Powers of RBI under Foreign Exchange Management Act (FEMA)

By Sahil Kumar 11 Minutes Read

Introduction

The Reserve Bank of India (RBI) holds substantial authority under the Foreign Exchange Management Act (FEMA), 1999 to regulate foreign exchange and external trade in India. Empowered to issue directives and guidelines, the RBI ensures adherence to FEMA provisions, overseeing cross-border transactions, capital account management, and the operations of authorized dealers. Its responsibilities include scrutinizing and approving foreign investments and enforcing penalties for violations. Through these powers, the RBI plays a crucial role in maintaining the stability of the Indian economy amid global financial dynamics.

Reserve Bank of India (RBI)

• The Reserve Bank of India (RBI) serves as India’s central bank and is a statutory body entrusted with various responsibilities, including printing currency notes, controlling monetary policy, and acting as a custodian for other primary banks in the country.
• The RBI was established on April 1, 1935, under the Reserve Bank of India Act, 1934, following the recommendations of the Hilton-Young Commission, also known as the Royal Commission on Indian Currency and Finance. Its headquarters are located in Mumbai.
• The primary objective of establishing the RBI was to separate currency control from the government and provide essential banking services.
• The Reserve Bank of India was nationalized on January 1, 1949, through the Reserve Bank of India (Transfer to Public Ownership) Act, 1948. The RBI’s operations are overseen by the RBI Governor, who is appointed by the central government of India and serves as the chief decision-maker within the institution.

Foreign Exchange Regulation Act (FERA)

• The Foreign Exchange Regulation Act (FERA) was enacted by the Indian Parliament in 1973 and became effective on January 1, 1974. This legislation was designed to regulate foreign exchange and securities transactions, with the primary goal of conserving India’s foreign exchange resources and ensuring their proper use in the country’s economic development.
• FERA applied throughout India and extended to Indian citizens both within and outside the country, as well as to branches and agencies of Indian companies or corporate bodies operating abroad.
• FERA imposed stringent controls on foreign exchange transactions, including the import and export of currency. In response to the evolving economic landscape, the Government of India drafted the Foreign Exchange Management Bill (FEMA) to replace FERA, aligning it with the liberalization of the Indian economy.
• FERA was eventually repealed in 1999 with the introduction of the Foreign Exchange Management Act (FEMA), which relaxed foreign exchange controls and eased restrictions on foreign investment.

Foreign Exchange Management Act (FEMA)

• The Foreign Exchange Management Act (FEMA) came into effect on June 1, 2000, replacing the Foreign Exchange Regulation Act (FERA). FEMA grants the central government the authority to regulate foreign exchange transactions.
• Financial dealings involving foreign exchange or securities must be conducted by “Authorised Persons”, such as authorised dealers, money changers, and offshore banking units, with approval from FEMA.
• FEMA categorizes foreign exchange transactions into capital account and current account transactions. The balance of payments under FEMA records transactions involving assets, goods, and services between nationals of different countries.
• The Act empowers the Reserve Bank of India (RBI) to determine the categories of capital account transactions and the applicable exchange restrictions in consultation with the Indian government. FEMA also includes provisions for the gradual liberalization of capital account transactions.

Furthermore, the Act permits individuals residing in India who previously lived abroad to own, hold, and transfer real estate or foreign securities acquired during their time outside India.

RBI and FEMA

• FERA was designed to regulate all transactions related to overseas trade, whereas FEMA introduced a framework where only transactions not explicitly protected are regulated. FERA sought to restrict foreign exchange transactions, while FEMA aimed to promote a more open and liberal foreign exchange market.
• The transition from FERA to FEMA signifies a legislative intent to establish a more permissive framework for foreign exchange transactions, allowing for post-facto approvals in specific instances.^[1]
• Section 5 of FEMA removes restrictions on the withdrawal of foreign currencies for current account transactions, thereby encouraging external trade. Since international trade (imports and exports of goods and services) involves current account transactions, there is no need to secure RBI permits for external trade remittances.
• Current account purchases are generally free, subject to reasonable limitations that may be imposed.
• FEMA serves as a regulatory framework that enables the RBI and the central government to issue foreign exchange regulations and rules in accordance with India’s foreign trade policy.
• It allows individuals to buy or withdraw foreign exchange without prior RBI approval, with subsequent notification to the RBI. FEMA focuses more on leadership and less on stringent regulations and controls.
• It facilitates foreign exchange dealings through licensed entities such as registered dealers and money changers. Additionally, FEMA recognizes the potential for capital account convertibility.

Powers of RBI under FEMA

1. Foreign exchange transactions are generally controlled through the issuance of permissions, except where specific rules, regulations, or laws apply. RBI holds the authority to grant permissions for foreign exchange transactions and to impose conditions on these transactions.^[2]

2. Section 3^[3] states that the Reserve Bank of India (RBI) does not impose restrictions on current account transactions.

3. Section 5 specifies that only the Central Government, in consultation with the RBI, can impose restrictions on current account transactions.

4. The Foreign Exchange Management (Current Account Transactions) Rules, 2000, outline various scenarios requiring prior RBI permission for current account transactions.

5. Section 6(2) defines the conditions for payments related to capital account transactions.

6. Section 6(3) allows for regulation or prohibition of the following via regulations:

• Transfer or issuance of foreign securities to residents and Indian securities to non-residents
• Borrowing and lending in foreign exchange or to foreign persons
• Export or import of currency or currency notes
• Transfer of immovable property outside India
• Provision of guarantees or sureties involving foreign exchange transactions
• The RBI has the authority to impose penalties for violations of FEMA provisions. However, unlike FERA, FEMA does not include provisions for criminal prosecution.^[4]

7. Section 8 establishes regulations for the timeframe and procedure for receiving foreign currency from exports of goods and services.

8. Section 9 provides exemptions from the requirements of realization and repatriation in specified circumstances.

9. Sections 10, 11, and 12 authorize “Authorized Persons” to conduct foreign exchange business, issue instructions, and undergo inspections. The RBI may authorize individuals or entities to engage in foreign exchange transactions, and any transaction that does not comply with FEMA provisions or lacks RBI authorization may be subject to scrutiny.^[5]

Conclusion

By fostering foreign investment and managing cross-border financial activities, the RBI has played a crucial role in India’s economic growth and development. The RBI’s responsibilities under FEMA encompass several crucial functions, including the regulation of the foreign exchange market, the monitoring of international transactions, the approval of foreign investments, the issuance of guidelines for effective foreign exchange management, and the enforcement of FEMA compliance.

Through its diligent efforts to encourage foreign investments and manage cross-border financial activities, the RBI has significantly contributed to the expansion and progress of the Indian economy. By facilitating a conducive environment for foreign capital inflows and managing international transactions with prudence and efficiency, the RBI has played a key role in attracting investment to India, thereby supporting economic growth and development.

^[1] Cruz City 1 Mauritius Holdings Decree Holder v. Unitech Limited Judgment Debtor 2017 SCC ONLINE DEL 7810.

^[2] Reserve Bank Of India v. Jayantilal N. Mistry 2016 SCC 3 525.

^[3] Foreign Exchange Management Act, 1999, No. 42 of 1999.

^[4] Vijay Karia And Others v. Prysmian Cavi E Sistemi Srl And Others 2020 SCC ONLINE SC 177.

^[5] M/S. Madhav Maganlal & Co. And Anr. v. Union Of India And Anr. S 2017 SCC ONLINE DEL 8978.

Sahil Kumar