Currently, domestic MFs can invest up to $7 billion in overseas stocks, and an additional $1 billion in ETFs. But what does this cap mean for investors?
Investing in assets abroad has always been a good way to diversify your portfolio. Since the early 2000s, Indian mutual funds (MFs) have been allowed to invest in overseas securities. And it’s an attractive opportunity: who wouldn’t want to own a piece of a bluechip tech stock listed on the NASDAQ, like Meta or Apple?
By design, mutual fund schemes are a tool to help investors diversify their portfolio. Investing across other countries is beneficial because it reduces country risk – ie, the impact of negative events like war, geopolitical tensions and domestic instability. But of course, as with all things investment and capital-outflow related, there are certain guardrails in place: limits on the amount of money that can be invested overseas.
Breaking down the limits on overseas investments
The RBI sets the overall limit on overseas investments, while market regulator SEBI sets the per fund house limit. The last overall limit was set in 2008 and has remained unchanged since: an overall limit of $7 billion, plus a $1 billion for foreign ETFs (exchange traded funds). The per fund house limit was increased at regular intervals by SEBI, from $300 million to $600 million to $1 billion which is the current limit.
But here’s the hiccup: when the industry-wide limit of $7 billion is breached, fund houses can’t invest anything further abroad, even if they haven’t breached their individual per fund house limits. Complicated? Not really. Frustrating? Perhaps. But our central bank and markets regulator take these measures for a reason.
Why the $7 billion cap?
How the RBI decided on the magic number of $7 billion as the limit is unclear, but why a limit was put in place could be because the RBI is known to be a conservative central bank and wants to keep things stable on home turf.
- Market volatility: The higher the exposure to global stocks, the greater the possibilities of global shocks hitting the domestic market.
- Rupee volatility: While the rupee is, at present, in a stable position, socio-economic and geopolitical factors can always shift the balance. By imposing capital controls in the form of a strict cap, the RBI can limit the free exchange of foreign currency and protect the rupee on the downside.
- Capital outflows: The RBI wants to avoid excess capital outflows to maintain financial stability and avoid a sudden depreciation in the rupee.
Timeline
→ The RBI set the $7 billion limit in 2007-08.
→ On February 1st 2022, investment in international securities was suspended, when the $7 billion industry cap was reached. This was also a time when the rupee was under pressure because of the Russia-Ukraine war and global interest rate hikes.
→ SEBI allowed mutual funds to resume subscriptions in June 2022, with a rider: the total foreign investment by the fund house would remain capped at the investment made as of 1 February 2022; any limit available due to redemptions over prior months, could be used by AMCs for fresh inflows.
→ As of 2024, the RBI still hasn’t increased the limit, despite calls from the MF industry. In January this year, former RBI Governor Shaktikanta Das stated that the central bank has not ruled out the possibility of an increase, but is waiting for the right time, based largely on the stability of the Indian rupee.
At the Mint Annual BFSI Awards, organised by financial paper HT Mint, the former governor said, “This request has been coming from the MF industry from time to time… We will take a call at the right time when we feel confident that the rupee is stable on a durable basis.”
What’s left for investors?
Simply put, investors are losing the option to invest abroad, and so are MF houses. With the US and Chinese markets as volatile as they are there could be an opportunity to invest abroad.
There are, however, other investment avenues like Liberalised Remittances Schemes (LRS).
Under the LRS, resident Indians can remit up to $250,000 per financial year towards purchase of foreign securities and funds in foreign currency. This limit is separate and doesn’t come under SEBI’s $7 billion cap on mutual funds.
AIFs or alternate investment funds are also an option, however their overseas investment cap has also been exhausted. AIFs are privately pooled investment vehicles for HNIs and UHNIs, the minimum investment amount starts much higher, at 1cr. Within AIFs, only Category III AIFs can invest in overseas securities, with the limit set at size instead of a number. With AIFs, the leverage of a Category III AIF shall not exceed 2 times the NAV of the fund.
So while the central bank and SEBI mull over when and how to increase the $7 billion cap for overseas MF investments, retail investors can either find other avenues (like the above) to get a slice of global securities, or play the wait and watch game.