility is allowed to convert any amount of ringgit into foreign currency for the lending to non-residents but for resident corporations with domestic credit facilities the amount can not exceed RM 50 million equivalents per calendar year. This facility is even extended to Resident Malay Individuals (See Exhibit 3). Accordingly, resident individuals can grant foreign credit facility of any amount funded by own foreign currency funds placed onshore and offshore or through conversion of ringgit (without any domestic credit facilities). These are surely innovative ways of allowing capital outflow which RBI may consider for India to ease the pressure of an appreciating rupee without having to resort to increasing foreign currency reserves. South Korea: South Korea which has transformed itself into a modern industrialized nation and also a member of OECD is again a very interesting point in case. The Korean economy has grown above 5% in 2006 (see Exhibit 3) and currently clocking a growth above 4% (2007) has been able to keep inflation low between 2.5% to 3.5% since mid-2005. The exchange rate has risen 9% relative to the dollar since the end of 2005 (and 4.19% in the last 1 year reaching its lowest of 909.9 to dollar on 26th October, 2007) and foreign IIMB-PGSEM Page 11 of 51
CAPAC Recommendations Economics and Social Sciences reserves of USD 247 billion (47% of GDP in 2007) driven by foreign exchange market intervention intended to smooth the upward trend in won. Korea is one country which has very systematically undertaken capital account liberalization since 1997. After the currency crisis broke out in November 21, 1997, Korea shifted to free-floating exchange rate system in December (BoK.kr 2007). By January, 2001 it completely removed ceiling on overseas travel expenses, emigration expenses, and withdrawals of domestic assets by nonresident nationals and deposits and trusts abroad (BoK.kr 2007). In June 2005, the government announced the Overseas Investment Activation Plan in which limits on real estate acquisition abroad and overseas direct investment by individuals were expanded (BoK.kr 2007). The limits on real estate acquisition abroad by residents, on overseas direct investment by individuals, on the overall net open positions of foreign exchange banks and on the obligation for repatriation of overseas claims were further expanded in 2006 (BoK.kr 2007). Currently Bank of Korea allows purchase of real estate for business and investment activities of corporation’s purchase of real estate of up to US$ 0.3 million for residence abroad by residents intending to sojourn abroad for more than two years, purchases to establish schools, hospitals or religious institutions, etc (BoK.kr 2007). The credit policy in Korea is also highly developed. Accordingly, Foreign Exchange Bank, general trading companies, institutional investors can provide foreign currency or domestic currency loans to non-residents. Corporations can grant up to USD 10 million to non-residents or up to 1 billion won per non-resident borrower upon declaration to the Bank of Korea (BoKLoan.kr 2007). With regard to the credit facilities to non-residents both South Korea and Malaysia is much in advance which allows for some capital outflows from the economy reducing some pressure on the Central Banks. Again Korea allows for residents to hold deposits abroad for asset diversification purposes without any quantitative ceiling (BoKDeposit.kr 2007). Residents except institutional investors who intend to deposit abroad by remitting more than US$ 50,000 per case from Korea must declare this to the Bank of Korea (BoKDeposit.kr 2007). IIMB-PGSEM Page 12 of 51
CAPAC Recommendations Economics and Social Sciences As of May 19, 2006, the Korean government announced its decision to advance the implementation schedule of the on-going foreign exchange liberalization from the initial time line of previous 2011 to 2009 in a phase wise manner (Appendix 4). Accordingly, Koreans will be allowed to acquire overseas real estate for investment purpose up to USD 1 million or less (the limit to be raised in a step by step manner). Meantime, Korean residents’ acquisition of overseas real estate for residential purpose does not entail any restrictions with respect to the intended investment amount. Thus we may note that South Korea has been far ahead of all its neighbors with regards to CAPAC of residents. It has clearly distinguished between acquiring foreign real-estate for investment purpose and for residing there. The amount of USD 1 million for acquiring foreign real estate is same as Thailand. RBI can surely take some cues from Korea with regards to implementing CAPAC for RIIs and make a proactive step towards raising the ceiling of outward remittance to USD 1 million. Philippines: Philippines economy has been growing on average 5% in the last 5 years clocking a growth rate of 7.27% in 2007 while inflation has been on the