An Overview of Foreign Exchange Management Act, 1999

By Md. Arif Imam

Published on: January 21, 2024 at 18:20 IST

The Foreign Exchange Management Act (FEMA) holds a significant position in India’s legal system, influencing the regulation of foreign exchange and transactions. Its roots trace back to the early 1990s when economic reforms were sweeping the nation. Before the advent of FEMA, the Foreign Exchange Regulation Act (FERA) was in place, but it was deemed rigid and incompatible with the changing economic landscape.

In response to the pressing need for a more flexible and contemporary regulatory framework, FEMA was enacted in 1999, replacing FERA. The primary purpose was to streamline and liberalize foreign exchange controls, aligning them with the burgeoning global economic trends. This marked a crucial shift towards a more open and market-oriented approach.

FEMA serves as a guardian for India’s external trade and payments, aiming to facilitate and regulate them effectively. The enactment of this legislation was a strategic move to adapt to the evolving international economic scenario, where globalization was becoming a defining feature. The Act recognizes the importance of foreign exchange reserves and aims to ensure their orderly development and maintenance.

One of the fundamental aspects of FEMA is its responsiveness to economic changes. The legislation grants the Reserve Bank of India (RBI) extensive powers to manage and regulate foreign exchange. The RBI plays a pivotal role in implementing FEMA, ensuring the smooth functioning of capital and current account transactions. This regulatory authority allows for a dynamic response to economic challenges and opportunities, fostering a more adaptable financial environment.

Evolution of FEMA

The transition from the Foreign Exchange Regulation Act (FERA) to the Foreign Exchange Management Act (FEMA) signifies a significant change in India’s approach to handling foreign exchange. FERA, enacted in 1973, aimed to regulate foreign payments and optimize the use of foreign currency within the country. However, evolving economic dynamics demanded a more adaptable and liberal framework, leading to the emergence of FEMA in 1999.

FERA was introduced during a period when India faced challenges related to low foreign exchange reserves. The primary objective was to regulate and control foreign payments to ensure the judicious use of limited foreign currency resources. The regulatory environment established by FERA was characterized by strict controls, treating violations as criminal offenses often resulting in imprisonment.

As the global economic evolved, India found itself in a more stable position with adequate foreign exchange reserves. The need for a more flexible and growth-oriented framework became apparent. FERA’s rigid and controlling regime was deemed unsuitable for the changing environment, prompting the Indian government to seek a more progressive and adaptable solution.

In response to these needs, FEMA was enacted in 1999, replacing FERA. The shift from FERA to FEMA marked a significant departure from the stringent controls of the past to a more dynamic and growth-centric approach. FEMA aimed to create a regulatory framework that not only addressed the contemporary economic landscape but also fostered economic growth and international trade.

The key aspects of the evolution from FERA to FEMA include:

1. Flexibility and Growth Orientation: Unlike FERA, which operated within a rigid and controlling regime, FEMA was designed to be more flexible and growth-oriented. The emphasis shifted from strict controls to facilitating economic growth through foreign trade and investments.
2. Adaptability to Changing Economic Environment: FERA was enacted during a period of economic challenges when foreign exchange reserves were low. FEMA, on the other hand, emerged at a time when India’s foreign exchange position was more stable. The new law was crafted to adapt to the changing economic environment and promote a more open and liberalized approach.
3. Civil Offenses vs. Criminal Offenses: FERA treated violations as criminal offenses, often resulting in imprisonment for individuals involved. In contrast, FEMA introduced a shift towards treating contraventions as civil offenses, imposing fines and penalties for non-compliance.
4. Promotion of Foreign Trade: While FERA focused on regulation and control, FEMA aimed to promote foreign trade and simplify external payments. The objective was to create a conducive environment for businesses engaged in international transactions.

