India eases foreign investment rules

The government of India has eased restrictions on direct equity investment, but the bid to backstop a sagging rupee, combat market volatility and attract foreign investment, may not mean much to the average Canadian investor.

In a historic move, the government of India recently announced plans to allow foreigners to invest directly in domestic companies listed on local bourses. The new rules are expected to take effect January 15.

An acronym-laden press release from India’s Finance Ministry said the government “decided to allow qualified foreign investors to directly invest in Indian equity market in order to widen the class of investors, attract more foreign funds, and reduce market volatility and to deepen the Indian capital market.”

Until now, India’s capital markets were only open to foreign institutional investors and Indians living overseas. The recent initiative will allow foreign individuals to buy as much as 5% of a company’s shares. However, total shares owned by a foreign investor cannot exceed 10% of a company’s capital, the ministry statement said.

“In my view this move has more symbolic value than likely tangible impact in the short-term,” says Pallav Sinha, chief executive and president, Fullerton Securities and Wealth Advisors, a wealth management firm in New Delhi, India.

“In early 2011, the Indian Government allowed such QFIs (qualified foreign investors) to invest in rupee-denominated mutual funds. At that time too, the move attracted much attention and was certainly a shot-in-the-arm for investor sentiment, but it did not result in significant flows from QFIs into Indian onshore funds.”

Individual investors in Canada are not likely to jump at the opportunity, as they will probably still need to jump through the hoops and survive a copious amount of paperwork, says David Kunselman, lead portfolio manager, Excel Investment Counsel Inc.

“It’s so complicated still at this point in time; I don’t think it can be summed up quickly and neatly,” he says. “It’s still not wide open, like our markets; it still looks like there is going to be sort of paperwork involved.”

He is also wary of costs and complications involved in certain accounts that foreign investors are required to set up for the purpose of investing in India.

“I just don’t know if the small retail investors are going to be able to do this quite yet because I still think there’ll be some of kind of costs involved with opening up [Depository Participants or DP] accounts and bank accounts,” says Kunselman. “It’s more that it’s allowing Canadian mutual fund firms [and other global financial institutions] to possibly enter this market. I don’t think it’s more [for] a retail investor.”

Then there are tax consequences to contend with as a foreign investor. “The other thing is we don’t understand the tax; [the government of India press release implies that] when the brokers make the sale there’ll be some taxes there. I’m still not sure what the foreign tax payment will be at this time.”

Kunselman does concede that increased foreign investment will help stabilize the sinking Indian rupee, which is one of the intended consequences of the decision.

Opening the market to attract overseas capital, say some experts, was a direct result of a dismal year for its financial markets. The Sensex, India’s benchmark index, lost 25% in 2011, becoming one of the world’s worst performing markets for the year. Foreign investor returns shrank further as the rupee lost 16% against the dollar last year.

Further, the world’s largest democracy received less than $20 billion in foreign direct investment in the first six months of 2011; its deficit is soaring and funding is drying up.

Officials hope lowering investment barriers for domestic Indian companies will boost India’s appeal as a foreign investment destination.

Kunselman is not alone in his skepticism over the outcome. There are other analysts who remain unconvinced that the initiative will result in an immediate rush of foreign capital to the flagging Indian market.

“A typical retail investor would still be better off investing through India funds, but I think several high net worth individuals would like to utilize the additional limits allowed for QFIs,” says Sinha. “In the long-term it can provide more room for QFIs to invest in Indian stocks. However, it would take a while before the infrastructure, systems and processes are aligned to allow for optimal utilization of this opportunity.”