New dimension to MF inflows

In a Budget that appeared at first flush lacklustre and devoid of pyrotechnics, there was an important policy initiative which perhaps has enthused the share markets more than the absence of any fresh increase in indirect taxes — permission to foreign individuals to invest in stock markets through SEBI-registered and regulated mutual funds.

This is a tremendous decision, the one that could prove to be as seminal as that taken way back in 1991 to let foreign institutional investors (FIIs) to operate in the Indian stock markets. Prior to 1991, bourses were a close club dominated by brokers, company promoters and other sundry insiders. Foreign individuals pining to invest in India had to open a sub-account with one of the FIIs closer home or invest vicariously again through the opaque Participatory Notes (PNs). Now they can invest upfront but still not directly; they will have to subscribe to the units of mutual funds.

The government rightly apprehends that allowing unbridled direct entry to foreigners would militate against and fly in the face of its avowed faith in Know Your Customer (KYC) norms.

One does not know if foreign individuals would collectively be able to bring in as much funds as the FIIs or for that matter play the same kind of ‘mover and shaker' role in the bourses, but one suspects the role played by them collectively would be, by no means, small.

Herd mentality

FIIs, despite their much-touted research capabilities and deep pockets, suffer from herd mentality that belies the surface impression one gets of heterogeneity in their behaviour. They enter in droves and leave in droves what with their time horizons and objectives being almost similar. One suspects they are well networked and keep tabs on each other. Their legendary ability to vote with their feet and stomp out of companies belying their expectations has had a salutary effect on corporate governance standards in India by and large.

But on the flip side they have also been lending themselves as cat-paws for money laundering of black money stashed away abroad through the process of round-tripping whose cause has been considerably helped by the inscrutable PNs. Would foreign individuals prove to be different?

One hopes there are reasonable limits up to which a foreign individual can subscribe to units of mutual funds though this by itself is no guarantee that the scheme would not be abused. Didn't the doughty lady Roopalben Panchal corner sizeable number of shares of YES Bank meant for retail investors by opening upwards of 5,000 demat accounts in various fictitious names?

Calibrated loosening

But unlike FIIs, foreign individuals perhaps will not be able to cause huge upheavals on the bourses because theirs would not be a direct investment but through the medium of a mutual fund which may refuse to dance to the tunes of its dominant investors. There is, however, no stopping the foreign individuals from pressing for redemption that could trigger distress sale in turn by the mutual fund in the bourses.

While allowing foreign individuals to invest in Indian bourses through mutual funds is welcome as it is another instance of calibrated loosening of capital controls, one is apt to wonder whether the trigger for this paradigm change came from fatalism born of the depressing thought that when (foreign direct investment) FDI is shying away from India, why not latch on to whatever can be garnered by way of foreign capital.

It is common knowledge that India suffers from perennial current account deficit on the balance of payments front, thanks mainly to the huge oil import bill and lack of fresh initiatives on the export front and that it is bailed out by capital account surplus at the end of the day.

But if a sizeable part of a country's forex reserves is accounted for by hot money or money that is likely to leave sooner than later, it is indeed a cause for concern. It is on this touchstone that FDI is hailed as the most preferred source on capital account whereas we willy-nilly have to settle for external commercial borrowings (ECB) and FIIs. Foreign individuals could, to be sure, boost the capital inflow but like the FIIs, they are also likely to be fair-weather friends for which they cannot be blamed; they can exit quickly unless simultaneously we resort to some sort of Tobin tax.

Parenthetically, what adds to the gloom on the FDI front is the outbound FDI had for the first time overtaken the inbound FDI last year. The Government would do well to ponder why FDI shies away from India even while courting China which is not a respecter of human rights, much less of intellectual property rights.

(The author is a Delhi-based chartered accountant.)

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