higher side (above 6% in 2004-2006), but it has been able to contain inflation to just 2.9% in 2007(See Exhibit 4). On the other hand, net international reserves have grown by 47% (since Oct'06) and the Philippine Peso has appreciated by 11% in the same period (See Exhibit 4). So, on 3rd August, 2007, the Governor of Bangko Sentral ng Philipinas (BSP) modified the Foreign Exchange Rules and Regulations of 1992 & 1993 (Circular No. 1327 and 1389). Accordingly, a Philippine Resident can purchase FX from AAB (Authorized Agent Banks) or NBBSE (Non-Bank Bangko Sentral ng Pilipinas-Supervised Entities) for outward investment in amount/s not exceeding USD 12 million per investor per year without prior BSP approval from USD 1 million earlier (See Appendix 5). Equity investments of BSP-supervised entities require prior BSP approval, regardless of amount. Outward investments by residents exceeding USD 12 million per investor per year shall IIMB-PGSEM Page 13 of 51
CAPAC Recommendations Economics and Social Sciences require prior approval by and subsequent registration with the BSP. So while the amount of outward investment is quite large, the BSP has made it mandatory for resident to purchase the amount from Government backed AABs and NBBSEs and have also specified that such outward investment can only be done in foreign currency denominated bonds/notes of the Republic of the Philippines (ROP) or other Philippine entities(See Appendix 5). So, no foreign real estate investment is allowed by resident Philippine. The growth in forex reserves and appreciation of the peso in Philippines seems to be much like the case of India and while BSP has at one step increased the limit on outward remittance to USD 12 million (not for foreign real estate acquisition), one may have to wait and see if this will have much effect on the foreign currency reserves and appreciating peso. Taiwan: Republic of China (Taiwan) has been growing at the rate of 4% and above in the last 2 years while inflation has been hovering around 1%. Interestingly, we find from Exhibit 5 that the New Taiwan Dollar has appreciated by just 1.96% (since Oct 06) and in fact con- tinuously depreciating against the dollar in the first half of 2007. Net forex reserves stood at USD 262 billion – a mere 0.4% increase (since Oct 06). An analysis of the BoP data reveals that Taiwan’s financial account consist of portfolio investment assets, including equity securities and debt securities, which saw an outflow of USD 10.96 billion in Q1(07-08) and USD 17.26 billion in Q2(07-08). Table: Showing Financial Account details of Taiwan in last 1 year 2006 2007 1 C. Financial Account .. Q1r Q2r Q3r Q4r Q1r Q2p Direct investment abroad -1,960 -1,684 -2,072 -1,683 -1,941 -2,071 Direct investment in R.O.C. (Taiwan)… 1,655 965 1,943 2,861 1,933 1,787 Portfolio investment assets… -10,613 -10,820 -9,932 -9,418 -10,961 -17,206 Equity securities… -3,465 -4,511 -4,338 -6,167 -7,336 -14,255 Debt securities.... -7,148 -6,309 -5,594 -3,251 -3,625 -2,951 IIMB-PGSEM Page 14 of 51
CAPAC Recommendations Economics and Social Sciences Portfolio investment li- abilities..... 3,588 4,868 2,647 10,711 -771 10,148 Equity securities… 4,480 5,291 2,524 10,367 -11 10,575 Debt securities… -892 -423 123 344 -760 -427 Source : http://www.cbc.gov.tw/EngHome/eeconomic/statistics/BOP/new/eAQ.xls Taiwan Headlines (2007) mentions that CBC officials indicate that Taiwanese enterprises and individual investors have become more interested in purchasing overseas financial products to diversify the risk of their financial investments. Since the real interest rate in Taiwan is quite low, domestic investors prefer to launch investments in financial items based on the U.S. dollar or in other foreign currencies. They have hence purchased main- ly overseas funds, bonds, and securities. This was the reason for the forex reserves re- maining almost same and not affecting the exchange rate of New Taiwan dollar. The Central Bank of China (CBC) has been targeting capital outflow and defending the TWD which have followed from the use of the TWD as a funding currency for carry trades. So, Taiwan has gone largely unscathed in the current economic scenario where other East Asian Economies has more or less met with the same fate of an appreciating currency. The Foreign Exchange Control Act of Taiwan (see Appendix 6) specifies that single any settlement of foreign exchange transaction (inward or outward) by a Taiwanese resident above NT$ 500,000 (apprx USD 15,000) requires to be declared to the CBC. The limit for non-residents is USD 100,000 but Article 6 also specifies that total accumulated foreign exchange purchased or sold not exceeding USD 5 million by an association or individual need not be declared to CBC. The Act has detailed the expenses and activities for which outward remittance is allowed in Article 13 which allows Government approved foreign investment or loan extended to foreign buyer. It does not specify if foreign investment can include real estate. In Article 19 it has mentioned that the CBC can suspend or restrict foreign exchange settlements any time in case of domestic instability or balance of payments deficit. Any violation in declaration of foreign exchange transaction limit will lead to heft fines as mentioned in articles 19-2 and 20 (see Appendix 6). Thus we may note that CBC has very well managed the CAPAC in Taiwan. It has set the IIMB-PGSEM Page 15 of 51
