Mutual funds push for higher overseas investment limits; cite minimal rupee impact

Seeking an Increase After Limits Reached

Two years after the Securities and Exchange Board of India (Sebi) placed restrictions on foreign investments due to concerns about exceeding the industry-wide limit of $7 billion, MFs are lobbying for an increase. Fund houses have approached the Reserve Bank of India (RBI) in recent weeks, proposing solutions like linking the limit to the country’s foreign exchange reserves to avoid manual revisions.

RBI’s Cautious Stance

The central bank remains cautious due to past episodes of pressure on the rupee, particularly during the 2022 Russia-Ukraine crisis. Governor Shaktikanta Das has emphasized that the decision will hinge on achieving long-term rupee stability.

MFs Downplay Impact on Rupee

MF officials argue that opening up the MF route for international investment won’t significantly impact the rupee. They highlight that other channels for foreign remittance already exist, and the investor base for overseas MF products remains relatively small.

“Money is already flowing out for various reasons like tourism or education. Opening up the MF investment option shouldn’t be an issue,” stated a senior MF official.

Portfolio Diversification Tool, Despite Challenges

While investments in foreign stocks via MFs haven’t seen widespread adoption, they are still considered crucial for portfolio diversification. As of March 2023, the value of overseas investments by domestic fund houses stood at $5.6 billion, reflecting a 13.5% decline from the previous year. This decrease is attributed to both a lack of fresh inflows and a correction in foreign markets, particularly the US.

Dampened Growth and Tax Hurdles

The restrictions on foreign equity investments dampened the growth of the Funds of Funds (FoFs) category, which had witnessed a near-doubling between March 2020 and March 2022. Additionally, changes in the taxation of non-equity MF schemes in the 2023 Budget have reduced the attractiveness of international funds.

Investor Outflows and Uncertain US Market

Overseas funds have experienced consistent outflows in the current financial year, with investors pulling out a net of Rs 2,700 crore between April and December. These outflows are primarily attributed to profit booking, creating room for fresh inflows.

Table: Investor Retreat (Month/Year & Net Inflows in Rs Crore)

While US markets delivered strong returns in 2023, concerns about a potential recession in 2024 linger. Global fund managers anticipate a significant slowdown in the US economy, highlighting the disconnect between current market expectations and potential economic realities.

Conclusion

The debate surrounding higher overseas investment limits for MFs reflects a balancing act between promoting investor diversification and safeguarding the rupee’s stability. While MFs present arguments for minimal impact, the final decision by the RBI will likely be based on its assessment of potential risks and prevailing market conditions, considering data like historical investment levels, investor behaviour, and global economic forecasts.

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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.