Laws governing finance and investment: FEMA, significance of and factors affecting foreign investment

1. Kinds of foreign investment

• Foreign direct investment (FDI): investment with a lasting interest and a degree of control or influence in an enterprise. Under the Indian rules, investment by a person resident outside India in an unlisted Indian company, or of 10 per cent or more of the post-issue paid-up equity of a listed company.
• Foreign portfolio investment (FPI): investment in listed securities below that threshold, for financial return, without control.
• Debt flows: external commercial borrowings, trade credit, and investment in bonds.
• Investment by non-resident Indians, on repatriation or non-repatriation basis.
• Outward investment by Indian residents abroad, now under the Foreign Exchange Management (Overseas Investment) Rules, 2022.

2. From FERA to FEMA

The Foreign Exchange Regulation Act, 1973 was a control statute: every foreign exchange transaction was prohibited unless permitted, contraventions were criminal offences, foreign-controlled companies were required to dilute foreign holding to 40 per cent, and enforcement was harsh. After the 1991 balance of payments crisis and liberalisation, it was replaced by the Foreign Exchange Management Act, 1999 (FEMA), in force from 1 June 2000. The object, in the long title, is to facilitate external trade and payments and to promote the orderly development and maintenance of the foreign exchange market. The emphasis moved from regulation to management.

3. Scheme of FEMA

• Residence (section 2(v) and (w)): the Act divides persons into those resident in India and those resident outside India, and the rules for each differ.
• Section 3: no person shall, except as provided or with general or special permission of the RBI, deal in foreign exchange with a person other than an authorised person, make payments to a person resident outside India, or receive payments from such a person otherwise than through an authorised person.
• Section 5: current account transactions (trade payments, interest, remittances for travel, education, medical care) are free, subject to reasonable restrictions the Central Government may impose by rules (the Current Account Transactions Rules, 2000).
• Section 6: capital account transactions (investment, borrowing, acquisition of property across borders) are permitted only as specified. Since the amendment by the Finance Act, 2015, effective 15 October 2019, the Central Government, in consultation with the RBI, prescribes transactions not involving debt instruments (equity investment, under section 6(2A)), and the RBI, in consultation with the Government, specifies transactions involving debt instruments (section 6(2)).
• Sections 7 and 8: exporters must declare the full export value and realise and repatriate the proceeds within the prescribed period.
• Section 10: authorised persons (authorised dealer banks, money changers) licensed by the RBI.
• Section 13: contraventions are civil, punishable with a penalty up to three times the sum involved, or up to two lakh rupees where the amount is not quantifiable, adjudicated by an Adjudicating Authority (section 16), with appeal to the Special Director (Appeals), the Appellate Tribunal and the High Court (sections 17, 19 and 35). Compounding is allowed (section 15).
• Section 36: the Directorate of Enforcement.
• Section 49: repeal of FERA.

4. Subordinate law and regulators

• Foreign Exchange Management (Non-debt Instruments) Rules, 2019, made by the Central Government: the legal basis of FDI, FPI and NRI investment in equity, with the sectoral caps and entry routes in Schedule I.
• Foreign Exchange Management (Debt Instruments) Regulations, 2019 and the Mode of Payment and Reporting Regulations, made by the RBI.
• The Consolidated FDI Policy issued by the Department for Promotion of Industry and Internal Trade (DPIIT), and its Press Notes.
• SEBI regulates portfolio investors under the SEBI (Foreign Portfolio Investors) Regulations, 2019.
• Competition Act, 2002: mergers and acquisitions above the thresholds (including the deal-value threshold introduced in 2023) need approval of the Competition Commission.
• Tax: the Income-tax Act, 2025, in force from 1 April 2026, read with India's double taxation avoidance agreements.

5. International protection: bilateral investment treaties

Foreign investors are protected internationally by bilateral investment treaties (BITs), which promise fair and equitable treatment, protection against expropriation without compensation, free transfer of funds and investor-State arbitration. India signed many BITs from 1994. After adverse awards, notably White Industries Australia Ltd. v. Republic of India (UNCITRAL arbitration, 2011), which found that long delays in Indian courts denied the investor effective means of asserting claims, India adopted a narrower Model BIT in 2016 and terminated most of its older treaties. Newer treaties on the model include those with Belarus, Kyrgyzstan, the UAE and Uzbekistan. Multilateral support comes from the World Bank's MIGA (political risk insurance) and ICSID; India is a member of MIGA but has not joined the ICSID Convention.

6. Significance of foreign investment

• Capital: supplements domestic savings and finances investment beyond what the economy generates.
• Foreign exchange: non-debt inflows strengthen the balance of payments without adding to external debt.
• Technology and management: FDI brings technology, know-how, managerial and marketing skills, and spillovers to local suppliers.
• Employment and skills, including in manufacturing and services.
• Exports and integration into global value chains: multinationals use India as a production base (electronics, automobiles, pharmaceuticals).
• Competition and consumer welfare: better products and lower prices.
• Infrastructure: investment in ports, airports, power and telecom.
• Development of capital markets through portfolio investment, improving liquidity and corporate governance.

The concerns are also part of a balanced answer: volatility of portfolio flows (“hot money”), repatriation of profits and royalties, crowding out of domestic firms, transfer pricing, security concerns in sensitive sectors, and the loss of policy space under investment treaties.

7. Factors affecting international investment

• Economic: market size and growth, costs of labour and inputs, availability of raw materials, infrastructure, and exchange rate stability.
• Political: stability of government and policy, and relations between the home and host States.
• Legal and regulatory: openness of the FDI regime, sectoral caps, ease of entry and exit, contract enforcement, speed of courts, protection of property and intellectual property, and investment treaty protection.
• Fiscal: tax rates, tax incentives, tax treaties and tax certainty. The retrospective taxation of indirect transfers after Vodafone International Holdings B.V. v. Union of India, 2012 INSC 45, (2012) 6 SCC 613, where the Supreme Court held that the transfer abroad of shares of a foreign holding company was not taxable in India, was widely seen as damaging investor confidence until the Taxation Laws (Amendment) Act, 2021 withdrew such demands.
• Financial: freedom to repatriate capital and profits, access to finance, and capital account convertibility.
• Social and cultural: skills, language, labour relations.
• Global factors: interest rates in source countries, supply-chain shifts, and geopolitical tensions.

How this is examined

For “significance of foreign investment”: kinds of investment, the significance points in section 6 with Indian examples, the concerns, and a paragraph on the FEMA framework that admits it. For “factors affecting international investment”: the list in section 7 arranged under heads, with Vodafone and White Industries as illustrations of legal and fiscal risk.