FERA and FEMA: Evolution of India’s Forex Laws

Introduction

The management of foreign exchange is a crucial aspect of a nation’s economic policy, as it directly influences trade, investment, currency stability, and overall macroeconomic development. In India, two important legislations have shaped the regulation and management of foreign exchange — FERA (Foreign Exchange Regulation Act, 1973) and its successor, FEMA (Foreign Exchange Management Act, 1999).

While FERA was a restrictive and regulatory framework that reflected India’s economic environment of scarcity and protectionism, FEMA emerged in the context of liberalization, globalization, and the need to facilitate rather than control foreign exchange transactions. Together, these two Acts represent a significant transition in India’s economic governance, moving from a control-oriented approach to a management and facilitation-based system.

Historical Background of FERA

1. Economic Conditions Leading to FERA

• After independence, India followed a planned economy model with strict state control over industry, trade, and finance.
  
  
• The foreign exchange reserves were limited, and the government was cautious about capital flight and unregulated foreign business operations.
  
  
• In the 1950s and 1960s, foreign investment was tightly monitored to prevent excessive foreign control over domestic industries.
  
  
• The Foreign Exchange Regulation Act (FERA), 1947, was initially enacted as a temporary law to regulate foreign exchange during crises.

2. Enactment of FERA 1973

• In 1973, the Government of India replaced the earlier version with the Foreign Exchange Regulation Act, 1973.
  
  
• It came into effect on 1st January 1974.
  
  
• FERA was considered one of the most stringent foreign exchange laws in the world.
  
  
• It gave sweeping powers to the Reserve Bank of India (RBI) and Enforcement Directorate (ED) to control foreign exchange dealings.

Objectives of FERA

1. To conserve foreign exchange and prevent its misuse.
2. To ensure that foreign exchange was utilized only for approved purposes.
3. To regulate the operations of foreign companies in India.
4. To check smuggling and money laundering involving foreign currency.
5. To ensure that foreign exchange resources were aligned with the national interest and planned economic goals.

Main Features of FERA

1. Wide Control Powers
   • RBI was given extensive authority to regulate foreign exchange dealings.
   • Every transaction involving foreign currency required prior approval.
     
     
2. Restrictions on Foreign Companies
   • Foreign companies could not operate freely in India.
   • Those with more than 40% foreign equity had to dilute their holdings (MRTP restrictions).
     
     
3. Criminal Offences
   • Violations under FERA were treated as criminal offences and led to imprisonment.
     
     
4. Licensing System
   • Every import, export, or foreign collaboration required licensing and approval.
     
     
5. Prohibition of Certain Transactions
   • Payments outside India without RBI approval were banned.
   • Acquisition of foreign assets by Indian citizens was restricted.

Criticism of FERA

• Considered a draconian law due to its criminal provisions.
• Created a culture of red-tapism and delays in foreign investment approvals.
• Hampered India’s integration into the global economy.
• Discouraged foreign companies from investing in India.
• Encouraged illegal transactions and black-market foreign exchange.

Liberalization and the Need for FEMA

By the early 1990s, India was facing a balance of payments crisis. The economic reforms of 1991 aimed at liberalizing trade, industry, and investment. In this context:

• The restrictive FERA framework was seen as incompatible with globalization.
  
  
• The Narashimham Committee and subsequent expert groups recommended replacing FERA with a more modern and facilitative law.
  
  
• This led to the introduction of the Foreign Exchange Management Act (FEMA), 1999, which came into force on June 1, 2000.

Objectives of FEMA

1. To facilitate external trade and payments.
2. To promote the orderly development and maintenance of the foreign exchange market in India.
3. To simplify procedures for foreign exchange transactions.
4. To replace criminal penalties with civil penalties.
5. To encourage foreign investment and cross-border business.

Main Features of FEMA

1. Civil Law Framework
   • Violations under FEMA are treated as civil offences, unlike the criminal provisions of FERA.
     
     
2. Management Approach
   • FEMA regulates and manages foreign exchange rather than restricting it.
   • Focus shifted from “control” to “facilitation.”
     
     
3. Authorized Persons
   • Only authorized dealers, money changers, or RBI-approved institutions can deal in foreign exchange.
     
     
4. Current Account vs Capital Account Transactions
   • FEMA distinguishes between current account transactions (generally free, except for prohibited items) and capital account transactions (regulated by RBI).
     
     
5. Power to RBI and Central Government
   • RBI regulates foreign exchange markets.
   • Central Government makes rules for capital account transactions.
     
     
6. Penalty Structure
   • Monetary penalties are imposed instead of imprisonment (except in extreme cases of money laundering).

Key Differences Between FERA and FEMA

Significance of FEMA in Post-Liberalization India

1. Boost to Foreign Direct Investment (FDI)
   • FEMA simplified rules, encouraging global companies to invest in India.
     
     
2. Integration with Global Economy
   • Helped India join the WTO framework and align with international trade norms.
     
     
3. Support to IT and Services Sector
   • Facilitated cross-border payments in IT, BPO, and services exports.
     
     
4. Improved Ease of Doing Business
   • Made foreign trade less bureaucratic and more efficient.
     
     
5. Stable Foreign Exchange Market
   • Helped RBI manage forex reserves and stabilize the Indian Rupee.
     
     
6. Encouragement to NRIs
   • Liberalized remittance facilities and investment opportunities for Non-Resident Indians (NRIs).

Challenges in FEMA Implementation

• Money Laundering Risks: Despite FEMA, illegal hawala transactions still exist.
  
  
• Capital Account Convertibility: India still follows partial convertibility; full convertibility remains a debated issue.
  
  
• Enforcement Delays: FEMA cases handled by Enforcement Directorate sometimes face backlog.
  
  
• Global Volatility: Sudden changes in global forex markets pose challenges.

Recent Developments Related to FEMA

1. Amendments to regulate cryptocurrency transactions under FEMA (discussion ongoing).
   
   
2. Strengthening compliance for cross-border mergers and acquisitions.
   
   
3. Tightening FDI rules in sensitive sectors like telecom, defense, and digital technology.
   
   
4. Liberalized Remittance Scheme (LRS) allowing Indians to remit up to USD 250,000 annually.

FEMA and India’s Economic Growth

FEMA has been crucial in aligning India’s economic policy with its Viksit Bharat 2047 vision. By encouraging investment and making foreign exchange transactions smoother, it has:

• Supported rapid growth of exports and imports.
• Attracted global capital in infrastructure and start-ups.
• Facilitated India’s emergence as a global services hub.

Conclusion

The journey from FERA to FEMA reflects India’s transformation from a closed, regulated economy to an open and globally integrated market.

• FERA was a product of its time — aimed at conserving scarce forex and controlling foreign business.
  
  
• FEMA reflects a liberalized era, designed to manage, facilitate, and promote foreign exchange transactions in line with globalization.

In essence, FEMA continues to play a vital role in ensuring India’s smooth integration into the international economy while maintaining safeguards against misuse of foreign exchange. As India advances towards becoming a $5 trillion economy, reforms in FEMA and foreign exchange management will remain crucial in balancing growth with financial stability.