Falling profits, strict SEBI rules may deter foreign investors

FPI sold equity in FY22 and FY23 1,40,010 crore and 37,632 crore, respectively, but turned sharply in FY24 11,631 crore in net purchases in April, 43,838 crore in May, and 7,133 crore so far in June. In just nine weeks in FY24, FPIs have bought 62,602 crore nett.

Data for May 2023 from the National Securities Depository Limited (NSDL) shows that FPIs focused on sectors such as IT, fast-moving consumer goods (FMCG), automobiles, auto components, metals and telecommunications. It also shows that he has reduced his exposure to energy, textiles and power sectors.

FPI held around till the end of May 48,79,628 crore in Indian equity assets. According to investment bank Goldman Sachs, more than half of the firms in the NSE-500 index (which tracks the top 500 companies listed on the exchange) have delivered capital gains of more than 1,000% over the past decade. This is an amazing record and explains why FPIs are attracted to India.

High historical returns aside, underlying reasons for optimism include stronger-than-expected GDP growth and moderate inflation. Latest GDP estimates indicate that the Indian economy may grow at 7.2% in FY23, beating expectations. Consumer inflation eased from 5.66% in March to 4.7% in April 2023, raising hopes that the central bank will not raise interest rates again.

High-frequency indicators such as electricity consumption, railway traffic and vehicle sales indicate that economic activity has increased. There is a strong possibility of India leading the world in terms of development this year. For FPIs with a mandate to invest in emerging markets, it is clearly the destination of choice.

However, there are two potential areas of concern that may dampen their enthusiasm. One is that profit margins of Indian companies have declined even as their revenues have increased. A recent study indicated that the largest 1,000 listed companies have seen little growth in their profits from FY2022 to FY23, owing to higher energy costs, interest rates and employee-related expenses. Presumably, FPIs are betting that this dip in earnings is temporary. Indeed, energy costs are declining, as is general inflation, which includes the prices of raw material inputs such as industrial metals, plastics, and semiconductors.

The second concern is regulatory. Capital markets regulator, SEBI has recently issued a consultation paper outlining its intention to impose stricter disclosure norms on certain categories of FPIs. In short, if SEBI feels that an FPI is “high-risk” and it has more than 25,000 crore exposure to Indian equities, or if a single corporate group accounts for more than 50% of its equity portfolio, the regulator will demand detailed information on its “beneficial” owners.

As is the case, an FPI may be controlled and funded by various opaque corporate entities that are themselves owned by unknown, opaque entities. That is, FPI ‘A’ may be controlled by Company ‘B’ which is itself initiated by Company ‘C’ which is owned by Company ‘D’. If A, B, C and D are all registered in a jurisdiction such as the Cayman Islands or Mauritius, the actual beneficial owners of these entities are unknown.

SEBI believes that some Indian corporate groups may use the FPI route to circumvent the norms of minimum public float of a listed company. To take a company public in India, the promoters have to sell a minimum of 25% stake in it. This is to prevent manipulation of the share price.

But promoters or entities working in tandem with them can set up companies with opaque ownership structures overseas and funnel funds through an FPI to buy a stake that actually belongs to the promoters. This would make it easier to manipulate stock prices and do money laundering.

SEBI also fears that FPIs are being used to sabotage its ‘Press Note 3’ (PN3). India has land borders with Pakistan, China, Bangladesh, Nepal, Myanmar, Afghanistan (through India’s claims on PoK) and Bhutan. PN3 is designed to prevent entities with ties to these countries from owning shares of Indian companies without explicit permission. SEBI has said that the FPI route can also be used to avoid this.

Thus it will seek detailed ownership information in cases where it classifies the FPI as high risk. If the information does not come, the FPI will have to cease operations within six months. SEBI itself has estimated this 2.6 lakh crore foreign investment is potentially “high-risk”. This represents about 6% of FPI’s total equity assets under management and less than 1% of the total market capitalization of Indian companies. But if the advisory paper turns into regulation, it could trigger some selling.

Updated: June 06, 2023, 04:27 PM IST