The Foreign Exchange Management Act (FEMA) is a key piece of legislation that regulates foreign exchange transactions in India. Enacted in 1999, FEMA replaced the previous Foreign Exchange Regulation Act (FERA) to liberalize rules for foreign exchange and facilitate external trade and payments.

An Overview of FEMA

FEMA aims to facilitate external trade and payments while also managing the foreign exchange market. It was enacted to replace FERA, which had become incompatible with the changing economic policies of liberalization and globalization.

Some of the key objectives and functions of FEMA include:

  • Facilitating external trade and payments and promoting the orderly development and maintenance of the foreign exchange market in India.
  • Regulating dealings in foreign exchange and securities as well as regulating payments outside the country.
  • Consolidating and amending the law relating to foreign exchange.
  • Preventing illegal activities such as money laundering, smuggling, etc. through monitoring and regulating foreign exchange transactions.
  • Empowering the Reserve Bank of India and the Central Government to regulate foreign exchange dealings.
  • Prescribing penalties for offenses under the Act.

Unlike FERA which imposed rigid restrictions, FEMA aims to create a framework that supports the country’s changing economic policies. It seeks to balance the objectives of liberalization while also monitoring forex transactions to prevent illegal activities.

Key Definitions under FEMA

Some important terms defined under FEMA include:

  • Authorized Person: An authorized person is an individual or organization authorized under FEMA to deal in foreign exchange or foreign securities. Authorized dealers, money changers, offshore banking units, or any other person for this purpose are considered authorized persons.
  • Capital Account Transaction: Capital account transactions are those that alter the assets or liabilities, including contingent liabilities outside India, of persons in India or those that attract in India of funds from outside.
  • Current Account Transaction: Transactions that impact the current or operating accounts constituted in the country’s balance of payments are current account transactions. These include payments due in connection with foreign trade, services, short-term banking and credit facilities, interest payments, living expenses of diplomats, etc.
  • Foreign Currency: Foreign currency is any currency other than Indian rupees.
  • Foreign Exchange: Foreign exchange means foreign currency and includes deposits, credits and balances payable in foreign currency, drafts, traveler’s cheques, bills of exchange drawn in foreign currency, and instruments payable in foreign currency.

Key Provisions

Some important provisions under FEMA include:

Regulation of Foreign Exchange Dealings

  • FEMA empowers the Central Government and RBI to frame rules and regulations for foreign exchange dealings including for current account and capital account transactions.
  • Rules can be framed for proper and efficient management of foreign exchange reserves to rectify any anomalies in the system.
  • The RBI can direct authorized persons to act or desist from acting in certain ways in the public interest and to secure compliance.

Restrictions on Dealings in Foreign Exchange

  • In general, all foreign exchange transactions are prohibited unless they are specifically permitted under the FEMA regulations.
  • Only authorized persons can buy, borrow or sell foreign exchange for the purposes permitted.
  • Holding foreign exchange without authorization is an offense.

Regulation of Capital Account Transactions

  • Capital account transactions are regulated and can be restricted in the interest of orderly and economic management of foreign exchange reserves.
  • The RBI and government can specify classes of capital account transactions that require prior permission.
  • They can also restrict the total amount of foreign exchange involved in such transactions.

Contravention and Penalties

  • Contravening any provisions of FEMA or its regulations can attract both civil and criminal penalties.
  • Penalties can range from cash fines to imprisonment or confiscation of currency, depending on the nature and severity of the offense.
  • Authorized dealers can also suspend operations and trading for contravention of FEMA provisions.

Key Bodies Under FEMA

FEMA establishes certain bodies and offices to administer the various provisions under the act:

Reserve Bank of India (RBI)

As the central bank, RBI plays a pivotal role in regulating foreign exchange under FEMA. Some of its powers and functions include:

  • Framing rules, regulations and notifications for foreign exchange transactions.
  • Regulating Authorized Persons to deal in foreign exchange.
  • Adjudicating cases of contravention of the Act.
  • Compounding offenses by levying penalties.
  • Maintaining the Foreign Exchange Reserves of the country.

