Foreign investment rules

India is seeing a sharp rise in portfolio inflows as investors in slow-growing developed markets look for higher returns in buoyant Asia.

India is seeing a sharp rise in portfolio inflows as investors in slow-growing developed markets look for higher returns in buoyant Asia. The inflows have sent the rupee to a 25-month high against the dollar but finance minister Pranab Mukherjee has said further controls on capital inflows are not needed yet. There are restrictions on capital inflows,specially in the debt market,although capital is needed to offset a current account that hit a record deficit in April-June. However,analysts say that if the tide of hot money shows signs of destabilising the economy India may consider further controls to stem the flow.

The following are rules about the regulation of foreign investor access to the capital markets:

FOREIGN INVESTORS

FIIs must register with Sebi and then apply to RBI for permission to buy equities or other securities. Overseas retail investors have limited access to the securities markets.

FOREIGN EXCHANGE

Story continues below this ad

All spot deals against the rupee must be settled onshore. The onshore forward market can be used to hedge commercial transactions by foreign companies operating in India. Regular importers/exporters can hedge up to 100% of the past thee years imports/exports,or the previous years turnover,(whichever is less). There is a service tax of 12.36% on foreign exchange transactions at the time of settlement.

Investors can bet on the currency offshore through non-deliverable forwards and interest rate swaps.

FIXED INCOME

The only overseas investors permitted to buy Indian government and corporate debt are non-resident Indians and registered FIIs. Total FII investment is limited to a ceiling of $10 billion in government debt and $20 billion in corporate debt. Both ceilings were raised by $5 billion on Sept. 23. Foreign investors have to pay a 20% withholding tax on interest income,unless tax treaties with other countries say otherwise.

EQUITIES

Individual FIIs can not hold more than 10 percent of paid-up capital in a single stock and total foreign institutional investment in an individual stock can not exceed more than 24% of equity,unless the Indian company has passed a special resolution to say otherwise. Dividend income is subject to a 10% withholding tax. Short-term capital gains tax is imposed on the sale of stocks held for less than one year.

OFFSHORE DERIVATIVES

Story continues below this ad

Many foreign investors,particularly hedge funds,invest in India via offshore derivatives,rather than register as FIIs. The SEBI has strict disclosure mechanisms for institutions issuing these products,requiring them to provide details of the ultimate beneficiary client. In the past year,foreign banks Barclays and Societie Generale were banned from issuing these products for failing to make the appropriate disclosure. Barclays has since had its ban lifted.