My article with this title appeared in the Dec 8 2012 issue of the Economic & Political Weekly as a commentary. It is reproduced below. The article has been quoted in the India blog of New York Times here
A considerable part of the discussion on economic policy in
is devoted to foreign investment in Indian equity and debt securities. The
reverse flow of capital from India
into foreign equity and debt, though equally important for this discussion, attracts
far less attention in the financial media and is the subject of this paper.
A rapid rise in the flow of Indian investments abroad was noted early on by Nagraj (2006). Nayyar (2008) extensively analysed investment by Indian firms in the context of international investment from developing countries using all available data. Both these studies used data up till 2006; since then,
’s investments abroad have grown
manifold as we will see later. India
More recently, Chalapati Rao and Dhar (2011) have examined direct investments from
in a critique of the policy regime governing cross-border direct investment
flows. They look at the sector wise composition of investments, derived from
recently available RBI data, as well as at individual cases to understand why
Indian business houses are investing abroad.
A major concern of this paper is with the official investment data. The RBI provides a confusing array of data sets relating to outward investments. This paper begins by looking for clues in RBI’s regulations and accounting practices to reconcile the different data sets. It goes on to uncover some of the key features of the outward investments and concludes by examining the shortcomings in the regulatory environment which allow the end use of investments to remain mostly opaque.
RBI’s accounting practices
The Reserve Bank of India (RBI) regulates cross-border investment in securities and is the primary repository of data on investment by Indian entities abroad. Following International Monetary Fund standards, RBI presents Indian investment abroad involving equity and debt securities (other than those held by the RBI as reserve assets) under two heads - ‘direct investment’ and ‘portfolio investment’ (RBI, 2010).
While ‘direct investment’, carries the usual connotation of being investment made with the objective of obtaining a “lasting interest and control” in a foreign enterprise, the key characteristic of ‘portfolio investment’ is considered its “negotiability”, facilitating ready withdrawal of investment by the investor.
RBI regulations permit various Indian entities including companies, mutual funds, and individuals to invest in equity and debt of foreign entities. Each entity has multiple avenues for making overseas investments. Companies can set up or acquire Joint Ventures (JV) or Wholly Owned Subsidiaries (WOS) abroad and invest in them. They can also invest in the securities of unrelated foreign companies (neither JV nor WOS). Individuals can invest in the equity of companies directly as well acquire a portfolio through the medium of mutual funds. The question under consideration is how RBI categorizes different investors and the different avenues of investment abroad as ‘direct’ or ‘portfolio’ investment.
The RBI Balance of Payments Manual (RBI 2010) documents “current practices” in compiling Balance of Payments statistics. According to the manual, the main component of ‘direct investment’ is the investment by Indian entities in equity and debt of JV companies or WOS. Another component is the investment by banks in their branches abroad. Investments by mutual funds and investment by Indian companies in equity and debt securities of unrelated foreign companies is considered ‘portfolio investment’. The manual is formally silent about the treatment of investments by individuals in foreign securities, but there are hints that these are being included in ‘direct investment’ instead of ‘portfolio investment’ where they should belong.
However, what has been described above is only “current practice”. Going back in time, reveals other practices. Companies were permitted to invest directly in non-related foreign entities that had a minimum of 10% holding in a listed Indian company, from Jan 2003; such investments were opened up to Mutual funds and even individual investors and all these investments were considered ‘direct investments’. The condition restricting this form of investment to companies with 10% Indian holding was dropped, first for mutual funds in July 2006 and then for companies in Sept 2007. However, Foreign Exchange Management Regulation of Dec 2007 still called such investments ‘direct investment’.
RBI documentation down to the present continues to shirk from providing sharp distinctions between ‘portfolio investment’ and ‘direct investment’, an indication that there have been no strong reasons from a policy perspective for RBI to distinguish between the two.
With this background, we proceed to look at the different data sets from RBI on investments abroad.
The disinterest in portfolio investment
Cross-border investments are available in two periodic statements of the RBI – the Balance of Payments (BOP) and the International Investment Position (InIP). The BOP statement reveals the movement of capital over a period while the InIP statement shows the stock of international financial assets and liabilities, held as direct and portfolio investment, at the end of a period.
