Capital Markets and Portfolio Investment
India ended 2018 as the best-performing Asian market and the best-performing major global market after Brazil. The benchmark Standard and Poor’s (S&P) BSE (erstwhile Bombay Stock Exchange) Sensex recorded a 6.67 percent increase for 2018. The imposition of a capital gains tax on equity investments contributed to a weak February; global market volatility and trade tensions also impacted Indian markets through the year. High oil prices hurt the value of the Indian rupee and contributed to some weakness in the second half of the year, and September saw the worst monthly return since February 2016. As oil prices stabilized and India’s economic outlook remained strong, the index recovered to finish the year strong.
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. SEBI also regulates the three national commodity exchanges: the Multi Commodity Exchange (MCX), 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. On September 19 2018, SEBI gave permission to BSE and NSE to launch commodity derivatives trading. SEBI also permitted foreign entities having actual exposure to Indian commodity markets to participate in the commodity derivative segment of recognized stock exchanges for hedging their exposure. Previously, foreign entities were not permitted to directly participate in the Indian commodity derivatives market, even if they imported or exported various commodities from and to India. SEBI also allowed mutual funds to participate in the commodities derivatives market.
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 growth in the bond markets. Combined trading at BSE, NSE, and MCX-SX in corporate bonds amounted to USD 263.75 billion in 2018, down from USD 266 billion 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 (but not non-resident Indians). 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 or statutory ceiling, as applicable. FPIs are not allowed to invest in unlisted shares, and investment in unlisted entities are treated as FDI. The RBI eased rules governing foreign investment in corporate bonds by excluding rupee-denominated securities from its overall debt limit. Rupee-denominated bonds sold overseas known as “masala bonds” do not count towards the investment limit for FPIs in corporate bonds and instead qualify under external commercial borrowings (ECB) norms. https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11127&Mode=0
Foreign investors (FPI and FII) pulled out USD 11.5 billion (net) in 2018, of which USD 4.7 billion was in equites and USD 6.8 billion in debt. FII 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 Indian rupee market in Non Deliverable Forwards (NDF) onshore, in order to deepen domestic markets, enhance downstream benefits, and generally obviate the need for an NDF market. FPIs with access to currency futures or the 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 including Yes Bank, Federal Bank, ICICI Bank, Kotak Mahindra Bank, IDBI Bank, State Bank of India, and IndusInd Bank have started IFSC banking units in GIFT city, but 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. The RBI announced in February 2019 that it would set up a task force on offshore rupee markets to examine and recommend appropriate policy measures to ensure the stability of the external value of the Rupee. 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://rbi.org.in/scripts/NotificationUser.aspx?Mode=0&Id=11456 The RBI, in consultation with the government, has decided to implement a rule-based dynamic limit for the total outstanding stock of ECB at 6.5 percent of GDP at current market prices. Based on the GDP figures on March 31, 2018, the soft limit was USD 160 billion for 2018-19.
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 19.25 percent of their net demand and time liabilities in government securities. The RBI plans to reduce this by 25 basis points every quarter until the investment requirement reaches 18 percent of their net demand and time liabilities.
PSBs currently face two significant hurdles: capital constraints and poor asset quality. As of September 2018, gross non-performing loans represented 10.8 percent of total loans in the banking system, with the public sector banks having an even larger share at 14.8 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 (IBC) in place, banks are making progress in non-performing asset recognition and resolution. As of January 2019, the resolution processes have been approved in 66 cases, involving around INR 800 billion as resolution value to creditors. Analysts note that haircuts under IBC have been high at around 70 percent and recent months have seen a withdrawal of many cases with promoters fearing loss of control and preferring settlements outside IBC.
As of latest September 2018 RBI data, the PSBs’ average total capital adequacy ratio of 11.3 percent was below the minimum 11.5 percent standard. In light of these asset quality problems, the government has injected USD 27 billion into public sector banks in the last two years. The capitalization largely aims to address the capital inadequacy of public sector banks under the prompt corrective action (PCA) framework and marginally provide for growth capital.
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. The Acting Finance Minister Piyush Goyal while delivering the 2019 budget speech mentioned that 70 percent of the beneficiaries of MUDRA initiative are women. Under the MUDRA initiative, 155.6 million loans have been disbursed amounting to USD 103 billion. 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. About 5,000 members are currently registered and using the services of the portal said a NITI Aayog officer who has an oversight of the project.
Foreign Exchange and Remittances
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.
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
The 2015-16 Union Budget established the National Infrastructure Investment Fund (NIIF), touted as India’s first sovereign wealth fund 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.