Decoding India's Proposed Foreign Investment Regime

The Reserve Bank of India (“RBI”), the nodal authority for determining rules and regulations concerning foreign investment in India, has recently released the draft Foreign Exchange Management (Foreign Investment) Rules, 2026 (“Draft Rules”), to replace the existing Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“2019 NDI Rules”). The draft rules are currently open for public comments till 31^st August, 2026. In this article, we discuss how the draft rules differ from the existing statutory framework.   

1. The big picture: from a self-contained code to a layered architecture

The most consequential change in the Draft Rules is not any single definition — it is the architecture of the regulation itself.

The 2019 NDI Rules were a self-contained code. They ran to 33 substantive rules across nine chapters, followed by ten detailed Schedules covering everything from FPI investment limits to immovable property acquisition. Sectoral caps, entry routes and prohibited sectors were embedded directly in Schedule I as part of the delegated legislation itself — meaning any tweak to a sectoral cap required a Gazette amendment to the Rules.

The 2026 draft strips this down to nine rules, organised across four short chapters, followed by three Annexures:

• Annexure-I — the international listing scheme (retained in substance)
• Annexure-II — the "Foreign Investment Policy (FDI Policy)," expressly described as "issued by the Government of India, as amended from time to time"
• Annexure-III — RBI regulations and directions

In effect, the draft externalises the sectoral caps, entry routes, sectoral conditions and prohibited-sector list from the Rules into a separately issued and separately amendable Policy document, while pushing operational/procedural detail (reporting, payment modes, pledge mechanics, etc.) into RBI directions.

2. Recalibrated powers: RBI's administration versus DPIIT's policy domain

The Draft Rules now clearly set out the domain of the RBI over the foreign investment statutory framework in India. Rule 4 of the Draft Rules provides:

• The RBI administers the Rules and may interpret the Rules and issue regulations, directions, circulars and clarifications for their effective implementation.
• Notwithstanding this, the power to interpret the Foreign Investment Policy (Annexure-II) — and to issue directions, circulars or clarifications in relation to the Policy — is carved out and vested in the DPIIT.
• The RBI retains responsibility for prescribing the mode of payment and reporting/operational requirements.

This is a formal bifurcation that the 2019 NDI Rules never spelt out this cleanly. Previously, RBI's Master Directions carried substantial interpretive weight even over what were, in substance, policy questions (sectoral caps, "what counts as this sector"), and DPIIT's role was exercised more informally through press notes and FAQs referenced by, rather than embedded in, the FEMA framework.

3. Definitional overhaul

3.1 "Equity" — from a closed instrument list to accounting-standards classification

This is one of the more technically significant, if quietly worded, changes.

The shift from a fixed statutory list to an accounting-standards test is significant because it makes FEMA's equity/debt line move with Ind-AS classification rather than with a static rule text. Instruments that a company's auditors classify as equity on the balance sheet (which can, under Ind-AS 32, include certain instruments that would have been "hybrid securities" and hence debt-like under the old FEMA test) may now automatically qualify as "equity" for FEMA purposes too — and vice versa. This removes a long-standing area of divergence between company law/accounting treatment and FEMA treatment, but it also means FEMA classification is no longer self-contained; practitioners will need to look at the investee's accounting policy, not just the instrument's legal terms, to determine its FEMA character.

3.2 FDI and FPI — a single, sector-and-listing-blind 10% threshold

Two changes stand out here.

First, investment in unlisted-company is no longer automatically FDI. Under the 2019 test, even a 1% stake in an unlisted Indian company was, by definition, FDI (because the "unlisted" limb of the FDI definition had no percentage threshold). Under the Draft Rules, the FDI/FPI line is a uniform 10% test regardless of listing status. This is a meaningful conceptual shift, since sub-10% stakes in unlisted companies would now sit definitionally in the "foreign portfolio investment" bucket even though genuine portfolio-style trading mechanics (recognised stock exchange dealing, SEBI FPI registration) are, practically speaking, built around listed securities. How Annexure-II and RBI/SEBI directions reconcile this definitional widening with the operational reality of FPI investing in unlisted paper will be an important thing to watch.