CAPAC Recommendations Economics and Social Sciences upper limit of remittances abroad to USD 5 million (without requiring to declare to CBC) per year but at the same time kept per settlement limit to NTD 500,000 (USD 15,000 apprx) which ensures that a resident cannot transact in large amount of foreign currency in a single transaction but overall outflow is ensured. Thus this does not affect the exchange rate. So for the case of India too, RBI can consider raising the upper limit of outward remittance to USD 1 million as in the case of Malaysia and South Korea. However, it can limit per settlement amount to avoid high volatility of fund flows during crisis as CBC has done in Taiwan. According to the second Asia-Pacific Wealth Report published by Merrill Lynch and Capgemini, India has the second fastest growing High Networth Individuals (HNI) in India which stood at 100,000 in 2006 and grew by 20% (Business Standard 2007, 3). As per the same Business Standard article HNIs are people with net financial assets of at least USD 1 million, excluding their primary residence and consumables while Ultra-HNIs are people with more than USD 30 million in financial assets. The number of Ultra-HNI is an estimated 858 and Indian HNIs hold a combined financial asset of USD 350 billion at the end of 2006 (Business Standard 2007, 3). With the economic expansion and strong financial markets, this number is growing by day. Hence many such resident Indians can afford to buy a home in a developed country or location of their choice - the attractiveness in terms of an investment decision and better quality of life and opportunity should be encouraged. And only liberalizing the CAPAC for RIIs can make such a dream true. We will hence study the feasibility (whether laws and regulations allows that) of RIIs acquiring homes in foreign locations like United States of America, Canada and United Kingdom. Real estate investment in Developed Countries: As Economywatch.com (2007) rightly points out Real Estate Investment also follows a business cycle and like any investment business-it has its peaks and troughs. Property investment can lead to diversification of ones investment portfolio, as real estate investments can be profitable and provide financial freedom in the long run. Real estate investment can be attractive if viewed as a business opportunity; it can generate rental IIMB-PGSEM Page 16 of 51
CAPAC Recommendations Economics and Social Sciences income, using it as collateral to secure a loan for a business venture, to offset otherwise taxable income through cash savings on tax-deductible interest rate losses, or simply from the profits garnered from its resale (Economywatch.com 2007). However, purchase of real estate in a foreign location requires careful planning starting from choice of country, location, future value, living conditions, immigration laws and tax considerations. With regard to tax the following require to be considered as mentioned in website of Henleyglobal.com (2007) 1. Real-estate transfer taxes – Most countries levy this tax and hence real estate is at times transferred indirectly by transferring the shares of a real estate holding company in order to avoid paying real estate transfer taxes. 2. Annual real estate taxes – Most countries collect annual taxes on immovable property which may not be very high. 3. Local inheritance and gift taxes – This is one of the main issues which relate to taxes to be paid based on the value of real estate in case of an inheritance situation or gifts which in many case is quite high. 4. Local inheritance laws and forced heirship rules – This is a big issue again. 5. Capital gains and other taxes upon the re-sale – This is an important consideration when choosing a particular location on the re-sale value of foreign real estate. Capital gains tax requires to be paid. 6. Immigration restrictions – Acquiring real estate in a particular country need not necessarily guarantee immigration 7. Personal tax liability and tax residence - There might be case of double taxation based on the location where foreign holiday home is situated. We shall hence evaluate options of RIIs buying real estate in some of developed countries of the West. United States of America: US real estate has traditionally been an attractive destination for foreign investors as it is less volatile than other investments, interest rates are low compared to those in most other IIMB-PGSEM Page 17 of 51
