The restriction on mutual fund investments further creates a troubling inequity. Affluent investors in India can use the LRS to access international markets. One must wonder whether wealth-building opportunities in India are exclusively reserved for the already privileged.
26 March 2025Indian Express
As the depreciation pressure on the rupee mounts, the RBI and the government have been turning up the heat on money outflows from India. Increasing regulatory interventions with respect to capital controls and heightened scrutiny of outward remittances demonstrate the policymakers’ anxiety about currency depreciation. A clear adverse fallout of these interventions is the continued imposition of industry-wide limits on Indian mutual funds investing in foreign stocks. It is unclear whether this limit has had any impact on the value of the rupee. This limit has, however, restricted the ability of Indian investors to diversify their portfolios by taking on exposure to assets around the world. Buying when assets are cheap, as they are given the global turmoil, is a great strategy for wealth accumulation, and a well-diversified portfolio is key to a healthy household balance sheet. The RBI and the government must stop inhibiting Indian residents from exploring the diversification potential of their portfolio.
The RBI has implemented a series of controls on who can invest outside India, for what purposes, in what kinds of instruments and on what terms and conditions. For retail investors, there are two routes. The Liberalised Remittance Scheme (LRS) allows Indian residents to annually remit up to $2,00,000 for any purpose. Investors can also invest indirectly through Indian mutual funds and exchange-traded funds (ETFs) with schemes dedicated to global stocks. The aggregate amount of investment that such mutual funds can make in foreign-listed securities was capped at $1 billion in 2002, which was progressively increased in the subsequent five years to $7 billion in 2009. The RBI then froze this limit together with a $1-billion limit for ETFs to prevent the destabilisation of capital outflows. The industry reached this limit in February 2022, and since then, Indian investors have not been able to make fresh investments in foreign assets. As the government moves towards implementing its deregulation objective in financial markets, it is useful to ask if this particular regulatory intervention passes the cost-benefit analysis test.
A common principle in life, as in finance, is to diversify one’s strategy. A portfolio should typically contain some mixture of risk-free and risky assets. Similarly, a portfolio is better diversified if it contains some mixture of domestic and international assets. The current thresholds prohibit this. According to a report by the investment bank UBS, the US market still makes up 61 per cent of the total world market. India makes up 2 per cent. Restricting Indian investors to this sliver of global capital markets is akin to locking up all their savings in the top two Indian companies. Since 1900, the US equity market has generated an annualised real return of 6.5 per cent, the highest common-currency return relative to the countries studied by the report. It is useful to point out that this is a “real return” and not a “nominal return”. Whether it was transformative companies like Google in the early 2000s or today’s artificial intelligence leaders, we were not able to participate in the gains.
Many people argue that retail Indian investors lack interest or sophistication to navigate international markets. The data indicates otherwise. Since 2002, when foreign investments were first allowed, Indian investors have demonstrated consistent interest and participation in international markets. This sustained demand clearly indicates that investors recognise the value of global diversification. In April 2020, the value of mutual fund investments in foreign companies was about $1 billion. This increased to about $7.7 billion by December 2021. Indian investors were not only interested but also navigated the difficult times around the Covid shock. Indian mutual funds have, in response to this demand, launched several international schemes offering diversification products to Indian investors.
The restriction on mutual fund investments further creates a troubling inequity. Affluent investors in India can use the LRS to access international markets. This requires one to engage a broker and set up international bank accounts, significantly increasing the transaction costs associated with this route, essentially leading to a situation where wealthy investors can diversify globally, at least up to a point, while average citizens remain confined to domestic markets. One must wonder whether wealth-building opportunities in India are exclusively reserved for the already privileged.
The primary justification for these restrictions is to stabilise the value of the Indian rupee by reducing outflows. This proposition must be examined more carefully. The current threshold for foreign investments by mutual funds represents a minuscule fraction of overall capital flows. While this exact proportion is hard to quantify, for some perspective, the FPI flows in India in the year 2022 were $18.7 billion, compared to the overall aggregate foreign investment limit of $7 billion for mutual funds since 2009. This magnitude may be too small to impact currency valuations. Even if these limits were removed, it remains highly improbable that mutual fund flows would reach volumes sufficient to disrupt currency markets.
The currency is influenced by much larger forces, including trade balances, foreign direct investment, and global macroeconomic trends. The RBI engages routinely in currency management, and these interventions have their own adverse consequences, including that of inflating the cost of Indian assets. If Indian assets continue to remain expensive, one must ask why Indian retail investors have to be penalised by being forced to pay this inflated price.
This article is co-authored with Bhargavi Zaveri-Shah
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