Over the last several years, there has been considerable liberalization in the inbound investment regime, especially on the foreign direct investment, or FDI, front. However, there has been a clamour for more changes in the inbound investment regime.
What has happened in the global economy in the last one month has led to the government actually making some important announcements (albeit more on the portfolio investment side), given the fact that certain reports indicate a net outflow of investments by foreign institutional investors, or FIIs, of approximately $6.5 billion (Rs32,045 crore) between April and September and the consequent depreciation of the rupee. Clearly, the government seems to be under pressure to introduce measures to attract foreign inflows.
This article seeks to look at some of these announcements, including in relation to the external commercial borrowing (ECB) and foreign currency exchangeable bonds (FCEBs) regime.
Investment by non-FIIs
India’s FII regime essentially provides that FIIs can broadly make investments in shares and permitted securities traded on the Indian stock exchanges, subject to certain parameters. These parameters broadly stipulate that an FII registered with the Securities and Exchange Board of India, or Sebi, can purchase and sell shares and convertible debentures of an Indian company through a registered broker on a recognized stock exchange.
Recently, there have been reports that a move is underway to permit foreign companies (that is, other than FIIs) to buy shares through the stock exchange. This seems to envisage investments which are not strategic in nature, but those where a foreign company can simply pick up, say, a 5% stake in a listed company, from the stock market.
There are several issues around this: one is the ability to distinguish between a portfolio and a strategic investment. Given that, what might appear to be a portfolio investment might turn out to be a strategic investment. In that context, is there a case for Indian industry to get worried? Is there a need for some checks and balances? The answer to both is, perhaps, yes. In the event the government does roll out such a policy, the policy should contain adequate safeguards to address the issues outlined above.
There have also been reports to the effect that this might enable a foreign company to hike its stake in a joint venture by buying shares through the stock market. In most cases, this concern may not be justified, because there would be in place a joint venture agreement that would envisage that the stake of both parties be kept at that level and that no one party can increase its take without consent of the other.
There are indications that the government may even consider replacing the FII regime with a qualified foreign investor, or QFI, regime, including allowing individual foreign investors to invest in the stock markets in India.
Some sectoral FDI issues
While there has been a clamour for increasing the FDI limit in insurance companies from the existing 26% to 49%, one would be very surprised if the government would be bold enough to make any major changes.
In retrospect, what appeared to be a very conservative regulatory viewpoint has turned out to be possibly a saviour in terms of the relative insulation of the Indian financial services sector and the banking sector.
The other issue, of course, is that even if liberalization measures were to come through, it is very doubtful whether international companies currently have the appetite to take advantage of a potentially liberalized regulatory regime. In the recent past, there have been changes in terms of liberalization in various sectors. However, given the turbulent times faced by the Indian aviation sector, it may be worthwhile for the government to consider opening up FDI in the aviation sector to foreign airlines with some safeguards. There has been talk of permitting FDI in multi-brand retail, as also further liberalizing FDI in the broadcasting and print media sector.
Liberalization of ECB
The ECB policy is regularly reviewed by the government in consultation with the Reserve Bank of India (RBI) to keep it in tune with the evolving macroeconomic situation, changing market conditions and sectoral requirements, among others. However, till recently, the ECB policy was restrictive in terms of end-use requirements and the quantum of ECB to be utilized in India.
These restrictions prima facie appear to have been imposed to curb the inflow of funds in India to prevent appreciation of the rupee and curb inflationary pressures.
RBI has now, in addition to the real and infrastructure sectors, also permitted companies in the services sector to avail of ECBs for import of capital goods through the approval route. Considering the huge funding requirements for meeting rupee expenditure and/or foreign currency expenditure, RBI has recently enhanced the existing limit of $100 million to $500 million per borrower per financial year for permissible end-use under the automatic route.
Given the tight liquidity situation in the international markets, the revised ECB guidelines have also enhanced the interest rate on ECBs with a maturity period of at least five years to 500 basis points over the six-month Libor (the London interbank offered rate is an international benchmark; one basis point is one-hundredth of a percentage point.) Now, companies can bring in the proceeds immediately and need not wait for the actual requirements of the funds in India.
Further, in order to boost the development of the telecom sector in the country, payment for obtaining a licence or permit for the so-called 3G, or third-generation, spectrum will be considered an eligible end-use.
Given the current global financial turmoil, the relaxations may not result in an immediate inflow of funds. However, these measures would improve the availability of funds for Indian companies to undertake expansion activities and improve the liquidity situation as and when the situation improves.
The Reserve Bank of India on 17 September issued a circular operationalizing the FCEB scheme. The purpose of this initiative is to provide greater funding options for Indian promoters, whereby a bond expressed in a foreign currency can be issued and subscribed to by a non-resident. The bond can be exchanged with the equity share of another company (called the “offered company”) which should be a part of the same promoter group, and should be a listed company.
Essentially, the bond would be like an ECB, but with the crucial variant of the ability of the investor to get equity shares of the promoter group company at a predetermined price. The end-use of the funds extend to investing in joint ventures or subsidiaries abroad as also for investment in promoter group companies. The minimum average maturity is five years.
The regime is quite interesting and provides an important fund-raising avenue. The attractiveness is further enhanced by certain liberal tax treatments prescribed. However, the challenge in the current environment is really not a regulatory or a tax challenge, but a funding challenge; in essence, the ability to attract lenders to subscribe to these bonds.
Investments through PNs
Participatory notes, or PNs, had been a common derivative instrument that FIIs were issuing to their clients for the purpose of taking an exposure in the Indian stock market. With a view to regulating such indirect investments, Sebi had imposed various restrictions in October 2007, including capping the issue of PNs up to 40% of the assets under custody, barring sub-accounts of FIIs from issuing PNs and barring the issue of PNs to unregulated entities.
The recent turmoil in the financial markets has resulted in FIIs unwinding their portfolio investments in the Indian stock markets. The consequent outflow of funds from India has depreciated the rupee substantially in the last month or so. To curb this flight of investments from India and to inject liquidity in the Indian stock markets, Sebi has recently lifted the curbs imposed on issuance of PNs by FIIs.
Eye on stability
From the above, it can be observed that the Indian government has opened up various sectors by liberalizing the inbound investment regulations and it continues to evaluate further liberalizing the Indian economy. However, given the current scenario of the global economy, especially the liquidity crisis, one would have to wait and watch the impact of the various measures being taken. The government may focus more on FDI, albeit with safeguards, rather than portfolio investments, with a view to attract relatively more stable, long-term investments.
Also read Ketan Dalal’s earlier columns
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at email@example.com