Capital Markets and Portfolio Investment
The S&P BSE SENSEX index – India’s benchmark 30-share index – ended 2016 marginally higher by 1.78% at 26,626. The SENSEX began the year with a low of 22,951 on February 11, 2016 largely due to weak quarterly earnings, as banks recognized non-performing assets (NPAs) after pressure from the RBI. The stock markets managed to keep investors on edge with reactions to the Brexit vote results in June, announcement of surgical strikes across the Line of Control in Kashmir in September, the demonetization of high value rupee notes, and the results of the U.S. elections in November. Market capitalization of the BSE stood at USD $1.6 trillion as of December 30, 2016.
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, 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.
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. Although private placements of corporate debt have increased (95% of corporate debt is privately placed), the corporate bond market is around 14% of GDP, compared to bank assets of 89% of GDP and equity markets of 80% of GDP. There were 2,636 corporate bond issuances for $62 billion in 2014-15. The Reserve Bank of India (RBI) announced several measures intended to further market development, enhance participation, facilitate greater market liquidity and improve communication on August 25, 2016: https://www.rbi.org.in/scripts/bs_pressreleasedisplay.aspx?prid=37875 .
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% of the paid up capital of the Indian company. All FPIs together cannot acquire more than 24% of the paid up capital of any Indian company. As per SEBI regulations, FPIs are not allowed to invest in unlisted shares, and investment in unlisted entities will be treated as FDI.
Foreign investors withdrew $3.47 billion from the Indian capital markets in 2016, the worst year in terms of overseas investment since 2008. Surprisingly, debt instruments took the biggest hit, after remaining a preferred investment avenue for foreign funds in recent years, while equities continued to attract net inflows – but not enough to compensate the huge outflows from the bond market. FPIs purchased $3.09 billion in equities, but sold $6.56 billion of bonds in 2016. 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.
India’s growing importance in the global economy has led to increased interest in the rupee. Yet, the persistence of capital controls in the onshore market has led to the development of an offshore INR market called Non Deliverable Forward (NDF), particularly in Singapore, Dubai, London, and New York. The RBI has taken a number of steps in the recent past to bring these offshore activities 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.
BSE, Asia’s oldest stock exchange, established the country’s first international exchange, called the India International Exchange at International Financial Services Centre (IFSC) GIFT city in Gujarat. SEBI has allowed trading in commodity derivatives at stock exchanges operating in IFSC. Under the IFSC regime, any recognized domestic or foreign stock exchange can set up a subsidiary in the financial services center, provided they hold at least a 51% stake in the venture. These norms aim to ease the establishment of stock exchanges and capital market infrastructure in such centers. SEBI has announced that they would introduce new products and allow more participants to deepen the commodity derivatives market.
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 the 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). SEBI allows FVCIs to register as a foreign portfolio investor if they meet certain guidelines.
Companies planning to issue an IDR are required to maintain pre-issued, paid-up capital, and free reserves of at least $100 million, as well as demonstrate an average turnover of $500 million during the three financial years preceding issuance. The company must be profitable for at least five years preceding the issuance, declaring dividends of no less than 10% each year and maintaining a pre-issue debt-equity ratio of no more than 2:1. 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 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 . ECBs cannot be used for on-lending, investments in financial assets, acquisition of real estate or a domestic firm, meeting of working capital requirements or repayment of existing INR loans. An infrastructure or manufacturing company can raise a maximum of $750 million in a financial year under ECB. Companies in software development sector can raise ECB up to $200 million. Companies engaged in micro-finance activities and microfinance institutions can raise ECB up to $100 million in a financial year, and must hedge 100% of their currency risk exposure. A Non-banking Finance Company – Infrastructure Finance Company (NBFC-IFC) can raise ECB up to 75% of its owned funds, and must hedge 75% of its currency risk exposure. The all-in cost ceilings for ECBs with an average maturity period of three-to-five years is capped at 300 basis points over the six-month LIBOR, and 450 basis points for loans maturing after five years. Indian companies borrowed close to USD $17.15 billion through ECBs in 2016.
Money and Banking System
The banking sector remained predominantly in the public sector, with public sector banks (PSBs) accounting for 72% of total banking sector assets, notwithstanding a gradual decline in their share in recent years. PSBs are not technically subject to any extra regulations relative to commercial banks, either in terms of lending practice nor deposits. They do, however, have their CEOs, upper management, and a number of their board of directors appointed by the government, meaning that the government can be quite influential in credit decisions.
