Think ease of engagement before ease of business

With foreigners dumping close to $40 billion of stocks over the past year, everyone – from Sensex savants to the stock market regulator -- is clamoring for the removal of equity tax on foreigners to reverse the dollar drain. Call it prime time firefighting.

But tax tweaks alone won’t cut it. We should first think of ease of engagement, starting with a reset of attitude and priorities.

Policy wonks in New Delhi have historically fussed too much about foreign capital buying domestic assets. But being perennially paranoid about the colour of money has only diminished our market appeal. Between the magnificent seven, US private credit, US treasuries or the trillion-dollar opportunity to bankroll AI chips, global data centres, power infrastructure and global assets, moneybags from around the world are getting pulled in by asset classes of all shapes and sizes. While there are multiple distractions, we continue to sour global investor sentiments.

Just last month, the yield spread between India's 10-year sovereign bonds and US Treasuries widened by 58 basis points -- the sharpest monthly surge since 2019 – skyrocketing our risk premium. Factor in rupee depreciation, withholding tax and the uneven playing field between domestic and international investors, there is very little incentive left for global fund managers to open their fat cheque books. India is too difficult relative to other opportunities where rules are clear, tax treatment is predictable, enforcement is credible and returns compensate for risk.

What then can we do to make long term, institutional capital want India again?

To start with, create a big institutional investor category. Large, regulated global investors – pension funds, alternative asset managers, financial institutions, sovereign wealth funds, or insurers – that meet clear thresholds on assets under management, regulatory oversight, disclosures, beneficial ownership and track record should be seen as part of the country’s capital architecture, not as a concession to foreign ownership. More importantly, they need to be treated at par with their domestic peers. Post a one-time vetting by the regulators, we should allow greater flexibility on instruments, pricing, end-use and secondary transactions, while being held to higher standards of reporting and transparency.

We already recognise special categories like Qualified Institutional Buyers (QIBs) for equity and debt, but it’s time to expand their scope of engagement. For example, our regulators must review norms to allow international investors to invest in optionally convertible instruments, redeemable preferred equity, even structuring warrants without conditions. The external commercial borrowing (ECB) route allows those with the requisite Foreign Venture Capital Investor (FVCI) license some leeway, but those investments are limited to a handful of specified sectors.

Even for listed companies issuing convertible preference shares, there is an artificially determined timeline of 18 months to convert those shares. In fear of allowing capital that might look like debt, several commonly accepted instruments are not allowed in India. It’s time we move from instrument control to risk control. Sophisticated capital providers and companies should be allowed to negotiate commercial instruments, provided the regulator has visibility on leverage, maturity, beneficial ownership, related-party transfers, pricing abuse and systemic exposure. Regulate risk, not ban structures.

We have forever oversold equity and undersold debt even at the cost of being a more efficient capital source in many cases. Borrowing is indeed risky, but if we do not learn risk taking, equity alone will not be able to fund large scale, capex heavy, transformative projects or deals.

The debt market also needs to be nurtured around the way capital actually moves. We fuss only about government bonds, but investors are increasingly preferring a taste the whole spectrum of capital structures: Corporate credit, performing and distress or special situations opportunities along with infrastructure and mezzanine capital or structured equity. India needs all that if banks are to lend more to households and MSMEs while larger companies and platforms access institutional capital. Rules that prevent bilateral credit trades, constrain prepayment flexibility or make exits uncertain reduce liquidity while raising the cost of capital.

It’s foolhardy to choose between self-reliance and foreign capital. Self-reliance requires capital but so does manufacturing, restructuring stressed assets or investments in AI data centres and energy transition. The policy choice is whether India continues to design capital rules mainly around preventing abuse or designs them to attract pedigreed and patient pools. The rapid financialisation of savings has its limitations too. There is a limit to what domestic capital can fund.

To be fair, regulators have started moving in the right direction. The RBI's recent liberalisation of the ECB framework, including higher borrowing headroom and a more market-based approach to pricing is a meaningful step much like the withdrawal of concentration limits for FPI investment in corporate debt through the general route. But they are still incremental.

A clearer framework that taxes income primarily in the investor's place of residence, subject to substance, beneficial ownership and anti-abuse rules - would make Indian debt more competitive. This is not tax forbearance; it is capital-market policy. Ease of engagement becomes crucial as we play catch up in the race to build AI data centres. If we aspire to make, build, compute and employ more, we must first make it easier for serious capital to enter, stay, compound and recycle. That is what ease of doing business in India should entail.