The Foreign Exchange Management Act (FEMA) of 1999 represents a landmark legislative shift in India’s approach to foreign exchange, moving from a restrictive, control-oriented regime under the erstwhile Foreign Exchange Regulation Act (FERA) of 1973 to a more liberalized, management-focused framework. The primary objective of FEMA is to facilitate external trade and payments, promote the orderly development and maintenance of the foreign exchange market in India, and enable cross-border transactions with greater ease and transparency. This paradigm shift was necessitated by India’s economic reforms initiated in the early 1990s, which advocated for greater integration with the global economy.

FEMA, 1999, fundamentally categorizes all foreign exchange transactions into two broad types: current account transactions and capital account transactions. This distinction is crucial as it dictates the level of regulatory scrutiny and the specific rules that apply to each type. While current account transactions are largely permitted freely, subject to certain reasonable restrictions, capital account transactions are more tightly regulated, requiring specific permissions or adherence to prescribed limits and conditions by the Reserve Bank of India (RBI) in consultation with the Government of India. This bifurcated approach allows for a nuanced management of foreign exchange flows, aiming to encourage legitimate economic activities while safeguarding against potential financial instability.

Types of Transactions Under FEMA, 1999

Under the Foreign Exchange Management Act, 1999, all foreign exchange transactions are classified into two primary categories: Current Account Transactions and Capital Account Transactions. Each type is governed by distinct regulations and principles, reflecting their differing impact on a nation’s balance of payments and overall economic stability.

Current Account Transactions

Current account transactions, as defined by Section 2(j) of FEMA, 1999, are those transactions other than capital account transactions. Essentially, they are transactions that do not alter the assets or liabilities, including contingent liabilities, outside India of persons resident in India, or assets or liabilities in India of persons resident outside India. These transactions primarily relate to international trade in goods and services, income flows, and unilateral transfers. The fundamental principle governing current account transactions under FEMA is that they are generally “freely permissible” unless specifically prohibited or regulated.

The primary regulation governing current account transactions is the Foreign Exchange Management (Current Account Transactions) Rules, 2000, issued by the Central Government in consultation with the Reserve Bank of India. These rules delineate the specific conditions, restrictions, and prohibitions on various current account transactions.

The Rules categorize current account transactions into three schedules:

  1. Schedule I: Transactions for which drawing of foreign exchange is prohibited. This schedule lists a limited set of transactions for which no foreign exchange can be drawn from an Authorized Person (AD Bank). These are typically transactions deemed against public policy or national interest. Examples include:

    • Remittance out of lottery winnings.
    • Remittance of income from racing/riding or any other hobby.
    • Remittance for the purchase of proscribed magazines (e.g., a “chit fund” or similar schemes).
    • Payment for call-back services of telephones.
    • Remittance of interest income on funds held in Non-Resident Special Rupee (NRSR) accounts.
    • Payments to a person resident in Nepal or Bhutan.

  2. Schedule II: Transactions for which prior approval of the Government of India is required. Certain current account transactions require prior approval from the concerned Ministry or Department of the Government of India before foreign exchange can be drawn. This ensures a higher level of oversight for specific sensitive or large-scale transactions. Examples include:

    • Cultural tours (Ministry of Human Resource Development).
    • Advertisement in foreign print media by Government departments/PSUs (Ministry of Finance).
    • Payment of import through gold/silver up to US$ 100,000 (Department of Commerce).
    • Remittance of freight of vessels chartered by a PSU (Ministry of Surface Transport).
    • Remittance of hiring charges of transponders by TV channels/internet service providers (Ministry of Information & Broadcasting).
    • Remittance of cash from export proceeds (Department of Revenue).

  3. Schedule III: Transactions for which prior approval of the Reserve Bank of India (RBI) is required for amounts exceeding specified limits. This schedule covers several common current account transactions where individuals or entities can draw foreign exchange up to specified limits without prior RBI approval. However, for amounts exceeding these limits, prior permission from the RBI is mandatory. This is often where the Liberalized Remittance Scheme (LRS) plays a significant role. The LRS permits resident individuals to remit foreign exchange up to a specified limit per financial year (currently US$ 250,000 as of the latest regulations) for any permissible current or capital account transaction. This limit is an aggregate for all purposes. If an individual needs to remit more than the LRS limit for any Schedule III transaction, they must seek prior RBI approval.

