Why Foreigners are Attracted Towards Indian Stock Market

Due to the global recession, sensex plunged to 8,160.4 (as of March 2009) but within a few months, it surged to 17,198 (as of November 2009). The reason it is not due to the strong fundamentals or because India is a developing country.  In recent times foreigners are investing huge amounts on Indian stocks.  There are some reasons which greatly attract foreign institutional investors (FIIs), as discussed below.

Capital Gain Tax (CGT):
A tax charged on capital gains or the profit realized on the sale of a non-inventory asset that was purchased at a lower price is called as Capital Gains Tax (abbreviated as CGT). Typically, capital gains are realized from the sale of stocks, bonds, property and precious metals. Not all countries implement a capital gains tax and most have different taxation rates for individuals and corporations.

In India, equities are considered as long term capital if the holding period is one year or more. Long term capital gains from equities are not taxed(ZERO TAX) if shares are sold through recognised stock exchange. However short term capital gains from equities held for less than one year, is taxed at 15% (Increased from 10% to 15% after Budget 2008-09) plus surcharge and education cess. This is applicable only for transactions that attract Securities Transaction Tax (STT).

The capital gain tax is paid only when an asset is sold, taxpayers can legally avoid the payment by holding on to their assets, a phenomenon known as the “lock-in effect”. This means Foreign Institutional Investors (FIIs) can pump in money and make thousands of crores in profits without paying any income taxes by selling the shares after one year, making India almost a ‘tax haven’.

Low interest rates in foreign banks
The interest rates in the banks in the developed courntries like USA and European courntries are very low, now about  less than one percent per year. If they invest in their banks, they get very meagre returns.

The returns from Indian stock market are attractive. Hence many foreign institutional investors are  investing a small part of their portfolio in the Indian stock market. Since many of these FII’s have investment portfolios in billions, even a small 2%  investment into India is a big amount for our markets.  Typically, they tend to buy only into the bigger companies in India (which they may consider mid sized by American and US standards).  This means they are buying mostly in BSE Sensex and BSE 100 type companies. This makes the indices to skyrocket. Well, they are not interested in investing in the smaller companies – the ticket size is too small.  The big company based indices continue to rise, while good companies in India which are smaller continue to deal with paucity of funds to grow.

As each month passes, more foreigners discover the world’s best kept open secret i.e. the legal tax haven called Indian stock market. As this happens more  new FII’s join the fray the indices continue to skyrocket.