Second, the "sticky FDI" savings clause is absent. Under the 2019 regime, once an investment crossed 10% and became FDI, a subsequent dilution below 10% did not revert it to FPI status — a deliberate anti-arbitrage design. The draft's silence on this point could mean either (a) it is a deliberate liberalisation allowing reclassification back to FPI on dilution, or (b) it is simply left to be addressed in Annexure-II/RBI directions.

3.3 "Eligible investee entity" — a broadened and consolidated universe

The draft introduces a single umbrella definition — "eligible investee entity" — covering companies, LLPs, SEBI-registered investment vehicles (REITs, InvITs, AIFs, VC funds, and equity-heavy mutual funds/ETFs), or any other investment vehicle which invest more than fifty per cent in equity which are registered and regulated under the respective Securities and Exchange Board of India (SEBI) regulations and, notably, registered partnership firms and proprietary concerns.

Under the 2019 NDI Rules architecture, investment in a partnership firm or proprietary concern was permitted only for NRIs/OCIsonly on a non-repatriation basis (Schedule IV, Part B) — it was not general "foreign investment" open to all persons resident outside India. While it is covered under the ‘eligible investee entity’, in our opinion, it will still only be open for NRIs/OCIs, once the policy comes out.  

3.4 A new express carve-out for IFSC financial institutions

Rule 2(2) of the draft expressly excludes investments in financial institutions set up or incorporated in an International Financial Services Centre (as defined under the IFSCA Act, 2019) from the applicability of these Rules altogether. This is a new, explicit carve-out reflecting the maturation of the GIFT City/IFSC ecosystem and its own dedicated regulator (IFSCA) — it did not, and could not, appear in the 2019 Rules in this form, since the IFSCA Act itself was still nascent at that time.

4. The FCE concept: formalising "FOCC" and rewriting downstream investment

4.1 From an informal market shorthand to a codified term

Practitioners have long used the shorthand "FOCC" (foreign-owned or controlled company) to describe an Indian company or LLP that is owned or controlled by persons resident outside India, for the purpose of working out whether its onward ("downstream") investments count as indirect foreign investment for the ultimate investee.

The draft formally defines this as "foreign controlled entity" or "FCE" — a resident company, LLP, or investment vehicle owned or controlled by a person resident outside India. This is a genuine drafting improvement: a concept the market has operated on by convention for years now has an actual statutory label and a stated location in the primary text (definition clause (h)), rather than having to be reverse-engineered from a downstream-investment rule buried deep in the Schedule.

4.2 Two different control tests, applied to two different questions

A subtlety worth flagging carefully: the draft actually uses two different ownership/control tests depending on what question is being asked.

• Is an entity itself an FCE? (Definition (h)) — Ownership and control here are determined first by whatever the relevant sectoral regulator has stipulated (in consultation with the Central Government); failing that, by the underlying incorporation statute — the Companies Act for companies, the LLP Act for LLPs, SEBI AIF Regulations for AIFs, and so on. This is a decentralised, sector-driven test.
• Is a foreign investment being routed "indirectly" through a commonly owned/controlled offshore person? (Definition (e)) — Here the draft supplies a specific, centralised test: ownership means beneficial holding of more than 50%, and — this is the headline change — control now expressly includes any shareholders' or voting agreement that entitles a person to 10% or more of voting rights, exercised individually or acting in concert, directly or indirectly.

4.3 The real prize: unifying "foreign investment," "indirect foreign investment" and "downstream investment" into one concept

The 2019 NDI Rules required stitching together several separate defined terms to work out whether a transaction was compliant: "foreign investment" (direct only) → "downstream investment" → "indirect foreign investment" → "total foreign investment" (the aggregate).

The draft collapses this entire chain into the primary definition of "foreign investment" itself. Definition (e) defines "foreign investment in equity" to include investment made directly, or indirectly through an FCE, or through any other person resident outside India under common ownership/control. Because the FCE's own onward investment is now simply "foreign investment" made through it (rather than a separate "downstream investment" concept layered on afterward), the need for a distinct "indirect foreign investment"/"total foreign investment" computation architecture largely falls away.

