SEBI's Curbs Keep Indian Investors Out Of Global Markets, Limiting Returns

The Securities and Exchange Board of India halted fresh investments in mutual funds that invested overseas in February 2022 after the industry breached the $7 billion overseas investment limit. The Reserve Bank of India set an additional $1 billion limit for investments in overseas exchange-traded funds, capping industry-wide mutual fund investments in foreign assets. Initially set in 2009 to protect forex reserves and retail investors, these limits no longer align with India's financial maturity.

For perspective, forex reserves stood at $283.47 billion in December 2009; today, they exceed $600 billion. Since then, India has demonstrated greater regulatory and policy confidence by opening up foreign direct investments in sectors once considered untouchable—insurance, multi-brand retail, and defence.

As a result, Indian retail investors are now stranded on the sidelines of global opportunities, while foreign institutional investors continue to dominate India's markets with minimal friction. The asymmetry is glaring, and the visible and hidden costs are stacking up against ordinary Indian investors.

Financial advisors have long preached diversification as the golden rule of investing. Yet, SEBI's restrictions have made this nearly impossible for Indian retail investors. Indian equities account for just 3% of global market capitalisation. By capping mutual funds' overseas exposure, SEBI has effectively shut investors out of sectors driving global innovation—artificial intelligence, biotechnology, electric vehicles, and advanced semiconductors—all of which remain underrepresented in Indian stock markets.

Take the case of a middle-class Indian investor. Before the ban, a middle-class Indian investor could easily invest in Nasdaq-focused mutual funds to gain exposure to global tech giants. Now, the choices are cumbersome: navigating foreign brokerage accounts, dealing with time zones, and filing US tax returns—or abandoning global diversification altogether.

There are not enough Indian mutual fund products to invest in overseas debt, as global debt yields have trailed India. Portfolio managers argue that investing in overseas debt is viable only if there is a 3% spread over India's risk-free yield.

LRS Hits Returns
Even for those willing to navigate LRS, additional hurdles remain, and the chief one is currency risk. The RBI's Liberalised Remittance Scheme allows individuals to invest up to $250,000 abroad annually. However, mutual fund investments are part of this limit, forcing investors to allocate their remaining LRS allowance for education, travel, or real estate. This stifles financial pragmatism and efficient capital allocation.

Investing directly via LRS exposes retail investors to the volatility of the rupee. To mitigate this risk, hedging becomes essential—but this comes at a steep price. Previously, mutual funds could absorb this cost due to scale. Now, retail investors must bear this burden alone. Moreover, the 20% Tax Collected at Source on LRS remittances over ₹700,000 could impact returns. For instance, a ₹1 million investment in US stocks triggers an immediate ₹200,000 deduction as TCS, tying up liquidity until the tax refund arrives.

The irony is hard to miss. Even as Indian investors grapple with these constraints, FPIs operate efficiently in India. They own nearly 20% of stocks listed on the National Stock Exchange of India, face no caps on inflows or outflows, and benefit from tax treaties that slash their liabilities. For instance, the India-Mauritius Double Taxation Avoidance Agreement allows FPIs to minimise capital gains taxes. But Indians investing abroad have no such tax breaks. While SEBI's Foreign Portfolio Investor compliance requirement is relatively more straightforward, domestic investors wade through LRS paperwork and TCS complexities.

This imbalance isn't just unfair—it's counterproductive. India aspires to be a global financial hub, but its policies trap domestic capital within borders while rolling out the red carpet for foreign capital. The result is a lopsided market in which Indian investors miss out on global opportunities, even as foreign funds shape local market trends.

The solution isn't to discard safeguards but to recalibrate them. SEBI and RBI must recognise that $600+ billion in forex reserves—a buffer far sturdier than in 2013's "taper tantrum" era—can withstand measured liberalisation. Here's how:

Raise Caps
A $20 billion–$25 billion cap, adjusted quarterly based on forex reserves, can be a starting point. Mutual fund investments should also be delinked from LRS, as these are regulated entities, not speculative bets. The finance ministry must reconsider the 20% upfront TCS on investments via LRS or exempt mutual funds from this requirement. Retail investors currently lack effective hedging options. The RBI can address this by directing banks to offer retail-friendly currency hedging at institutional rates, which could slash costs by 3–4%.

Finally, regulators must look to educate investors rather than restrict them from participating in global markets. Like the wildly successful Mutual Funds Sahi Hai campaign, they could launch investor awareness initiatives focused on global market risks—currency fluctuations, geopolitical shocks, and sector concentration—to empower investors with informed choices.

SEBI's restrictions were born of legitimate concerns—forex stability, retail protection—but have morphed into barriers that disproportionately penalise Indian investors. The contrast with FIIs, who operate with enviable freedom, underscores a deeper inequity in India's financial ecosystem.

We are already hearing of global wealth managers recommending EU and China funds to well-heeled Indians via the LRS route. Indian mutual funds, too, will likely announce schemes that ensure trust and transparency while allowing global diversification.

Reform isn't just about fairness—it's about recognising that India's growth story cannot be confined within its borders. SEBI must extend its principles of trust and transparency to retail investors, ensuring they can participate in global markets just as foreign investors operate freely in India. Easing caps, rationalising taxes, and fostering financial literacy will transform Indian investors from bystanders into global participants.

In a world where capital knows no borders, India's investors deserve a seat at the table.