Capital Markets and Portfolio Investment
The Indian equity market outperformed most global equity markets in 2022 despite challenging events including high inflation, high-interest rates, geopolitical uncertainties led by Russia’s invasion of Ukraine, and China’s zero covid-tolerance policy. Equity indices SENSEX and NIFTY both rose about four percent.
After 2021’s all-time high in equity and debt fundraising, private fundraising and initial public offerings (IPO) slowed in 2022 due to volatile stock markets caused by geopolitical tensions. The number of IPOs in 2022 dropped to 31 from 65 in 2021. Despite this, India also saw one of its biggest ever listings in 2022, with the Life Insurance Corporation of India raising $2.7 billion.
Foreign Portfolio Investors (FPIs) were net sellers in 2022 selling $17.94 worth of equities and bonds, the first time in four years, while domestic investors remained net buyers in 2022, buoyed by continued inflows in mutual funds.
In August 2022, the RBI issued a new overseas investment framework: https://rbi.org.in/scripts/NotificationUser.aspx?Mode=0&Id=12381 . The framework supersedes RBI’s old regulations on the transfer of foreign security and acquisition and transfer of immovable property outside India, rationalizes definitions, and provides clarity with respect to various existing definitions.
The Security and Exchange Board of India (SEBI), the financial market regulator, is considered one of the most progressive and well-run of India’s regulatory bodies. SEBI regulates India’s securities markets, including enforcement activities, and is India’s direct counterpart to the U.S. Securities and Exchange Commission (SEC). In June 2022, SEBI asked intermediaries to report cyber incidents within six hours of detecting such incidents, to narrow the reporting timeline for cyber incidents and enable stock exchanges, depositories, and SEBI to act immediately.
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, 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), 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 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. ECB rules can be accessed at: https://rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11510 .
The RBI has taken several steps 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 allows 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 2020, RBI began allowing foreign branches of Indian banks and branches located in IFSCs to participate in the NDF. To remove the segmentation between onshore and offshore overnight indexed swap markets and improve the efficiency of price discovery, the RBI in August 2022 began allowing standalone primary dealers, who are market-makers like banks, to offer foreign currency settled overnight indexed swaps.
The International Financial Services Centre at Gujarat International Financial Tech-City (GIFT City) is being developed to compete with global financial hubs. In 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. The RBI in June 2022 provided a regulatory framework for the participation of Indian banks’ branches in the GIFT-IFSC to provide clearing and settlement services on the India International Bullion Exchange IFSC Limited.
Money and Banking System
Public sector banks (PSBs) dominate the Indian banking sector, accounting for about 59 percent of total banking sector assets. However, the share of public banks in total loans and advances has fallen sharply in the last few years (from 70.84 percent in FY 16 to 57.7 percent in FY 22), primarily due to inefficiencies and technological challenges. In recent years, India has rolled out innovative banking models including the payments and small finance banks. It has also focused on increasing its banking sector reach, through digital payments, neo-banking and fintech. Recently, the Indian authorities have consolidated ten public sector banks into four, 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. Some foreign banks continue to express concerns regarding a lack of level playing field in the sector.
As of September 2022, gross non-performing loans represented 5 percent of total loans in the banking system, with the PSBs having a larger share of 6.5 percent of their loan portfolio compared to private banks at 3.3 percent. In December 2022, the RBI conducted macro-stress tests to assess the resilience of banks’ balance sheets in the face of unforeseen shocks. The results revealed that Indian banks are well-capitalized, capable of absorbing shocks and would comply with the central bank’s minimum capital requirements even under adverse stress scenarios.
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.
Foreign Exchange and Remittances
The Indian rupee depreciated over 11 percent in 2022 against the dollar — its poorest performance since 2013 and the worst among Asian currencies. Volatility in the forex market caused the RBI to frequently dip into its reserves to support the rupee. In July 2022, the RBI announced a number of measures to boost foreign exchange inflow including include easing regulations for FPI investment in the debt market, allowing banks to temporarily raise fresh Foreign Currency Non-Resident Bank and NRE deposits without regulating interest rates. As part of its measures to internationalize the rupee and ease the pressure on the local currency from a steeply rising dollar, the RBI announced it would allow settling of international trade in rupees.
The RBI launched a pilot of its central bank digital currency (CBDC), called the e-rupee or the digital rupee, for wholesale transactions in November 2022 and retail transactions in December 2022.
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, and 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 ).
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 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. 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 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 information ( https://rbi.org.in/scripts/NotificationUser.aspx?Mode=0&Id=12089 ).
The RBI in June 2022 announced an e-mandate framework with an additional factor of authentication while processing the first transaction in case of e-mandates/ standing instructions on cards, prepaid payment instruments and Unified Payments Interface to ensure safety of card transaction. In June 2022, the RBI announced restrictions on storage of credit and debit card data, replacing it with an RBI-approved data tokenization scheme. All entities in the card transaction/payment chain, except card issuers and card networks, were required to purge existing card data from their databases prior to October 2022.
Remittances are permitted on all investments and profits earned by foreign companies in India, once taxes have been paid. Certain sectors including construction, development projects, and defense, are subject to special conditions, under which 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 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. The NIIF Fund of Funds is focused on building a portfolio of private equity funds across diversified sectors. The NIIF Strategic Opportunities Fund aims at providing long-term capital to large entrepreneur-led or professionally managed domestic champions and unicorns.