Indian government treats NRIs as criminals- So prevalent
and enforcing is this view that today, hardly any NRI invests directly
in the stock market in India Read This:
and responsible regulation
New Dellhi, October 29, 2007
Surjit S Bhalla
It's time for some honourable FII* to argue for a transparent regulation
of foreign portfolio inflows. But Godot might arrive sooner.
India is facing large capital inflows. This is a problem. So let
us begin at the beginning. What determines capital inflows? The
answer is simple — the owner of the inflow wants to make a
profit higher than that can be obtained in the country of the foreign
investor or in other emerging market countries. A simple point —
it is relative returns, not absolute ones, that matter. Who are
the foreign investors in India? People of Indian origin (PIOs) or
non-resident Indians (NRIs) and genuine foreigners. Let us examine
the determinants for each. But before that, a comment on the recent
policy on participatory notes (P-notes) banning off-shore derivatives.
This is a very positive development. About $30 billion, or 16 per
cent of FII assets, were devoted to trading in off-shore derivatives.
This component of P-notes demand existed for two reasons. First,
the use of off-shore P-note derivatives allowed FIIs to build positions
in individual stocks in excess of that allowed by Indian law. This
was not possible with inflows into most other emerging markets —
hence, the exaggeration in the buy-India campaign. Second, the off-shore
use of the derivatives allowed foreign investors to not pay the
33 per cent tax rate that ordinary Indians pay. Income from trading
derivatives is not considered as capital gains in India and, therefore,
it is unlikely that the use of Mauritius or Singapore treaty would
prevent a 33 per cent tax on on-shore derivatives. Hence the demand
for off-shore derivatives.
This leveraging demand on one of the few stock markets in the world
to allow P-notes, and an emerging market that gifted a large currency
appreciation as well, meant an unexceptionally excessive demand
for Indian stocks. This demand for P-notes would be removed in 18
months, possibly earlier. It is important to note that capital inflow
is not affected much by this removal. Financial engineering and
margining requirements would mean that at a maximum, about 10-20
per cent of the $30 billion would be removed. This is a very small
dent in the capital inflow problem.
PIO/NRI foreign inflows: There are two forms such
inflows can take: equities and debt (fixed-income instruments, deposits).
Unknown to many, and not emphasised by many in the know,
the Indian government treats NRIs as criminals. Period. In my interaction
with several government officials over the last decade, and participation
in several government committees (including RBI and Sebi), I can
say with some confidence that this rather wrong and pig-headed view
is quite prevalent. So prevalent and enforcing is this view that
today, hardly any NRI invests directly in the stock market in India.
I am a fund manager (Oxus Fund Management) and I have had to turn
away numerous applicants because the procedure to handle their money
is quite prohibitive — possible de jure but impossible de
Why this naïve and misguided view of our own citizens? There
is the argument that the NRIs act as a conduit for round tripping,
that is, a domestic Indian sends money abroad and brings it back
into India to take advantage of the taxation treaty in Mauritius
or Singapore. However, while it may have been true when capital
gains taxes were 30 per cent, it is not so since 2004; the short-term
capital gains tax in India is now only 10 per cent, and the fees
and hassles of setting up shop in Mauritius is so large that it
is not a factor influencing most individuals.
These Indians are some of the prime legitimate demanders of P-notes
(the illegitimate use of derivatives is over). This demand remains
and the only purpose of the FII licensing system is to transfer
the hard-earned money from these thin cat citizens to fat cat FIIs
— a more regressive transfer of money is difficult to imagine.
FIIs love the licensing regime for this reason,
and given their enormous fatness and catness, they can be expected
to lobby, and lobby hard, for the continuation of the licensing
regime. And as foot soldiers they have their “lobbyists”
in India. Who are these lobbyists? The
clerks, accountants and lawyers working at firms which process FII
applications, and the brokers who handle FII trading in India. But
these brokers do not get any share of the much larger profit made
by FIIs in charging shamefully high fees from foreign-based Indian
clients and other investors barred entry into India by the regulator.
The fees charged by FIIs from Indian clients is a further embarrassment
since it is the Indian government that is facilitating this exploitative
trade. But this doesn’t matter for Indian lobbyists as they
would rather make the extra buck today, than share in the extra
growth which would make them even richer.
You can see the lobbyists in the media — print and TV. They
rather inaccurately and shamelessly argue that the
FII licensing regime is necessary to contain the markets and not
let “market fundamentalism” operate. They think
they are striking a chord among those who believe in sensible regulation,
with the bogeyman being hedge funds. Just as there is disclosure
required of fund managers and stock analysts to state their positions
in the market to avoid “conflicts of interest”, so there
should be a requirement that those who file FII applications and/or
broker for FIIs should state how their business and profits are
bloated because of the continuation of the present non-transparent
The operational view of the lobbyists is that licensing can prevent
hedge funds and bad money from entering the country. Hence, licensing
will ban hedge funds and is therefore useful. Who is the most conservative
and stable of money managers? Endowments and pension funds. And
who do these squeaky cold money managers employ to manage their
money? In large part, hedge funds.
To Sebi’s credit, even the regulator does not buy this absurd
self-serving view. It has already allowed some hedge funds to enter
the country. Why not rapidly move to a transparent policy allowing
all to enter the Indian market, especially off-shore Indians? The
correct policy is the registration of all investors with Sebi. With
this transparent policy, hedge funds would be just like any other
investor and subject to the same FII limits as NRIs and other cold
money managers. Neither the regulator nor the government (nor self-styled
and self-interested experts) should care as to who the holder of
the money is; the only thing we should care is that the investors
follow domestic laws. So please, let us stop using virtual imaginary
evils to implement real bad policies.
Won’t this transparent policy increase capital inflows into
India and thereby make the copious inflows problem worse? No, because
the Indian, like the foreigner, is subject to on-shore stock purchase
limits. If this limit is reached, as it has for several major stocks
(such as SBI, Tata Steel and Zee News), the foreign (and NRI) investor
would have to buy riskier second and third tier stocks. And that
means less inflow.
One clarification. The stated limits for foreign ownership are quite
high, in some cases even 100 per cent. If a liberal foreign investor
share of 50 per cent is taken as the average allowed share for FIIs,
and since the average promoter holding is 52 per cent, the foreigner’s
50 per cent share entitles him to only 24 per cent of the market
cap in India. Today, foreigners own about 20 per cent of the market
cap. In other words, there isn’t much room for additional
transparent capital inflow.
But the real culprit behind copious inflows is the interest rate
and exchange rate policy of India. But that will need a separate
treatment. Forthcoming soon.
- FII- Foreign
- SEBI- Securities And Exchange
Board Of India