    Examples of Schedule III transactions include:

    • Private visits abroad (except Nepal and Bhutan).
    • Gift remittances.
    • Donations.
    • Going abroad for employment.
    • Emigration.
    • Maintenance of close relatives abroad.
    • Travel for medical treatment abroad.
    • Studies abroad.
    • Remittances by artists for their performances abroad.

    The LRS has significantly simplified outward remittances for resident individuals. Under LRS, individuals can freely remit funds up to the prescribed limit for permissible current account transactions (like travel, education, medical treatment, gifts, maintenance of relatives) and certain permissible capital account transactions (like purchasing shares, property, or opening foreign currency accounts). The AD Banks are responsible for ensuring that the remittances are within the LRS limits and adhere to Know Your Customer (KYC) norms. Any transaction that falls under Schedule I is strictly prohibited even under LRS. Similarly, transactions requiring government approval (Schedule II) are outside the purview of LRS and require specific approval.

    For all other current account transactions not listed in these schedules, there is a general permission, meaning they can be freely undertaken without any specific approval, provided they are bonafide and supported by proper documentation. This includes payments for imports and exports of goods and services, which constitute the bulk of current account transactions. Authorized Persons (AD Banks) are empowered to allow such transactions after satisfying themselves that the transaction is genuine and in conformity with FEMA provisions and other existing regulations.

Capital Account Transactions

Capital account transactions, as defined by Section 2(e) of FEMA, 1999, are transactions which alter the assets or liabilities, including contingent liabilities, outside India of persons resident in India, or assets or liabilities in India of persons resident outside India. Unlike current account transactions, capital account transactions are not freely permissible. Section 6 of FEMA, 1999, explicitly states that “any person may sell or draw foreign exchange to or from an authorised person for a capital account transaction specified by the Reserve Bank to be permissible.” This means that capital account transactions are permissible only if specifically allowed by the RBI.

The primary regulation governing capital account transactions is the Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000, along with various other specific regulations issued by the RBI from time to time. These regulations outline the types of capital account transactions that are permitted, the conditions for undertaking them, and the limits applicable.

Capital account transactions can be broadly categorized based on whether they involve a person resident in India or a person resident outside India.

Capital Account Transactions by a Person Resident in India

These transactions involve a resident individual or entity acquiring or disposing of foreign assets or incurring/discharging foreign liabilities.

  1. Overseas Direct Investment (ODI): This refers to investments made by an Indian entity in a Joint Venture (JV) or Wholly Owned Subsidiary (WOS) abroad. ODI is governed by the Foreign Exchange Management (Overseas Investment) Rules, 2022, and Foreign Exchange Management (Overseas Investment) Regulations, 2022.

    • Permissibility: Indian entities can make ODI under the automatic route or the approval route. Most bonafide business activities fall under the automatic route, subject to certain conditions.
    • Conditions: The investment must be in an overseas entity engaged in a bonafide business activity, not in real estate or financial services if the Indian entity is not engaged in the same. The financial commitment by the Indian entity (including equity, loan, guarantee) is subject to limits, generally tied to the investor’s net worth (e.g., up to 400% of net worth for a body corporate).
    • Reporting: Detailed reporting requirements exist, including filing Form ODI Part I, Annual Performance Reports (APRs), and reporting on disinvestment.
    • Approval Route: Certain types of ODI, such as those exceeding specified limits or in specific sectors, require prior RBI approval.

  2. External Commercial Borrowings (ECB): These are commercial loans raised by eligible resident entities from recognized non-resident entities. ECB is a crucial source of foreign currency funding for Indian companies. The Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulations, 2000, and the Master Direction – External Commercial Borrowings, Trade Credits and Structured Obligations govern ECBs.