Enforcement Directorate

The Enforcement Directorate enforces the FEMA provisions to prevent illegal activities such as money laundering and terror financing. Key functions include:

  • Investigating suspected contraventions under FEMA.
  • Adjudicating major offenses relating to unauthorized dealings in foreign exchange.
  • Imposing penalties and prosecuting offenses under FEMA.
  • Executing orders for confiscation of foreign exchange and securities.

Appellate Tribunal

The Appellate Tribunal hears appeals against orders by the RBI and Enforcement Directorate. It has powers similar to a civil court and can:

  • Review any orders passed by the regulators under FEMA.
  • Confirm, modify or set aside the order appealed against.
  • Adjudicate on the penalties imposed on contraventions.

Special Courts

Special courts are established to quickly try offenses and impose penalties under FEMA. Special courts have jurisdiction across states and can try offenses punishable under the act.

Types of Permissible Foreign Exchange Transactions

While the general principle is that all forex transactions are prohibited unless allowed, FEMA does allow several types of transactions and activities:

Current Account Transactions

Transactions under the current account do not alter assets or liabilities outside India. They are usually permitted unless specifically prohibited or regulated. Common examples include:

  • Payments due to foreign trade, services, loans, interests, dividends, etc.
  • Remittances by NRIs or foreign tourists.
  • Expenses of embassies, diplomatic personnel and their dependents.
  • Fees for participation in global events.
  • Foreign education up to specified limits.
  • Medical treatment expenses up to a limit.

Capital Account Transactions

Capital account transactions require RBI’s permission and are subject to specified limits and regulations. These include:

  • Borrowing and lending in foreign exchange.
  • Deposits with Indian companies by NRI or PIO.
  • Investment in Indian securities by FIIs/FPIs.
  • Setting up Wholly Owned Subsidiaries or Joint Ventures abroad by Indian entities.
  • External commercial borrowing.
  • Trade credit raised overseas.
  • Real estate and immovable property purchases abroad.

Current and Capital Account Transactions by Residents

Resident individuals can undertake certain transactions under both the current as well as capital account. These include:

  • Taking foreign education loans and making payments for permissible education expenses.
  • Making payments for medical treatment abroad up to a limit.
  • Taking loans for going abroad for permissible purposes.
  • Making investments outside India within a limit.
  • Acquiring and holding immovable property outside India within a limit.

Forex Trading by Residents

Residents are allowed to trade in forex instruments and derivatives to hedge against foreign exchange risk exposures. Permitted forex trading by residents include:

  • Hedging forex risk on current or capital account transactions.
  • Remittances to relatives abroad.
  • Buying, selling or otherwise transacting in foreign securities.
  • Hedging exchange rate risk of transactions permitted under overseas direct investments.

Forex Transactions by Authorized Persons

Authorized dealers and money changers can undertake several foreign exchange transactions subject to RBI guidelines. These include:

  • Selling or purchasing foreign currencies and traveler’s cheques.
  • Handling outward and inward remittances for various permitted purposes.
  • Issuing forex prepaid cards within a limit.
  • Providing money changing facilities.
  • Entering into forward contracts with residents to hedge foreign exchange risk.

Compliances Under FEMA

Certain compliances are required by individuals and entities entering into foreign exchange transactions:

  • Obtaining PAN card and PAN declaration for transactions over a specified amount.
  • Submitting tax clearance certificate for certain capital account transactions beyond a threshold.
  • Reporting transactions above a threshold to the RBI.
  • Maintaining proper records of transactions as required by Authorized dealers.
  • Reporting export proceeds realization as per the RBI timelines.
  • Repatriating foreign exchange due from abroad and surrendering unused forex to an Authorized dealer.
  • Ensuring overseas direct investments are within permissible limits and necessary approvals are taken.

Conclusion

In conclusion, the Foreign Exchange Management Act plays a crucial role in regulating India’s foreign exchange market. By moving from stringent controls to a liberalized framework, FEMA aims to balance the goals of facilitating external trade and combating illegal forex activities. It provides the legal basis for RBI and the government to regulate cross-border transactions, payments and investments involving foreign exchange. While easing transactions for trade and payments, FEMA also empowers regulators to monitor and restrict capital flows to manage critical economic priorities.