Mutual funds knock RBI door for hike in foreign investment limits

Proposals shared include linking MFs' foreign investment limit to forex reserves

Several mutual funds (MFs) have recently approached the Reserve Bank of India (RBI) as they renew efforts to increase their overseas investment limit.
 

In June 2022, the capital markets regulator Securities and Exchange Board of India (Sebi) permitted MFs to invest in foreign stocks within the aggregate mandated limit of $7 billion after a correction in stocks.

One of the proposals shared with the RBI is to link MFs' foreign investment limit to the country’s foreign exchange reserves.

This will take away the need for a manual revision of the limit.

One factor that has kept the RBI from raising the limit was the pressure on the rupee, especially in 2022, owing to the Russia-Ukraine crisis.

Last month, RBI Governor Shaktikanta Das said the call on raising the MFs' international investment limit will be taken once the central bank is confident the currency is stable on a durable basis.

According to MF officials, opening the MF route for international investment should not make much of a difference to the rupee's stability, given other routes for foreign remittance remain open.

 

They also point to the low investor base of overseas MF products.

“Money is anyway going out, be it for tourism or education. Opening up the MF investment option shouldn't be an issue,” a senior MF official said.

While investing in foreign stocks via the MF route hasn’t taken off in a big way, it is nevertheless considered a key portfolio diversification tool. 

As of March 2023, the value of overseas investments of domestic fund houses stood at $5.6 billion, 13.5 per cent lower than the March 2022 tally, according to RBI data.

The decline was due to a lack of fresh inflows into overseas MF schemes and a sharp correction in foreign markets, especially the US.

The restrictions on foreign equity investments proved to be a dampener for the emerging category.

Fund of funds (FoF) investment overseas nearly doubled between March 2020 and March 2022 to 45, as fund houses rose the growing awareness around geographical diversification post the March 2020 market slump in the wake of Covid-19.

The changes in the taxation of non-equity MF schemes, which was part of the 2023 Budget, also took away the sheen of international funds.

In the fresh regulations, there are no tax concessions for investors of MF schemes that have less than 35 per cent allocation to domestic equities.

Earlier, all non-equity funds had the advantage of indexation benefits, provided the investor stayed invested for over three years.

Overseas funds have been seeing consistent outflows in the financial year 2024 with investors pulling out a net of Rs 2,700 crore during the April-December period.

According to MF officials, the outflows were mostly a result of profit booking.

The outflows created room for fund houses to re-open their schemes for fresh inflows.

US funds, which ended the calendar year 2022 in the red, delivered up to 95 per cent gains in 2023.

However, the 2024 outlook for the US market is not that bright. Global fund managers see a risk of a significant slowdown in the US economy.

“Currently, the markets are discounting a soft landing; however, our base case remains recession as the pre-conditions we track persist. The leading economic indicators (LEIs) have declined sharply over the last two years and are showing a disconnect with GDP growth. There are often lags in the impact of the LEIs,” Franklin Templeton said in its outlook for 2024.