‘Sudden change in taxes is never welcome’

Lokeshwarri S. K. | Updated on January 26, 2013 Published on January 26, 2013

Ongoing reform process, expectation of interest rate cut, improvement in corporate earnings and improvement in sentiment are key reasons for FII to become positive on Indian markets. — Vikas Khemani, President and Head-Wholesale Capital Markets, Edelweiss Financial Services.

Foreign institutional investors have been gung-ho on the Indian markets pumping in large amounts since last calendar. Is this flow sustainable, what is driving these flows and how concerned are they about General Anti Avoidance Rules (GAAR). Here is the take of Vikas Khemani, President and Head-Wholesale Capital Markets, Edelweiss Financial Services, on these issues.

Despite slowing corporate earnings and economic growth and weak rupee, FIIs have brought in $24 in 2012. What could have prompted this bullish stance last year?

There are two major reasons for such large inflows despite weak Indian macro and sentiment. One, Emerging Markets funds in general received large flows given the developed markets performance and secondly lack of many alternatives within EMs. China was going through slow down and amid political transition, Brazil, Russia and other markets are largely commodities dependent. Indonesia and Thailand did very well and did receive flows but they are relatively smaller economies to absorb large flows. Moreover, rupee was one of the few currencies which depreciated , and this acted as an additional attraction.

What are your expectations on the FII inflows in 2013?

Ongoing reform process, expectation of interest rate cut, improvement in corporate earnings and improvement in sentiment are key reasons for FII to become positive on Indian markets and put in more money. However, one needs to keep in mind that China coming back may divert some flows from India to China and hence the proportion of flows will not be same.

Of the various categories of FIIs — global mutual funds, pension funds, SWF, wealth management funds, hedge funds etc — which categories are most active in India? Is there a shift in the components of FII money over the years?

Post-2008 crisis, global trend has been in favour of passive long only style of management and the same has been reflected to a great extent in the Indian markets. Last year, a large part of money came from endowment funds, ETFs, long only MFs. There was insignificant hedge fund activity.

What is the feedback you have got from your clients on GAAR? Is the postponement good for our market?

GAAR created a huge amount of uncertainty in the minds of global investors including private equity funds. Everyone planned their structure and a sudden change left investors completely clueless about future course of action. This led to huge amount of inaction and upset within the community. Tax structures take time to create and unwind and any sudden change is never welcome. Postponement will give time to investors to plan their structure as per new rules.

Why are FIIs worried about GAAR? Is it because many are routing money through tax havens or is it because a lot of FII money is round-tripping money?

GAAR is not a new phenomenon and is prevalent in many countries. I think the key worry was the way it was implemented along with handling of Vodafone issues. This escalated worries in the minds of investors as to future tax incidence. Especially when you are managing third party money with open-ended exit, it leads to collapse of business model. As a manager you can’t absorb future tax liability and its recoverability in future is always a question mark in future as and when it gets levied. This uncertainty is not welcome by anyone.

What is the issue with the QFI route that the Government has opened last year? Why is no money coming in through this route?

There is nothing wrong with the QFI route. You need a hugely positive market sentiment around India to attract money from wealthy non-institutional investors across the globe. We had a year with poor India press and sentiment, this is unlikely to attract flows but I am sure it will pick up. Also investors will watch stability of environment and clarity of few issues around these guidelines. I am sure it will pick up in time to come.

Numbers show that equity derivative volumes were slightly down last year? Did FIIs also reduce their participation in equity futures and options?

Market volumes in general were down last year and derivatives being linked got impacted. FII participation over the years has shifted from onshore to offshore exchanges such as Singapore.

What are budget proposals that FIIs would like to see?

Foreign investors would like to see fiscal consolidation measures achieved though boosting growth and reducing expenditure. Any attempt to consolidate through additional taxes would be counter productive. Investors would also like to see measure to improve retail participation in the capital markets.

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