Column | Easing Overseas Investment Cap a Question of Financial Market Maturity: Systematix's Dhananjay Sinha

Indian mutual fund houses are urging the government to ease the $7bn cap on their collective overseas investments, arguing that the restriction limits domestic investors' ability to diversify globally and access markets unavailable in India. The government, however, has prioritised capital controls and domestic stability over financial liberalisation.

To assess whether this restriction is really in India's interest, finance experts Michael Debabrata Patra and Dhananjay Sinha offer their perspectives. Click here to read Michael Debabrata Patra's view.

The debate around increasing the overseas investment limit for Indian mutual funds (MFs) has intensified in recent years as the industry's size, maturity and investor base have expanded significantly.

At present, Indian MFs are subject to an industry-wide overseas investment limit of $7bn, along with a separate $1bn limit for overseas exchange-traded funds (ETFs) and a per-fund-house cap of $1bn.

Given that the Indian MF industry's assets under management (AUM) now exceed $860bn, the existing overseas investment ceiling represents barely 0.8% of industry AUM. Several fund houses have argued that this limit is no longer adequate and have urged regulators to liberalise the framework.

The principal argument against raising the overseas investment limit stems from concerns regarding India's balance of payments (BoP) position. The Indian economy has witnessed substantial pressure on its external accounts in recent years. The rupee has depreciated significantly to an all-time low of 97 to a dollar, due to elevated global oil prices, persistent foreign institutional investor (FII) outflows, weaker foreign direct investment (FDI) inflows, and a widening trade deficit. Growth-oriented capital inflows have remained subdued despite India's strong headline gross domestic product (GDP) growth.

These concerns deserve consideration.

A Compelling Case

In an environment where several developed markets, particularly those benefiting from the artificial intelligence (AI) investment boom, have delivered stronger returns than Indian equities, investors may naturally seek greater exposure to overseas assets.

With many global markets outperforming India and the rupee continuing to depreciate, there is a perception that additional overseas investment capacity could lead to a significant shift of domestic savings into foreign assets.

However, the magnitude of this risk is often overstated. Even the entire $7bn overseas investment ceiling represents barely 1% of the industry's AUM and roughly 1% of India's foreign-exchange reserves. From an investor's perspective, there is a compelling case for greater diversification opportunities.

Given that the total market capitalisation of Indian equities constitutes only 3–4% of global, it is germane for Indian investors to have greater global access. Indian households have invested aggressively in domestic MFs over the past five to six years. Since 2024, monthly equity MF inflows have remained exceptionally strong, reflecting investors' confidence in financial markets despite subdued returns.

Yet, retail investors have not been adequately rewarded for their participation. Domestic institutional investors (DIIs) have absorbed massive amounts of equity supply through initial public offerings, follow-on public offers, promoter stake sales, private equity exits, and other fundraising activities.

Consequently, a significant portion of household savings into equities has funded corporate fundraising rather than generating proportionately attractive returns for investors.

Home Truths

Another argument frequently advanced against liberalisation is that domestic savings must remain within India to finance domestic investment, manufacturing and job creation.

This home-bias argument assumes that keeping household savings invested in Indian equities will automatically translate into higher private capital expenditure and stronger economic growth.

However, empirical evidence over the past decade suggests otherwise. Despite significant domestic fundraising by corporates, corporate-tax reductions, extensive public infrastructure spending, banking-sector reforms, large-scale balance-sheet repair and significant trade protectionism, private-sector capital expenditure has remained relatively subdued. The anticipated crowding-in effect from these supply-side policies has not materialised to the extent hoped.

In contrast, the $156bn that DIIs put into equities between 2024–25 and 2025–26 was largely offset by FII retrenchment and by $100bn of domestic fundraising. Meanwhile, overseas investment by Indian companies through the FDI route has scaled up to $54.4bn over the same two years. Over the six years since 2020–21, total FDI outflows from India have aggregated $123bn, about 17.5 times the limit set for MFs.

This suggests that the primary constraint on private investment is not a shortage of domestic capital. Rather, it reflects a lack of sufficiently attractive investment opportunities and growth prospects, notwithstanding the reported robust real GDP growth of 7–8% and India ranked among the topmost global economies.

Consequently, restricting overseas investment to preserve domestic savings for Indian corporates appears increasingly difficult to justify. Domestic investors should not be denied diversification opportunities merely because policymakers hope that captive domestic savings will encourage greater corporate investment.

Meaningful Diversification

For these reasons, policymakers should consider moving away from a fixed dollar-based framework and instead adopt a dynamic cap linked to industry AUM. An overseas investment limit equivalent to 10–15% of MF assets, implemented gradually over time, would provide meaningful diversification benefits while remaining manageable from a macroeconomic perspective.

Such a framework would evolve naturally alongside the growth of the MF industry and would better reflect India's increasing integration with global financial markets.

In conclusion, increasing the overseas investment limit for Indian MFs is not merely a question of investor convenience but one of financial market maturity. The BoP concerns are overstated and the risks associated with a calibrated increase in overseas investment limits are likely far smaller than commonly perceived.

Liberalisation would enhance investor choice, improve diversification, strengthen capital allocation, impose greater competitive discipline on Indian corporates, and ultimately contribute to a more efficient and globally integrated financial system.

Rather than viewing overseas investing as a threat, policymakers should increasingly regard it as a necessary feature of a mature economy and a long-term positive for both investors and economic development.

Dhananjay Sinha is chief executive and co-head of equities at Systematix Group