Indian markets fell sharply on Monday after a set of fund managers raised fresh concerns over an April circular from the market regulator related to tighter rules on foreign funds ownership by entities of Indian origin, which they said could lead to massive dollar outflows from the economy.

The Securities and Exchange Board of India (SEBI) had in a circular on know-your-customer norms said a company majority owned by non-resident Indians (NRIs) or persons of Indian origin (PIOs) will not be allowed to invest as a foreign portfolio investor in the country. It has directed such funds to be closed or the ownership structure should be changed by December 31, 2018.

Markets plunged on Monday after a body of asset managers - Asset Manager's Roundtable of India said these restrictions will put $75 billion worth of foreign funds, that are managed by Indians, at stake of the total $450 billion of existing foreign portfolio investments.

The Indian rupee closed at 71.22 to the dollar after touching a record low of 71.25, while the 10-year benchmark bond yield rose to 8.00 per cent, highest since June 11. The broader NSE index ended 0.8 percent lower reversing gains in the final hour of trade.

“... from Dec. 31, 2018, the said $75 billion investment ... will be disqualified from investing into India and will have to be withdrawn and liquidated within a short time-frame, thereby, adversely affecting the Indian markets and the Indian currency,” the asset manager's body said in a letter to SEBI, seen by Reuters.

While SEBI did not have an immediate comment, bankers said the regulator came up with the rule to prevent money laundering by Indian investors who might be round-tripping their unaccounted cash via offshore funds. Round-tripping is when a local investor tries to reinvest his/her funds in a circular fashion through offshore routes to avoid tax or for money laundering.

“Since there is a tax benefit on foreign portfolio equity investments, some Indian investors try to route their unaccounted cash through foreign funds which is a kind of round-tripping of money,” said a senior banker at a foreign bank.

“However, SEBI should try to nab those who round-trip funds instead of issuing a blanket ban on all such funds.”