Table 1 contains select data from InIP statements showing the stock of
‘direct investment’ and ‘portfolio investment’ abroad. India’s
investment abroad is overwhelmingly in the form of direct investment and is
growing rapidly. The remainder of this paper will be confined to a discussion
of direct investment.
Cross-border flows of direct investment
Table 2 shows the net yearly flow of direct investments out of and into
(columns A and D respectively). Heightened
flows are observed in both directions from 2006-07. Data from the table shows
that net Indian direct investment abroad in the last six years is just over 50%
of the net FDI that has come into India. Interestingly, the percentage is the
same if the comparison is extended to the last decade.
A closer look at the components of direct investment provides additional insights. Following IMF standards, direct investment flows reported by RBI include flows into equity and debt as well as reinvested earnings. Columns B and E in Table 2 show the reinvested earnings of Indian investment abroad and FDI in India respectively. While the reinvested earnings of foreign capital show a steady increase over the years, the reinvested earnings of Indian capital abroad have remained constant from 2005-06 in a period when the stock of investment increased over 10 times (see Table 1). RBI figures of reinvested earnings of Indian companies seem doubtful.
A useful comparison between direct investment flowing abroad and FDI flowing into India is from the point of view of how they affect the balance of payments. In such a comparison, reinvested earnings must be excluded from the flows as they do not affect the balance of payments. Figure 1 shows the yearly flow of Indian direct investments abroad and FDI in India after excluding reinvested earnings in both cases.
Intriguingly, as the figure shows, outflows have moved more or less in tandem with FDI inflows between 2002-03 and 2009-10. Net annual outflows rose sharply between 2004-05 and 2006-07 to plateau at higher levels, with the exception of a sharp dip in 2011-12. In 2010-11, from a balance of payments perspective, more direct investment went out of India than came into India! Again, from the same perspective, the net outflow in the last six years is nearly 65% of the net inflow, showing the extent to which the contribution of FDI to shoring up India’s balance of payments is negated by outward investments.
Another point of interest is the performance of
direct investments abroad in terms of the return on investment. Unfortunately, the data available publicly is rather
limited in extent and quality. There are two components to the returns –
earnings reinvested abroad and dividend and profits repatriated. The unreliable
nature of the estimates of the earnings reinvested abroad has already been
pointed out. The data on dividend and profits is available only up till 2008-09. It
shows maximum yearly dividend and profits of under $ 0.5 billion on an
investment stock that amounted to nearly $ 50 billion by the start of 2008-09.
The announcement of a 50% reduction in the tax rate on dividends from
investments in joint ventures and subsidiaries abroad in the last budget
is an indirect admission by the government that dividend repatriation is below
Disaggregating direct investments
As has been noted earlier, RBI data on Indian direct investment abroad aggregates several categories of investments including investments by Indian entities in Joint Ventures (JV) and Wholly Owned Subsidiaries (WOS). More recently, RBI has started making another data set publicly available - the outward investment flow into JV/WOS abroad as reported by authorized dealers.
The financial commitments of Indian entities towards their JV/WOS abroad are in the form of equity, loans and guarantees. The equity and loan components together constitute the outward investment flow into JV/WOS. The guarantees (backed by assets in
India), provided to obtain financing abroad, do not entail an
immediate flow of funds. Table 3 shows these components of the financial
commitment in JV/WOS. It also contains the outward direct investment in equity
and debt reported in the BOP
statements for comparison.
The cumulative investment into JV/WOS abroad by Indian entities in the last five years has been to the tune of nearly $70 billion, while the cumulative direct investment is a little over $82 billion. Investment in JV/WOS forms the most part – nearly 85% - of outward direct investment.
However, a substantial amount - $12 billion spread over five years - is being invested elsewhere (unless RBI data on JV/WOS investments is somehow incomplete). This would include investment of banks in their branches abroad and investments by individuals. One hopes that in the interest of greater transparency, RBI will also provide details of these investments in future.
Table 3 reveals another important feature of the financial commitments in JV/WOS abroad, namely the large guarantee component, pointing to the highly leveraged nature of acquisitions by Indian companies. The financial commitment made in the form of guarantees is about 47% of total financial commitments made in the last 5 years. Guarantees have been rarely invoked in the past. However, with the strong possibility of acquired companies failing to perform in a deteriorating economic environment, mounting guarantees pose heightened risks to Indian banks backing the guarantees made by companies.