The evolution from FERA to FEMA represented a significant shift in India’s foreign exchange management. The transition underscored the government’s commitment to embracing a more open, adaptable, and growth-oriented approach that aligns with the dynamic nature of the global economy. FEMA, with its emphasis on facilitating trade, easing external payments, and maintaining a healthy forex market, has become a cornerstone in India’s economic system.

Objectives of FEMA

The Foreign Exchange Management Act (FEMA) of 1999 was introduced with distinct objectives that aimed to modernize and streamline India’s foreign exchange regulations. Unlike its predecessor, the Foreign Exchange Regulation Act (FERA), FEMA sought to adapt to the changing economic scenario and facilitate a more conducive environment for international trade and investments. The key objectives of FEMA are outlined below:

1. Reformation and Amendment of Foreign Exchange Laws:
   • FEMA was enacted to replace the outdated FERA and bring about comprehensive reforms in foreign exchange laws. The objective was to create a modern legal framework that aligns with the contemporary economic needs.
2. Simplification and Facilitation of External Trade and Payments:
   • One of the primary goals of FEMA was to simplify and ease the processes related to external trade and payments. The Act aimed to remove bureaucratic hurdles, making it more convenient for businesses engaged in international transactions.
3. Systematized Development of a Healthy Forex Market:
   • FEMA sought to promote the organized development and maintenance of a robust foreign exchange market in India. This included measures to ensure transparency, efficiency, and fair practices within the forex market.
4. Removal of Disparities in Payments:
   • The Act aimed to remove disparities in payments by establishing a more equitable system. It sought to create a level playing field for all entities involved in foreign exchange transactions.
5. Control and Regulation of Non-Residents’ Employment, Business, and Investment:
   • FEMA vested powers in the Reserve Bank of India (RBI) and the Central Government to control and direct the employment, business, and investment activities of non-residents. This was intended to ensure that such activities align with the overall economic interests of the country.
6. Effective Utilization of Foreign Exchange Resources:
   • FEMA envisioned the effective utilization of foreign exchange resources for the benefit of the nation. It aimed to strike a balance between inflows and outflows of foreign currency, ensuring prudent management of forex reserves.

These objectives collectively reflected a departure from the restrictive and controlling nature of FERA. FEMA embraced a more forward-looking approach, emphasizing the need for a regulatory framework that not only addressed the challenges of the time but also laid the foundation for a more dynamic and globally integrated economy.

Features of FEMA

FEMA has 49 sections which is divided into 7 chapters, introduced several features that distinguished it from its predecessor. These features were crafted to align with the changing economic landscape and promote a more liberalized and growth-centric approach. Some noteworthy features of FEMA include:

1. Non-Applicability to Indian Citizens Residing Outside India:
   • FEMA does not apply to Indian citizens residing outside India unless their stay in India exceeds 182 days in the preceding financial year. This provision ensures that Indian citizens abroad are not unduly burdened by FEMA regulations.
2. Authority of the Central Government to Impose Restrictions:
   • The Central Government, under FEMA, has the authority to impose restrictions on and supervise payments to or from any person outside India, foreign exchange transactions, and deals involving foreign securities.
3. Classification of Transactions into Current and Capital Accounts:
   • FEMA classifies transactions into current and capital accounts, each subject to specific regulations. This classification helps in effectively managing different types of transactions based on their nature and impact on the economy.
4. Specific Areas Requiring RBI or Government Permission for Holding Forex:
   • FEMA specifies areas where holding foreign exchange requires specific permission from the RBI or the government. This ensures a controlled and regulated approach to certain forex holdings.
5. Applicability to the Whole of India:
   • FEMA is applicable to the entire geographical expanse of India, ensuring a uniform regulatory framework across the country.
6. Inclusion of Three Categories for Regulation:
   • FEMA includes three categories—person resident in India, person resident outside India, and foreign currency. Each category is dealt with separately, ensuring targeted regulation based on residency and currency involved.

The incorporation of these features marked a departure from the stringent provisions of FERA, reflecting a more contemporary and adaptable approach to foreign exchange management in India.

