Capital Markets and Portfolio Investment

Equity markets rose strongly in 2017, with the benchmark Standard and Poor’s (S&P) Bombay Stock Exchange (BSE) Sensex closing at a record high, up over 28 percent for the year. Analysts credit the gains to positive developments such as a bank recapitalization plan which was expected to enhance bank lending and propel economic growth, as well as an announcement by Moody’s Investor Services to upgrade Indian sovereign debt to “Baa2” from “Baa3.” After the November 2016 demonetization exercise, domestic investors shifted from physical savings to financial savings, leading to a sharp inflow into equity mutual fund schemes. India was the third best performing emerging market in the world in 2017 after Argentina and Turkey, according to Bloomberg. Market capitalization of the BSE crossed USD 2.25 trillion as of the end of 2017.

The Securities and Exchange Board of India (SEBI) is considered one of the most progressive and well-run of India’s regulatory bodies. It 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 BSE Ltd. (formerly the Bombay Stock Exchange), the National Stock Exchange (NSE), and the Metropolitan Stock Exchange. Since its September 2015 merger with the Forwards Market Commission, the then commodities market regulator, SEBI is tasked to deal with three national commodity exchanges: the Multi Commodity Exchange, the National Commodity & Derivatives Exchange Limited, and the National Multi-Commodity Exchange. In the board meeting on December 28, 2017, SEBI approved integration of the equity and commodity markets and allowed stock exchanges to trade in both beginning October 2018.

Unlike Indian equity markets, local debt and currency markets remain underdeveloped, with limited participation from foreign investors. Indian businesses receive the majority of their financing through the banking system, not capital markets. However, constraints in the banking system’s ability to provide funding, cyclical factors including the significant lowering of interest rates; structural factors including demonetization, implementation of the insolvency and bankruptcy codes; and regulatory focus on shifting large corporates to bond market and away from banks, and the issuance of green bond and municipal bond guidelines have driven significant growth in the bond markets. Corporate debt securities at BSE and NSE surged by 37 percent to a record in 2017.

Foreign investment in India can be made through various routes, including FDI, Foreign Portfolio Investor (FPI), and venture capital investment: https://www.rbi.org.in/SCRIPTS/FAQView.aspx?Id=26 . FPIs include investment groups of FIIs, Qualified Foreign Investors (QFIs) and sub-accounts. Non-Resident Indians do not come under FPI. Investment by an FPI cannot exceed 10 percent of the paid up capital of the Indian company. All FPIs together cannot acquire more than 24 percent of the paid up capital of any Indian company, this limit of 24 percent can be increased by the Indian company to the sectoral cap/ statutory ceiling, as applicable. As per SEBI regulations, FPIs are not allowed to invest in unlisted shares, and investment in unlisted entities will be treated as FDI. The RBI eased rules governing foreign investment in corporate bonds by excluding rupee-denominated securities from its overall debt limit. Starting October 3, 2017, rupee-denominated bonds sold overseas known as “masala bonds” did not count towards the investment limit for FPIs in corporate bonds and instead qualified under external commercial borrowings (ECB) norms. https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11127&Mode=0 .

Foreign investors (FPI and FII) invested USD 30 billion (net) in India in the calendar year 2017 of which USD 7.7 billion was in equites and USD 22.36 billion in debt. 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. Non Resident Indians (NRI) 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.

The RBI has taken a number of steps in the past few years to bring the activities of the offshore INR market called Non Deliverable Forward (NDF) onshore, in order to deepen the domestic markets, enhance downstream benefits, and generally obviate the need for an NDF market. In addition, FPIs with access to currency futures or exchange traded currency options market, can hedge onshore currency risks in India and may directly trade in corporate bonds. The International Financial Services Centre at Gujarat International Financial Tec-City (GIFT city) in Gujarat is being developed to compete with global financial hubs. The BSE was the first to start operations in January 2016. The NSE and domestic banks like Yes Bank, Federal Bank, ICICI Bank, Kotak Mahindra Bank, IDBI Bank, State Bank of India and IndusInd Bank have started their IFSC banking units in GIFT city, however, no foreign banks have established a presence there. SEBI announced a set of guidelines in January 2017 for foreign investors participating in GIFT city: https://www.sebi.gov.in/legal/circulars/jan-2017/guidelines-for-participation-functioning-of-eligible-foreign-investors-efis-and-fpis-in-international-financial-services-centre-ifsc-_33955.html .

