Proposal to ease FII investment limits fails to make headway

MUMBAI: The proposal to liberalise investment limits for foreign institutional investors is stuck in the near term, as the government and the Reserve Bank of India are facing a policy dilemma.

An announcement relating to this was first made in the ‘02-03 Union budget. Later, in mid-’04, a committee headed by chief economic advisor Ashok Lahiri recommended the relaxation of investment limits.

However, the government is unable to let go easily, as a liberalised regime for FIIs would only fuel more inflows, leading to problems on the monetary policy management front. The banking sector regulator has apprehensions on this count, due to which the policy response to the proposal is yet to be carried out, sources said.

The Lahiri committee had recommended higher FII limits in a host of sectors, as well as for public sector banks and in sectors like insurance, telecom, defence, civil aviation, petroleum and coal.

The committee had specifically recommended that in general, FII investment ceilings, if any, may be reckoned over and above the prescribed foreign direct investment sectoral caps.

For instance, it had recommended 20% investment by FIIs, over and above the existing composite cap of 20%, a composite cap of 49% for insurance, which would include FDI, 80% for domestic airlines, which is inclusive of FDI and 100% for private sector banking.

In ‘04 alone, record inflows aggregating $8.5bn had posed a major challenge for the RBI, which had to mop up these flows and ensure that the resultant impact on money supply and inflation was not severe. This fiscal, absorbing higher capital flows has come at a cost for the government, which had issued market stabilisation bonds.

While the central bank is naturally worried about the repercussions of the move on monetary policy management, the government on the other hand, has to view liberalisation of FII investment limits from a long-term perspective.

The policy dilemma for the government centres around the fact that it does not want to be viewed as an investment destination which picks and chooses, instead of presenting a stable policy.

“At this point of time, when the foreign exchange reserves are high, it may suit the country fine to adopt such an approach. One also has to factor in the possibility of a less-enthusiastic FII response later if the limits are enhanced at a time when capital flows taper off,“ said a senior banker.

However, the government would like to take the regulator fully on board before further opening up the portfolio investment route. The Lahiri committee had made out a case for liberalising FII investment limits in a host of sectors, citing several benefits.

According to the committee, these include the accepted preference for non-debt creating inflows, better corporate capital structures, improvements in compressing yield differentials between equity and bonds, financial innovations, including hedging instruments and improved corporate governance, besides enhancing competition in financial markets.

Given the existing savings-investment gap of close to 1.6%, FII inflows could help contribute in bridging the investment gap to achieve the stated growth of 8% for the economy, it reckons.

The committee also recommended that the special procedure for raising FII investments beyond 24% in a company may be dispensed with by amending Sebi regulations. However, the existing limit of 10% investment by a FII in a single company may continue, it said.