CAPAC Recommendations Economics and Social Sciences countries, and U.S. real estate is seen as a “safe” investment (Yun and Fears 2005, 19-23). The U.S. market contains a large supply of real estate. US real estate has high turnover rate and an easy exit option. Many international buyers also appreciate the equal opportunity that U.S. real estate affords. There are few barriers to homeownership, purchase or transfer of real estates in the U.S. except to the extent that may be necessary to enforce U.S. Criminal laws or national security provisions (Yun and Fears 2005, 19-23). As per the same report, United States also does not restrict or scrutinize most property purchases by foreigners, as do other countries. Foreign investors have the same rights as those of American property owners. Real estates are also less exposed to the effects of inflation than many other investments. NATIONAL ASSOCIATION OF REALTORS® (NAR) established in 1908 helps buyers and sellers of real estate properties in US. NAR conducted a survey of REALTORS® in Florida in 2005 in order to better understand the extent of non-U.S. resident homebuyers, why those buyers purchased homes in the U.S. The results are as given below. Source: Yun and Fears 2005, 22 US homes are generally considered more affordable compared to Europe and US is often seen as a politically stable, economically strong country having good living conditions. The top few countries investing in US real estate is as below. IIMB-PGSEM Page 18 of 51
CAPAC Recommendations Economics and Social Sciences Source: Yun and Fears 2005, 21 However, there are a number of issues which may hinder foreign real estate purchase in the USA as described in web-site HenleyglobalUSA.com (2007) mentioned below: 1). Foreign investors/sellers have numerous reporting requirements - failure of which may be punished with severe penalties (ranging from up to 25% of the fair market value o the real estate). 2). Foreigner holding real estate in US may be required to pay up to 55% of inheritance or gift taxes. 3). Even if one owns a house in US, he/she is not necessarily guaranteed entry and could be denied entry for reason that one had immigration intent. 4). Foreigners are subject to estate tax with depending on the location of the property situated in US while US citizens tax exposure is based on the personal status and not on the location of assets. 5). Transferee of US real estate from foreign person is required to deduct and withhold 10% of the amount realized by the foreign person in the disposition. Canada: Canada is again a popular destination for immigration and foreign settlement because of social and political stability, economic development, living conditions and spectacular scenery. Residential property in Canada is generally cheaper than UK, USA and along IIMB-PGSEM Page 19 of 51
CAPAC Recommendations Economics and Social Sciences with healthy appreciation provides good investment opportunities (Buyassociation.com 2007). Canada's economy has been growing above 2.5% (Ontario.com 2007) for the last 3 years and with its wealth of natural resources makes it a self-sufficient economy with focus on manufacturing, mining, energy and services sector. Buying real estate property in Canada is very easy. As per Assignmentscanada.ca (2007) if anyone stays in Canada for 6 months or less per year, the government considers them as non-residents who are entitled to open a bank account and buy property. If staying for more than 6 months, one must apply for immigration status. Majority of the provinces in Canada have no restrictions on foreign ownership of real estate but some do limit the amount of property/land that a non-resident can purchase. Purchase and sale of property in Canada is usually done through realtors – the seller's agent and buyer's agent. A non-resident can also try to qualify for mortgage financing in which case generally 35% down payment is required and 65% through mortgage (Assignmentscanada.ca 2007). A non-resident can also engage in sale of Canadian real estate held subject to payment of Canadian tax of 50% of the gain (Assignmentscanada.ca 2007). This again is quite high. If the property has been used for rental purpose, then 25% non-resident tax must be paid on the gross rent a tenant pays(Assignmentscanada.ca 2007). However, non- residents may be required to pay additional costs like various taxes - Property Transfer (or Purchase) Tax/Land Transfer Fees, Clearance Certificate of CAD 300-1000, Good and Services Tax on newly constructed homes, Provincial Sales Tax and Property Tax which is to be paid annually(Assignmentscanada.ca 2007). A non-resident may have to shell out additional expenses like Realtor's fees (3-7% of home's market value), Appraisal fee, Survey fee, Lawyer's fees, Home Inspection fees, Property insurance, Service Charges, and Condominium Fees (Assignmentscanada.ca 2007). Canada is however less crowded, has easy availability of homes, high quality, less expensive overall (land is less expensive, the cost of living is lower, the standard of living is high). Purchasing a second home in Canada as an investment decision is attractive IIMB-PGSEM Page 20 of 51
