FPI Pullout: Foreign fund inflow into infrastructure turns negative

Foreign fund inflow into infrastructure turns negative

India is among the most preferred investment destinations within Asia due to its high growth potential. So far, foreign portfolio investor (FPI)/ foreign institutional investor (FII) participation has been consistent over the years. However, according to the Economic Survey 2016-17, net FPI investment during 2016 turned negative for the first time since the meltdown of 2008, reflecting an outflow from the Indian market (to the tune of Rs 230.79 billion). This was not an India-specific phenomenon as most emerging markets witnessed a pullout due to higher returns in advanced economies.

Current investment landscape

From 2012-13 to 2014-15, FPI equity investments in the country’s infrastructure sector increased consistently. FPI equity inflow peaked during 2014-15, when the new government took charge at the centre. Thereafter, however, “hot money” lost steam (including in the infrastructure sector) owing to factors such as tax uncertainty on capital gains, an impending rate cut by the US Federal Reserve, and general panic due to a slowdown in the Chinese economy.

The selling spree continued in 2016-17 (till December). During the quarter ended December 2016, there was a net outflow of FPIs, primarily due to the US election results, a strengthening of the US dollar and an increase in in-terest rates by the US Federal Reserve. Domestic factors that sparked the intense selling pressure in the capital market were the impact of the demonetisation drive, uncertainty over the impact of the goods and services tax, a slowdown in manufacturing, and laggard policy with respect to the minimum alternate tax on FIIs. However, according to market experts, the FPI pullout is an emerging-market phenomenon, and not exclusive to India.

Between 2012-13 and 2015-16, the highest inflow took place in the construction materials and ports and shipping sectors. In 2016-17 (till December), only the ports and shipping sector witnessed an FPI inflow, while there was an outflow in other sectors, with the highest being in telecom.

As far as the insurance sector is concerned, in 2011-12, its exposure to the infrastructure space stood at 6.7 per cent, increasing to only 8.1 per cent in 2015-16, despite being permitted a 15 per cent exposure level. According to the Insurance Regulatory and Development Authority (IRDA), investments by insurance companies in the sector grew at a compound annual growth rate (CAGR) of 18 per cent between 2011-12 and 2015-16. Of this, investments by life insurance companies grew at a CAGR of 17.6 per cent, while those by non-life insurers grew at 20.4 per cent during the same period. Insurance companies continue to be constrained by rating requirements and investment norms, which have inhibited them from investing in the infrastructure space.

Union Budget 2017-18

In a bid to attract FPI investments, it has been proposed to keep such investors including sovereign wealth funds, pension funds and central banks, out of the ambit of indirect transfer

provisions. The step is expected to correct the overall net outlow of FPI funds, including in infrastructure. Category I FPIs include foreign central banks, sovereign wealth funds and government agencies, while pension funds and insurance companies come under Category II FPIs.

Had these indirect transfer provisions been applied, profits made by the funds with underlying assets (including equity) in India would have been taxed and thus would have been subject to double taxation (as they are already liable to pay short-term capital gains tax and securities transaction tax on the gains earned on the transfer of Indian securities listed on the stock exchanges).

The budget also proposed measures to ease the business environment for FPIs by reducing paperwork. The move is expected to enhance operational flexibility and ease of access to Indian capital markets.

Other tax changes proposed in the budget that will impact FPIs include:

  • Concessional tax rate of 5 per cent on interest income extended to June 30, 2020.
  • Restrictions on long-term capital gains tax exemption on equity shares.
  • Conversion of preference shares into equity shares not to be regarded as a taxable transfer.
  • Capital gains from the sale of rupee-denominated bonds (masala bonds) outside India not taxable in India.

Stressed assets

Global investors are queuing up to acquire stressed assets or debt of cash-strapped companies in India. Canadian pension fund Caisse de Dépôt et Placement du Québec (CDPQ), along with the State General Reserve Fund (Oman) and the Kuwait Investment Authority, joined hands with Tata Power International Private Limited and ICICI Venture Fund Management Company Limited to launch a platform for buying out stressed power assets. Together, the global investors are infusing $650 million equity in the platform, which has an initial capital of $850 million. CDPQ has also entered into a long-term partnership with Edelweiss Financial Service Limited to invest around $750 million in stressed assets and specialised corporate credit in India till 2020.

Earlier, in March 2016, the Kotak Mahindra Group signed an agreement with the Canada Pension Plan Investment Board (CPPIB) to invest up to $525 million in stressed assets in the country’s banking and corporate sectors. The CPPIB will invest up to $450 million of the total amount. The two partners will invest in stressed asset sales by banks with the aim of restructuring and turning around companies in distress.


Overseas investment in the Indian market will depend on investor sentiment for emerging markets overall. Developed countries such as the US have resorted to protectionism, post the election results, and this is likely to hurt global trade. Moreover, the Indian economy is yet to recuperate from the short-term slowdown resulting from the recent demonetisation. In such a scenario, the capital market is not expected to witness a major turnaround, and, therefore, the first half of calendar year 2017 is expected to remain subdued in terms of foreign capital flows. The uncertainties are expected to reduce and reforms are likely to fructify in the second half of 2017. Policy measures have also resulted in a bullish outlook for the capital market in the coming years, especially due to mega programmes such as Make in India, reforms for the ease of doing business, the Digital India initiative, etc., thereby making India one of the more likely contenders for foreign funds.