The S&P BSE SENSEX index – India’s benchmark 30-share index – ended the year about 5% lower at 26,117. The Sensex hit a record high of 30,024 on March 4 bolstered by a surprise interest rate cut by RBI, the second inter-meeting interest rate cut in less than two months. However, on September 8 on back of concerns of a China slowdown and domestic monsoon worries, the Sensex hit a low of 24,833. Market capitalization of the BSE was at USD 1.5 trillion on December 31, 2015. The Securities and Exchange Board of India (SEBI) is considered one of the most progressive and well-run of India’s regulatory bodies. According to the World Bank Ease of Doing Business Report, India has climbed from number 49 in 2012 to being number eight this year on the parameter of shareholder protection. SEBI regulates India’s securities markets, including enforcement activities, and is India’s direct counterpart to the U.S. Securities and Exchange Commission (SEC). SEBI oversees three national exchanges: the National Stock Exchange, BSE Ltd., and Metropolitan Stock Exchange. On September 28, 2015, the Forwards Market Commission, the commodities market regulator, was merged with SEBI. The move was directed towards infusing confidence in the commodity market, which had collapsed after the $900 million National Spot Exchange scam broke out in 2013. With the merger, SEBI is tasked to deal with three more national commodity exchanges: the Multi Commodity Exchange, National Commodity & Derivatives Exchange Limited, and the National Multi-Commodity Exchange.
Unlike Indian equity markets, local debt and currency markets remain relatively underdeveloped, with limited participation from foreign investors. Indian businesses receive the majority of their finance through the banking system, not through capital markets. Although private placements of corporate debt have increased, India’s corporate bond market is around 14% of GDP as compared to bank assets (89% of GDP) and equity markets (80% of GDP).
Foreign investment in India can be made through various routes, including: FDI, Foreign Portfolio Investor (FPI), and venture capital investment. The FPI route provides access to a wide range of foreign portfolio investors, including foreign institutional investors (FIIs), FII sub-accounts, Qualified Foreign Investors (QFIs), and Non-resident Indians (NRIs). FIIs are divided into two categories: regular FIIs, which invest in both equity and debt; and 100% debt-fund FIIs. Eligible FIIs include the following: overseas pension funds, mutual funds, banks, foreign central banks, sovereign wealth funds, endowment and university funds, foundations, charitable trusts and societies, insurance companies, re-insurance companies, foreign government agencies, international and multilateral organizations, broad-based funds, asset management companies, investment managers, and hedge funds. FIIs must be registered and regulated by a recognized authority in their home country; as a result, many U.S.-based hedge funds cannot register as FIIs. “Sub-account” refers to any person residing outside of India on whose behalf investments are made within India by an FII. These include foreign individuals and corporations, broad-based funds, proprietary funds under the name of a registered FII, endowment and university funds, and charitable trusts and societies. NRIs are not eligible to apply as sub-accounts. The revised FPI regulations (that combine existing FIIs, FII sub-accounts, and QFIs into a new class termed as FPI) issued in January 2014 by SEBI have made registration of foreign investors much simpler and require foreign investors registered to register with designated depository participants like NSDL and CDSL.
In 2015, foreign fund flows into Indian stocks have been the lowest in the past four years. FIIs invested nearly USD 9.56 billion in the Indian debt market in 2015. Keeping in line with the 2014 trend, FII investment in debt outpaced that in the equity market, as most debt inflows have gone to government securities. FIIs invested USD 6.89 billion in Indian debt as against USD 2.67 billion in equities in 2015.
Indian equity markets have few restrictions on capital flows, but do limit foreign ownership stakes. FIIs and sub-accounts can own up to 10% and 5% respectively of the paid-up equity capital of any Indian company. Aggregate FPI investment in an Indian company is capped at 24%, unless specifically authorized by that company’s board of directors. All investor classes are permitted to sell short, except for NRIs. Investors must, however, maintain a minimum margin requirement.
In 2014, the RBI allowed FPIs to access the currency futures or exchange traded currency options market to hedge onshore currency risks in India, a move that was touted as a significant initiative in attracting Dollar inflows into the country. Further in December 2015, the RBI allowed FPI’s to take positions in the cross-currency futures and exchange traded cross-currency option contracts without having to establish underlying exposure subject to the position limits as prescribed by the exchanges. While the NSE recorded a 49% increase in the value of currency futures and options traded in 2015, the BSE logged a 111% jump. Analysts have explained that high volatility in currency markets could also have resulted in higher interest in this segment last year. India’s growing importance in the global economy has led to increased interest in the Indian Rupee (INR). Yet, the persistence of capital controls in the onshore market has led to the development of an offshore INR market called Non Deliverable Forward (NDF), particularly in Singapore, Dubai, London, and New York. The RBI has taken a number of steps in the recent past to bring these offshore activities onshore, in order to deepen the domestic markets, enhance downstream benefits, and generally obviate the need for an NDF market.
SEBI has allowed trading in commodity derivatives at stock exchanges operating in International Financial Services Centre (IFSC). Under the IFSC regime, any recognized domestic or foreign stock exchange can set up a subsidiary, in the financial services center, provided they hold at least 51% stake in the venture. These norms are aimed at easing the setting up of stock exchanges and capital market infrastructure in such centers. SEBI has announced that they would introduce new products and allow more participants to deepen the commodity derivatives market.
SEBI allows foreign brokers to work on behalf of registered FIIs, but these FIIs can also bypass brokers and deal directly with companies in open offers. FII bank deposits are fully convertible, and their capital, capital gains, dividends, interest income, and any compensation from the sale of rights offerings post tax, may be repatriated without prior approval. NRIs are subject to separate investment limitations. They can repatriate dividends, rents, and interest earned in India, and specially designated NRI bank deposits are fully convertible.
