Capital curbs feeding cynicism

Written by Sidharrth Shankar | Updated: Aug 23 2013, 08:01am hrs
Through a recent move that reeks of the pre-1991 era of capital controls, RBI has severely restricted the liberalised remittance scheme (LRS) window available to resident individuals to make investments in offshore assets. It has also announced reforms restricting avenues for overseas direct investments (ODI) by Indian companies. The purported rationale behind reintroducing capital controls on overseas investments is to curb outflow of foreign exchange with a view to cure the ailing rupee.

Prior to the recent amendments introduced by RBI (on the eve of the Independence Day), resident individuals had been permitted to make overseas investments of up to $200,000 per financial year under LRS, without any requirement of RBI approval. With the amendments, the limit on overseas remittance has now been significantly reduced to $75,000 per financial year. Acquisition of immovable property abroad, whether directly or indirectly, allowed under the erstwhile LRS regime, has also been disallowed under the revised prescription.

Notably, RBI has now allowed overseas remittance of funds within the revised LRS limit of $75,000 per year for purposes of setting up a joint venture/wholly-owned subsidiary abroad (JV/WOS), subject to the target company being an operating entity, with a clear restriction on the acquisition or setting up of a step down subsidiary by the JV/WOS. In 2010, RBI had clarified on its website that resident individuals could not use LRS to set up companies offshore. Additionally, through a rather innocuous tweak to the July 1, 2013, master circular on Miscellaneous Remittances from India, RBI had effectively closed the LRS window for resident individuals looking to acquire securities of unlisted offshore companies. Permitting overseas investments by resident individuals in foreign securities of a JV/WOS abroad is a welcome change on account of the growing uncertainty in the minds of the Indian investors seeking to utilise LRS for making investments in securities of offshore unlisted companies (portfolio investments in listed companies has always been permitted by RBI). However, the general reduction of investment limit under LRS will continue to act as a dampener on the opening of this investment option as well.

While resident individuals will need to contend with the new restrictions at the time of planning their exposure in overseas assets, on account of amendments made to the ODI regime (applicable to Indian companies), the ability of Indian companies to invest abroad has also been adversely and significantly impacted. Hitherto, an Indian company could invest in a JV/WOS abroad engaged in any bona fide business activity an amount up to 400% of the net worth of the company as on the date of the last audited balance sheet, in terms of the automatic route of RBI. As per the new amendments to the ODI regime, an Indian company will now only be able to make overseas direct investments under the automatic route for an amount of up to 100% of its net worth, a 75% reduction in the total limit! The revised ODI regime will now also be applicable to domestic companies setting up unincorporated entities overseas in the energy and natural resources sectors.

The change in ODI regime has been made prospective, but the language adopted by RBI is not self- explanatoryleading to ambiguity in interpretation. For instance, how a fresh infusion of funds in an already existing JV/WOS abroad would be treated, as far as the revised investment limits are concerned, remains unclear. Would such investments in existing JVs/WOSs be grandfathered under the erstwhile cap of 400% of the Indian companys net worth, or would such follow on investments also be subject to the 100% cap Interestingly, while defining the reduced investment limit, RBI has alluded to the term overseas direct investment rather than the term financial commitment. This too may have its own set of implications, as the extant ODI regulations define direct investment as a subset of financial commitmentwith the latter including not just equity and loan contributions but also guarantees issued by the Indian company and bank guarantee issued by a resident bank on behalf of the overseas JV or WOS of the Indian company, among others. Therefore, another question which begs an answer is, whether on account of RBI using the term overseas direct investment as against the term financial commitment, the revised investment cap of 100% of the net worth of the Indian company is to be applicable only to overseas investments in the form of equity and loan contributions, and not to financial commitments such as guarantees issued to or on behalf of the overseas JV/WOS

Only time will tell whether reintroducing capital controls on outflow of foreign exchange will have any serious positive effect on the sliding rupee. However, until that time comes, the recent measures introduced by RBI will certainly add to the already prevalent cynicism surrounding the state of the Indian economy.

Sidharrth Shankar is a partner and Vatsal Gaur is an associate with J Sagar Associates. Views are personal