An important attribute of the RBI data is that it allows the identification of investing entities by name and provides the amounts they have invested. An analysis of the data for the last five years (July 2007 – June 2011) reveals that just over 380 companies have invested over $10 million each and account for over 82% of the investments flowing abroad in the last five years.
Grouping the companies by business conglomerates shows the ten largest outward investor groups to be Tata, Bharti Airtel, Essar, Gammon, Reliance, Religare, Suzlon, Reliance – ADAG, Vedanta and United Phosphorous in that order. These groups, through their 35 odd companies, account for more than a third of the investment outflows for this period. Just five of these groups – Tata, Bharti Airtel, Reliance, Reliance-ADAG, and Suzlon account for over half of the total guarantees extended for this period.
The opaqueness of investments in foreign ventures
The main drawback of the RBI data on JV/WOS is that it identifies only the immediate recipient of the investment. These by and large turn out to be intermediaries - shell companies that do not have any operations; few Indian companies directly invest in the company that is the actual target of their investment.
There is a marked preference for locating these intermediaries in
Singapore, Mauritius, and Netherlands - countries that provide an attractive ‘tax neutral’
regime for holding companies. These have been the top three investment
destinations for Indian investors’, together accounting for over 55% of the
outward investment in the period April 2008 to Feb 2012.
The distancing of the foreign target from the Indian investor is often through multiple layers of shell companies. Multi-tiered intermediate structures located across several countries are justified as necessary to exploit tax treaties between different countries to the most advantage. With RBI regulations not insisting on full disclosure of how investments are routed to the target companies, these complex structures make it difficult to identify the actual destination of the investments and its end use, unless the investors volunteer this information.
With a liberal policy regime in place, companies can generally make investments without seeking prior approval, within generous limits. Combined with a weak regulatory environment, this leaves enough room for investment from
India to be channeled into areas prohibited by regulation, such
as real estate and banking, or else be ‘round tripped’. ‘Round tripping’ allows
investors to hide their identity and avoid taxes by taking the investment out
of India and bringing it back under the cloak of foreign investment.
The opportunity for tax arbitrage arises from the differential tax treatment meted out by
India to foreign investors from certain countries in comparison
to Indian investors. Mauritius and Singapore are popular staging points for investing in India. India’s tax treaties with these countries allows investors
coming through intermediaries based there to avoid paying taxes on capital
gains made in India.
The existence of ‘round-tripping’ is periodically confirmed by media reports on investigations into suspect cases. The RBI is aware of the problems with the policy on direct investments abroad and it appears that these have been transmitted to the government. The government, however, has chosen to maintain the status quo.
Export of capital by Indian companies rose dramatically in tandem with FDI and measures up to a sizeable fraction of the FDI inflows over the last six years. While there is a keen debate on the public interest in allowing or limiting FDI, it is surprising given its scale, that there is no such engagement with Indian direct investment abroad.
The government justifies the public interest in this policy by repeating the ‘textbook’ benefits – the markets that will open up for Indian goods and services increasing exports and employment, the technology and skills infusion that will take place, or the energy resources that will be secured for India’s benefit.
It is difficult to evaluate if any of these benefits indeed accrue to India, given the absence of even basic data on the end use of investments, leave alone metrics designed to measure the efficacy of policy. What is clear from the enthusiasm with which
business conglomerates export capital is that the policy certainly works in
 RBI puts out data on outward investment from
as part of the Balance of Payments statement and in
monthly press releases on “Overseas Direct Investment”. RBI also occasionally
publishes articles on Indian direct investment abroad in its monthly bulletins.
For a recent example of the latter, see Table 1 in Khan (2012). India
 The latest regulations are available in RBI’s “Master Circular on Direct Investment by Residents in Joint Venture (JV)/ Wholly Owned Subsidiary (WOS) Abroad,
July 02, 2012” (http://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=7352),
last accessed on 7 Aug 2012.
 See sections 5.59 to 5.61 and 5.68 of RBI (2010).
 See section 6.20 of RBI (2010) - “On the issue of survey on outward portfolio investments .... transactions of high net-worth individuals are not being included.” See also the comments at the end of Table 1 in the article “Indian Investment Abroad in Joint Ventures and Wholly Owned Subsidiaries: 2009-10 (April-March)” in the RBI monthly bulletin of July 2010.