Public sector banks (PSBs) face two significant hurdles: capital constraints and poor asset quality. Under the Indradhanush roadmap, which Jaitley announced in the 2016 budget to revive Public Sector Banks, the government will infuse $10.52 billion in PSBs over four years, while these banks will have to raise a further $16.53 billion from the markets to meet their capital requirements in line with global capital norms under Basel-III. PSBs are to get $3.76 billion in each fiscal year, 2015-16 and 2016-17, and $1.5 billion each in 2017-18 and 2018-19. In July 2016, the government infused 75% of the earmarked fund for fiscal 2016-17 and said the remaining amount would be linked to the banks’ performance.
The consolidated balance sheets of the banking sector continued to grow at a modest pace during 2015-16 with the ratio of assets to liabilities expanding at 7.7%, compared to 9.7% in 2014-15. Bad loans continue to be a challenge for banks, with the gross NPA for at 8.4% for banks as of March 31, 2016. Improved recognition of NPAs led to a more than 60% drop in net profits for the banking sector as a whole, though it remained in positive. In addition to regulatory provisions, including strategic debt restructuring (SDR) and scheme for sustainable structuring of stressed assets (S4A), banks are selling NPAs to ARCs. Under RBI norms announced on September 1, 2016, if security receipts make more than 50% of the value of the asset under consideration, banks then have to provide for these loans as if the loans continued on the books of the bank. This norm ensures stressed asset sales by banks are classified as “true sales.” Security receipts are issued by ARCs to banks pending recovery from an account.
Under the government’s 2014 Jan Dhan program, to provide universal access to banking facilities, as of March 22, 2017, 280 million accounts had been opened and 219 million RuPay debit cards issued. The program provides no-fee basic banking accounts and RuPay debit cards to all households, conducts financial literacy programs, guarantees credit, and offers micro-insurance and unorganized sector pension schemes. Though the number of accounts opened is immense, some of these still maintain a zero-balance, and six months of “satisfactory transactions” are necessary before the account-holder qualifies for benefits including overdrafts and life insurance.
Takeover regulation in India applies equally to domestic and foreign companies. The regulations do not recognize, however, any distinct category of hostile takeovers. RBI and lead ministry clearances are required to acquire a controlling stake in Indian companies. Takeover regulations require disclosure on acquisition of shares exceeding 5% of total capitalization. As per SEBI’s Substantial Acquisition of Shares and Takeovers (Amendment) Regulations, released in 2013, acquisition of 25% or more of the voting rights in a listed company triggers a public offering of an additional 26% stake at least. Under the creeping acquisition limit, an acquirer holding 25% or more voting rights in the target company can acquire additional shares or voting rights up to 5% of the total voting rights in any financial year, up to a maximum permissible non-public shareholding limit of 75% generally. Acquisition of control over the target company, irrespective of shares or voting rights held by the acquirer, will trigger a mandatory open offer.
Foreign Exchange and Remittances
The Indian rupee extended its 2015 losses by falling a further 2.7% against the dollar in 2016. According to market experts, demonetization of INR 500 and INR 1000 notes, as well as U.S. Federal Reserve rate hike worries, dampened sentiment towards the currency.
The RBI, under the Liberalised 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 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 $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; funds exceeding 5% of investment brought into India or 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 the lead ministry.
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%.
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
India does not have a sovereign wealth fund. In 2015 the Government of India created a fund – the National Investment and Infrastructure Fund (NIIF) for enhancing infrastructure financing in India. Finance Ministry officials said that the “NIIF will be a commercially run organization and will operate at arm’s length from the government.” Looking to attract larger inflows from sovereign wealth funds and foreign pension funds, government and financial sector regulators have renewed their efforts to make Indian markets, especially government bonds, much more appealing to such investors. Policymakers view overseas investments by sovereign wealth funds, multilateral agencies, endowment funds, pension funds, insurers, and foreign central banks as much more stable in nature, as compared to institutional investors and hedge funds. Finance Minister Arun Jaitley visited Australia last year and pitched for investments from sovereign wealth funds in the NIIF and pension and insurance funds in India. Media reports suggest that the $100 billion Australian Government Future Fund is looking to invest in the Indian infrastructure space, including roads, telecommunications and clean energy through the NIIF. The UAE has committed to invest $75 billion in the NIIF, and in April 2017 the UK agreed to invest $300 million in a fund for green energy under the NIIF.