The Reserve Bank of India is considering raising the cap on overseas investments by companies to partly offset the impact of large foreign currency inflows on money supply and in turn inflation.
Companies are currently allowed to invest overseas to the extent of 200 per cent of their net worth every year.
The RBI, in consultation with the government, is exploring the option of allowing companies to invest up to 250 per cent of their net worth overseas.
The discussions follow large inflows on account of investments in equities and projects, exports and remittances by non-resident Indians. In an attempt to prevent the rupee from gaining too much, the RBI was an aggressive buyer of foreign currency in the first two months of calendar 2007.
However, the rupee gained over 2 per cent in March as the RBI stayed away from the foreign exchange market, since buying dollars would have released more rupees into the system and impacted the central bank's efforts to keep a tight check on liquidity.
In fact, the central bank's forex purchases in January and February contributed to a 22.1 per cent rise in money supply in early March, from 19.4 per cent in late December 2006.
This, in turn, forced it to raise both the cash reserve ratio -- the proportion of cash deposits banks must keep with the RBI and the rate at which it lends short-term money to banks against government securities.
The attempt at allowing higher level of foreign exchange outflows is meant to lower the net foreign exchange inflows. It comes at a time when a growing number of Indian companies are planning overseas acquisitions.
According to the Ministry of Finance, the total outward FDI in 2005-06 was $3.2 billion and the inward FDI flow was to the tune of $5.5 billion.
India can consider allowing outflows on account of investments overseas as the foreign exchange reserves position is extremely comfortable. Foreign exchange reserves have increased by $25.84 billion to $203.09 billion since January 2007.
The S S Tarapore committee report on fuller capital account convertibility had also recommended gradual liberalisation of outward FDI. The committee had proposed raising the ceiling for outward investments by companies to 400 per cent of their net worth in three phases.
Bankers said the proposed increase in the investment limit will be a morale booster and indicates the slow but steady transformation towards fuller account convertibility.
An investment banker, however, said any foreign acquisition depends on the economic benefit the acquirer hopes to derive from the target company. Once that is in place, the cap on investment does not really matter, he adds.
