Foreign Investors' Interest In India: Reasons Explained

India's stock markets have become the fourth largest in the world, overtaking Hong Kong's, as investors flock to a fast-growing alternative to China's floundering stock indexes. As the country heads for elections this year, India continues to attract foreign investors, who have a number of ways to invest in the country. Foreign investors can invest in India's listed companies through the foreign portfolio investment (FPI) route, and non-resident Indians can invest through the portfolio investment scheme. In addition, foreign investors can invest in Indian shares through offshore derivatives instruments or participatory notes. The ease of FDI rules in India has also contributed to the country's improved investment climate, with total FDI inflows in the last 24 years amounting to $1,013.4 billion.

Foreign Portfolio Investments

Foreign Portfolio Investment (FPI) is the route that foreign investors must take if they want to invest in shares of India's listed companies. Investors, whether individuals or firms, need to be registered with the country's markets regulator, the Securities and Exchange Board of India (SEBI), and adhere to its disclosure requirements.

There are no restrictions on investing in Indian companies via this route, but an FPI cannot hold more than 10% in a listed company. If an FPI invests more than 10% in any company, it is categorised as a foreign direct investment, for which there are restrictions in some sectors. All FPI investments must be in Indian rupees and dealt with through brokers. All FPI transactions are taxed at par with taxes applicable to domestic investors, including capital gains at 15% for short-term holdings of less than a year and 10% for long-term holdings.

SEBI has a hands-off approach to offshore funds' registrations but mandates custodian banks, through whom foreign money flows into India, to disclose details of the investors in these funds. Custodians are typically domestic banks or Indian branches of foreign banks. There are currently 17 custodian banks registered in India, including Citi Bank, Deutsche Bank, ICICI Bank, and HSBC.

Under India's anti-money-laundering rules, regulators also require details of any investor holding 10% or more of the assets of a fund. SEBI has also enhanced disclosure requirements for funds that have concentrated holdings in a single corporate group.

Non-Resident Investments

Non-resident Indians (NRIs) can invest in the Indian stock market through the portfolio investment scheme (PIS). Transactions are routed through a non-resident ordinary (NRO) savings account. The overall investment limit for NRIs and any person of Indian origin (PIO) in stocks is 10% of the company’s paid-up capital, with an individual investment cap of 5%.

NRIs cannot engage in intra-day trading, and must take delivery of shares and cannot trade derivatives.

Under the PIS, Foreign Institutional Investors (FIIs), NRIs, and PIOs are allowed to invest in the primary and secondary capital markets in India. FIIs/NRIs can acquire shares/debentures of Indian companies through the stock exchanges in India.

The ceiling for overall investment for FIIs is 24% of the paid-up capital of the Indian company and 10% for NRIs/PIOs. The limit is 20% of the paid-up capital in the case of public sector banks, including the State Bank of India.

The ceiling of 24% for FII investment can be raised up to the sectoral cap/statutory ceiling, subject to the approval of the board and the general body of the company passing a special resolution to that effect. The ceiling of 10% for NRIs/PIOs can be raised to 24% subject to the approval of the general body of the company passing a resolution to that effect.

The Reserve Bank of India monitors the ceilings on FII/NRI/PIO investments in Indian companies on a daily basis.

Offshore Derivatives

Foreign investors are increasingly turning to offshore derivatives as a means of gaining exposure to the Indian market. This is especially true for those who do not wish to go through the process of registering with the Securities and Exchange Board of India (SEBI). By investing in offshore derivatives or participatory notes (P-notes), foreign investors can access Indian shares without direct registration. P-notes are issued by foreign portfolio investments (FPIs) against securities held by the FPI in India.

Participatory notes have gained popularity due to their ability to obscure investors' positions when taking a short position in India, which would otherwise require upfront disclosures. The use of P-notes has come under scrutiny, particularly after the Hindenburg Report on Adani, which has led to concerns about the ultimate ownership of foreign funds.

In addition to P-notes, foreign investors also utilise other derivative instruments such as total return swaps (TRS) and offshore interest rate swaps (OIS). These derivatives allow investors to gain exposure to Indian debt, particularly ahead of its inclusion in global benchmark indexes like the JPMorgan emerging market debt index. By using offshore derivatives, investors can avoid the onerous investment regulations and taxes that direct investment in Indian debt entails.

The notional value of offshore derivatives on Indian debt has been increasing, according to data from SEBI, reaching 167.31 billion rupees in January 2024, up from 104.62 billion rupees in September 2023. This rise in offshore derivatives activity highlights the attractiveness of the Indian market for foreign investors, who are seeking alternative investment opportunities outside of the struggling Chinese market.

India's fast-growing economy

The FDI inflow in India has been steadily increasing, from $45.14 Bn in FY 2014-15 to $60.22 Bn in 2016-17, and reaching its highest-ever level of $84.83 Bn in FY 2021-22. The total FDI inflows for FY 2023-24 stand at $70.95 Bn, with Mauritius, Singapore, the USA, the Netherlands, and Japan being the top 5 countries for FDI equity inflows.

The top 5 sectors attracting the highest FDI equity inflow during FY 2023-24 are the services sector (including finance, banking, and insurance), computer software & hardware, trading, telecommunications, and the automobile industry. The top 5 states receiving the highest FDI equity inflow during the same period are Maharashtra, Karnataka, Gujarat, Delhi, and Tamil Nadu.

The Indian government has been working to improve the ease of doing business, and the country is now part of the top 100 clubs on the Ease of Doing Business (EoDB) rankings. The investment climate in India has improved significantly since the opening up of the economy in 1991, with relaxed FDI rules making it easier for foreign investors to enter the market.

With its large and growing market, talented workforce, and favourable economic policies, India offers a range of investment opportunities for foreign investors seeking to capitalize on the country's rapid economic growth.

Ease of Doing Business

India has become an increasingly attractive destination for foreign investors, with its stock markets becoming the fourth largest in the world. One of the key reasons for this is the ease of doing business in the country.

The investment climate in India has improved significantly since the liberalisation of the economy in 1991, with the country now ranking among the top 100 on the Ease of Doing Business (EoDB) index. This improvement can be largely attributed to the relaxation of rules governing foreign direct investment (FDI).

FDI inflows into India have increased consistently over the last decade, reaching a record high of $84.83 billion in the financial year 2021-22. The total FDI inflows into the country in the financial year 2023-24 are $70.95 billion, with the top 5 investing countries being Mauritius, Singapore, the USA, the Netherlands, and Japan.

The Indian government has implemented a range of policies to facilitate FDI, including the automatic route, which allows non-resident investors and Indian companies to invest without prior government approval. The government route, on the other hand, requires approval from the Government of India before investment.

The ease of doing business in India is further enhanced by the availability of Special Economic Zones (SEZs), which offer tax incentives and a streamlined regulatory framework for businesses operating within them. These zones have helped to attract FDI in sectors such as manufacturing, information technology, and biotechnology.

In conclusion, India's improved business environment, characterised by relaxed FDI rules and streamlined regulatory procedures, has played a pivotal role in attracting foreign investors to the country.

Frequently asked questions