India's Restrictions on Global Mutual Funds: Explained

Indian investors seeking global portfolio diversification are currently facing significant constraints due to regulatory caps on overseas investments. The Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) have implemented industry-wide limits that have effectively paused fresh inflows into most international mutual funds.

This guide provides a comprehensive analysis of the current restrictions, the rationale behind them, and the strategic alternatives available to investors.

Understanding the Regulatory Caps

The core of the issue lies in three specific limits imposed on the mutual fund industry:

1. Industry-Wide Limit: A cap of USD 7 billion on the total amount that Indian mutual funds can invest in overseas securities.
2. ETF-Specific Limit: A separate cap of USD 1 billion for investments in international Exchange-Traded Funds (ETFs).
3. AMC-Specific Limit: An individual cap of USD 1 billion for each Asset Management Company (AMC) on their total overseas investments.

Currently, the industry has reached the ceiling for both the USD 7 billion and USD 1 billion limits, leading to the suspension of new investments.

Key Regulatory Changes: Timeline

• January 2022: SEBI restricted mutual funds from accepting new investments in international funds (except those investing in overseas ETFs) as the industry breached the USD 7 billion limit.
• February 2024: Funds like Nippon India US Equity Opportunities, Nippon India Japan Equity, Nippon India Taiwan Equity, and Nippon India ETF Hang Seng BeES stopped accepting new investments, though existing Systematic Investment Plans (SIPs) and Systematic Transfer Plans (STPs) were allowed to continue.
• April 1, 2024: The USD 1 billion cap for overseas ETFs was reached, leading to a complete ban on fresh inflows into these funds as well.

Currently, no new lump-sum investments or SIPs are permitted in most overseas equity schemes or ETFs unless redemptions (investors withdrawing their money) create room within these caps.

Why These Restrictions on International Mutual Funds?

The primary reason behind these caps is to protect India’s foreign exchange reserves and maintain macroeconomic stability. Here’s a closer look at the rationale:

1. Preventing Rupee Depreciation: When Indian mutual funds invest in US stocks, they must convert large amounts of Rupees into US dollars. This sudden demand can weaken the Rupee, making imports like fuel, iPhones, or foreign travel more expensive. To avoid such pressure on the currency, regulators have capped how much can be invested abroad.
2. Managing Forex Volatility: Despite India’s robust forex reserves of over USD 700 billion, regulators remain cautious. Global uncertainties, such as geopolitical tensions or rising US interest rates, can affect the rupee. The caps act as a safeguard to prevent excessive capital outflows.
3. Controlling Pooled Investments: While individuals can remit up to USD 250,000 annually under the Liberalised Remittance Scheme (LRS), mutual funds pool investments from lakhs of investors, creating significant demand for foreign currency. For instance, the Motilal Oswal Nasdaq 100 FoF, with an AUM of Rs 5,041.5 crore, alone accounts for a substantial portion of the overseas investment cap.

However, critics argue that these restrictions limit investor choice and hinder portfolio diversification. For someone like Anjali, a Bengaluru-based IT professional who wants to invest in global tech giants, these caps mean fewer options to spread her risk across international markets. Some analysts also suggest that with India’s strong economic fundamentals, SEBI and RBI could consider gradually relaxing these limits.

Which Funds Are Affected?

Around 70 schemes in India focus on overseas investing, but their ability to accept new investments is constrained by industry-wide limits. Here is the current status of some notable funds:

• Motilal Oswal Nasdaq 100 FoF: As the largest international fund with an AUM of approximately Rs 5,041.5 crore, it has suspended new lump-sum investments. However, it remains open for Systematic Investment Plans (SIPs).
• Franklin India Feeder-Franklin US Opportunities Fund (Growth): This fund is officially open, but new investments (both SIP and lump-sum) are subject to the availability of headroom within the regulatory cap.
• Edelweiss US Technology Equity FoF (Growth): Similar to the Franklin fund, it is open for new SIPs, offering exposure to US tech giants, but this is contingent on available investment limits.
• Nippon India US Equity Opportunities: This fund stopped accepting new investments in February 2024, and its status remains restricted.

For investors with existing SIPs in these funds, continuation depends on whether the fund house has “headroom” under its USD 1 billion AMC-specific cap.

Alternatives for Indian Investors

While direct investment in international mutual funds is paused, investors have several effective alternatives to gain global market exposure:

1. Invest in Multinational Company (MNC) Funds: This is an excellent way to get indirect global exposure. These funds invest in the Indian-listed subsidiaries of global giants.
   1. Example: A fund like the ICICI Prudential MNC Fund invests in companies such as Nestlé India or Maruti Suzuki. When you invest in them, you benefit from the global brand recognition, technology, and governance of their parent companies, without sending money overseas.
2. Use the Liberalised Remittance Scheme (LRS): This is the most direct route for global investing. Under LRS, an individual can remit up to USD 250,000 per financial year abroad to invest in foreign stocks, ETFs, or other securities.
   1. Example: An investor can open an account with a brokerage like INDmoney that offers the option to invest in US stocks, and directly buy shares of companies such as Apple, Tesla, or Google on US stock exchanges. This route provides full control but also demands more research and active involvement.
3. Wait for the Investment Headroom to Open Up: The investment limits are dynamic. When existing investors redeem (sell) their units, it frees up capacity.
   1. Action: Investors should keep a close watch on updates from AMCs. A fund might temporarily reopen for new SIPs or lump-sum investments when enough headroom becomes available.

Taxation on International Mutual Funds

Investing in international mutual funds comes with specific tax implications:

• Short-Term Capital Gains (STCG): If held for less than 24 months, taxed at your slab rate.
• Long-Term Capital Gains (LTCG): If held for 24 months or more (non-specified mutual funds), taxed at 12.5% without indexation.
• Specified Mutual Funds: Always taxed at slab rate, regardless of holding period.
• Dividends: Taxed at slab rate with a 10% TDS (if above Rs 5,000) and eligible for Foreign Tax Credit (FTC).

For example, if Priya from Pune earns a long-term capital gain of Rs 1 lakh from the Edelweiss Greater China Equity Offshore Fund after two years, she’ll pay a flat 12.5% tax (Rs 12,500). However, if she redeems within a year, her gains will be taxed at her income tax slab rate, which could be higher.

What Does This Mean for You?

For Indian investors, these restrictions can feel like a roadblock to global diversification. If you want to invest in US tech giants or European markets, you might find your options limited. The caps could also lead to premiums in ETF prices, making them less cost-effective. However, funds like the SBI Magnum Global Fund or ICICI Prudential MNC Fund can offer indirect exposure to global companies while staying within India’s regulatory framework.

The Road Ahead

These limits are meant to protect India’s foreign exchange reserves, but they’ve also raised questions about how to balance investor freedom with the country’s economic stability. As India’s economy grows, there’s a chance that SEBI and RBI may ease these restrictions in the future. Until then, staying informed and looking at other ways to invest globally can still help you reach your goals.

What You Can Do:

• Check with your fund house to see if there’s space available to start or continue SIPs in international funds like Motilal Oswal Nasdaq 100 FoF.
• Look at MNC funds that invest in Indian arms of global companies, a good way to get some international exposure.
• Talk to a financial advisor about options like the Liberalised Remittance Scheme (LRS), which lets you invest directly abroad.

Disclaimer
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