MF News: Should RBI consider raising overseas investment limits for mutual funds?

As of August 2, 2024, India’s foreign exchange reserves have reached an all-time high of $675 billion, a milestone highlighted by the Reserve Bank of India (RBI) in its latest monetary policy update. This significant achievement has sparked debates within the Indian mutual fund (MF) industry on whether the time is right for the Reserve Bank of India increase the current limits on foreign investment to mutual fundsThis article explores the possibility of the RBI reviewing these limits, considering the prevailing economic scenario and the potential advantages.

Current limits on foreign investments
Currently, the RBI imposes a cap on the amount that Indian mutual funds can invest in foreign securities, with an aggregate industry-wide cap of $7 billion and a $1 billion limit per fund manager. In addition, a separate $1 billion limit is set for investments in foreign exchange-traded funds (ETFs). These limits have been in place since 2008, and investment in international securities by Indian mutual funds was discontinued on February 1, 2022, when the $7 billion industry cap was reached.

Given India’s record-high foreign exchange reserves, there is a growing sentiment within the mutual fund industry that the RBI should review and possibly increase these limits.

Arguments for increasing the limits
The Indian mutual fund industry, which manages assets worth around Rs 64 trillion, currently holds around Rs 75,000 trillion in overseas equity investments. These investments include international funds of funds (FoFs), direct equities, international ETFs and domestic equity schemes. With the substantial increase in foreign exchange reserves, many believe that raising overseas investment limits is timely and necessary.

The stability of the Indian rupee in recent years further reinforces the need to expand these limits. By allowing more overseas investment, investors would gain more options to diversify their portfolios, which is especially valuable in mitigating risks during potential market downturns.

The increase in the limit would also respond to the growing demand for global diversification among Indian investors. As international markets present a variety of opportunities, higher investment limits would enable investors to better manage risks and take advantage of global economic growth.India’s strong macroeconomic position
India’s macroeconomic fundamentals are currently strong and are characterised by a low current account deficit (below 1% of GDP), strong foreign institutional investment inflows and a substantial cushion provided by foreign exchange reserves. These indicators suggest that the Indian economy is well positioned, which could justify a relaxation of existing restrictions on overseas investments. Moreover, recent changes in the budget have made international investments more attractive. Taxation of international funds of funds (FoF) has been revised to 12.5% ​​on long-term capital gains after 24 months, down from the highest marginal rate imposed the previous year. This adjustment has increased the attractiveness of international investments for Indian investors, further amplifying the demand for higher limits.

Weighing the risks and benefits
Although the reason for being of Increase foreign investment While imposing limits is imperative, it is essential to consider the associated risks. The Indian rupee has experienced pressure in the past and increased foreign investment could lead to capital outflows that could destabilise the currency. In addition, the global economic environment remains volatile, with geopolitical uncertainties and market fluctuations posing challenges to international investments.

So while raising investment limits could bring significant advantages, it also poses potential risks that need to be carefully assessed. The RBI is likely to consider these factors before making a decision, trying to balance the need for greater investment flexibility with the imperative to maintain economic stability.

Final Thought
With India’s foreign exchange reserves at a record high and the economy showing robust growth, the Reserve Bank of India has strong reasons to consider raising overseas investment limits for mutual funds. Such a move would offer investors greater opportunities for global diversification and risk management. However, any decision to raise such limits will require a nuanced assessment of the potential risks and the continued need for financial stability in the Indian economy.

As the mutual fund industry and investors await the RBI’s decision, the hope is that the current favourable economic conditions will lead to more significant investment opportunities in global markets, benefiting both the industry and the economy at large.

(Author Chakravarthy V. is Co-Founder & CEO of Prime Wealth Finserv. Opinions are his own)