FEMA Basics for Forex Operations
The Act behind every forex transaction, and the handful of sections a branch banker uses.
The Foreign Exchange Management Act, 1999 (FEMA) is the law behind every forex transaction an Indian bank handles. It came into force on June 1, 2000, replacing the older Foreign Exchange Regulation Act (FERA). The change in name is the change in approach: FERA regulated foreign exchange as something to be controlled; FEMA manages it, with most transactions permitted subject to rules.
The Act itself is short. The working detail sits in rules made by the Central Government, regulations made by RBI, and RBI's Master Directions and A.P. (DIR Series) circulars to authorised dealers. CCFE expects you to know the structure and the handful of sections that come up at a branch counter.
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Current Account and Capital Account
FEMA classifies every foreign exchange transaction into one of two types, and the rules for each are different.
- Current account transaction
- A transaction by a resident that does not alter his or her assets or liabilities, including contingent liabilities, outside India. Examples: paying for imports, travel, education fees, medical treatment abroad.
- Capital account transaction
- Broadly the opposite: a transaction that changes cross-border assets or liabilities. Examples: investing abroad, a foreign loan, a non-resident buying shares in India.
The Sections a Branch Banker Uses
2(v)
What it does
Defines 'person resident in India' (the 182-day and intention test)
Where you meet it
Every account and remittance decision
5
What it does
Residents may buy or sell foreign exchange for any current account transaction, except those the Central Government prohibits or restricts
Where you meet it
Remittances for travel, studies, imports
6
What it does
Governs capital account transactions, through Central Government rules and RBI regulations; 6(4) lets a resident keep assets acquired while non-resident or inherited from a non-resident
Where you meet it
LRS investments, ODI, ECB, NRI property
7
What it does
Governs export of goods and services
Where you meet it
EDPMS, export realisation
10
What it does
RBI authorises persons to deal in foreign exchange; 10(5) requires the AD to obtain a declaration; 10(6) limits use of bought forex to the declared or another permitted purpose
Where you meet it
Form A2, customer declarations
13
What it does
Penalty on adjudication for any contravention
Where you meet it
Breaches of FEMA rules or directions
15
What it does
Compounding of contraventions
Where you meet it
Voluntary settlement of a breach
| Section | What it does | Where you meet it |
|---|---|---|
| 2(v) | Defines 'person resident in India' (the 182-day and intention test) | Every account and remittance decision |
| 5 | Residents may buy or sell foreign exchange for any current account transaction, except those the Central Government prohibits or restricts | Remittances for travel, studies, imports |
| 6 | Governs capital account transactions, through Central Government rules and RBI regulations; 6(4) lets a resident keep assets acquired while non-resident or inherited from a non-resident | LRS investments, ODI, ECB, NRI property |
| 7 | Governs export of goods and services | EDPMS, export realisation |
| 10 | RBI authorises persons to deal in foreign exchange; 10(5) requires the AD to obtain a declaration; 10(6) limits use of bought forex to the declared or another permitted purpose | Form A2, customer declarations |
| 13 | Penalty on adjudication for any contravention | Breaches of FEMA rules or directions |
| 15 | Compounding of contraventions | Voluntary settlement of a breach |
Who Writes Which Rules
Current account transactions run under the Foreign Exchange Management (Current Account Transactions) Rules, 2000, made by the Central Government. These list transactions that are prohibited outright (such as remittance of lottery winnings) and those that need permission or are limited.
On the capital account the split changed in 2019. The Central Government now frames the rules for non-debt instruments (equity, most FDI and immovable property) through the Non-debt Instruments Rules, 2019, while RBI regulates debt instruments such as ECB and trade credits. RBI also issues FEMA regulations on deposits, borrowing, exports and imports, and authorised persons, for instance the Authorised Persons Regulations, 2026.
For an AD branch, the practical layer is RBI's Master Directions, consolidated by topic (LRS, deposits, imports, exports, remittance of assets) and updated through A.P. (DIR Series) circulars.
Sections, current vs capital account. No signup.
Penalties and Compounding in Brief
- check_circleA contravention is liable, on adjudication, to a penalty up to three times the sum involved where it can be quantified, or up to ₹2 lakh where it cannot. A continuing contravention attracts up to ₹5,000 for each day after the first.
- check_circleMost contraventions can be compounded: the person admits the breach and pays a sum fixed by RBI. RBI aims to pass the order within 180 days of a complete application.
- check_circleContraventions of section 3(a) cannot be compounded by RBI; those applications go to the Directorate of Enforcement.
How CCFE Tests This
Expect classification questions (is this a current or capital account transaction), section-number questions (which section defines a resident, which empowers RBI to authorise dealers, which governs compounding), and the start date of the Act. The trap is assuming current account means unrestricted: section 5 freedom is subject to the prohibited and restricted lists in the Current Account Transactions Rules.
FAQs
When did FEMA come into force?expand_more
The Foreign Exchange Management Act, 1999 came into force on June 1, 2000, replacing FERA.
What is the difference between current account and capital account transactions under FEMA?expand_more
A current account transaction does not change a resident's assets or liabilities outside India; a capital account transaction does. Current account dealings are free unless prohibited or restricted; capital account dealings follow the specific rules and regulations made for each type.
Which section of FEMA deals with authorised persons?expand_more
Section 10. It lets RBI authorise persons to deal in foreign exchange, and sub-sections 10(5) and 10(6) set the declaration duty and the purpose limit on forex acquired.
What is the penalty for contravening FEMA?expand_more
On adjudication, up to three times the sum involved if quantifiable, or up to ₹2 lakh if not, plus up to ₹5,000 a day for a continuing contravention.
Next steps
- Residential statusarrow_forward
- AD categoriesarrow_forward
- Current Account Rulesarrow_forward
- FEMA & Trade Finance Conceptsarrow_forward
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