Capital Markets and Portfolio Investment
Indian stocks experienced significant losses at the start of 2021, stemming from the effects of the COVID-19 pandemic on the economy. By midyear, markets began to recover, with India’s stock benchmarks reaching record highs and becoming among the top performers globally. Indian companies raised a combined $15.57 billion through 121 IPOs in 2021, the highest amount ever raised in a single calendar year compared with the previous high of $8.4 billion in 2017.
Foreign investment inflows drove markets higher through February 2021. However, these investments began exiting the market when faced with the potential for faster-than-expected withdrawal of monetary stimulus and the Delta variant of COVID-19. Domestic institutional investors compensated outflows of foreign investment through significant investment in Indian stocks. Foreign investors’ net investment in 2021 was about $7 billion, significantly lower than the $14.5 billion in 2020 and $19 billion in 2019. Domestic investors put about $12.5 billion in 2021 into Indian domestic equity markets. Indian investors opened 27.4 million new stock trading accounts in 2021, up from 10.5 million accounts opened in 2020.
The SEBI is considered one of the most progressive and well-run of India’s regulatory bodies. The SEBI regulates India’s securities markets, including enforcement activities and is India’s direct counterpart to the U.S. Securities and Exchange Commission (SEC). The Board oversees seven exchanges: BSE Ltd. (formerly the Bombay Stock Exchange), the National Stock Exchange (NSE), the Metropolitan Stock Exchange, the Calcutta Stock Exchange, the Multi Commodity Exchange (MCX), the National Commodity & Derivatives Exchange Limited, and the Indian Commodity Exchange.
Foreign venture capital investors (FVCIs) must register with the 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, as well as 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) based on SEBI guidelines. Standard Chartered Bank, a British bank was the only foreign entity to list in India but delisted in June 2020. Experts attribute the lack of interest in IDRs to initial entry barriers, lack of clarity on conversion of the IDRs holdings into overseas shares, lack of tax clarity, and the regulator’s failure to popularize the product.
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. The rules are published by the RBI: https://rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11510
According to RBI data, ECB by corporations and non-banking financial companies reached $38.8 billion in 2021. Companies have been increasingly tapping overseas markets for funds to take advantage of low interest rates in global markets. On December 8, 2021, the RBI announced a switch in calculation of interest rates for ECB and trade credits from the London Interbank Offered Rate (LIBOR) to alternative reference rates (ARRs).
The RBI has taken several steps in the past few years to bring the activities of the offshore Indian rupee (INR) market in Non-Deliverable Forwards (NDF) onshore, with the goal of deepening domestic markets, enhancing downstream benefits, and obviating 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 RBI allowed banks to freely offer foreign exchange quotes to non-resident Indians. The RBI has stated that trading on INR derivatives would be allowed and settled in foreign currencies in International Financial Services Centers (IFSCs). In June 2020, the RBI allowed foreign branches of Indian banks and branches located in IFSCs to participate in the NDF. With the INR trading volume in the offshore market higher than the onshore market, the RBI felt the need to limit the impact of the NDF market and curb volatility in the movement of the INR. In August 2021, the RBI released a working paper discussing the influence of offshore markets on onshore markets.
The International Financial Services Centre at Gujarat International Financial Tech-City (GIFT City) is being developed to compete with global financial hubs. In January 2016, BSE Ltd. was the first exchange to start operations there. The NSE, domestic banks, and foreign banks have also started IFSC banking units in GIFT city. As part of its FY 2021-22 budget proposal, the government recommended establishing an international arbitration center in GIFT City to help facilitate faster resolution of commercial disputes, akin to the operation of the Singapore International Arbitration Centre (SIAC) or London Commercial Arbitration Centre (LCAC).
Money and Banking System
The public sector remains predominant in the banking sector, with public sector banks (PSBs) accounting for about 66 percent of total banking sector assets. However, the share of public banks in total loans and advances has fallen sharply in the last five years (from 70.84 percent in FY 2015-16 to 58.68 percent in FY 2021-22), primarily driven by stressed balance sheets and non-performing loans. In recent years, several new licenses were granted to private financial entities, including two new universal bank licenses and 10 small finance bank licenses. The government announced plans in 2021 to privatize two PSBs. This followed Indian authorities consolidating 10 public sector banks into four in 2019, which reduced the total number of PSBs from 18 to 12. However, the government has yet to introduce the necessary legislation needed to privatize PSBs. 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 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. Additionally, all banks are required to invest 18 percent of their net demand and time liabilities in government securities.