    • Eligible Borrowers/Lenders: The policy specifies who can borrow (e.g., corporate, NGOs, individuals for housing) and who can lend (e.g., international banks, foreign equity holders).
    • Forms of ECB: Can be in the form of bank loans, securitized instruments (e.g., Floating Rate Notes and Fixed Rate Bonds), buyers’ credit, suppliers’ credit, foreign currency convertible bonds (FCCBs), foreign currency exchangeable bonds (FCEBs).
    • Maturity Period: Minimum average maturity period (MAMP) is prescribed, varying with the purpose and amount of the loan (e.g., 3 years for general corporate purposes).
    • End-use Restrictions: Certain end-uses are prohibited, such as investment in real estate, capital market, or for on-lending.
    • All-in-Cost Ceiling: There’s a maximum permissible cost (including interest, fees, charges) linked to a benchmark rate.
    • Routes: Automatic route (most ECBs up to specified limits) and approval route (for higher amounts or specific purposes).

  3. Acquisition of Immovable Property Outside India: Generally prohibited for resident individuals/entities, with specific exceptions.

    • Individuals: A resident individual can acquire immovable property outside India through inheritance, gift, or out of foreign currency held abroad. It is also permitted under the LRS for residential purposes, within the overall LRS limit.
    • Entities: Indian companies are generally not permitted to acquire immovable property abroad, except for their bonafide business use (e.g., office premises) for which approval might be needed.

  4. Opening of Foreign Currency Accounts by Residents:

    • Resident Foreign Currency (RFC) Account: Permitted for residents returning to India after a period of employment or stay abroad. Funds in these accounts can be freely used for various purposes.
    • Exchange Earners’ Foreign Currency (EEFC) Account: Permitted for exporters or other foreign exchange earners to retain up to 100% of their foreign exchange earnings without conversion into rupees. These funds can be used for permissible foreign currency expenses.

  5. Guarantees to Non-residents: Permitted by resident entities for their overseas JVs/WOSs within the overall ODI limits. For other cases, specific RBI approval might be required.

Capital Account Transactions by a Person Resident Outside India

These transactions involve a non-resident individual or entity acquiring or disposing of Indian assets or incurring/discharging Indian liabilities.

  1. Foreign Direct Investment (FDI) in India: Investment by a non-resident entity/person in the capital of an Indian company. FDI is governed by the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (which replaced the FDI Policy Circular), and various notifications/circulars issued by the Department for Promotion of Industry and Internal Trade (DPIIT) and RBI.

    • Sectors: Most sectors are under the ‘automatic route’, meaning no prior government/RBI approval is required. Certain strategic or sensitive sectors (e.g., defense, broadcasting, multi-brand retail trading) are under the ‘approval route’ and require prior government permission.
    • Prohibited Sectors: There are certain sectors where FDI is completely prohibited (e.g., lottery business, gambling and betting, atomic energy, Nidhi company, manufacturing of cigars, cheroots, cigarillos, and cigarettes).
    • Entry Routes: FDI can be through fresh issue of shares, transfer of existing shares, or by subscribing to units of investment vehicles like REITs and InvITs.
    • Pricing Guidelines: For unlisted companies, shares must be issued at a price not less than the fair value. For listed companies, it should be at a price not less than the SEBI guidelines.
    • Reporting: Indian companies receiving FDI must report the inflows and issue of shares to the RBI via specific forms like ARF (Advance Remittance Form) and FC-GPR (Foreign Currency – Gross Provisional Return).

  2. Foreign Portfolio Investment (FPI): Investment by non-resident entities/persons in Indian securities (e.g., shares, debentures, bonds) through stock exchanges, without assuming control over the management. FPI is regulated by the SEBI (Foreign Portfolio Investors) Regulations, 2019, and FEMA notifications.

    • Registration: FPIs must be registered with SEBI.
    • Eligible Instruments: Can invest in equity, debt instruments, mutual funds, REITs, InvITs, etc.
    • Investment Limits: Subject to sectoral caps and aggregate investment limits for a single company (e.g., 10% of paid-up capital for individual FPI, 49% or sectoral cap for all FPIs combined).
    • Routes: Generally through stock exchanges.
    • Distinction from FDI: FPI is typically passive investment, focused on returns, whereas FDI implies a strategic long-term interest and management control.