To Whom FEMA is Applicable?

FEMA’s applicability is broad and covers various entities and individuals involved in different capacities. The Act recognizes three main categories and deals with each category separately:

1. Person:
   • For the purposes of FEMA, a person includes individuals, Hindu undivided families (HUFs), companies, firms, associations of persons, artificial judicial persons, and agencies, offices, or branches owned or controlled by such persons.
2. Person Resident in India:
   • A person residing in India for more than 182 days during the preceding financial year is considered a resident in India. However, certain exceptions exist, such as individuals going abroad for employment or business and those coming to India for similar purposes.
3. Person Resident Outside India:
   • This category includes individuals or entities that are not residents in India. It encompasses foreign citizens, companies, or entities with no residential ties to India.

The clear delineation of these categories helps in targeted regulation based on residency and facilitates effective foreign exchange management.

Important Provisions in FEMA

FEMA includes crucial provisions that form the backbone of its regulatory framework. Some of the important provisions in FEMA are highlighted below:

1. Authorised Person (Section 2(c)): Section 2(c) defines an authorized person as an entity authorized by the RBI to deal in foreign exchange or foreign securities. This includes authorized dealers, money changers, offshore banking units, and other entities authorized under Section 10(1) of FEMA.
2. Dealing in Foreign Exchange (Section 3): Section 3 of FEMA establishes that dealings in foreign exchange must be conducted only through authorized persons. This includes authorized banks and financial institutions. The section emphasizes the importance of adhering to the regulatory framework and conducting foreign exchange transactions within the prescribed channels.
3. Power of RBI to Compound Contraventions (Section 9): Section 9 grants the RBI the power to compound contraventions of FEMA. Compounding refers to the process of settling offenses by payment of monetary penalties. This section provides a mechanism for resolving certain violations without resorting to lengthy legal proceedings, promoting a more efficient resolution of non-compliance issues.
4. Authorisation and Powers of the Reserve Bank (Section 10): Section 10 grants the Reserve Bank of India the authority to authorize any person to deal in foreign exchange or foreign securities. The authorization is subject to regulations, and the RBI can revoke it if public interest demands, or if the authorized person fails to comply with conditions.
5. Export of Goods and Services (Section 7): Section 7 mandates that every exporter of goods and services must provide a declaration or statement to the Reserve Bank, containing accurate particulars, including the full export value. This provision ensures transparency in export transactions and facilitates the realization of export proceeds.
6. Adjudication and Appeal (Sections 16-18): Sections 16-18 outline the adjudication process, appeals to the Special Director (Appeals), and the establishment of an Appellate Tribunal for foreign exchange. These provisions ensure a fair and efficient mechanism for addressing contraventions and appeals.
7. Power of Search, Seizure, etc. (Section 37): Section 37 empowers the Director of Enforcement and other designated officers to investigate contraventions through search and seizure if necessary. The powers conferred are similar to those exercised by Income-tax authorities under the Income-tax Act, 1961.

These provisions collectively contribute to the effectiveness of FEMA in regulating foreign exchange transactions and maintaining the integrity of the financial system.

Restrictions on Dealing in Foreign Exchange with Provisions

FEMA imposes certain restrictions on dealing in foreign exchange, and these restrictions are backed by specific provisions within the Act. Understanding these restrictions is crucial for entities and individuals engaged in foreign exchange transactions. Some of the key restrictions and provisions include:

