How foreigners are investing in India's share market

India has consistently been the preferred destination for foreign investment. However, now that India's stock markets have surpassed Hong Kong's to become the world's fourth largest, investors are flocking to a fast-growing alternative to China's struggling stock indexes.

As India heads for elections this year, the country continues to attract foreign investors, who have a number of ways to invest in the country.

Here is a closer look.

Foreign portfolio investments

To invest in shares of listed companies, foreign investors have to use the foreign portfolio investment (FPI) route. Investors, whether individuals or firms, need to be registered with the markets regulator SEBI and adhere to its disclosure requirements. Most of the 10,800 FPIs are funds.

More from Explainers

There are no restrictions for investing in Indian companies via this route, however an FPI cannot hold more than 10 per cent in a listed company. If an FPI invests more than 10 per cent in any company, it is categorised as foreign direct investment for which there are restrictions in some sectors.

All FPI investments must be in Indian rupees and dealt through brokers. All FPI transactions are taxed at par with taxes applicable to domestic investors, which includes capital gains at 15 per cent for short-term holdings of less than a year, 10 per cent for long term holdings and a surcharge and securities transaction tax.

Disclosures

The Securities and Exchange Board of India (SEBI) has a hands-off approach for offshore funds' registrations but mandates custodian banks, through whom foreign money flows into India, to disclose details of the investors in these funds.

Indian stock markets have become the fourth largest in the world, overtaking Hong Kong's, as investors flock to a fast-growing alternative to China's floundering stock indexes. File image/Reuters

Custodians are typically domestic banks or Indian branches of foreign banks. There are a total of 17 custodian banks registered in India including — Citi Bank, Deutsche Bank, ICICI Bank, Kotak Mahindra Bank, DBS Bank, HSBC, State Bank of India, Standard Chartered Bank among others, according to SEBI website.

Under anti-money-laundering rules, regulators also require details of the so-called beneficial owners, which refers to any investor holding 10 per cent or more of the assets of a fund.

Further, SEBI has enhanced disclosure requirements for funds which have concentrated holdings in a single corporate group.

Non-resident investments

Non-resident Indians can invest in the Indian stock market through the portfolio investment scheme and transactions are routed through a non-resident ordinary (NRO) savings account. The overall investment limit for NRIs and any person of Indian origin (PIO) in stocks is 10 per cent of the company's paid-up capital. Individual investment is capped at five per cent.

NRIs cannot engage in intra-day trading, they have to take delivery of shares and can't trade derivatives.

Offshore derivatives

If a foreign investor does not wish to go through the process of registering with SEBI, they can invest in Indian shares through offshore derivatives instruments or participatory notes (P-notes). SEBI defines these instruments as ones issued overseas by an FPI against securities held by the FPI in India.

Taking a short position in India requires upfront disclosures, but investors can do so via P-notes to obscure their positions.

Foreigners can also invest in the roughly 150 American and Global Depository Receipts (ADRs/GDRs) of Indian firms listed on offshore exchanges. In recent years, the number of companies raising funds via ADR/GDR has reduced.

With inputs from Reuters