 RBI circular “A.P. (DIR Series) Circular No.66 dated
Jan 13, 2003” (http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=1038&Mode=0),
last accessed on 8 Aug 2012
 RBI regulation “Foreign Exchange Management (Transfer or Issue of any Foreign Security) (Second Amendment) Regulations, 2003” (http://rbi.org.in/Scripts/BS_FemaNotifications.aspx?Id=1300) last accessed on
8 Aug 2012.
 RBI circular “A.P. (DIR Series) Circular No. 3 dated
July 26, 2006” (http://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=3028&Mode=0),
last accessed on 8 Aug 2012
 RBI circular “A. P. (DIR Series) Circular No.11 dated
Sept 26, 2007” (http://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=3833&Mode=0),
last accessed on 8 Aug 2012
 RBI Regulation “Foreign Exchange Management (Transfer or Issue of any Foreign Security) (Third Amendment) Regulations, 2007” (http://rbi.org.in/Scripts/BS_FemaNotifications.aspx?Id=4652) read along with “Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations, 2004” (http://rbi.org.in/Scripts/BS_FemaNotifications.aspx?Id=2126) last accessed on Aug 8 2012
 In the latest available regulations (referenced in note 2), Section B6.1(i) concerning “Portfolio investments by listed Indian companies” is a subsection of Section B titled “Direct Investment outside India”
 This is in line with the assertion made by Chalapati Rao and Dhar (2011:111) that regulations for investing abroad have been primarily designed to “move towards full capital account convertibility”
 The dataset in Khan (2012: Table 1) on outflows in respect of outward FDI has not been considered in this paper as it does not come with any explanation of how it can be reconciled with BOP data.
 See section 2.3 of RBI (2010) for the differences between BOP and InIP data.
 RBI puts out InIP data in press releases every quarter. The data up to Mar 2012 is available at (http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=26761), last accessed on
8 Aug 2012
 BOP statement is included in the Reserve Bank of India Bulletin issued every month, available at the RBI website (http://www.rbi.org.in)
 Earnings from pre-existing direct investment may be reinvested in the enterprise or paid out as dividend.
 Poor data has been attributed in the past to RBI’s data collection through a “Survey of India’s Foreign Liabilities and Assets” to which it was not mandatory for companies to respond. The author is unaware of the current practice.
 Reinvested earnings of FDI in India appear as a credit entry under the ‘foreign direct investment’ head of the ‘capital account’ of the BOP and as a debit entry under the ‘investment income’ head of the ‘current account’. Reinvested do not affect the balance of payments. Indian investment abroad is similarly treated.
 There is some inconsistency in RBI data that could account in part for the sharp dip. This inconsistency is also seen in RBI’s figure on investments in joint ventures and subsidiaries (see Table 3) for 2011-12 which are higher than its BOP figure for the total direct investment outflow.
 See “Invisibles in
’s Balance of Payments: An Analysis of Trade in
Services, Remittances and Income” India Mar 10, 2010 available at http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=11029
last accessed on 27 Sept 2012
 This tax concession has been noted by Khan (2012: para 43)
 Data on Outward Direct Investment is published every month by the RBI and is available at (http://www.rbi.org.in/scripts/Data_Overseas_Investment.aspx), last accessed on
8 Aug 2012
 In this table, the outward direct investment abroad is the direct investment in equity and debt in that year and does not include reinvested earnings or the proceeds of disinvestment.
 See note 24
 For BOP data see note 17
 See table 1 in Khan(2012) for the guarantees invoked each year
 Analysis carried out by the author using outward direct investment flow data (note 24).
 Calculated from the data in table 4 of Khan (2012)
 The reporting requirements are specified in Appendix A of the ‘master circular’ detailed in note 2
 Exhibit 1 in Section E of Khan (2012) explains how the policy has been ‘relaxed’ in the last few years
 See for example the PTI report “
funds into Indian stocks face Sebi, RBI probe” Times of India, Mauritius July 22, 2012
accessed on Aug
See Deepshikha Sikarwar: “Frame a policy on overseas
investments: RBI to government” Economic Times,
19, 2011 (http://articles.economictimes.indiatimes.com/2011-08-19/news/29905392_1_tax-havens-spvs-direct-taxes-code)
accessed on 8 Aug 2012