Foreign venture capital investors (FVCIs) must register with SEBI to invest in Indian firms. They can also set up domestic asset management companies to manage funds. All such investments are allowed under the automatic route, subject to SEBI and RBI regulations, and to FDI policy. FVCIs can invest in many sectors including software business, information technology, pharmaceuticals and drugs, biotechnology, nanotechnology, biofuels, agriculture, and infrastructure. Companies incorporated outside India can raise capital in India’s capital markets through the issuance of Indian Depository Receipts (IDRs). In 2015, SEBI clarified that Foreign Venture Capital Investors (FVCIs) can be granted registration as a foreign portfolio investor if they meet certain guidelines.
Companies are required to maintain pre-issued, paid-up capital, and free reserves of at least USD 100 million, as well as an average turnover of USD 500 million during the three financial years preceding issuance. The company must be profitable for at least five years preceding the issuance, declaring dividends of no less than 10% each year and maintaining a pre-issue debt-equity ratio of no more than 2:1. Standard Chartered Bank, a British bank which was the first foreign entity to list in India in June 2010, remains the only foreign firm to have issued IDRs.
External commercial borrowing (ECB), or direct lending to Indian entities by foreign institutions, is allowed if funds are used for outward FDI, or for domestic investment in industry, infrastructure, hotels, hospitals, software, self-help groups or microfinance activities, or to buy shares in the disinvestment of public sector entities. ECBs cannot be used for on-lending, investments in financial assets, acquisition of real estate or a domestic firm, meeting of working capital requirements or repayment of existing INR loans. An ECB can raise a maximum of USD 750 million in a financial year, unless it is in the hotel, hospital, software, or miscellaneous services sectors. NGOs engaged in micro-finance activities and Micro Finance Institutions can raise ECB up to USD 100 million in a financial year, and must hedge 100% of their currency risk exposure. A Non-bank Finance Company – Infrastructure Finance Companies (NBFC-IFCs) can raise ECB up to 75% of its owned funds and must hedge 75% of its currency risk exposure. The all-in cost ceilings for ECBs with an average maturity period of three-to-five years is capped at 300 basis points over the six-month LIBOR, and 450 points for loans maturing after five years. Indian companies borrowed close to USD 28.39 billion through ECBs in 2014-15.
Money and Banking System, Hostile Takeovers
The banking sector in the country remained predominantly in the public sector with the public sector banks (PSBs) accounting for 72% of total banking sector assets, notwithstanding a gradual decline in their share in recent years. PSBs are not technically subject to any excess regulations over commercial banks, neither in terms of lending practice nor deposits. They do, however, have their CEOs, upper management, and a number of their board of directors appointed by the government, meaning that the government can become quite influential in credit decisions.
According to data from Capitaline, banks in India added nearly $14.63 billion (Rs.1 trillion) in bad loans in the quarter that ended December 31, 2015. In December 2015, RBI Governor Rajan set a March 2017 deadline for banks to clean up their balance sheets and nudged them to treat some troubled loan accounts as bad loans and make provisions for them by the end of March 2016. Banks have since seen sharp erosion in profits, and some started reporting losses as they set aside capital buffers to cushion the bad loans. Indian public sector banks need an estimated $27 billion in capital over the next four years, according to Indian government estimates, to comply with new Basel III norms for higher capital requirements. The IMF, in the India 2015 Article IV consultation, reports that if the government were to provide the full amount of required capital injection, the estimate rises to between 1.2 to 1.7% of 2018/19 GDP. In August 2015, the Finance Ministry declared its plan to infuse $11 billion in the next four years, less than half the total capital requirement, hoping that improving the banks’ balance sheets would allow them to raise the remainder from the market. Additionally, RBI’s loosening tier one or core capital requirements at the beginning of March 2015 would help public sector banks shore up capital.
As on December 9, 2015, 195.2 million accounts have been opened and 166.7 million RuPay debit cards have been issued under Pradhan Mantri Jan Dhan Yojana (PMJDY). The scheme was launched on August 28, 2014 with the objectives of providing universal access to banking facilities, providing basic banking accounts with overdraft facility and RuPay Debit card to all households, conducting financial literacy programs, creation of credit guarantee fund, micro-insurance and unorganized sector pension schemes. The objectives are expected to be achieved in two phases over a period of four years up to August 2018. Though the number of accounts opened is immense, some of these still maintain a zero-balance, and six months of “satisfactory transactions” are necessary before the account-holder qualifies for benefits including overdraft and life insurance. It is likely the number of transactions will rise once the government expands its initiative for providing subsidies and benefits through direct bank transfers.
Takeover regulation in India applies equally to domestic and foreign companies. The regulations do not recognize, however, any distinct category of hostile takeovers. RBI and FIPB clearances are required to acquire a controlling stake in Indian companies. Takeover regulations require disclosure on acquisition of shares exceeding 5% of total capitalization. As per SEBI's Substantial Acquisition of Shares and Takeovers (Amendment) Regulations, released in 2013, acquisition of 25% or more of the voting rights in a listed company triggers a public offering of an additional 26% stake at least. Under the creeping acquisition limit, the acquirer holding 25% or more voting rights in the target company can acquire additional shares or voting rights up to 5% of the total voting rights in any financial year, up to a maximum permissible non-public shareholding limit of 75% generally. Acquisition of control over the target company, irrespective of shares or voting rights held by the acquirer, will trigger a mandatory open offer.