4.4 A meaningful compliance relaxation for FCEs

Perhaps the most commercially important change: Rule 8(1)(a)'s proviso states that foreign investment made by an FCE need only comply with the applicable sectoral conditions for sectors specifically prescribed in the Foreign Investment Policy for that purpose.

Compare this to Rule 23(1) of the 2019 Rules, which imposed a blanket requirement: any Indian entity receiving indirect foreign investment had to comply with the entry route, sectoral caps, pricing guidelines and all other attendant conditions applicable to foreign investment, across every sector, with no carve-out.

If carried through into the final Annexure-II, this will be a real liberalization for downstream investment norms. What needs to be seen is whether this has been really dropped or deferred to RBI's directions under Annexure-III.

5. Gifts of equity: liberalised in some respects, narrowed in others

Three things worth flagging:

1. Narrowing to natural persons. The 2019 Rules did not restrict gifting to individuals — corporate or other entities could, in principle, be donors or donees under the general transfer-by-gift language. The draft's Rule 6A(3) restricts this specific gifting route to "natural persons" only
2. Removal of the prior-approval requirement, replaced by dynamic value linkage. The draft appears to do away with the specific RBI prior-approval requirement for a non-repatriation-to-repatriation gift, substituting instead a self-monitored compliance test pegged to the LRS limit — which is both higher in absolute terms today (USD 250,000 vs. the old fixed USD 50,000) and future-proofed, since it will move automatically with any RBI revision to the LRS ceiling rather than requiring a rules amendment. This is a genuine liberalisation in tone, even though it comes bundled with the narrower "natural persons only" scope.
3. A drafting ambiguity to watch. The Companies Act, 2013 defines "relative" under Section 2(77) — it does not, as far as the statute goes, separately define a narrower category called "close relative."  This may be tweaked as part of the final draft.

6. Pledge of equity: detailed mechanics delegated to the RBI

All of the category-specific pledgee rules, the ECB-tenure linkage, the statutory auditor certification, and the AD-bank no-objection mechanics have been stripped out of the Rules text. Given the overall architecture of the draft, this detail has almost certainly not disappeared substantively — it is far more likely to reappear in RBI's directions under Annexure-III. For now, though, the Rules text alone gives no operative guidance on how a pledge may be structured — only that its invocation must respect ordinary FDI conditions.

7. Pricing guidelines: one arm's-length standard instead of direction-specific floors and ceilings

The 2019 Rules (Rule 21) prescribed different pricing floors and ceilings depending on the direction of the transaction: a floor price for issuances/transfers to a person resident outside India, and a ceiling price for transfers by a person resident outside India to a resident — each with its own sub-clauses for listed and unlisted companies, and separate treatment for swaps and share warrants.

The draft's Rule 8(2) replaces this with a single, direction-agnostic standard:

• SEBI regulations govern pricing for listed companies and investment vehicles;
• Annexure-I conditions govern companies listed on an international exchange;
• for everything else, a single arm's-length valuation — certified by a Chartered Accountant, SEBI-registered Merchant Banker, or Cost Accountant — governs, regardless of the direction of the transfer.

Separately, the draft fully exempts rights issues from pricing conditions without any strings attached to it.

What’s important is that the RBI has still not recognized the growing class of registered valuers as eligible persons for valuation purposes.

Closing thought

The Draft Rules reads less like a rewrite of what foreign investment rules say, and more like a rewrite of where those rules will live going forward. The Draft Rules themselves are now a slim statement of principle; the real substance — caps, routes, sector-by-sector conditions — has been consciously relocated to a more agile Policy instrument and to RBI's own directions. For a regulatory framework that has, over the last decade, been amended sector-by-sector at a fairly rapid clip, that agility is probably the point. But it also means that a genuinely complete picture of India's foreign investment regime, post-notification, will require reading three documents together rather than one — and, for now, two of those three are still to come.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.