Investing abroad via MFs: cap the investor, not the industry

A few days ago, at an event in New Delhi, I asked Reserve Bank of India Governor Sanjay Malhotra about a strange situation for Indians who want to invest abroad, who have two main routes.

One is Indian mutual funds that invest abroad. This route is simple because it works like any other mutual fund. You invest in rupees, can invest small amounts, run SIPs, and Sebi regulates it like domestic mutual funds. But this route has been largely blocked since 2022. All mutual funds together are limited to $7 billion in overseas investments, plus a separate $1 billion for foreign exchange-traded funds (ETFs). The RBI set this limit in April 2008, and it has not been raised since, despite the explosion in mutual fund investing. In 2008, the industry managed about ₹5 trillion. Today it manages more than ₹80 trillion.

The second route is through GIFT City, the Gujarat International Finance Tec-City, an 886-acre enclave near Ahmedabad that counts as offshore for financial transactions. Under the Liberalized Remittance Scheme (LRS), any Indian can send up to $250,000 a year abroad, including into dollar-denominated funds that some asset management companies (AMCs) have launched in GIFT City. This route has its own regulator and isn't bound by the $7 billion ceiling. A few months ago, I wrote approvingly about it, and I still think a large investor should understand it. But it is not a route for someone who wants to start a ₹5,000 SIP. The minimum is usually $5,000, the all-in cost of some feeder funds is close to 3%, and anything above ₹10 lakh a year attracts a 20% TCS (tax collected at source), which blocks your money even if it’s eventually credited back.

The business has gone there anyway. Fund houses have lined up to launch GIFT City funds for resident Indians: five opened by July, and more have since. The pooled cap did not stop money from leaving the country. It only decided who could take it out.

Tighter leash on overseas investments?

The governor said the RBI was monitoring investments through the GIFT City route. Then, disarmingly, he turned the question around and asked me what I thought should be done.

Meanwhile, the stakes have gone up. A business television channel has carried a ‘source-based’ report that the RBI has suggested to the government that investment remittances under LRS, which need no approval today, should each need RBI approval. If something like this happened, and the governor said the RBI was watching GIFT City flows, practically every route for investing abroad would be shut.

Here is my considered answer, thought through more thoroughly than a quick Q&A allows. The basic issue is that the well-regulated, cheaper, easier way to invest in the world is shut, while the costly, complex way that only the rich can use remains open.

Cap the investor, not the industry

First, the main route for investing abroad should work like any domestic mutual fund. If the worry is that money leaving the country must be watched, this is the cleaner solution, because every rupee goes through a Sebi-regulated fund house. And democratizing investing abroad means opening the mutual fund route, not rationing it to those with wealth to spare for an offshore account.

Second, and most importantly, the limit should be per person and annual, not a single pooled limit for the entire country. A modest per-person annual cap, say $10,000, would let the RBI defend reserves without shutting out small investors because big investors got to the pooled limit first. $10,000 a year is enough for a monthly SIP of over ₹70,000, far more than most small investors need. It would also control what leaves the country each year, which is what matters for the rupee. The pooled limit is a blunt instrument. Once it is full, it shuts the door on everyone.

A per-person limit may not have been practical in 2008, because tracking one investor’s foreign investing across fund houses would have been hard, if not impossible. Now, with PAN and Aadhaar linked to every investment account, that problem has gone. The industry’s registrars can already see each investor’s holdings across fund houses by PAN.

Some global diversification is an important part of a mutual fund portfolio. So, that would be my answer to the governor: cap the investor, not the industry. A modest annual limit per person would serve the regulatory purpose while also giving investors who need it most an easy route.

Dhirendra Kumar is founder and chief executive officer of Value Research, an independent investment advisory firm