Strategic Management and Corporate Finance · Foreign Funding - Institutions

Foreign Exchange Management Act (FEMA) Basics for Foreign Funding

Updated 11 October 2026 · Fact-checked

FEMA 1999 is the Indian law that regulates foreign exchange dealings and cross-border transactions to facilitate external trade and payments and promote orderly development of the foreign exchange market. It divides transactions into current and capital account. RBI frames rules; authorised dealers carry out the transactions. To solve questions, classify the transaction first, then apply the rules.

Understand Foreign Exchange Management Act (FEMA) Basics

Every foreign funding route, such as FDI, ECB or depository receipts, involves money crossing India's border. FEMA 1999 is the main law that governs this. Its purpose is to facilitate external trade and payments and to promote the orderly development and maintenance of the foreign exchange market in India.

FEMA replaced the Foreign Exchange Regulation Act, 1973 (FERA). FERA was restrictive and treated most foreign exchange dealings as offences, with criminal consequences. FEMA is built on a liberal, management-focused approach. Contraventions are generally dealt with as civil matters, with penalties and compounding, rather than as criminal offences.

FEMA splits cross-border transactions into two types. A current account transaction is one that does not alter the assets or liabilities, including contingent liabilities, outside India of a person resident in India, or inside India of a person resident outside India. Examples include payments for imports and exports, remittance for services, short-term banking and credit facilities in the normal course of business, small remittances for living expenses, studies and medical care, and interest and loan repayment instalments. A capital account transaction is one that alters those assets or liabilities. Examples are foreign direct investment, overseas borrowing and lending, and investment abroad by residents.

The general approach: current account transactions are freely permitted, subject to restrictions the Central Government may impose in consultation with RBI. Capital account transactions are permitted only to the extent allowed by rules and regulations; the power to specify classes of permissible capital account transactions and limits is exercised by RBI in consultation with the Central Government. The Central Government makes rules, while RBI issues regulations, directions and master directions.

The Reserve Bank of India is the central regulator. It issues regulations, authorises persons to deal in foreign exchange, and issues directions. Authorised persons, mainly authorised dealers (usually banks), are the front line. They handle foreign exchange transactions, report them, and check that the documents match the rules. For a company raising foreign funds, the authorised dealer bank is usually the channel through which inflows are received and reported to RBI.

Key rules to remember

Current account transaction: Transaction that does NOT alter assets or liabilities outside India (of a resident) or inside India (of a non-resident); Includes trade payments, services, small remittances, interest and loan instalments. Freely permitted, subject to Central Government restrictions.
Capital account transaction: Transaction that alters assets or liabilities outside India (of a resident) or inside India (of a non-resident), including contingent liabilities; Examples: FDI, ECB, overseas investment. Permitted only as per rules and regulations made under FEMA.
General rule on permission: Current account: free unless restricted | Capital account: restricted unless permitted; This is the key contrast to state in every answer.
Who makes what: Central Government → rules | RBI → regulations, directions, authorisation of dealers; Do not credit RBI with rule-making that belongs to the Central Government.
Person resident in India: Residence is a status under FEMA, not citizenship; Test residence under the Act's definition, usually based on stay in India and purpose, not on nationality.

How to solve Foreign Exchange Management Act (FEMA) Basics questions

Use this method for any case-based question on FEMA and foreign funding.

1Identify the parties and check who is a person resident in India and who is resident outside India. Do not use nationality.
2Identify the transaction: payment for goods or services, loan, equity investment, or remittance.
3Classify it as current account or capital account by asking whether it changes assets or liabilities across the border.
4State the general rule: current account is free unless restricted; capital account needs to fit the permitted rules and regulations.
5Name the authorities involved: Central Government for rules, RBI for regulations and directions, authorised dealer for execution and reporting.
6Apply the facts to the rule and check if any limit, route or reporting condition is breached.
7Conclude clearly: permitted, permitted with conditions, or contravention with civil consequences such as penalty or compounding.
8Add a practical compliance point, such as routing the transaction through an authorised dealer and filing the required reports.

Quickest way: Two-question FEMA test

When to use it: Use when time is short and the question asks you to classify a transaction or identify the regulator's role.

Ask: does this change an asset or liability across the border? Yes means capital account; no means current account.
Write the rule in one line: current account is free subject to restrictions; capital account is regulated.
Name RBI and authorised dealer with one function each.
Finish with the compliance consequence: civil penalty under FEMA, not criminal prosecution as under FERA.

