SEBI does well to ease FII norms. But guiding portfolio investment on to the right track will require more
The SEBI board has substantially endorsed one big idea of the U.K. Sinha Working Group on Foreign Investment (2010): to replace a bunch of classes of foreign investors with a single category. There should just be one main mechanism through which foreign capital comes into India. This is an important step towards reducing red tape. It is also the first piece of reform of the capital account in many years.
Indias engagement with financial globalisation was designed in the early 1990s in an environment of great fear and inadequate understanding. An elaborate set of restrictions was put in place. With the benefit of hindsight,we know that the Indian bureaucrats instinct in favour of rules,procedures,restrictions and categories delivered a mess. India has become famous as a delight for lawyers,as one of the most unfriendly emerging markets for a global investor to operate in. There are three main problems in Indias portfolio investment: the procedural constraints,the quantitative restrictions on the bond market and the tax treatment.
The SEBI has taken a step in the right direction,but more is required to put portfolio investment in India on the right track. The first requirement is to get away from the Indian obsession with KYC,towards our treaty requirements under the Financial Action Task Force,which require a principles-based customer due diligence. The SEBI boards decisions continue to micro-manage KYC,which is the wrong strategy. The second step is to get rid of the foreign venture capital investment,and merge it into the single mechanism. The third measure is to get rid of the quantitative restrictions on the bond market,to make foreign investment in rupee denominated bonds exactly like foreign investment in equities. The fourth requirement is to shift our tax treatment from source-based taxation (where we think that non-resident activity in India is our tax base) to a residence-based framework (where all countries get the Mauritius treatment,where the Indian authorities treat the global activities of all Indian residents as their tax base). India depends on foreign investors to fund the current account deficit with capital inflows of Rs 2,000 crore every working day. In an environment of global monetary tightening,there is no time to lose in moving forward with these four steps.