Raise component for ETFs within cap, RBI

Reluctance by RBI to allow higher limits for overseas equity investments through mutual funds is seen more as a risk-mitigation exercise than an effort to stabilise the rupee. The $7 bn ceiling on mutual fund investments in stocks listed on foreign bourses, and a $1 bn cap on investments in exchange-traded funds (ETFs), is paltry when seen against the $250,000 allowed annually to individual Indians to invest in equities overseas, should they choose to. The evidence shows they do not choose to in any meaningful manner. Investment in individual stocks abroad is expensive, granted. But mutual funds, too, are not finding enough takers for their international exposure, except in ETFs. This mirrors stock market returns in mature markets where passive investing trumps stock picking. If a case is to be made for liberalisation, the first step should involve a higher component for ETFs within the existing cap for all mutual fund investments overseas before considering raising the overall ceiling, which remains unbreached.

Diversification offers a potent argument in favour of linking the overseas investment limit for mutual funds to foreign exchange reserves, if that is the primary concern of the central bank. That does not seem to be the case, given RBI has kept the ceiling intact during phases of depletion and addition to forex reserves. RBI’s inactivity would suggest a bigger worry over transmission of financial shock to small investors. Since Indian stock indices are delivering reasonable returns against the US and China, it would take some convincing for RBI to ease up on risk.

Indian investing behaviour would have to become more sophisticated for RBI to cede risk mitigation to the markets. Changing preference of demand for passive investment abroad may not be conclusive for a conservative regulator such as RBI. The Indian mutual fund industry may have to operate in the tighter framework of Indian regulation for a while before it can rely on a bigger dose of international diversification.