Shubham Thakare is a 4th Year B.A LLB (Hons.) student at National Law School of India University

Introduction

On 21 July 2026, the Reserve Bank of India (“RBI”) released the draft Foreign Exchange Management (Foreign Investment) Rules, 2026 (“draft Rules”) for public consultation, with comments invited until 31 August 2026. If notified, the draft Rules will supersede the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”) in their entirety, subject only to a saving for actions taken before their commencement.

Although not many days have passed since the draft’s release, early commentary has largely focused on the definitional changes. For instance, commentators have examined the revised treatment of “control” under Rule 3(1)(e)(II). A more significant structural change, however, has received little attention. Unlike the NDI Rules, the draft does not prescribe sectoral caps, entry routes, sector-specific conditions, or prohibited sectors in its operative provisions. Instead, Annexure II provides that investments must comply with the Foreign Direct Investment Policy (“FDI Policy”) as issued by the Government of India.

This article argues that, although this may appear to be an innocuous drafting simplification, removing these conditions from the text has sizeable legal consequences. It contends that the draft substitutes a requirement under the statute with an obligation to comply with an external executive instrument, raising a serious question of vires under FEMA. To develop this argument, the article first explains the existing statutory and executive framework governing sectoral caps. It then examines the legal effect of Annexure II before considering its implications for parliamentary oversight and judicial review. Finally, it addresses the principal counterarguments and explains why they do not justify the draft’s approach.

The Statutory Scheme and the Duality of Sectoral Caps

Sectoral caps governing foreign investment under the Foreign Exchange Management Act, 1999 (“FEMA”) presently exist in two forms. The first is statutory. Section 6(2A) of the FEMA empowers the Central Government, in consultation with the RBI, to prescribe the permissible classes of capital account transactions not involving debt instruments, the limits up to which foreign exchange is admissible for such transactions, and the conditions governing them. Section 46(2)(ab) confers the corresponding rule-making power, while Section 2(x) defines “prescribed” to mean prescribed by rules made under the Act.

The second form is executive. The Department for Promotion of Industry and Internal Trade (“DPIIT”) issues Press Notes and the Consolidated FDI Policy in exercise of the Union’s executive power under Article 73 of the Constitution, read with Article 77(3) and the Government of India (Allocation of Business) Rules, 1961. As Bharat Vasani explains, Press Notes are not delegated legislation because their issuance is not traceable to any statutory rule-making power. Rather, they are executive instruments that guide foreign investment policy without being laid before Parliament.

Where the two conflict, the statutory instrument prevails. The Consolidated FDI Policy Circular, 2020 (para 1.1.2) expressly provides that, in the event of any inconsistency, the relevant notification issued under the NDI Rules shall govern. Practice reflects the same understanding. When DPIIT issued Press Note 2 of 2026 in March 2026, both AZB & Partners and Argus Partners advised that the changes would take legal effect only upon the corresponding notification under FEMA, which was issued on 1 May 2026.

The coexistence of these two instruments has created uncertainty regarding the applicable legal position, resulting in implementation difficulties. In this respect, the draft is justified in seeking to resolve these issues. For instance, Ladha and Rao observed in 2019 that the notified NDI Rules had restored single-brand retail trading to the automatic route only up to 49 per cent, thereby reversing a liberalisation introduced the previous year, and had failed to incorporate Press Note 4 of 2019. They anticipated that the inconsistency would be corrected, but it remained. A year later, Vinod Kothari Consultants noted that the sectoral cap for private security agencies, revised through a 2016 Press Note, continued to be reflected at the earlier level in the Rules. Seeking greater uniformity through the draft is undoubtedly a legitimate objective. The question this article asks, however, is not whether consolidation is desirable, but whether the method the Government employs to achieve it is sound.

Prescription and Its Conditions

Before analysing the draft rules, it is worth considering why Parliament required sectoral caps to be prescribed by rules rather than being left to executive policy in the first place.

Until 2019, capital account transactions of every kind were governed by regulations made by the RBI under Section 6(3) read with Section 47. The change was first recommended by the Financial Sector Legislative Reforms Commission in 2013. The Commission proposed that the Central Government should make rules governing inbound capital flows in consultation with the RBI, while regulations governing outbound flows should remain with the RBI in consultation with the Government. It reasoned that the imposition of capital controls involved political considerations and that rule-making should therefore rest with the politically accountable branch of the State. Three of the Commission’s ten members dissented from this allocation, showing that this institutional choice was itself contested.

The finance minister adopted the same premise in the Budget Speech for 2015-16, describing capital account controls as “a policy, rather than a regulatory, matter” and proposing, on that basis, to amend Section 6 so the Government would exercise that control over equity capital flows in consultation with the RBI. Sections 139, 143(i) and 144 of the Finance Act, 2015 gave effect to that proposal, although the amendments came into force only on 15 October 2019.

