Instant cross-border payments vs. current account inconvertibility

by Ajay Shah and Bhargavi Zaveri-Shah.

The Reserve Bank of India announced a project that may potentially link an Indian payments system, UPI, with PayNow, a peer-to-peer payment system operated by the Monetary Authority of Singapore. A UPI-PayNow linkage will facilitate instant peer-to-peer cross border payments. It would be a striking solution to the long-standing problems of high transaction costs faced by cross-border transactions. It would help increase India's internationalisation.

In this article, we examine the legal foundations for making this project a reality for the end consumer and merchant. We argue that connecting Indian payment systems with cross-border payment systems would face significant procedural complexities involving current account transactions. While UPI-PayNow connectivity is desirable -- as is connectivity between diverse cross-border payments systems -- barriers to convertibility on the current account can render this connectivity illusory.

Current account inconvertibility

What does a desirable cross border payments system look like? It should allow economic agents to make and receive payments with high speed and low cost. It should impose the minimum inconvenience upon every user. In the field of international trade, there is a clear distinction between tariff barriers and non-tariff barriers, in recognition of the idea that there can be substantial barriers to trade even when an overt tariff barrier is absent.

As per India's commitment to the IMF's Articles of Agreement, Indian residents enjoy full current account convertibility. This means that Indian residents should be able to exchange Indian currency, free of restrictions, for any foreign currency of their choice at market determined or pre-fixed (in case of managed currency regimes) rates. Article VIII(2) of the IMF's Articles of Agreement codifies the obligation of full current account convertibility for its members, thus:

Subject to the provisions of Article VII, Section 3(b) and Article XIV, Section 2, no member shall, without the approval of the Fund, impose restrictions on the making of payments and transfers for current international transactions.

Section 3(b) of Article VII deals with the replenishment of scarce currency. Section 2 of Article XIV deals with transitional arrangements. None of these provisions, which are more exceptional in nature, apply to normal circumstances.

A multilateral treaty such as the IMF's Articles of Agreement is given binding effect by enacting domestic law to that effect. In India, the International Monetary Fund and Bank Act, 1945 ("IMF Act"), was enacted to give effect to the IMF's Articles of Agreement. However, at the time of its enactment, the IMF Act excluded the said Article VIII(2) as India was not a fully current account convertible country at that time.

When India graduated to current account convertibility in 1993, the Foreign Exchange Regulation (Amendment) Act, 1993 amended FERA to reflect a more liberalised current account regime. However, it allowed the RBI to wield considerable discretion in introducing frictions for making and receiving cross-border payments on the current account. At the same time, the IMF Act was not amended to give binding effect to the said Article VIII(2) of the IMF's Articles of Agreement as domestic law.

After FERA was replaced by the Foreign Exchange Management Act, 1999, more transactions in foreign exchange became feasible for Indian residents than was once the case. However, the economic notion of full current account convertibility of being able to buy and sell foreign exchange, free of all restrictions, for current account transactions, was not realised in the new law. The FEMA, six years after the 1993 announcement, allows the Central Government to impose restrictions on current account transactions. The current account is less restricted than the capital account. But in 2021, Indian residents continue to face barriers to realising the benefits of `full current account convertibility'. Several barriers, both substantive and procedural, exist that make current account transactions difficult or costly for the average Indian retail consumer and merchant, that are not found in countries that have current account convertibility. These barriers are of two types:

1. Some hurdles are explicitly imposed by the foreign exchange law and its ad hoc enforcement.
2. India has restrictions on capital account convertibility. To ensure that the payments ostensibly made or received for current account transactions are not applied towards settling obligations arising from restricted capital account transactions, banks are appointed as gatekeepers. Banks, in turn, have implemented an elaborate procedural machinery to effectively vet each foreign exchange transaction made by a consumer. This creates frictions that hinder current account transactions.

The IMF Articles of Agreement envisage this possibility and attempt to pre-empt it. Article VI(3) of the IMF Articles of Agreement, which allows members to impose controls necessary to regulate international capital movements, specifically provides that, "no member may exercise these controls in a manner which will restrict payments for current transactions or which will unduly delay transfers of funds in settlement of commitments."

There is a third set of rules and regulations under FEMA that violate the spirit of current account convertibility, even if not the strict text of the IMF's Articles of Agreement. These rules and regulations mandate exporters and earners of foreign exchange to repatriate their foreign exchange earnings within a certain period after their realisation. While this period is generally in the range of six to nine months, again, like all other provisions of FEMA, this too is amenable to revision by the RBI and the Central Government.

Barriers to instant peer-to-peer cross-border payments

While the technicalities may differ across transaction type, the bank in question, the merchant and the jurisdiction of the counter-party involved, the hurdles that consumers and merchants face when making cross border payments for current account transactions can be broadly classified into three categories:

Legal restrictions on current account transactions

In exercise of the power conferred on the Central Government under the FEMA, the Central Government has enacted the Current Account Transaction Rules, 2000. These rules prohibit some current account transactions altogether. For example, they prohibit remittances for "hobbies" or the purchase of banned magazines. They also mandate the prior approval of the Central Government for certain types of current account transactions, such as remittances for cultural tours or publishing advertisements in foreign print media. For a third set of transactions, the rules impose caps that may be revised by the RBI from time to time. This effectively means that authorised dealers in foreign exchange must check the rule book when undertaking current account transactions, for they may fall in any of these categories. Particularly, since the restrictions are imposed by rules and legislation made by agencies (not the Parliament), the frequency of revisions is likely to be higher and allow for lesser transition time as they often take effect overnight.