1. Regulation of Current Account Transactions (Section 5): Section 5 empowers the Central Government to impose restrictions on current account transactions in consultation with the Reserve Bank. These restrictions are imposed to maintain the stability and integrity of the country’s financial system.
2. Dealings in Foreign Exchange, etc. (Section 3): Section 3 prohibits dealing in foreign exchange or foreign securities except through an authorized person. Any person contravening this provision is liable for penalties.
3. Export of Goods and Services (Section 7): While Section 7 mandates the declaration of accurate particulars by exporters, non-compliance with this provision can lead to penalties. This ensures the proper documentation and reporting of export transactions.
4. Transactions in Capital Account (Section 6): Section 6 mandates that capital account transactions, involving debt instruments, require authorization from authorized persons. The Reserve Bank, in consultation with the Central Government, can specify permissible transactions, set limits, and impose conditions. Exceptions are provided for amortization-related payments, and the RBI has the authority to regulate establishments by non-residents in India.
5. Power to Prohibit Transactions in Certain Cases (Section 9): Section 9 grants the Central Government the power to prohibit any person from entering into any transaction involving foreign exchange or foreign security if it is satisfied that such a transaction is prejudicial to the country’s interests.

These restrictions and provisions are designed to strike a balance between facilitating foreign exchange transactions and preventing activities that may undermine the economic stability and security of the nation.

Adjudication and Appeal under FEMA

FEMA establishes a structured adjudication and appeal mechanism to address contraventions and ensure due process. The adjudication process, as outlined in Sections 16-18, involves the following key elements:

1. Adjudication Officer (Section 16): The Central Government appoints Adjudicating Officers to adjudicate contraventions under FEMA. These officers are responsible for determining the penalties and taking appropriate actions based on the nature and severity of the contravention.
2. Notice to the Contravener (Section 16): Before initiating the adjudication process, the Adjudicating Officer issues a notice to the contravener, informing them of the alleged contravention and providing an opportunity to present their case.
3. Opportunity for Personal Hearing (Section 16): The contravener has the right to a personal hearing during the adjudication process. This ensures that they can present their case, provide explanations, and address any concerns raised by the Adjudicating Officer.
4. Order of Adjudication (Section 17): After considering the contravener’s response and evidence, the Adjudicating Officer passes an order, specifying the contravention and imposing penalties. The order includes the amount of penalty and the manner of payment.
5. Appeal to the Special Director (Appeals) (Section 17): Aggrieved parties have the right to appeal the Adjudicating Officer’s order to the Special Director (Appeals) within 45 days of receiving the order. The appeal process provides an additional layer of review to ensure fairness and justice.
6. Appellate Tribunal for Foreign Exchange (Section 19): In cases where parties are dissatisfied with the decision of the Special Director (Appeals), they can further appeal to the Appellate Tribunal for Foreign Exchange. The tribunal is a higher appellate authority that reviews decisions made at the previous stages.
7. Appeal to High Court (Section 35): Individuals not satisfied with the decisions of the Appellate Tribunal can file appeals in the High Court. The High Court may grant an extension of time for filing appeals under certain circumstances.

This adjudication and appeal mechanism under FEMA ensures a fair and transparent process for addressing contraventions, providing individuals and entities with the opportunity to defend themselves and seek redressal through established legal channels.

Contraventions and Penalties under FEMA

FEMA prescribes penalties for contraventions to ensure compliance with its provisions. Contraventions may involve violations of rules related to foreign exchange transactions, dealings in foreign securities, and other specified activities. The penalties are categorized based on the nature and gravity of the contravention. Some key contraventions and corresponding penalties include:

1. Penalties for Contravention:
   • Individuals violating the Foreign Exchange Management Act are subject to penalties. Penalties may be up to three times the sum involved, or up to two lakh rupees where the amount is unquantifiable. Continuous contraventions may result in additional daily penalties.
2. Penalties for Exceeding Threshold (Section 13A):
   • Exceeding the threshold for acquiring foreign exchange or property abroad may result in penalties up to three times the sum involved and confiscation of equivalent value in India. Prosecution may be initiated, and imprisonment up to five years with a fine may be imposed.
3. Enforcement of Adjudicating Authority’s Orders (Section 14):
   • Failure to pay penalties within 90 days may lead to civil imprisonment. Arrest and detention can occur if the defaulter attempts to obstruct penalty recovery or has means but refuses to pay.
4. Detention and Release (Section 14):
   • The Adjudicating Authority may order confiscation of currency, securities, or property related to the contravention. Detention in civil prison may last up to three years for large amounts and up to six months for smaller amounts. Release is possible upon payment of the arrears.
5. Compounding of Contravention (Section 15):
   • Contraventions under Section 13 can be compounded within 180 days from the date of the application. Compounding ends further legal proceedings against the individual for the specific contravention.
6. Power to Recover Arrears (Section 14A):
   • Enforcement officers can recover penalty arrears, following procedures similar to income tax authorities. The Adjudicating Authority can authorize an officer to recover penalties from defaulters.

