The Government needs to address flip-flops in taxation to get foreign funds re-thinking their India strategy.
Viewed in isolation, many of the recommendations of the SEBI committee on rationalising channels of foreign portfolio investments are quite useful in creating a conducive atmosphere for foreign capital. But it would be too optimistic to expect that they would, in themselves, trigger a stampede among foreign investors rushing to enter the country. The record this year is dismal with not a single addition to the number under the Foreign Institutional Investor category. The $15 billion of net FII inflow this year does not imply a positive sentiment towards India since most of these funds have come in as a part of a larger allocation to emerging/Asian markets In fact global India-dedicated funds have recorded net outflows in the first quarter of 2013.
The government's flip-flop on taxing incomes of foreign investors has soured sentiment. The Government needs to address this in order to get foreign funds re-thinking their India strategy. Registrations of new FIIs have dried up since the inclusion of the General Anti Avoidance Rules in the 2012 Union Budget. Though its implementation has been deferred to April 2016, fears on taxation persist. The market regulator had stipulated that the depository participants should deduct tax at source on the profits made by Qualified Foreign Investors. This resulted in DPs dragging their feet in soliciting investors in this category.
That said, the recommendation to let foreign investors register with a dedicated depository participant, instead of SEBI is a good idea since it will significantly reduce the time taken to enter the country. This will make equity markets follow the banking system where compliance with 'Know Your Client' procedures are undertaken by the banks themselves with the Reserve Bank of India playing a supervisory role. Since this system of delegation has worked well with banks, there is no reason why it should not work in equity markets too. The stock market regulator can then put its limited man-power to better use in improving market surveillance and investor protection. The recommendation to merge the three existing categories of Foreign Institutional Investors, Sub Accounts and Qualified Foreign Investors in to one category – Foreign Portfolio Investor -- will help simplify the process. It will put an end to the practice of foreign investors playing on regulatory arbitrage by registering as a Sub Account instead of a Foreign Institutional Investor. The recommendation on dividing Foreign Portfolio Investors into three risk categories based on their potential for causing turbulence in the market is another useful suggestion which should be accepted as it allows the regulator to focus on those classified as 'riskier' and subject them to greater scrutiny.
(This article was published on June 13, 2013)