Strong Rupee May Help Ease India Outbound Investment Rules

(Bloomberg) -- A surging rupee, rising currency reserves and a comfortable current-account gap could see India's central bank consider relaxing rules on outward investments, paving the way for domestic companies to step up their shopping abroad, especially in Latin America and Africa.

An uptick in overseas acquisitions would help keep a lid on the rupee, which is among the top performers this year. While the strengthening currency is helping the central bank keep inflation in check, additional gains are threatening to snuff out a nascent recovery in exports.

Analysts like Santosh Pai, a New Delhi-based legal expert on foreign exchange rules, say any easing will be a gradual process, especially at a time when China, with which India wants to compete in the global arena, is putting restrictions on capital outflows as it tries to check declines in its own currency reserves. 

One option is to raise the limit on outward investments -- currently capped at 400 percent of a company's net worth -- however this may have to be done on a case-by-case basis, he said.

Since India opened up its economy in 1991, it has been trying to attract a bigger share of foreign direct investments to make up for chronic shortages of domestic capital. 

In the past few years, backed by robust growth and healthy balance sheets Indian companies like Tata Steel Ltd., Tata Motors Ltd. and Bharti Airtel Ltd. have shown an increased appetite to snap up overseas operations as they seek to achieve bigger economies of scale, acquire better technology and display their global ambitions.

"There is a case to allow more outward investments," said Radhika Rao, Singapore-based economist at DBS Bank. "There are gaps as a country cannot produce everything. Those gaps can be filled and Indian companies can always look at Latin America and Africa to acquire assets. But I think it will be a calibrated approach since there is always the risk of capital flight."

Central bank spokeswoman, Alpana Killawala, didn't respond to emails or phone calls seeking comment. Last week, the Reserve Bank of India proposed new foreign exchange rules to govern cross- border mergers and acquisitions. Solicitors Argus Partners said in a note that the draft rules are likely to make cross-border mergers less cumbersome and more transparent.

"There are several issues which are required to be ironed out and clarified before such transactions can be implemented,” Argus Partners said.

While India allows the rupee to be exchanged freely for trade-related purposes, it imposes restrictions on capital flows. In 2013, the central bank established stricter capital controls to stabilize a sliding rupee after foreign funds started pulling out of the country in the wake of speculation over when the Federal Reserve would taper its massive bond buying program.

The environment has changed since then. Asia's third-largest economy has been growing at a robust pace, foreign exchange reserves are rising and are enough to cover nearly a year of imports. The country is also attracting sufficient foreign direct investments to plug deficits on the external account.

Global Arena

The Reserve Bank of India has relaxed norms for foreign investment by Indian companies in the past few years. It raised the cap that an Indian entity can buy in an overseas firm to 400 percent of the local company's net worth, from 100 percent.

According to India Brand Equity Foundation, a trust run by India's Department of Commerce, Indian firms invest in foreign countries mainly through mergers and acquisitions. Earlier, most of the investments were directed to resource rich countries such as Australia, United Arab Emirates and Sudan, but lately they've been channeled into countries providing higher tax benefits such as Mauritius, Singapore and British Virgin Islands.

"Investment outlook in some of the overseas market looks positive," IBEF said in a note released last week. "For instance, the Indian industry is projected to increase its revenue from Africa. IT services, infrastructure, agriculture, pharmaceuticals and consumer goods are vital to India boosting Africa revenues to $160 billion by 2025," the report said, citing Mckinsey and Co Inc., a consultancy firm.

Gradual Approach

Analysts caution against a simplistic approach in relaxing rules, especially at a time when the western world is becoming more protectionist. RBI Governor Urjit Patel has warned against trade barriers while some senior officials have told Indian companies that these protectionist policies would pose challenges to their investments.

"A clear policy that is in the national interest must be formulated," said Pai, a partner in Link Legal India Law Services. "National interests and commercial opportunities must be aligned to generate the highest rate of return," he said, adding that China's recent experience offered a lesson.

China has clamped down on outward investments, but not before local companies snapped up significant assets around the world in the past few years.

"China's forex reserves are several times larger than India's and so are its export earnings -- so there is a lesson here for India," said Pai.

To contact the reporter on this story: Anirban Nag in Mumbai at anag8@bloomberg.net.

To contact the editors responsible for this story: Ruth Pollard at rpollard2@bloomberg.net, Jacqueline Thorpe