  3. Investment by Non-Resident Indians (NRIs) and Overseas Citizens of India (OCIs): FEMA has specific provisions to facilitate investments by NRIs and OCIs in India, often offering more flexibility than for other foreign investors.

    • Portfolio Investment Scheme (PIS): NRIs/OCIs can invest in shares and convertible debentures of Indian companies through stock exchanges under the PIS.
    • Direct Investment: Can invest in Indian companies on a non-repatriable basis without any limits in most sectors. They can also invest on a repatriable basis under the general FDI policy.

  4. Acquisition/Transfer of Immovable Property in India:

    • General Rule: A person resident outside India (other than an OCI) cannot acquire or transfer immovable property in India, except for specific permissions.
    • NRIs/OCIs: Can acquire residential or commercial property in India without RBI approval. Agricultural land, farmhouses, and plantations cannot be acquired by NRIs/OCIs.
    • Foreign Nationals/Companies: Generally require prior RBI approval, except for certain types of property like those acquired by way of inheritance or gift from a resident relative, or property held by an Indian company where the foreign entity holds shares.

  5. Opening of Accounts by Non-residents in India:

    • NRE (Non-Resident External) Account: Rupee accounts for NRIs/OCIs, fully repatriable. Funds are held in India but can be freely transferred abroad.
    • NRO (Non-Resident Ordinary) Account: Rupee accounts for NRIs/OCIs, where funds earned in India (e.g., rent, dividends) can be deposited. Repatriation is limited to US$ 1 million per financial year, along with other bonafide remittances.
    • FCNR (Foreign Currency Non-Resident) Account: Foreign currency accounts (fixed deposits) that can be maintained by NRIs/OCIs, repatriable.

The RBI plays a continuous and dynamic role in regulating these transactions, often issuing Master Directions, Circulars, and Notifications to update policies, clarify ambiguities, and adapt to changing economic conditions. The overall framework aims to strike a balance between encouraging foreign capital inflows and prudential management of the external sector, while simultaneously providing avenues for residents to undertake legitimate foreign exchange transactions. Adherence to these regulations, including timely reporting, is crucial, as non-compliance can lead to significant penalties under FEMA.

The Foreign Exchange Management Act, 1999, fundamentally transformed India’s foreign exchange regime, replacing the restrictive FERA with a framework designed to facilitate rather than control cross-border transactions. This progressive legislation categorizes all foreign exchange dealings into two distinct types: current account transactions and capital account transactions, each governed by specific sets of rules and principles. Current account transactions, predominantly related to trade in goods and services and income flows, are largely permitted freely, subject only to a few negative lists and specific government or RBI approvals for certain high-value remittances. The Liberalized Remittance Scheme (LRS) further empowers resident individuals by allowing significant outward remittances for a wide array of current and specified capital account purposes without individual approvals.

Conversely, capital account transactions, which alter the asset or liability position of residents vis-à-vis non-residents, are more tightly regulated. These transactions are permissible only if specifically allowed by the Reserve Bank of India, in consultation with the Government. This ensures a measured approach to capital flows, balancing the need for foreign investment and overseas expansion with the imperative of maintaining financial stability. Regulations governing Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI), Overseas Direct Investment (ODI), and External Commercial Borrowings (ECB) define the permissible limits, entry routes, and conditions for these critical capital flows, ensuring that India’s integration with the global economy is managed prudently.

The dynamic nature of FEMA regulations, characterized by continuous updates through Master Directions and Circulars from the RBI, underscores the Indian government’s commitment to adapting to evolving global economic landscapes and domestic policy requirements. This adaptive framework seeks to foster an environment conducive to international trade and investment, while simultaneously providing robust safeguards against speculative flows and illicit transactions. The shift from control to management under FEMA signifies a mature approach to foreign exchange, aimed at promoting orderly market development and facilitating India’s growing engagement with the world economy.