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Introduction to foreign exchange law

Seeking investment from a foreign VC is a coveted goal for many Indian startups. Companies that manage to seek funding from Google Ventures, Intel Capital or Accel Partners are envied by startup entrepreneurs. In 2012, Olacabs, an aggregator of car rentals and point-to-point services secured investment of USD 10 million (approximately INR 50 crores) from Tiger Global, a New York based firm which has also invested in JustDial. InMobi, one of the most successful Indian startup raised $200 million from Softbank Corp of Japan which was completed in April 2012. Earlier, InMobi raised venture capital from Kleiner Perkins Caufield & Byers and Sherpalo Ventures.


Startups in India are becoming globally competitive, and drawing attention of foreign investors. Apart from startups, as companies grow in scale and stature, they often raise growth capital from foreign investors. Existing investors and promoters often liquidate their stock holdings as well as exit companies when they find foreign investors. Foreign investors are often considered to buy shares at significantly better prices/ valuation compared to domestic buyers. A major instance was that of International Paper buying a 75% stake in Andhra Pradesh Paper Mills for $388 million, a price which was much higher than the prevalent stock prices of Andhra Paper and was considered to be a windfall for the promoters who exited the company.


Foreign investors are attracted to Indian companies in various stages of growth for various reasons - India has a growing consumer base and foreign capital can witness more growth in an emerging economy like India as compared to saturated western markets which offer limited growth opportunities. An Indian startup looks at foreign investment for many reasons, which equally apply to most established companies as well. Some of the reasons are listed below:

i)  a foreign investor may be able to invest much more money compared to an Indian source, which can help the startup expand faster. It is a reality that risk capital, which is a name given to the capital available to startups, is in short supply in India. For instance, the amount of risk capital available to be invested in early stage startups in Silicon Valley, Tel Aviv or Los Angeles is many hundred times more than what is available in Indian startup eco-systems. Since the domestic venture capital investment market is still at a nascent stage, startups with global potentials need to look for investments outside India.

 a foreigner who is a sophisticated financial investor may let the Indian business enjoy more autonomy to operate post the investment compared to an Indian investor. Seasoned financial investors are likely to be less concerned with day-to-day management as opposed to overall performance and long-term growth.

 a foreign strategic investor (that is, one which runs a business in a similar or related sector) who wants to acquire an Indian business may offer a great synergy, and may allow the Indian product to integrate with a foreign offering and expand to global markets.


iv) in various sectors technical expertise is necessary, which local businesses in India may not be able to provide without an experienced foreign partner. For example, modernized airports, metro railway, etc. are being built by Indian companies in collaboration with experienced foreign JV partners. Many automobile manufacturers also operate on a joint venture basis – e.g. Maruti Suzuki, Mahindra Renault, etc.


Similarly, taking foreign loans can be a great boon for Indian businesses because they are available at a fraction of the interest rate on domestic loans. For non-profit organizations, knowing how to avail of donations from foreign sources (called foreign contributions) increases their funding options greatly and provides them access to a much wider pool of capital. International funding organizations such as the Ford Foundation are also usually eager to find Indian non-profits they can donate to, as they have committed budgets to donate for charitable causes in third world nations, or in poverty/ disease stricken regions.


This module will explain the basics of foreign exchange law, and how Indian companies can source foreign investment as loans from foreign lenders. It will take you through the essential concepts in Indian exchange control regulations, so that you are able to grasp the provisions dealing with bank accounts, foreign investments, foreign loans and foreign donations.

Legal framework


Before going in detail into the process of foreign investment, loans and donations, it is important have a brief idea about the legal framework. This part will explain the legal framework governing foreign exchange transactions. The primary legislation governing foreign exchange transactions in India is the Foreign Exchange Management Act, 1999 (FEMA). FEMA classifies foreign exchange transactions into two categories– current and capital account transactions. A capital account transaction is a transaction which alters the assets/ liabilities outside India of residents or assets/ liabilities in India of non-residents. The act also lists certain transactions as capital account transactions (list provided in Annex A).


A current account transaction is a transaction which is not a capital account transaction. Certain transactions are specifically included within the ambit of a current account transaction, such as payments in connection with foreign trade, business services short term banking and credit facilities, interest payments on loans, living expenses of parents or children residing abroad, expenses incurred on foreign travel and education, etc.


As per the above definitions, investments in shares and other securities of Indian companies qualify, and loans given to Indian companies are considered capital account transactions.


Under the FEMA, a capital account transaction can be undertaken only if it is specifically permitted. A current account transaction can be undertaken also long as it is not specifically prohibited under FEMA and related rules.


Donations are dealt with by the Foreign Contribution Regulation Act, 2010 (FCRA). More details about FCRA are explained in a separate discussion in this module.


FEMA regulates the entities which can deal in foreign currency in India. It also stipulates the bank accounts that a resident who requires foreign exchange, or a foreigner who requires rupees, can maintain in India. Therefore, before discussing foreign direct investment, foreign loans and foreign contributions in detail, we will briefly discuss the handling of foreign exchange and various bank accounts that can be used for foreign exchange transactions.