CAPAC Recommendations Economics and Social Sciences considering the fact that the buying process a relatively easy and hassle free affair which can only add even more value (Ezinearticles.com 2007). United Kingdom: There are again no restrictions on foreigners for purchasing real estate in the United Kingdom. Investment in UK property has been very popular both because of the stability of the UK property market and because of its tax friendly investment regime (compared to other European countries) especially for those non-domiciled in the country (Scfgroup.com 2007). A foreign investor in UK can avoid paying real estate transfer tax by purchasing a property through an offshore vehicle and transferring the shares in the real-estate owning company, thus leaving the title to the UK real estate unchanged(Scfgroup.com 2007). One can thus avoid inheritance tax, capital gains tax and stamp duty land tax (which is 1% - 4% of the real estate value and much less compared to other European countries) through this offshore company vehicle (Scfgroup.com 2007). Where a non-resident individual owns property a withholding tax of 22% or 40% will be levied on rental income paid to the overseas landlord (Scfgroup.com 2007). A non- resident of the UK is not subject to Capital Gains Tax in respect of gains made from the sale of investment property with a UK sites provided a permanent establishment has not been created in the UK. From the website Scfgroup.com (2007) the purchase of the property is deemed to be an investment if gains may be realized tax-free and the following points will indicate that the acquisition is an investment: - the property should be held for as long as possible - income is derived from rental of the property - only a small amount of development should be carried out - if the property is to be sold then it should be sold as a whole rather than sub divided IIMB-PGSEM Page 21 of 51
CAPAC Recommendations Economics and Social Sciences Other expenses include local property tax, value added tax, solicitor's fees, estate agent fees. It has been estimated recently that as much as 70% of all property in prime areas of London (such as Kensington, Chelsea and Belgravia) are owned via offshore tax efficient structures (Scfgroup.com 2007). A comparison of the appreciation in property prices in some industrialized nations is shown in the below table. Property prices have shown to have risen by 14.8 percentage changes in UK, 10% in Canada and 7% in US. Nominal growth in house prices (Four quarter percentage changes, in national currency units; period averages) Source: Egert, B. and Mihaljek, D. Sep 2007, BIS Working Papers No 236: Determinants of house prices in central and Eastern Europe IIMB-PGSEM Page 22 of 51
CAPAC Recommendations Economics and Social Sciences Conclusion: Before we analyze, the effect of liberalizing capital outflow for resident individuals, one may stop to ponder if the present situation of sustained capital inflows into emerging markets is really sustainable (Watanagase 2007). Does the investor community consider investment in India less risky or has their risk appetite changed? There are some permanent factors to ponder like – changing demographics (aging population of west holding large pension funds), low cost of IT and telecommunication, opening up of the economy and strong growth has led to investors money finding its place in developing countries of Asia (Watanagase 2007). Moreover, the depreciation of the dollar to other currencies and low interest rates worldwide has led to search for high yield riskier funds. So, one may be accurate to say that inflow of funds will continue in the short-term and may be in the long term if conditions prevail. And central banks in emerging markets of Asia are left with a challenge to deal domestic inflation, transmission mechanism of monetary policy and financial stability (Watanagase 2007). Table: Comparison of Economic Indicators and CAPAC outflow policy for residents GDP Inflation Net Currency Outflow policy for resident growth (06-07) Foreign appreciation individuals (06-07) currency (Oct-06 to reserves Oct-07) (Oct-06 to Oct-07) Thailand 4.4% 1.9% 32.5% 6.43% Can remit up to $1 mil abroad for real estate purchase and $100 mil for aliens Can hold foreign currency accounts balance of $ 0.5 mil and $50 mil for aliens Malaysia 6% 1.9% 21.25% 3.3% Can remit up to $30000 (apprx) for real estate purchase and no limit for resident without domestic ringgit credit Can invest up to $1.5 mil (apprx) in foreign currency assets without domestic ringgit credit South 4.02% 2.3% 4.19% Can remit up to $1 mil Korea abroad for real estate Residents can hold deposits abroad without IIMB-PGSEM Page 23 of 51