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, 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).

Companies planning to issue an IDR are required to maintain pre-issued, paid-up capital, and free reserves of at least USD 100 million, as well as demonstrate 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. 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 it conforms to parameters such as minimum maturity, permitted and non-permitted end-uses, maximum all-in-cost ceiling as prescribed by the RBI 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: https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10204 .

Money and Banking System

The public sector remains predominant in the banking sector, with public sector banks (PSBs) accounting for about 75 percent of total banking sector assets. Although most large PSBs are listed on exchanges, the government’s stakes in these banks often exceeds the 51 percent legal minimum. Aside from the large number of state-owned banks, directed lending and mandatory holdings of government paper are key facets of the banking sector. The RBI now requires commercial banks and foreign banks with more than 20 branches to allocate 40 percent of their loans to priority sectors which include agriculture, small and medium enterprises, export-oriented companies, and social infrastructure. In February 2018, the RBI tightened regulations on qualifying loans to priority sectors. Additionally, all banks are required to invest 19.5 percent of their net demand and time liabilities in government securities.

PSBs currently face two significant hurdles: capital constraints and poor asset quality. As of September 2017, stressed loans represented 12.2 percent of total loans in the banking system, with the public sector banks having an even larger share at 16.2 percent of their loan portfolio. The PSBs’ asset quality deterioration in recent years is driven by their exposure to a broad range of industrial sectors including infrastructure, metals and mining, textiles, and aviation. With the new bankruptcy law in place, banks are making progress in non-performing asset recognition and resolution. However, some bank managers reportedly are reluctant to write-off loans for fear of punishment for lending.

As of latest September 2017 RBI data, the PSBs’ average total capital adequacy ratio of 12.2 percent was above the minimum 11.5 percent standard. However, market participants point out that the existing under-provisioned stress assets may bring these numbers below the minimum capital adequacy requirements. In light of these asset quality problems, the government announced a substantial INR 2.1 trillion (USD 32 billion) recapitalization package for PSBs in October 2017. The package included INR 1.35 trillion in new recapitalization bonds, a previously announced allocation of INR 180 billion (under the Indradhanush Scheme), and an INR 580 billion allocation expected from private market fundraising. Financial sector experts point out that the recapitalization plan’s sufficiency hinges on key assumptions concerning further loan deterioration and haircuts on existing bad debt.

Women in the Financial Sector

Women in India receive a smaller portion of financial support relative to men, especially in rural and semi-urban areas. In 2015, the Modi government started the Micro Units Development and Refinance Agency Ltd. (MUDRA), which supports the development of micro-enterprises. The initiative encourages women’s participation and offers collateral-free loans of around USD 15,000. In the 2018 budget, the government announced new lending of USD 46.15 billion through the MUDRA initiative. Currently, women hold around 76 percent of the MUDRA loan accounts. Following the Global Entrepreneurship Summit (GES) 2017, government agency the National Institute for Transforming India (NITI Aayog), launched a Women’s Entrepreneurship Platform, https://wep.gov.in/ , a single window information hub which provides information on a range of issues including access to finance, marketing, existing government programs, incubators, public and private initiatives, and mentoring.

Foreign Exchange and Remittances

Foreign Exchange

In 2017, the rupee appreciated by 6 percent to INR 63.92 per U.S. dollar, snapping a six year downtrend. The rupee started the year on weak footing after the currency withdrawal from demonetization, but appreciated on the support of strong FDI flows, significant interest rate differentials and low, stable inflation, and a sovereign debt rating upgrade by Moody’s Investors Service.

The RBI, under the Liberalized Remittance Scheme, allows individuals to remit up to USD 250,000 per fiscal year (April-March) out of the country for permitted current account transactions (private visit, gift/donation, going abroad on employment, emigration, maintenance of close relatives abroad, business trip, medical treatment abroad, studies abroad) and certain capital account transactions (opening of foreign currency account abroad with a bank, purchase of property abroad, making investments abroad, setting up Wholly Owned Subsidiaries and Joint Ventures outside of India, extending loans). The INR is fully convertible only in current account transactions, as regulated under the Foreign Exchange Management Act regulations of 2000 (https://www.rbi.org.in/Scripts/Fema.aspx ).