Even when Parliament transferred the control over capital flows to the Government, it required that control to be exercised through rules, rather than any executive instrument. This choice of form is important.

Executive instruments are issued under Article 73. They are therefore co-extensive with Parliament’s legislative competence and may be exercised without statutory authorisation. Delegated legislation is different. It is legislative in character, derives its authority from a power conferred by the parent statute, and is consequently confined by the terms of that conferment. It is also subject to procedural requirements, such as publication and laying before Parliament, and, more fundamentally, to judicial review for want of vires. These constraints reflect the constitutional terms on which Parliament delegates a function that, as the Supreme Court explained in In re Delhi Laws Act, is otherwise properly its own. It is precisely these limits that the new draft Rules appear to bypass.

An Obligation Without a Limit

Rule 3(1)(i) of the draft defines the foreign investment policy as a policy issued by the Government stipulating entry routes, sectoral caps, sectoral conditions and prohibited sectors, and provided in Annexure-II. Rule 3(1)(k) provides that a sectoral cap shall be as per that policy, and Rules 3(1)(c) and 3(1)(l) do the same for entry routes and sectoral conditions. Rule 8(1)(a) makes compliance with the policy a condition of every foreign investment.

Annexure-II reads, in its entirety: “Foreign Investment Policy (FDI policy) issued by the Government of India (as amended from time to time).”

Two observations here need to be noted. First, the incorporation is ambulatory. [3] [4] The draft does not adopt the policy as it exists when the Rules are made, but the policy as it may be amended from time to time, including amendments that cannot be anticipated at the time of framing the Rules. Secondly, Rule 4 draws a clear institutional distinction. While sub-rule (1) entrusts the administration of the Rules to the RBI, sub-rule (2) assigns the interpretation of the policy to the DPIIT. That allocation makes sense only if the policy is conceived as an instrument distinct from the Rules themselves.

Viewed in this light, the draft appears to depart from the statutory scheme. Rule 8(1)(a) requires a person to comply with the applicable sectoral cap, but the Rules themselves do not prescribe what that cap is. Instead, Annexure II merely points to the policy as the source from which the applicable limit is to be ascertained. In my view, there is an important distinction between prescribing the substantive limit and requiring compliance with whatever limit is contained in another instrument. Section 6(2A), read with Section 2(x), appears to contemplate the former. The draft, however, adopts the latter approach.

Existing practice illustrates this point. On 2 May 2026, the Central Government issued S.O. 2186(E) under Sections 46(2)(aa) and (ab), amending serial F.8 of the Table in Schedule I to permit 100 per cent foreign investment in the insurance sector under the automatic route.

This is what prescribing a sectoral cap by rules has conventionally meant. The substantive limit is incorporated into the Rules themselves through a formal amendment. The draft, by contrast, contemplates no comparable exercise. Since the Rules contain no schedule or table of sectoral caps, any change to the applicable limit would be brought about solely through an amendment to the policy, without any corresponding amendment to the Rules.

Two Consequences

The draft has two important consequences. The first concerns parliamentary oversight. Section 48 of FEMA requires every rule and regulation made under the Act to be laid before both Houses of Parliament for thirty days. If both Houses agree to modify or annul a rule, it thereafter operates only in its modified form or ceases to have effect. Since sectoral caps are presently contained in the Rules, any revision to them must pass through this process. Under the draft, however, changes to sectoral caps would occur through amendments to the FDI Policy alone, without any corresponding amendment to the Rules. Parliament would therefore have no occasion to exercise its power under Section 48.

It may be argued that this makes little practical difference because laying requirements are often treated as procedural formalities. The decision in Atlas Cycle Industries Ltd. v. State of Haryana is sometimes cited in support of that view. There, the Supreme Court held that the laying requirement under Section 3(6) of the Essential Commodities Act, 1955 was merely directory, so that failure to lay a notification before Parliament did not invalidate it. Drawing on the classification in Craies on Legislation, which it had earlier approved in Hukam Chand v. Union of India, the Court distinguished between simple laying and laying subject to parliamentary control through affirmative or negative resolution. Since Section 3(6) required nothing more than laying, with no consequence attached, the Court held that compliance was not mandatory.

That reasoning does not readily apply to Section 48 of FEMA. Unlike the provision considered in Atlas Cycle, Section 48 expressly provides that Parliament may modify or annul a rule, while preserving anything previously done under it. Those consequences are characteristic of a negative resolution procedure. The very feature that led the Court to treat the provision in Atlas Cycle as directory is absent here.