Handling of foreign exchange and bank accounts

This part will explain the process of holding foreign currency, and exchanging and converting money.


1. Authorised dealers in foreign exchange


Under Section 10 of the FEMA, all foreign exchange transactions are required to be routed only through entities licensed by the RBI. Currently, RBI has licensed the following classes of entities to deal in foreign exchange:


Sl. No.

Category of license (Number)


Major Activities


Authorised Dealers (AD)

Commercial Banks, State and Urban Co-operative Banks (UCBs)

All current and capital account transactions according to RBI directions issued from time-to-time.


Restricted Authorised Dealers (RADs)





Financial Institutions, EXIM Bank, IFCI, Small Industries Development Bank, Clearing Corporation of India and Factoring Agencies

Activities incidental to financing of international trade related activities undertaken by these institutions.



  1. Upgraded Full Fledged Money Changers (FFMCs)
  2. Select UCBs
  3. Select Regional Rural Banks
  4. Thomas Cook India Ltd.

Specified non-trade related current account transactions


Full Fledged Money Changers (FFMCs)


Department of Post, Urban Coop Bank, Other FFMCs

Sale/Purchase of foreign exchange for private and business visits abroad.

For investments and loan transactions, services of banks licensed to deal in foreign exchange are required. These banks possess the Authorized Dealer – Category I license. List
of Category I, Category II and Category III authorized dealers is available here.



2. Bank accounts in India

Readers will be familiar with the most common types of bank accounts - current accounts (used for business transactions), savings accounts (usually maintained by individuals to deposit savings) and fixed deposit accounts (which can be used to park money which will not be required for a certain period of time, as receive maximum interest). These bank accounts are sufficient for any transactions which do not involve movement of foreign exchange.

Thus, they are suitable for

i) a business operating within the country and which has no imports or exports,

ii) which does not contemplate receiving foreign investment or

iii) take foreign borrowings.


Engaging in any of the above activities will attract Indian exchange control regulations. These transactions are not undertaken in cash and involve use of banking channels. In such a situation, lenders and investors will be dealing with the business through separate bank accounts which foreigners are entitled to maintain with Indian banks as per Indian law. In certain circumstances, the business may itself consider it prudent to maintain separate accounts when engaging in certain kinds of transactions.

Purchase and sale of shares in India must be undertaken through bank accounts that are permitted to be utilized for the such transactions under FEMA. Therefore, understanding the different types of bank accounts that can be opened in India and the purposes for which money can be deposited or paid out from such accounts must be understood. 

While considering opening an account, factors such as the i) currency in which the account can be opened, ii) sources from which money can be received or transferred into the account, iii) manner in which the money can be spent from the account, iv) whether the foreigner can repatriate the balance to his home country in foreign currency and v) whether the account is interest bearing, are usually relevant. 

This part will cover various types of bank accounts that can be opened if foreign investment, foreign loans and import-export transactions are contemplated. Note that as a general principle, citizens of Bangladesh and Pakistan require approval of the RBI for opening a bank account in India.


i) Bank accounts for exporters/ foreign exchange earners

An Indian can open a foreign currency account with a bank in India, or with a bank abroad. An Exchange Earner’s Foreign Currency account (EEFC Account) can be opened for retaining foreign exchange earned in respect of any exported products or services that are rendered to professionals. Permitting exporters to hold the proceeds in foreign exchange instead of converting into rupees saves on transactions costs that would have been incurred in conversion. It also subjected them to exchange rate risk.

For example, assume that USD 100 earned in May 2012 was required to be converted into rupees on receipt, and that 1 USD cost INR 50. If an exporter needs USD in September 2012 and the value of the dollar has risen to INR 55, the exporter will have to contribute INR 5 more for every dollar. This could encourage exporters to park money in offshore bank accounts in jurisdictions where it cannot be traced by Indian regulators.

Initially foreign exchange could be retained in the EEFC account indefinitely, which enabled them to hedge their risk against currency fluctuations (called currency risk or exchange rate risk) so long as they used money from the EEFC account to make payments.( See:  AP (Dir Series) Circular 15 dated 30 November 2006 available here). For example, while an increase in the value of the dollar from INR 55 to INR 60 would ordinarily impose additional economic burden on an Indian who converts his rupee into dollars (when the rate is INR 60) to make a purchase of USD 1000. He will have to pay an additional amount o INR 5000 [(60-55) x 1000]. However, it will not have any impact on a person who had USD 1000 dollars lying in his EEFC account, which were purchased at the rate of INR 55 per dollar.

However, there have been multiple regulatory changes introduced to this. On 10 May 2012 RBI issued a circular stating that only half of the proceeds could be retained and the balance half must be converted and transferred to rupee accounts.(See: AP (Dir Series) Circular 174 dated 10 May 2012, available here).

On 31 July 2012,
RBI revised that, and required all accruals in a particular month to be transferred and converted into a rupee account by the last day of the next month.(AP (Dir Series) Circular 12 dated July 31, 2012 available here.). Let’s take an example to understand this. As per the new position, if a sum of USD 10,000 was received in an EEFC account on 15 September 2012, it could be retained until 31 October 2012, when it would have to be transferred to a rupee account.

