In her Budget 2026 speech, Finance Minister Nirmala Sitharaman promised a comprehensive review of the Foreign Exchange Management (Non-debt Instruments) Rules. In plain speak, these are the rules governing cross-border flows in all asset classes other than debt. This announcement matters more for what it signals than what it promises. It acknowledges that government spending and domestic savings are insufficient to support India’s 10 per cent growth ambitions. In short, despite the deep-seated desire for self-reliance in matters ranging from trade to technology, India will have to rely on foreign capital to deliver its growth targets. This self-awareness is important for a capital-scarce country.
That said, it is hard to predict what this Budget promise would mean in practice. Even as we wait for the fine print on this, this budget proposal offers an opportunity to pursue a grander vision – one that goes beyond incremental revisions to the “rules governing foreign investment in non-debt instruments”. An ambitious version of this proposal would be to restart India’s journey towards full capital account convertibility, or the unrestricted ability to convert the Indian rupee into any other currency and vice versa. This is essential both for attracting long-term foreign investment and for allowing Indians to diversify abroad.
The transition to full capital account convertibility requires repealing the two-and-a-half-decade-old Foreign Exchange Management Act. Replacing it with a modern foreign investment law that transitions India into a fully capital account convertible economy, could be the most lasting economic legacy of the Narendra Modi-led NDA government.
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Policy consensus on fuller capital account convertibility
Within a decade of India’s economic liberalisation in 1991, a broad consensus had emerged in favour of full capital account convertibility to meet India’s investment needs. In 2006, Manmohan Singh, in a speech at the Reserve Bank of India in Mumbai, said: “Given the changes that have taken place over the last two decades, there is merit in moving towards fuller capital account convertibility within a transparent framework…I will therefore request the Finance Minister and the Reserve Bank to revisit the subject and come out with a roadmap based on current realities.”
Two committees, set up by the Reserve Bank of India at close intervals in the late 1990s and early 2000s, recommended progressively moving towards full capital account convertibility. There was great continuity in this policy project, with several government reports also recommending the gradual sequencing of measures to make India a fully capital account convertible country. The last major report on this subject, the report of the Financial Sector Legislative Reforms Commission in 2011, proposed a much simpler foreign investment law focused on ‘transparency, accountability and legal process’, while leaving the questions of sequencing and timing of capital account liberalisation to future policymakers.
Over time, many of the restrictions on foreign capital inflows were done away with, even as some – such as sectoral caps on foreign investment, approval requirements for investing in some sectors, quantitative restrictions on debt investments – obstinately continued. Even so, the policy regime was directionally moving towards full capital account convertibility.
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Post-2015 reversal
From 2015-16, however, the promise of full capital account convertibility was practically abandoned. This happened through increasing policy complexity and uncertainty for foreign investors. Three instances of this stand out.
First, the power to regulate foreign investment was split by the type of asset class. Foreign investment in debt-related asset classes came to be regulated by the RBI, and that in other asset classes was regulated by the government. Indeed, this split led to the enactment of the Foreign Exchange Management (Non-debt Instruments) Rules, which Budget 2026 promises to review. Reporting requirements for investment in debt and non-debt, however, were to be regulated by the RBI. This fragmented an already complex rule-heavy regime, not to mention the unpredictability that came with it.
The second, and more important, development was a persistent suspicion of cross-border capital flows. In 2015, the Foreign Exchange Management Act was amended to reintroduce criminal prosecution for the violation of exchange control laws. If convicted, the person could be sentenced to imprisonment for up to five years. This effectively recriminalised foreign exchange violations, which were deliberately decriminalised as part of the 1991 reforms package. In 2020, cross-border flows from all countries sharing a land border with India were banned overnight, even as some of this was subsequently allowed with government approval on a case-by-case basis by 2022.
Finally, in the last few years, the government suspended the approval of foreign contribution remittances for several non-profit organisations in India, signalling its inherent mistrust of foreign capital. It signals that foreign capital is welcome only in activities the government approves of. In a similar vein of unpredictability, foreign portfolio investors are routinely vulnerable to rule changes on taxation, endless compliance requirements for identifying the ultimate beneficial owners of Indian assets, and eligibility requirements regarding who can or cannot beneficially own such assets.
Current account transactions have become equally vulnerable to this bias, with several puzzling developments, such as the imposition of a 20 per cent tax to be collected at source on credit card expenditures abroad, a ban on keeping money in overseas accounts for more than six months, and a licence requirement for importing laptops. Although some of those proposals were eventually diluted after enough “noise” was made, their very introduction signalled a clear retreat in the government’s approach towards cross-border flows.
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What works for a modern economy
A modern economy cannot afford a love-hate relationship with foreign capital. The Indian government needs to lower its guard on foreign capital inflows and outflows. A simple foreign investment law that allows full current and capital account convertibility for India, with minimal reporting requirements, is the need of the hour.
The policy progress of post-2015 reforms, including the enactment of a monetary policy framework with an inflation target, the Insolvency and Bankruptcy Code, and banking reforms, has provided India with a stable foundation for dealing with several apprehensions of macroeconomic instability commonly associated with full capital account convertibility. It is time to capitalise on this foundation and go for broke.
Bhargavi Zaveri-Shah is the Co-founder and CEO of The Professeer. She tweets at @bhargavizaveri. Views are personal.
(Edited by Prashant Dixit)