The second consequence is even more significant. Rules made under FEMA are subordinate legislation and may be challenged on familiar administrative law grounds, including that they are ultra vires the parent statute, inconsistent with it, or manifestly arbitrary. Executive policy, by contrast, is reviewed far more deferentially. In M.P. Oil Extraction v. State of Madhya Pradesh, the Supreme Court held that courts should interfere with executive policy only where it is capricious, arbitrary, unsupported by reason, or based on mere ipse dixit. The Court adopted the same approach in Manohar Lal Sharma v. Union of India, where the challenge to the Government’s multi-brand retail FDI policy failed because the policy was neither unconstitutional nor contrary to statute, nor could it be characterised as arbitrary or irrational. Vasani’s observation that challenges to the FDI Policy are “difficult, if not impossible” therefore reflects the current position of the law.

The events of December 2012 are a good example for the practical significance of this distinction. The Government’s decision to permit foreign investment in multi-brand retail survived judicial review in Manohar Lal Sharma. At the same time, however, the corresponding amendments to the FEMA Rules had to be laid before Parliament under Section 48, prompting a political dispute over whether the approval of one House or both was required. Contemporary reports suggested that, had the Government lost that vote, the retail policy itself could not have taken effect because the enabling amendments to the Rules would have failed. Judicial review therefore proved highly deferential, but parliamentary oversight remained a meaningful constraint. The draft preserves the former while effectively dispensing with the latter.

Anticipating the Counterarguments

There are three potential objections to my position that merit response.

The first is that Annexure II may simply be a placeholder, to be completed before the Rules are notified. Annexure III, after all, also consists of a single line. There are, however, several reasons to doubt this understanding. Annexure I is fully set out over several pages, suggesting that the drafters populated annexures wherever they intended substantive content to appear. More importantly, the words “as amended from time to time” would serve little purpose if Annexure II were itself to be amended whenever the Rules were amended. Their inclusion makes sense only if the Annexure is intended to incorporate an external instrument whose future amendments take effect automatically. The RBI’s accompanying press release points in the same direction. It identifies as a key feature of the draft the separation of procedural FEMA provisions from policy and sector-specific requirements in order to improve regulatory coherence and facilitate timely policy changes. Policy changes become timelier only if they no longer require amendments to the Rules.

The second objection is that ambulatory incorporation by reference is an accepted drafting technique, and that a rule adopting an external instrument “as amended from time to time” prescribes the applicable limit just as effectively as one setting it out expressly. In Gwalior Rayon, Parliament adopted State-determined tax rates that could change in the future. The Supreme Court held that this did not amount to an abdication of legislative function because the rates were fixed by plenary State legislatures acting within their own sphere, while Parliament retained the power to repeal the adopting provision. On this reasoning, it appears that the draft would likely survive a constitutional challenge. However, two features distinguish the present case. First, Gwalior Rayon concerns what a plenary legislature may do, whereas the Central Government under Section 46 is a delegate and must act within the power conferred by the parent Act. As the Canadian Standing Joint Committee for the Scrutiny of Regulations has similarly recognised, the question is not whether ambulatory incorporation is permissible in the abstract, but whether that power has been conferred on the particular delegate. Second, the FDI Policy does not carry the same procedural and legal constraints as legislation or delegated legislation that we discussed above.

The final objection is that maintaining two instruments has created unnecessary uncertainty and that a single authoritative source is therefore desirable. I agree entirely. But that answers only the question of whether consolidation is needed, not which instrument should become the authoritative source. Consolidating sectoral caps into the Rules while treating the FDI Policy as explanatory would eliminate the present inconsistency, comply with Section 6(2A), preserve Parliament’s role under Section 48, and retain the more searching standard of judicial review applicable to subordinate legislation. The draft adopts the opposite approach, but offers no explanation for that choice.

Conclusion

The draft Rules are, in most respects, a careful and welcome exercise in consolidation. The decision to abandon the existing two-document treatment of sectoral caps is, in my view, long overdue. My objection is not to consolidation itself, but to the form it takes. By locating sectoral caps in an instrument outside the Rules and incorporating that instrument in ambulatory form, the draft leaves the limits contemplated by Section 6(2A) unprescribed within the meaning of Section 2(x). In doing so, it removes future revisions from the parliamentary scrutiny contemplated by Section 48 and shifts sectoral caps from the domain of subordinate legislation to that of executive policy, where judicial review is substantially more limited.

None of these consequences is necessary to achieve the draft’s objective of creating a single, authoritative source of sectoral caps. The same objective could be achieved by incorporating the substantive contents of the existing Schedule I into an annexure forming part of the Rules, with future amendments made by notification. If the present approach is nevertheless retained, the Ministry of Finance and the RBI should clarify whether Annexure II forms part of the Rules for the purposes of Sections 46 and 48. The draft is silent on that question. With the consultation closing on 31 August 2026, this is the appropriate opportunity to provide that clarification.