Hence, this provision can only be used to save transaction fee (transaction fee can be as high as 3.5 percent of the transaction value, which can be a significant sum in case of high value transactions) incurred at the time of conversion of foreign exchange, but cannot be used to effectively hedge currency risk. RBI explains the new stance requiring conversion of foreign exchange balances into rupee by saying that India still does not allow full capital account convertibility - hence an Indian cannot indefinitely hold foreign currency and freely convert it into rupee at his will.


The balance in the account can be used for payments in foreign exchange. Payment for a current account transaction, customs duty, cost of goods imported (by an export oriented undertaking, or a unit in an electronic hardware technology park or software technology park) are permitted. The amount can be freely converted into rupee and utilized for domestic payments, but no re-conversion into foreign exchange is permitted once an amount is withdrawn from the EEFC Account. 

An EEFC account can only be maintained in the form of a current account and no interest is payable on its balance. SEZ units are not allowed to open an EEFC account.

Moreover, by a notification dated 22 January, 2013, RBI allowed the account holders and the authorized dealer banks to access the forex market, even when they have available balances in their EEFC accounts.


ii) Foreign currency bank accounts opened with banks offshore

An Indian entity can also remit money from India to an account maintained in a foreign currency in the name of its offshore branch, subject to certain conditions:


i) The overseas office should not create a financial liability for the Indian office. Even creation of a liability for the Indian office that is subject to the happening of an uncertain event (i.e. a contingent liability) is not permitted. This is to ensure that the money can be used for the business of the offshore office, but no ‘further’ monetary outgo in foreign currency will be required from the Indian office.

 Any surplus funds must be repatriated by the overseas office to India. Investment of surplus funds (offshore) requires the prior approval of the RBI. 


An Indian resident can maintain a resident foreign currency account (domestic) [RFC (Domestic)] in India, if he has earned foreign exchange i) while performing a service on a visit to a place outside India, or ii) by way of gift or iii) if foreign exchange that he obtained for a trip outside India is unspent. The balance can be spent towards any permitted current account transaction in India.

iii) Bank accounts opened by foreigners

A non-resident can open a Non-Resident Ordinary Rupee Account (NRO Account) with an Indian authorized dealer bank. This is a rupee account – i.e. transactions from the account will be in rupees (except for initial transfer of foreign currency from an offshore account and repatriation of rupees by the foreigner to his home account). This account can be used for investing in Indian companies (subject to compliance with other regulations of RBI) and making other payments in Indian rupees.

The foreigner can transfer foreign currency from his offshore accounts to the NRO Account, and receive payments in respect of his dues in India – such as rent, interest and dividends from entities in India. 

Remittance of up to INR 1 million per financial year can be made from the account, subject to production of documentary evidence by the remitter, an undertaking by the remitter and certificate by a Chartered Accountant in the format prescribed by the Central Board of Direct Taxes. Citizens of Sri Lanka, China, Afghanistan and Iran cannot remit amount received from sale of immovable property. Citizens of Pakistan, Bangladesh, Nepal and Bhutan cannot remit sale proceeds of any assets (including immovable property, also see CBDT circular No.10/2002 dated October 9, 2002).

The account may be opened as a savings account, recurring account, fixed deposit account or current account.

An NRO account can also be opened by Non-Resident Indians (NRIs).

(For more details, see the Master Circular on Non-Resident Ordinary Rupee Account dated 1 July 2014 available here).


iv) Accounts for Non-Resident Indians (NRIs)

In addition to NRO accounts, NRIs can also open Foreign Currency (Non Resident) Accounts (FCNR (B) Accounts) and Non Resident (External) Accounts (NRE Accounts). An FCNR (B) Account is a foreign currency account which can be maintained for a term between 1 to 5 years. Proceeds received into the account are repatriable offshore. The account can only be in the form of a term deposit.

NRE Accounts are rupee denominated accounts. They can be opened in the form of savings, current, fixed deposit, recurring or current accounts. The amount in an NRE Account is repatriable.


v) Bank accounts used for purchase and sale of securities

The FDI Policy and FEMA Regulations specify the types of bank accounts that can be maintained by foreigners engaging in specific types of transactions. For example, a Foreign Institutional Investor (FII) (FIIs typically invest in listed securities) purchasing shares must pay through a special non-resident rupee account. Sale proceeds of shares can also be credited to its special non-resident rupee account.

An NRI purchaser can pay through an NRE/FCNR(B) account. In case of NRI, if the shares sold were held on repatriation basis, the sale proceeds (net of taxes) may be credited to his NRE/ FCNR(B) accounts and if the shares sold were held on non-repatriation basis, the sale proceeds may be credited to his NRO account subject to payment of taxes.

Indian companies which issue shares to foreign investors as per the FDI Policy can retain the amount paid for subscription with the prior approval of the RBI in a foreign currency account.

Amounts received from sale of shares sold by a non-resident can be remitted outside India.

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