Restrictions linked to payment instruments

Several restrictions against current account convertibility operate through rules about the payment instrument or payment service provider even when it is used for current account transactions.
The Current Account Rules, 2000 impose restrictions on the usage of international credit cards (ICCs) from an Indian issuer. Some of these are in the letter of the law. For example, the rules explicitly prohibit the usage of an ICC for making payment to foreign airlines in a currency other than INR. Other restrictions manifest themselves through enforcement processes. For example, there have been instances of the RBI having issued enforcement letters to holders of ICCs for availing cloud computing services by a foreign company not having operations in India. The basis of the enforcement actions was that the ICCs were meant to be used for current account transactions 'while on a visit outside India'. The outcomes and due process underyling the enforcement actions undertaken by the RBI are rather opaque. The RBI does not issue reasoned orders for its enforcement actions, unlike most other regulators in India. Owing to this opacity, we are not able to know whether holders of ICCs actually ended up paying fines for having used their credit cards for certain current account transactions and the legal foundations of such enforcement actions.
Similarly, until 2015, Indian residents could use the services of online payment gateway service providers (OPGSPs) for the receipt of export proceeds of upto USD 10,000. Later, in order to promote online e-commerce, the RBI allowed Indian importers to use the services of OPGSP to make payments of upto USD 2,000 for imports. Additionally, the RBI mandated OPGSPs that wish to facilitate cross border payments from or to India to set up liason offices in India.

Transaction vetting by banks

RBI has vested banks with the responsibility of acting as gatekeepers for ensuring that payments ostensibly made for current account transactions are not used for engaging in capital account transactions. Technically, this requires banks to vet every single cross border transaction in order to judge its compliance with the FEMA.
To make cross border outward remittances easier for Indian individual residents (as distinguished from corporate bodies and other artificial juridical entities), the RBI issued a `Liberalised Remittance Scheme', which sets annual caps on the amount of foreign exchange that Indian residents can repatriate outside the country, for both capital and current account transactions. This means that making outward remittances requires a payer to fill up atleast one form swearing compliance with the limits and the terms and conditions of the LRS.
Counter intuitively, the friction is exacerbated for inward remittances in the INR denominated bank account of the recipient. To comply with the letter of the law, banks have put in place a system that requires the beneficiary to furnish the bank with a whole bunch of information, such as the purpose of the inward remittance, the bill numbers where the remittance is on account of exports, etc. This form is required to be filled up and submitted for every transaction. Depending on whether the recipient bank is a public sector bank or not and its operational efficiency levels, these forms may require to be furnished in hard copy by visiting a bank branch. It may involve a couple of phone calls from bank representatives asking this, that or the other clarification. For a first time or the occasional recipient of a foreign payment, this practically puts inward remittances on a T+1 settlement cycle!

Current account convertibility means that there is no difference between going onto an e-commerce website and buying from an Indian merchant vs. buying from an overseas merchant. But Indian residents are often asked to perform know-your-customer checks, uploading images of identity documents, when buying from an overseas merchants. In contrast, domestic purchases only require supplying money and not the burden of KYC procedures. This violates globally accepted notions of full current account convertibility, and will be a significant hurdle to making instant cross-border payments a reality for the average Indian consumer.

The problem of convertibility on the current account

Current account convertibility means that cross-border transactions, for the purpose of current account activity, are as frictionless as domestic transactions. Many people believe that India is fully current account convertible; it is sometimes claimed that India has achieved current account convertibility in 1993 and is now inching towards convertibility on the capital account. This is an inaccurate depiction of where India is. There are explicit prohibitions, restrictions or tarriff barriers. There are procedural barriers that drive up the cost of cross-border transactions. There are threats of ad hoc enforcement or disparity across payment instruments or payment service providers.

At first blush, UPI-PayNow connectivity is a sweet and logical idea, there is the possibility of obtaining a quantum leap in reducing transactions costs for cross-border payments. However, it requires the invisible infrastructure of current account convertibility, which is at present lacking in India. The project of building UPI-PayNow connectivity is a great opportunity to re-open these questions and remove all the frictions, whether on paper or in practice, described above. Our objective should be to make India-Singapore payments on the current account as frictionless as (say) payments between the UK and the US.

This situation is not unique to the UPI-PayNow connection. The `fintech revolution' is limited by infirmities of financial regulation in numerous dimensions. Many ideas that first appear eminently sensible tend to break down when placed into the Indian policy environment [example: regulatory sandbox].

Ajay Shah is a researcher at xKDR Forum and Jindal Global University. Bhargavi Zaveri-Shah is a doctoral candidate at the National University of Singapore.