Expanding the Mutual-Fund Window Can Improve the Quality of Outward Investment: Nilesh Shah

The Indian Rupee’s long-term depreciation reflects structural features of the economy rather than isolated policy failures. Persistent merchandise trade and current-account deficits have been the norm for decades. India typically records higher inflation than its major trading partners, and productivity growth, while respectable, has not consistently outpaced that of competitors in a manner that generates sustained real appreciation.

These factors, operating through the relative purchasing-power channel, have produced a gradual nominal decline against the dollar and other reserve currencies. Episodes of sharper weakness have coincided with oil-price spikes, risk-off shifts in global capital markets, or both.

Services exports—especially information technology, business process, and related professional services—have grown rapidly enough in recent years to offset a substantial share of the energy and electronics import bill. Remittances have provided further support. Gold (and, to a lesser extent, silver) imports remain the large residual drag. Annual net gold imports commonly range around 700 tonnes costing between $35 billion and $55 billion; over multi-year windows they have frequently matched or exceeded the combined net foreign direct and portfolio investment inflows. When gold and silver purchases are reclassified from current-account consumption to capital-account investment (a treatment consistent with their store-of-value character and global liquidity), India’s underlying trade and current-account balances turn surplus for extended periods. In accounting terms, therefore, a large fraction of the recorded deficit is the counterpart of household accumulation of internationally accepted, dollar-linked assets.

Over roughly the last two-and-a-half decades, cumulative official gold and silver imports have absorbed more foreign exchange than the net stock of FDI and FPI liabilities that India has accumulated. Unrecorded channels—smuggling and under- or over-invoicing—amplify the outflow. The result is that domestic savings have been transformed, at scale, into claims on foreign currency rather than into domestic productive capital. This pattern has coexisted with sizeable gross capital inflows; the net position has been closer to equilibrium only after the gold outflow is recognised.

The Reserve Bank of India operates under a set of mandates that are more numerous and potentially conflicting than those of many peer central banks. It must deliver price stability, support growth, ensure financial-sector soundness, facilitate the government’s borrowing programme at sustainable yields, and manage the external value of the rupee. When crude prices rise, the current-account deficit widens mechanically, importers accelerate dollar purchases, and speculative positioning often intensifies. Swings in FPI equity and debt flows, or in net FDI (gross inflows less repatriation and outward investment), amplify the pressure. In such episodes the RBI has repeatedly mobilised Foreign Currency Non-Resident (Bank) deposits from the NRI community, offering swap facilities or interest-rate incentives. These instruments have temporarily replenished reserves and dampened speculative momentum, as illustrated by large FCNR(B) mobilisations during periods of oil and geopolitical stress. They do not, however, alter the underlying demand for foreign currency arising from the gold and energy bills.

Persistent external financing needs and the associated trend depreciation have narrowed the practical room for full capital-account convertibility. Convertibility already exists in both formal and informal, legal and illegal forms. Purchases of gold, silver, diamonds and pearls constitute an informal channel: these assets are priced in dollars, enjoy global acceptance, and deliver a dollar-linked return without any formal capital-account transaction. On the formal side, the Liberalised Remittance Scheme, overseas direct investment, overseas portfolio investment, and the mutual-fund overseas investment window are legal routes. Hawala networks, under-invoicing of exports and over-invoicing of imports remain illegal routes. Empirical coexistence is visible in Indian real-estate purchases abroad, the presence of high-net-worth Indian clients in private-banking centres, global acquisitions by Indian firms, and the documented cases of bank defaulters and other individuals maintaining substantial lifestyles overseas without commensurate declared income or business activity in India.

From the standpoint of the mutual-fund industry, an increase in the long-standing $7 billion industry-wide overseas investment ceiling (plus the separate $1 billion ETF limit) is preferable to further expansion of the other channels. Mutual-fund vehicles provide professional portfolio construction and risk management, generate transparent reporting, and create a documented trail of both outward investment and subsequent repatriation. Because redemptions and portfolio rebalancing can reverse flows, the net foreign-exchange impact is more controllable than under the Liberalised Remittance Scheme, where funds may remain abroad indefinitely. Compliance and know-your-customer standards are higher than in informal or illegal channels, reducing leakage and improving the quality of capital-account data available to the authorities.

The government’s gradual and selective approach to capital-account liberalisation has been consistent with the need to preserve reserves and financial stability amid recurrent external shocks. The mutual-fund ceiling, unchanged for more than a decade and effectively binding since early 2022, is one element of that framework. Raising it would enlarge the set of regulated, reversible channels for resident savings to obtain foreign-currency exposure. In periods of heightened global volatility, such channels can complement rather than undermine the RBI’s toolkit: they allow diversification that reduces the incentive for purely speculative or informal outflows, while the ability to repatriate provides a potential source of future inflows. The broader policy constraint remains the structural current-account position once gold is treated as investment; until productivity differentials, inflation differentials and the composition of the import bill improve more decisively, the room for large, permanent capital outflows will stay limited. Within that constraint, expanding the mutual-fund window represents a measured step that improves the quality of outward investment without materially enlarging the unmonitored portion of the capital account.

(The writer is managing director, Kotak Mahindra Asset Management Company)