Foreign exchange withdrawal is prohibited for remittance of lottery winnings; income from racing, riding or any other hobby; purchase of lottery tickets, banned or proscribed magazines; football pools and sweepstakes; payment of commission on exports made towards equity investment in Joint Ventures or Wholly Owned Subsidiaries of Indian companies abroad; and remittance of interest income on funds held in a Non-Resident Special Rupee Scheme Account (https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10193#sdi ). Furthermore, the following transactions require the approval of the Central Government: cultural tours; remittance of hiring charges for transponders for television channels under the Ministry of Information and Broadcasting, and Internet Service Providers under the Ministry of Communication and Information Technology; remittance of prize money and sponsorship of sports activity abroad if the amount involved exceeds USD 100,000; advertisement in foreign print media for purposes other than promotion of tourism, foreign investments and international bidding (over USD 10,000) by a state government and its public sector undertakings (PSUs); and multi-modal transport operators paying remittances to their agents abroad. RBI approval is required for acquiring foreign currency above certain limits for specific purposes including remittances for: maintenance of close relatives abroad; any consultancy services; funds exceeding 5 percent of investment brought into India or USD USD 100,000, whichever is higher, by an entity in India by way of reimbursement of pre-incorporation expenses.

Capital account transactions are open to foreign investors, though subject to various clearances. NRI investment in real estate, remittance of proceeds from the sale of assets, and remittance of proceeds from the sale of shares may be subject to approval by the RBI or FIPB.

FIIs may transfer funds from INR to foreign currency accounts and back at market exchange rates. They may also repatriate capital, capital gains, dividends, interest income, and compensation from the sale of rights offerings without RBI approval. The RBI also authorizes automatic approval to Indian industry for payments associated with foreign collaboration agreements, royalties, and lump sum fees for technology transfer, and payments for the use of trademarks and brand names. Royalties and lump sum payments are taxed at 10 percent.

The RBI has periodically released guidelines to all banks, financial institutions, NBFCs, and payment system providers regarding Know Your Customer (KYC) and reporting requirements under Foreign Account Tax Compliance Act (FATCA)/Common Reporting Standards (CRS). The government’s July 7, 2015 notification

(https://rbidocs.rbi.org.in/rdocs/content/pdfs/CKYCR2611215_AN.pdf ) amended the Prevention of Money Laundering (Maintenance of Records) Rules, 2005, (Rules), for setting up of the Central KYC Records Registry (CKYCR)—a registry to receive, store, safeguard and retrieve the KYC records in digital form of clients.

Remittance Policies

Remittances are permitted on all investments and profits earned by foreign companies in India once taxes have been paid. Nonetheless, certain sectors are subject to special conditions, including construction, development projects, and defense, wherein the foreign investment is subject to a lock-in period. Profits and dividend remittances as current account transactions are permitted without RBI approval following payment of a dividend distribution tax.

Foreign banks may remit profits and surpluses to their headquarters, subject to compliance with the Banking Regulation Act, 1949. Banks are permitted to offer foreign currency-INR swaps without limits for the purpose of hedging customers’ foreign currency liabilities. They may also offer forward coverage to non-resident entities on FDI deployed since 1993.

Sovereign Wealth Funds

India does not have a sovereign wealth fund. The 2015-16 Union Budget established the National Infrastructure Investment Fund (NIIF) to promote investments in the infrastructure sector. The government has agreed to contribute USD 3 billion to the fund, while an additional USD 3 billion will be raised from the private sector primarily from sovereign wealth funds, multilateral agencies, endowment funds, pension funds, insurers, and foreign central banks. The Abu Dhabi Investment Authority (ADIA) was the first institutional investor in the NIIF, committing USD 1 billion in October 2017. In January 2018, the NIIF announced the launch of its first sectoral investment platform, in partnership with DP World, to invest USD 3 billion of public and private capital in the logistics sectors in India. This investment platform made its first asset acquisition, acquiring Indian logistics company Continental Warehousing Corporation.