EXCLUSIVE: Has RBI Allowed Backdoor Convertibility with a Limit?
Investor Interest Exclusive

In an astonishing development, even as the Indian rupee is in trouble, the Reserve Bank of India (RBI), on 22 August 2022, issued a circular ostensibly to permit overseas investment by persons resident in India, in order to "enhance the scale and scope of business operations of Indian entrepreneurs by providing global opportunities for growth." The guideline is available here.

In a nutshell, RBI has permitted capital convertibility with an overall limit of US$1bn (billion) at a time when the government is trying to raise non-resident Indian (NRI) deposits because the rupee is under pressure.

Shorn of jargon, RBI's new outbound investment regulations seem to allow any Indian entity that is not engaged in financial services and has a three-year profit track record to invest anywhere in the world for financial services without any permission from the central banker.  

The limit for such investment is four times the net worth of the entity, thus opening a virtually unlimited window for any company in India—even unlisted ones—to set up global investment entities in foreign jurisdictions, says a person familiar with the developments, who does not want to be quoted. He points out that companies wanting to send money abroad can easily increase net worth at will through equity injection.

Ernst & Young on its website says the new rules have been issued by the government of India in consultation with RBI and the circular issued on 22nd August, in effect, supersedes the earlier master directions on direct investment by resident Indians in joint ventures and wholly-owned subsidiaries abroad.

The big question is: Was this really intended? If yes, why was such a bombshell announcement quietly introduced as a circular? Or has the central bank quietly opened a temporary window to permit some entities to invest abroad and it will quickly be shut down?

We have not received any clarification from the central bank. Senior RBI officials, now retired, are also perplexed at the circular and its timing.

This suggests that the very detailed circular is not a mistake, nor has it been issued with full deliberation at a time of global uncertainly when there is the pressure of India's foreign exchange reserves which comprise a big chunk of borrowings.

However, in the past week, leading wealth, law and advisory firms are actively reaching out to high net worth groups and clients asking them to use this opportunity to take out as much capital as they can as these provisions may be inadvertent and clients should use the provisions before RBI closes this window.

One such webinar conducted by IIFL Wealth is available on YouTube.

When I reached out to one of the experts who has conducted some of the webinars to ask if the circular appears to be a mistake or a loophole, he said: "I can't comment or say it is a loophole. The government has put built in safeguard by prescribing an overall ceiling of outflow from the country."

Specific Provisions:
The operative change on page 5 of the circular now defines "Overseas Direct Investment (ODI)" to mean
(i)    acquisition of any unlisted equity capital or subscription as a part of the Memorandum of Association of a foreign entity, or
(ii)    investment in 10% or more of the paid-up equity capital of a listed foreign entity, or
(iii) investment with control where investment is less than 10% of the paid-up equity capital of a listed foreign entity.

It explains: Once an investment in a foreign entity is classified as ODI, the investment shall continue to be treated as ODI even if such investment falls below 10% of the paid-up equity capital or the investor loses control in the foreign entity.

Further, it defines "Overseas Portfolio Investment (OPI)" as investment, other than ODI, in foreign securities, but clarifies that OPI shall not be made in
i. any unlisted debt instruments; or
ii. any security which is issued by a person resident in India who is not in an IFSC; or
iii. any derivatives unless otherwise permitted by Reserve Bank; or
iv. any commodities, including Bullion Depository Receipts (BDRs).

However, point d) says, an unlisted Indian entity may make OPI in accordance with schedule II of the OI Rules; and f) says—resident individuals may make OPI within the overall limit for liberalised remittance scheme (LRS) in terms of schedule III of the OI Rules.

Hemant K Chitale
2 years ago
Round-Tripping ?
2 years ago
2 years ago
I am equally shocked over this unequivocal intervention. Some black money will take this route with the help of obliging auditor that would increase networth of intending firms four fold.
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