In its quest for embracing fuller capital account convertibility, the Union government and the Reserve Bank of India (RBI) have been progressively loosening the strings on outbound investments. “Outbound investments” comprise strategic investments in overseas joint ventures and subsidiaries by any means otherwise than as portfolio investment. Besides, there is a separate window available for Indian corporations, individuals and mutual funds for investing in equity and specified instruments of listed companies located abroad.
In the above context, RBI’s recent liberalization on 26 September is the latest in a series of such measures. There are four separate measures that have been taken by RBI, two of which deal with outbound strategic investments and outbound portfolio investments; these are the two dimensions that are the focus of this article.
Basically, the limits for such investments and the conditionalities have been liberalized. In essence, outbound investments satisfying certain predefined conditions can be made without RBI’s prior approval. The paramount criterion in determining the eligible limits for outbound investments is the net worth of the Indian investing corporate, registered partnership firm or other registered or incorporated entity (except in case of mutual funds, where an overall monetary ceiling has been prescribed).
The overall limit for outbound investments by Indian companies has been raised from 300% of net worth (200% in the case of registered Indian partnerships) to 400% of net worth. Similarly, the monetary ceiling for investment in equity and specified instruments of overseas listed companies has been raised from 25% of their net worth to 50% of their net worth, while the monetary ceiling for investment by mutual funds has been raised to $5 billion (Rs19,650 crore) from $4 billion. Also, outbound portfolio investments have been liberalized, both in terms of limits and conditions.
A double-edged sword
Outbound strategic investments can take the form of greenfield investments (that is, setting up subsidiaries or joint ventures abroad) or acquisitions. While a large number of investments are being made in terms of the greenfield space, it is the recent spurt in acquisitions that has been in focus of late.
(In 2007, more than half of the M&A deals were cross-border; out of 460 deals till August, 237 were cross-border, of which 164 were outbound.) These include the acquisition of Corus by Tatas, Hansen by Suzlon Energy and Flag Telecom by Reliance Communications.
What is particularly interesting is a trend of mid-size companies joining the M&A rush and, in fact, acquiring companies significantly larger than them. These include the acquisition of ECU by All Cargo Logistics and that of Azure by Subec Systems, among others. There are a couple of dimensions that need to be understood in this context, which is that liberalization of this nature, while very welcome, is also a double-edged sword in the sense that it might embolden (needlessly?) companies to overreach themselves.
This would be especially important in terms of the ability to culturally integrate the target and, indeed, having the management bandwidth to digest the acquisition. India is relatively new in the game of cross-border acquisitions and time will tell whether the recent bold moves will pay off.
A key issue here is the fallout arising out of risks taken by Indian investors, especially given that the Indian investor is no longer required to have experience in the same field as that of the overseas investment (with the exception of financial services companies).
A shot in the arm
The monetary ceiling for investments in equity and specified instruments of overseas listed companies in the form of portfolio investments was raised from 25% to 35% a few months back, and has now been further raised to 50% of the net worth. There was earlier a restriction of reciprocal shareholding, in the sense that the investee company was required to have a shareholding of at least 10% in Indian companies listed on a recognized stock exchange. This condition has now been removed and this has obviously widened the choice of investments for Indian investor companies.
There are a couple of dimensions here that are worth a mention: an investor invests in a company on the basis that the company is engaged in a particular activity, and is usually unlikely to find comfort in the fact that the Indian company is making portfolio investments in overseas listed companies.
Also, the Indian company is taking a forex risk, especially in the context of a continuing trend of the rupee appreciating against the dollar and, indeed, against many other currencies. There are, of course, requirements in terms of taking corporate approvals, including shareholders approval in terms of Section 372A of the Indian Companies Act, 1956, where certain limits of investments are exceeded, but that does not take away the risks/issues mentioned above. Accordingly, while this is liberalization, a large outflow is unlikely to be expected on this count, as contrasted with the situation of the liberalization for strategic investments.
Clearly, continuing review and liberalization of such nature is always welcome; there are, of course, risks in such moves and one hopes that Indian companies will have the maturity and sense of responsibility to avail of the enhanced limits with a sense of caution.
Ketan Dalal is executive director of PricewaterhouseCoopers. Your comments and feedback are welcome at email@example.com