FEMA TWEAKING – MADE IN INDIA YET NOT INDIAN

The markets are down? Not to worry – either the FM will throw ‘hints’ about another reforms package coming your way or ‘sources’ will leak information about tax sops. And God forbid if the FIIs are unhappy and there is even an inkling of them offloading!

As many say, the Govt has its one ear to the ground on Dalal Street – anything which perturbs the market, especially the FIIs, the Govt will rush to the rescue. So when it comes to the market, the Govt is the doting grandfather, who cannot see even a frown on his precious granddaughters face; he will do anything to always keep the child, even if spoilt rotten, very happy.

Today the market began the day on a somber note and started on its southwards journey but soon there was some recouping after market read reports of FM ‘hinting’ about giving a big boost to the realty sector and was working with RBI on resolving the issues faced by the sector. Just this much; nothing more, nothing less. That was enough the Nifty realty sector was trading over 2.5% higher with all 8 stocks in the green.

And then the real clincher – there is news that there might be a rethink and relook at the new FEMA laws which RBI imposed on mutual funds. This presents the biggest threat of FII flight.

In the middle of October, RBI quietly issued a circular wherein it said that Asset Management Companies (AMCs) which have a majority stake held by a foreign company, will come automatically under the ‘indirect foreign investment’ category. This in turn means that these AMCs will come under the ‘FII limit’  or ‘cap’ which currently applies to the various listed companies.

Currently, there are only two listed AMCs - Standard Life Investments holds a 29.94% stake in HDFC AMC and in Reliance Nippon AMC, it is Nippon which has a 75% stake. So the rules of Foreign Exchange Management Act (FEMA) will apply in Reliance Nippon but HDFC AMC is a little bit dicey – the foreign partner holds just 29.94% and the parent, HDFC holds 52.76% but HDFC itself is owned mainly by FPIs, whose collective hold in HDFC is at 72.52%. So will this rule apply to HDFC AMC or no?

But more than the listed entities alone, there are many mutual funds where foreign companies do have a majority stake and through their mutual funds, they hold large stakes in listed entities, which most certainly would have surpassed ‘limits’ as till date there was no limit at all. ICICI Prudential, Nippon India, Franklin Templeton, Mirae Asset, Invesco and BNP Paribas are among the fund houses that could be affected the most by the circular.

There is fear this rule will lead to widespread selling by FIIs as this new FEMA rule will mean foreign owned mutual funds will be forced to either sell their stake or buy into large companies. If and when the rule kicks in, before that, there is fear that there could be a big selling spree by these mutual funds in order to adhere to the amended limit. The first reporting under the amended FEMA guidelines is to be done by the mid-Nov.

RBI brought in this rule as it believes that AMCs owned by foreign companies violate FEMA rules as their holding in Indian companies if beyond the cap, constitutes indirect foreign holding. So if an FII holds stake in an Indian company directly to the stipulated limit of 24% but holds more through his mutual fund then it is a violation of FEMA rules. Once this rule kicks in, the FII will either have to trim his direct stake or sell through the mutual fund. But sell is the underlying worry here.

Those in the market say this is really dumbfounding – on one hand the Govt is going all out to bring in more FDI and then this rule, where money for the domestic fund is collected from domestic investors but because it is owned by a foreign company, it will get treated like an FPI. In an FPI, the investment money and the owner, both are foreign but why restrictions on money which has come from Indians in India?

The mutual funds say that this rule puts them at a huge disadvantage when compared with the domestic funds. By putting a limit on how much they can invest, RBI is putting an anchor on the returns while domestic funds will have no such limits. Further the various compliance needs which are required by FPIs will make investment procedure itself very cumbersome for these mutual funds.

The Association of Mutual Funds in India (Amfi), an industry body, has taken up the issue with Sebi on behalf of these fund houses while mutual funds themselves too are making individual representations to the Department of Economic Affairs and the RBI.

RBI is treating this like a manufacturing unit - a company, which makes in India, uses Indian work force and raw material and sold for Indians, yet it is treated as 'foreign' because majority stake in the company is held by a foreign partner. FEMA rules apply to such 'foreign' manufacturing/services companies. Is the same yardstick extended to the mutual funds too?

Lets see where this goes…..