PSBs continue to face two significant hurdles: capital constraints and poor asset quality. As of September 2021, gross non-performing loans represented 6.9 percent of total loans in the banking system, with the PSBs having a larger share of 8.8 percent of their loan portfolio. The government announced its intention to set up the NARCL and India Debt Resolution Company Limited (IDRCL) to take over legacy stressed assets from bank balance sheets. With the IBC in place, banks are making progress in non-performing asset recognition and resolution.
To address asset quality challenges faced by public sector banks, the government has injected $32 billion into public sector banks in recent years. The capitalization largely aimed to address the capital inadequacy of public sector banks and marginally provide for growth capital. Bank mergers and capital raising from the market, improved public sector banks’ total capital adequacy ratio (CAR) from 13.5 percent in September 2020 to 16.6 percent in September 2021.
Women in the Financial Sector
Women’s lack of sufficient access to finance remained a major impediment to women’s entrepreneurship and participation in the workforce. According to experts, women are more likely than men to lack financial awareness, confidence to approach a financial institution, or possess adequate collateral, often leaving them vulnerable to poor terms of finance. Despite legal protections against discrimination, some banks reportedly remained unwelcoming toward women as customers. International Finance Corporation (IFC) analysts have described Indian women-led Micro, Small, and Medium Enterprises (MSME) as a large but untapped market that has a total finance requirement of $29 billion (72 percent for working capital). However, 70 percent of this demand remained unmet, creating a shortfall of $20 billion.
The government-affiliated think tank NITI-Aayog provides information on networking, mentorship, and financing to more than 25,000 members via its Women Entrepreneurship Platform (WEP), launched in March 2018. The government’s financial inclusion scheme Pradhan Mantri Jan Dhan Yojana (PMJDY) provides universal access to banking facilities with at least one basic banking account for every adult, financial literacy, access to credit, insurance, and pension. As of March 2, 2022, 249 million women comprised 55 percent of the program’s 448 million beneficiaries. In 2015, the 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 $15,000 to non-corporate, non-farm small and micro enterprises. As of October 29, 2021, 215 million loans have been extended to women borrowers.
Foreign Exchange and Remittances
The RBI, under the Liberalized Remittance Scheme, allows individuals to remit up to $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 accounts 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://m.rbi.org.in/scripts/FAQView.aspx?Id=115 ). 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 activities abroad if the amount involved exceeds $100,000; advertisement in foreign print media for purposes other than promotion of tourism, foreign investments, and international bidding (over $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; and funds exceeding five percent of investment brought into India or $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. Non-resident Indian 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, 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, non-bank financial companies, and payment system providers regarding Know Your Customer (KYC) and reporting requirements under Foreign Account Tax Compliance Act (FATCA)/Common Reporting Standards (CRS). In May 2021, the RBI amended KYC provisions to further utilize the Video-based Customer Identification Process (V-CIP) and to simplify the process of periodic updating of KYC ( https://rbi.org.in/scripts/NotificationUser.aspx?Mode=0&Id=12089 ). The Prevention of Money Laundering (Maintenance of Records) Rules, 2005 for setting up the Central KYC Records Registry (CKYCR), a registry to receive, store, safeguard and retrieve the KYC records in digital form of clients, was amended by the government’s July 7, 2015, notification ( https://rbidocs.rbi.org.in/rdocs/content/pdfs/CKYCR2611215_AN.pdf ).
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
In FY 2016, the Indian government established the National Infrastructure Investment Fund (NIIF), India’s first sovereign wealth fund, to promote investments in the infrastructure sector. The government agreed to contribute $3 billion to the fund, with an additional $3 billion raised from the private sector primarily from foreign sovereign wealth funds, multilateral agencies, endowment funds, pension funds, insurers, and foreign central banks. Currently, the NIIF manages over $4.3 billion in assets through its funds: Master Fund, Fund of Funds, and Strategic Opportunities Fund. The NIIF Master Fund is focused on investing in core infrastructure sectors including transportation, energy, and urban infrastructure.