RBI for only pure FDI in realty

Written by Sunny Verma | New Delhi | Updated: Feb 27 2012, 07:01am hrs
The Reserve Bank of India (RBI), which has taken a firm stand against allowing external commercial borrowings (ECBs) in the real estate sector, now wants to clamp down on overseas investments in the sector through instruments that carry a fixed or variable internal rate of return. The central bank seems to be clear on allowing only pure foreign direct investment (FDI) in real estate where not firms but only specified projects can accept these foreign funds.

In what could choke a crucial source of funding for the sector, the RBI has, in recent months, rejected investment proposals through the aforementioned instruments from foreign investors, including private equity firms, sources privy to the process told FE.

Despite a recent clarification from the commerce ministry, the RBI has maintained that such instruments were in the nature of an overseas loan and, hence, should be subjected to ECB rules.

Since ECB rules do not permit foreign investment in the real estate sector, this would close a crucial source of financing for real estate companies. The central bank is cautious of any overseas loan to the real estate sector as it has the potential to create a bubble. The RBI has always kept a relatively higher risk weight for the sector.

Excessive lending to subprime borrowers in the US housing sector was one of

the chief causes of the global economic meltdown, which, till date, continues to weigh on the performance of economies across the globe.

The commerce ministry last October reversed its earlier order that said only pure equity with no inbuilt options would be treated as FDI. This was done following opposition from industry players. But the RBI has been opposing any application of foreign equity investment in real estate firms that has an element of debt to it.

A Delhi-based securities lawyer said the central bank has rejected investment applications of his foreign clients on the ground that the instruments had an inbuilt option of repayment of a fixed or variable return. The RBI's emphasis is that only pure equity should flow into the real estate sector.

In other sectors where ECB is allowed, the RBI is approving foreign investment into such instruments, subject to the investors and the investee companies adhering to ECB rules, which specify the usage of such funds. The Reserve Bank used to allow foreign investment with options of variable return. Now, they have started rejecting those proposals as well, the lawyer said, who asked not to be named.

The RBI has in the past issued show-cause notices to foreign investors who put money into real estate companies' convertible debentures that carried an assurance of a fixed internal rate of return. Hedge fund DE Shaw's $400-million investment in DLF-controlled companies convertible preference shares which assured a fixed return of at least 27% at the time of exit is one such example.

Reeling under the burden of high-cost domestic debt, real estate companies are scouting for foreign investment. Real estate companies' combined debt has risen 36% so far this fiscal to about R1.2 lakh crore.