Foreign portfolio investors, popularly known as FIIs — those who buy stocks and bonds in India — have emerged as a dominant force since they were first allowed to invest here in September 1992.
The market for this class of investors was opened up a year after the 1991 economic crisis and, interestingly, midway through the work of a high-level committee on Balance of Payments, headed by Dr C Rangarajan, who was then a member of the Planning Commission. One of the inputs to the Committee — which was formalised later as a recommendation and made public in its 1993 Report — was on encouraging non-debt creating flows or, in other words, equity flows or direct investment in building factories or plants.
The government and the newly empowered capital markets regulator, Sebi, acted on the recommendation even before it was formalised. A month after the Sebi Act was notified in April 1992, G V Ramakrishna, its then Chairman, wrote to the Finance Minister, Dr Manmohan Singh, recommending that foreign institutional investors be allowed — and the rules were soon firmed up.
Ramakrishna recalled that these investors were initially uncomfortable with what they perceived as a cumbersome registration process, with the government keen to allow only well-regulated and reputed institutional investors. The government’s aim was to discourage hot money flows — prompting regulators Sebi and RBI to insist on track record, sound financials, competence, and supervision by their home regulators. The securities scam of 1992 had brought home the need to strengthen regulation of stock brokers and stock exchanges — and it did not help that the brokers were seen as a cosy club who, when told to register with the regulator in April 1992, went on strike.
Once the concerns of foreign portfolio investors were addressed, rules were issued in September 1992. FIIs were allowed to invest in all securities — in primary issues or public offerings by listed companies, as well as in the secondary market. They were initially allowed to invest up to 5 per cent individually — and, as a class of investors, up to a maximum of 24 per cent of a company’s issued capital. Progressively, in keeping with a gradualist approach to opening up, investment limits were raised for FIIs as more Indian firms started raising capital, and flows rose along with economic growth. The regulations that related to foreign portfolio investors came much later — in November 1995 — after the Sebi Act was amended.
By April 1997, the overall FII investment limit was raised to 30 per cent. (It is now 100 per cent, except in select sectors such as insurance.) Yet, the debt market was shut to them. As Governor of RBI (1992-1997), Rangarajan wrote to the Finance Ministry proposing that as the next stage in the process, these investors should be allowed to buy government bonds or securities. His rationale was that India’s debt markets lacked depth — and unless there were enough investors taking two-way bets or contrarian positions, the growth of the market would be stunted. A price discovery process would also come about only with the entry of more players, and it would do no good if the government securities market was populated by just state-owned banks and institutions.
This was well before the new private banks started functioning a little after 1994-95. The first note of caution came from mid-level officials in the Finance Ministry, who flagged the dangers of allowing debt inflows. An abrupt reversal of such flows could have an impact on the rupee — and given the experience of several countries, it would be preferable to keep debt investors away, they noted. Finance Secretary Montek Singh — known even then as a liberaliser — first agreed with the views of the RBI Governor, but ultimately deferred to the views of his officials.
The file containing the proposal was thus shelved — until a personal letter from the Governor to the then Finance Minister. P Chidambaram, who had by 1997, taken over as Finance Minister in the United Front government, marked it to his officials who, however, continued to labour the same point. What followed was classic, according to two people aware of the developments of that period.
After the meeting, the Minister wrote on the file that a “lot of mumbo jumbo was thrown around” during the discussions. However, the RBI Governor must be right, he apparently wrote, while directing his officials to issue a notification pronto — which was done in a day!
Debt securities were opened up for investment in 1997, with FIIs allowed to invest 100 per cent of their portfolios in debt securities with Sebi approval, to hedge their foreign exchange exposure. They were allowed to invest in dated government securities in April 1998 — with an initial limit of $ 1 billion, which was raised to $ 1.75 billion in 2004 — and, subsequently, in Indian corporate debt too. Today, FIIs can invest as much as $ 30 billion in government securities and $ 51 billion in corporate debt instruments such as commercial paper and bonds. Yet, years after those policy changes, the debate continues on the wisdom of allowing foreign flows into debt — or rather, on the extent to which they should be permitted.