QFIs can invest directly in Indian equity markets

After foreign institutional investors (FIIs) turned net sellers in the Indian stock markets in 2011, the finance ministry came out with a mechanism to arrest market volatility in the new year. The ministry on Sunday decided to allow foreign individuals and pension funds, as well as other entities, to invest directly in equity markets.

The individual and aggregate investment limit for these investors would be capped at five per cent and 10 per cent, respectively, of the Indian company’s paid-up capital. These limits will not include FII and NRI investment ceilings.

Against government optimism that the move would address volatility in stock markets, analysts say it would not lead to any immediate upsurge in the flow of funds into equity markets and may not interest foreign investors as far as companies already listed on foreign bourses through ADRs and GDRs are concerned.

THE NEW MECHANISM

* RBI to grant permission to QFIs for investment under the Portfolio Investment Scheme route similar to FIIs 

* QFIs to invest through Sebi-registered qualified depository participants (DPs) 

* A QFI shall open only one demat account and a trading account with any qualified DP. The QFI shall buy and sell equities only through that DP 

* DP to be responsible for deduction of tax at source before making redemption payments to QFIs

However, long-term investors like pension funds do hold out hope for reducing volatility in the markets, as they won’t eye short-term gains. “This is a step to increase the number of players and make the stock markets deeper. In a sense, it will not be hot money, as the new players are not the ones who would move out at the drop of a hat,” Economic Affairs Secretary R Gopalan told Business Standard.

The new scheme to allow QFIs, to directly invest in equity markets would be put into operation by January 15 through circulars by Sebi and RBI.

It is being seen as the next logical step after QFIs were allowed to invest through mutual funds in Indian capital markets earlier last year. QFIs include individuals, groups or associations of a foreign country compliant with the Financial Action Task Force, a global body to boost national and international policies to counter terror funding and money laundering. These countries will also have to be signatories of the International Organisation of Securities Commissions, a federation of bodies which regulate the world's securities and futures markets.

Under the present arrangement related to foreign portfolio investments, only FIIs/sub-accounts and NRIs are allowed to directly invest in the equity market. Others come through an instrument, called participatory notes, issued by FIIs. As of November 2011, the total value of assets under these notes stood at Rs 1.79 lakh crore or 19.1 per cent of the assets managed by FIIs.

However, a large number of QFIs, in particular a large set of diversified individual foreign nationals desirous of investing in the Indian equity market, do not have direct access to the market. “In the absence of a direct route, many QFIs face difficulties in investing," the ministry said.

The ministry statement said the move would widen the class of investors, attract more foreign funds and reduce market volatility.

"QFIs have been already permitted to have direct access to Indian mutual fund schemes pursuant to a Budget announcement of 2011-12. Foreign capital inflows to India have significantly grown in importance over the years," the statement added.

Jagannadham Thunuguntla, Strategist & Head of Research with SMC Global Securities Ltd, said, "It is a positive development, but may not have an immediate effect. If the market conditions recover, probably, some investment may come."

Asked if the rupee fall should encourage those investors to come to India, he said exchange rate volatility was a two-way movement and may reverse its course. “So, foreign investors may not want to face these risks,” he added.