Foreign Exchange Management Act, 1999

The Foreign Exchange Management Act, 1999 (FEMA) provides the legal framework for managing foreign-exchange transactions in India. A capital-account transaction changes the assets or liabilities, including contingent liabilities, outside India of an Indian resident, or the assets or liabilities in India of a person resident outside India. FEMA regulates these transactions through permissions, limits and conditions rather than allowing unrestricted capital movements.

What falls within the capital account

Section 2(e) defines capital-account transactions by their effect on cross-border assets and liabilities, not merely by whether foreign currency changes hands.

• Transactions covered include foreign investment in Indian securities, overseas investment by Indian residents, cross-border borrowing and lending, and specified guarantees or property transactions.
• FEMA distinguishes persons by residential status, which is determined under the Act and is not synonymous with citizenship.
• Capital-account transactions differ from current-account transactions, such as payments for foreign trade, services and interest. FEMA treats these categories under different regulatory provisions.

Who regulates capital-account transactions

Section 6 distributes regulatory responsibility between the Reserve Bank of India and the Central Government according to whether transactions involve debt instruments.

• The Reserve Bank of India, in consultation with the Central Government, specifies permissible classes of capital-account transactions involving debt instruments, their limits and applicable conditions.
• The Central Government, in consultation with the RBI, specifies permissible classes of transactions not involving debt instruments, their limits and applicable conditions.
• The Central Government determines which instruments are debt instruments in consultation with the RBI.
• Foreign direct investment through equity instruments falls within the non-debt framework, while external commercial borrowing falls within the debt framework.

How regulation operates in practice

Permissions are implemented through rules, regulations and directions. Consequently, permission for one category of capital flow does not imply unrestricted permission for every transaction within it.

• The Foreign Exchange Management (Non-debt Instruments) Rules, 2019 govern matters such as eligible investment, entry routes, sectoral caps and conditions for investment in equity instruments.
• An automatic route investment does not require prior government approval, but it must still satisfy applicable limits, eligibility requirements and other conditions.
• Debt transactions, including external commercial borrowing, are subject to applicable conditions concerning matters such as eligible borrowers, lenders, borrowing limits, maturity and end-use.
• Authorised persons, principally authorised dealer banks, facilitate permitted foreign-exchange transactions and check compliance with applicable requirements.
• Contraventions attract monetary penalties under FEMA; the Act also provides adjudication and compounding mechanisms.