CAPAC Recommendations Economics and Social Sciences any ceiling. Per transaction limit $50,000 Philippines 7.27% 2.9% 47% 11% Can remit up to $ 12 mil in Philippine instruments abroad Funds to be from Govt. backed entities and invested in FCDU of Philippine institutions Taiwan 4.45% 0.5% 0.4% 1.96% Can remit up to $ 5 mil per year No declaration required for remittance up to $ 15000 (apprx) per transaction India 9% 5% 58.79% 15.07% Can remit up to $ 200,000 per year A comparison of the capital controls for resident individuals in various East Asian economies as summarized in table below shows that in spite of having the highest increase in foreign currency assets and maximum appreciation of the currency, India’s outward remittance policies for RIIs is lowest among other developing countries. All countries like Thailand, Malaysia and South Korea revised their outward remittance policies appropriately in the last 6 months in wake of the high dollar inflow. Taiwan is the only Asian country much less affected by this as the Taiwanese residents invest in overseas portfolio markets as they have upward limit of up to USD 5 million. We however do not have adequate data to validate how much Indians have been remitting abroad since RBI had revised the upward limit to USD 200,000 or for that matter what has been the increase in outflows successive to every increase in ceiling by RBI. However, it is imperative that RBI acts fast to remove barriers for foreign outflow for resident individuals. As the number of HNIs and Ultra-HNIs increase in India, people would like to hold diversified assets and be given the option of better quality of life. RBI holds the key to that. Block and Forbes (2004, 3) rightly argues it is a myth that lifting capital controls increases a country’s vulnerability to financial crises and capital controls should only be lifted after strengthening other financial, institutional and macroeconomic capabilities. IIMB-PGSEM Page 24 of 51
CAPAC Recommendations Economics and Social Sciences Appendices: Appendix 1: Circular issued by Bank of Thailand on 24th July, 2007 The Ministry of Finance and the Bank of Thailand deem it appropriate to relax regulations on capital flows to promote more balanced capital movements, and to increase flexibility for Thai businesses in managing their foreign currencies in order to enhance their competitiveness in the world market. The key details are summarized as follows. 1. Allow companies registered in the Stock Exchange of Thailand, most of which are high- performance businesses and subject to supervision by government agencies, to purchase foreign currencies to invest abroad in an amount up to USD 100 million per year. Such registered companies must have positive shareholder equity as shown in their latest financial statement, and do not belong to the group of companies under business rehabilitation category. 2. Provide Thai residents, both juristic persons and individuals, with greater flexibility in depositing foreign currencies with financial institutions in Thailand as follows. 2.1. Residents with funds originated abroad regardless of sources, such as export earnings or foreign borrowing, may deposit foreign currencies with financial institutions in Thailand under the following conditions: a) Foreign currency accounts with future foreign exchange obligations. The total outstanding balance for all foreign currency accounts can be up to the obligations within the next 12 months but not exceeding USD 1 million for an individual or USD 100 million for a juristic person. b) Foreign currency accounts with no future foreign exchange obligations. The total outstanding balance for all foreign currency accounts can be up to USD 100,000 for an individual or USD 5 million for a juristic person. 2.2. Residents with foreign currency funds originated within the country, obtained either by converting baht into foreign currencies, or by borrowing foreign currencies from financial institutions in Thailand, can deposit such foreign currencies with financial institutions in Thailand under the following conditions: a) Foreign currency accounts with future foreign exchange obligations. The total outstanding balance can be up to the obligations within the next 12 months but not exceeding USD 500,000 for a natural person or USD 50 million for a juristic person. b) Foreign currency accounts with no future foreign exchange obligations. The total outstanding balance may be up to USD 50,000 for an individual, or USD 200,000 for a juristic person. 