These penalties are designed to serve as deterrents and encourage compliance with FEMA’s provisions. The severity of penalties reflects the gravity of contraventions and emphasizes the importance of adhering to the established regulatory framework.

Difference Between FERA & FEMA

Aspect	Foreign Exchange Regulation Act (FERA)	Foreign Exchange Management Act (FEMA)
Enactment and Applicability	Enacted in 1973 with stringent controls; applied comprehensive restrictions on foreign exchange transactions.	Enacted in 1999, reflecting a shift to a more liberal and growth-oriented framework, allowing flexibility in foreign exchange transactions.
Number of Sections	It consisted of 81 sections, providing a detailed and exhaustive regulatory structure.	It comprises 49 sections divided into 7 chapters, aiming for a more streamlined and adaptable regulatory approach.
Position of Foreign Exchange Reserves	Enacted during a period of lower foreign exchange reserves in the country.	Enacted when foreign exchange reserves were relatively healthier, allowing for a more positive and growth-oriented outlook.
Outlook Towards Foreign Exchange Reserves	Characterized by a rigid approach, emphasizing control over foreign exchange.	Adopted a flexible approach, recognizing the need for adaptability and facilitating foreign trade and payments.
Determining Residential Status	Residential status determined primarily based on citizenship.	Residential status determined by the number of days spent in India, with a criterion of more than 182 days’ stay during the preceding financial year.
Transfer of Funds	Required prior permission from the Reserve Bank of India (RBI) for external transfers and operations.	Removed the requirement for pre-approval from RBI, allowing for more straightforward external fund transfers and trade.
Contravention/Violation	Considered a criminal offense, subjecting the guilty party to imprisonment.	Considered a civil offense, imposing fines and potential imprisonment for violations.
Punishment for Violation	Imposed imprisonment as the primary penalty for contravention.	Imposes fines and may lead to imprisonment, offering a more balanced approach to non-compliance.

Conclusion

The shift from the Foreign Exchange Regulation Act (FERA) to the Foreign Exchange Management Act (FEMA) in 1999 signifies a important transformation in India’s approach to foreign exchange governance. FEMA’s enactment was a pragmatic response to the changing economic dynamics, steering away from the restrictive controls of its predecessor.

FEMA, designed to be more flexible and growth-oriented, aimed at fostering economic development through streamlined foreign trade and investments. It acknowledged the significance of foreign exchange reserves and prioritized their orderly development and maintenance. The Act introduced features that distinguished it from FERA, promoting adaptability to the evolving economic environment.

The objectives of FEMA were clear-cut, seeking to modernize regulations, simplify external trade and payments, promote a robust forex market, eliminate payment disparities, and regulate non-residents’ activities. These objectives collectively shaped a regulatory framework geared towards a more open and globally integrated economy.

The Act’s applicability spanned across various entities and individuals, categorizing them into residents in India, residents outside India, and different types of persons. Specific provisions within FEMA outlined penalties for contraventions, underscoring the importance of adherence to regulatory guidelines.

In essence, FEMA’s evolution marked a departure from stringent controls to embrace a regulatory approach encouraging economic dynamism and adaptability. It represents a critical juncture in India’s economic evolution, aligning with the country’s aspirations for a more liberalized and growth-centric foreign exchange management system.