Regulatory discrimination

Overseas limit for MFs must be reviewed

One of the most basic principles of portfolio management is diversification. It is always advisable to not put the entire corpus in one stock, or one asset class for that matter. Investors thus diversify their portfolios at different levels, depending on investment objectives, the time horizon, exposure to different instruments and assets, and the size of the portfolio. Depending on the investment objectives, diversification also helps generate better returns over time. Aside from different assets, investors also tend to diversify their portfolios in different geographies, depending on the regulatory architecture. Foreign investment worth billions of dollars flow in and out of Indian financial markets regularly, for instance. Since India doesn’t have full currency convertibility, there are restrictions on how much money residents can take abroad.

Indian regulatory architecture, to be fair, is being liberalised over time. Earlier this month, for instance, trading in stocks of firms based in the US was started at the National Stock Exchange’s International Exchange for domestic investors. For now, investing in eight big companies will be allowed, and the number would soon go up to 50. This will increase the ease of investing for domestic investors who intend to invest in top US-based companies and have to deal with foreign brokerages. While this is encouraging, there is a significant regulatory disconnect when it comes to mutual funds. The Securities and Exchange Board of India (Sebi) earlier this year advised mutual fund houses to stop investing in foreign securities as the overall investment was expected to hit the ceiling of $7 billion. As a result, mutual funds investing in foreign securities had to suspend subscriptions. One of the fund houses with a scheme that invests part of its corpus overseas has decided to open subscriptions, but will invest only in the domestic market for now. It will rebalance the portfolio once the limit is increased.

This is an unfortunate situation and a clear case of regulatory oversight. It is not clear why the limit has not been reviewed, despite knowing fully well that it will affect domestic investors. The mutual fund industry, the pool of investors, the size of the market, and India’s interconnectedness with the global economy have all grown significantly over the years. Thus, there is a strong case for an urgent review, and the limit must be fixed in a manner that reflects overall regulatory and macroeconomic realities. It is difficult to gauge what is holding back Indian regulators, particularly the Reserve Bank of India (RBI). Despite the uncertainty in the global economy, higher foreign exchange reserves mean that financial-stability risks emanating from currency are relatively low. India’s reserves are the fifth-highest in the world.
 

Further, India is not restricting, and rightly so, heavy selling by foreign portfolio investors, which is putting pressure on the rupee. The RBI is also, again rightly, not reported to be considering reducing the limit under the Liberalised Remittance Scheme. Therefore, there is no conceivable reason why investors taking exposure to foreign stocks or assets through mutual funds should be treated differently. If the concern is about the level of investment, individual exposure can easily be tracked because all mutual fund investments are connected to the permanent account number. Thus, both Sebi and the RBI must review the existing position and end the regulatory discrimination.