3. Adjust the limit of fund remittances by Thai residents for various purposes. From now, the limit of remittances for each purpose -for example, remittances to a family or a relative who is a permanent resident abroad, donation to public, and remittances for purchase of real estates abroad-will be raised to USD 1 million or equivalent per per year. 4. Relax the repatriation requirement for Thai residents with foreign currency receipts by extending the period in which such receipts must be brought into Thailand from within 120 days (if exceeding 120 days but not exceeding 360 days, a financial institution may provide approval on behalf of the Competent Officer), to within 360 days. Further extension is possible only with permissions by the Competent Officer. This relaxation will provide greater flexibility to the Thai businesses in their granting of trade credits to their foreign customers. 5. Abolish the surrender requirement for Thai residents with foreign exchange receipts from abroad to sell or deposit such receipts within the period of 15 days. This rule change not only will provide more flexibility to Thai businesses and individuals in managing their foreign exchange receipts, but will also allow financial institutions to set the procedural guidelines that best suit their IIMB-PGSEM Page 25 of 51
CAPAC Recommendations Economics and Social Sciences operations. However, financial institutions must announce such procedural guidelines to the public so that customers can make an informed decision in choosing services from financial institutions appropriately. 6. Relax the regulation on foreign portfolio investment by the institutional investors by allowing institutional investors to invest in the form of deposits with financial institutions abroad without seeking approval from the Competent Officer. Nevertheless, the deposited amount shall be counted as part of the total amount allowable for investing abroad according to the foreign exchange regulations. The relaxation is aimed at providing greater flexibility for institutional investors in managing their investment funds. The Notifications and related information can be viewed from the Bank of Thailand's website at www.bot.or.th under the "Highlight" topic. Further information can also be obtained from the BOT Hotline center at 0-2283-6000 The above- mentioned relaxation takes effect from 24 July 2007 except the relaxation on repatriation requirement in No.4 which will come into force on the following day after the publication of related Ministerial Regulations in the Government Gazette. The Bank of Thailand will notify financial institutions of the effective date of the regulations. Source: http://www.bot.or.th/bothomepage/General/PressReleasesAndSpeeches/PressReleases/ news2550/Eng/n3350e.htm IIMB-PGSEM Page 26 of 51
CAPAC Recommendations Economics and Social Sciences Appendix 2: Circular issued by Central Bank of Malaysia (1-Apr-2007) Source:http://www.bnm.gov.my/view.php? ch=190&pg=595&ac=7&fname=file&dbIndex=0&ex=1178566008&md=ju2-%C0a%9Db %04.%D8u_8%BE%C7 IIMB-PGSEM Page 27 of 51
CAPAC Recommendations Economics and Social Sciences IIMB-PGSEM Page 28 of 51
CAPAC Recommendations Economics and Social Sciences Appendix 3: Summary of Credit Facilities allowed in Malaysia Source:http://www.bnm.gov.my/view.php? ch=190&pg=595&ac=5&fname=file&dbIndex=0&ex=1184992510&md=y%2B%91%BCc%2F %C9VWWU.A%FBO%F9 IIMB-PGSEM Page 29 of 51
CAPAC Recommendations Economics and Social Sciences IIMB-PGSEM Page 30 of 51
CAPAC Recommendations Economics and Social Sciences Appendix 4: Forex Liberalization Plan in South Korea (19 May 2006) The gist of medium and long term forex liberalization plan is summarized as below. (Table 3) Phase 1 (2006~2007) Phase 2 (2008~2009) Won's a. Expand won-holdings by non- a. Expand scope of the won transactions internationalizati residents exempted from reporting compliance on b. Pursue listing of KRW/US$ futures in overseas exchange house c. Lower tax rates applied to non- residents’ interest earnings from investments in won-denominated local bonds d. Consolidate won accounts of similar nature held by non-residents e. Completely scrap limits on export/import of the won Liberalization of a. Allow acquisition of overseas real a. Liberalize acquisition of overseas real overseas estate up to US$1 million or less estate by residents with complete lift of investment by (‘ceiling’) for investment intent by investment ceiling Korean individuals and companies nationals * Ceiling to be upwardly adjusted in phases Abolishment of a. Mark up the threshold principal a. Put an end to the mandatory the mandatory amount subject to the mandatory collection obligation collection of collection obligation b. Instead, institutionalize ‘a reporting’ external credit b. Convert current ‘approval’ regime to system for the purpose of sound ‘reporting’ system with respect to ‘monitoring’ on overseas lending and/or exemption from collection obligation capital transactions of such nature exceeding certain amount Appeasement of a. Soften procedural restrictions on a. Most capital transactions shall be procedural capital transaction executed with simple reporting to restrictions on (i.e, reporting to MOFE and/or BOK ‘foreign
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