Common mistakes in Foreign Exchange Management Act (FEMA) Basics

Classifying a transaction by the amount or by whether money is paid in foreign currency.
Students assume large or foreign-currency payments are capital account.
Fix: Classify only by the effect on assets or liabilities across the border. A large import payment is still current account.
Saying FEMA is a restrictive law like FERA.
The two Acts are confused because both deal with foreign exchange.
Fix: Write that FERA was regulatory and penal in approach, while FEMA is facilitative and management-oriented, with civil consequences for contraventions.
Using citizenship to decide who is a resident.
Everyday language links residence with nationality.
Fix: Apply the FEMA definition of person resident in India. An Indian citizen working abroad long-term may be a non-resident for FEMA.
Treating all capital account transactions as prohibited.
Students over-read the word restricted.
Fix: Say they are permitted to the extent allowed by the rules and regulations, with routes, limits and conditions.
Mixing up the roles of the Central Government and RBI.
Both issue binding instruments, so roles blur.
Fix: Remember: Central Government makes rules; RBI makes regulations and directions and authorises dealers.
Ignoring the authorised dealer in the answer.
Students focus on the law and forget execution.
Fix: Always mention that the transaction is routed through an authorised dealer, who checks documents and reports as required.

Worked examples

Example 1

Bharat Textiles Ltd, an Indian company, (a) pays ₹40,00,000 to a US supplier for imported machinery parts, and (b) receives ₹5,00,00,000 from a Singapore company as subscription to its equity shares. Classify both transactions under FEMA and state the general approach to each.

Show the solution

Transaction (a): payment for imported goods. It settles a trade obligation and does not create a lasting asset or liability across the border. It is a current account transaction.
Transaction (b): a non-resident acquires equity in an Indian company. This creates an asset of a non-resident inside India. It alters assets and liabilities, so it is a capital account transaction.
General approach for (a): freely permitted, unless the Central Government has imposed restrictions, and it is handled through an authorised dealer.
General approach for (b): permitted only as per the capital account rules and regulations, within the allowed route, sectoral conditions and pricing and reporting norms.
Compliance point: the company should receive the inflow through an authorised dealer bank and make the required reports to RBI.

Answer: (a) is a current account transaction and is generally free; (b) is a capital account transaction and is allowed only within the prescribed FEMA rules and regulations, with routing through an authorised dealer and reporting.

Example 2

Explain the role of RBI and authorised dealers under FEMA, and state two differences between FEMA and FERA.

Show the solution

RBI role: it is the main regulator for foreign exchange. It issues regulations, directions and master directions, and in consultation with the Central Government specifies permissible capital account transactions and limits. It also authorises persons to deal in foreign exchange.
Authorised dealer role: banks and other persons authorised by RBI buy, sell and handle foreign exchange. They examine documents, ensure the transaction fits the rules, and report it as required.
Difference 1: FERA was regulatory and restrictive in approach; FEMA is facilitative and aims at promoting external trade and the orderly development of the foreign exchange market.
Difference 2: contraventions under FERA were largely treated as offences with criminal consequences; under FEMA they are generally civil in nature, handled through penalties and compounding.
Conclude by linking to foreign funding: every inflow or outflow for funding must follow FEMA rules through an authorised dealer.

Answer: RBI regulates and authorises, while authorised dealers execute and report transactions. FEMA differs from FERA by being facilitative rather than restrictive and by treating contraventions mainly as civil, not criminal, matters.

Exam tips

Begin every case answer by classifying the transaction as current or capital account; examiners reward this first step.
Use the structure: provision, facts, conclusion. Add one compliance point such as routing through an authorised dealer.
For FEMA vs FERA, give two or three crisp points on objective, approach and consequence rather than a long history.
Do not quote section numbers or limits unless you are certain; state the rule in plain words.
Link FEMA to the foreign funding routes you study next, like FDI, ECB and depository receipts, to show application.

Practice questions from Foreign Funding - Institutions

Foreign Exchange Management Act (FEMA) Basics in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Foreign Exchange Management Act (FEMA) Basics: frequently asked questions

What is the main objective of FEMA 1999?

Its objective is to facilitate external trade and payments and to promote the orderly development and maintenance of the foreign exchange market in India. It replaced FERA, which was more restrictive.

What is the difference between current account and capital account transactions?

A current account transaction does not alter assets or liabilities across the border, for example payment for imports. A capital account transaction does alter them, for example FDI or overseas borrowing. Current account is generally free, while capital account is regulated.

What do authorised dealers do under FEMA?

Authorised dealers are persons, mostly banks, authorised by RBI to deal in foreign exchange. They carry out transactions, check that documents and conditions are met, and report as required.

How is FEMA different from FERA?

FERA was restrictive, and many contraventions were treated as offences. FEMA is facilitative and manages foreign exchange, and contraventions are generally civil, dealt with by penalty or compounding.