Indian IT companies, eager to become global players, have no patience for the exchange control rules they face. But Indian officials and regulators are stuck in an era where capital was scarce and controls were needed to fence it in. It is a clash of two mindsets.
Since economic reforms began in the early 1990s, controls on inward investments were eased. But those on outward investments remain tight. The IT companies and investors have been working to change this in recent months. The oYcials, still cautious, are now more open to change.
Software companies that plan to list on Nasdaq, partly to acquire currency to buy companies abroad, were stumped because Indian rules restricted them to companies worth just $100 million, and required clearance by the regulators. After intense lobbying that rule was eased in March; they can now buy companies worth up to 10 times their export earnings.
Ashank Desai, CEO of Mastek, a Mumbai-based software services company, says: “I don’t see why the government should put any restrictions on how we spend the money as long as we raise the cash abroad. There is no forex outflow from India.” Mastek set up subsidiaries abroad partly so that it could float them on the stock market without being subjected to Indian rules.
Under Indian tax rules, employees paid tax when they sold their stock options and when they exercised them. This defeated the purpose of ESOPs and encouraged employees to sell their options. Recently the finance minister announced that options would only be taxed on sale, putting them in line with international practice.
India’s capital controls create distortions in the stock market. Infosys’s ADRs on Nasdaq trade at nearly twice the price of its shares in the local market, partly because its floating stock on the American bourse is small. Yet investors cannot arbitrarge the difference as Indian investors (including foreign portfolio investors) cannot sell their shares on Nasdaq.
Foreign venture capitalists point out that if investment rules were simpler, their investments in India would be larger. Most are parked offshore to avoid regulatory tangles, and Indian tax laws that do not treat venture funds as pass-through vehicles.
Yet they must still clear each investment and sale (including the sale price) with the regulator. CDC’s Donald Peck says: “A hassle-free single window clearance from the Securities Exchange Board of India (SEBI) would remove the friction involved in investment.”
Abhay Havildar, of venture firm Draper International, argues that geography is irrelevant. “Companies will be located where regulations, tax laws and capital market valuations are attractive.”
Last December a committee set up by SEBI, headed by KB Chandrasekar, a prominent Indian American entrepreneur, suggested regulatory, tax, legal and institutional changes that should boost the flow of risk capital into India.
Local listing rules for companies require a three-year proWt record, precluding most internet companies from listing in India and depriving Indians of a chance to invest in them. Satyam Infoway, the first Indian internet company listed on Nasdaq last October, is not listed locally. Rediff.com, an Indian portal, is poised to follow. E Capital Solutions, a foreign company, listed in India by merging with Leading Edge, an Indian software services company.
The committee suggested that the listing rule should be waived for companies that have venture fund investors and for Indian companies listed on foreign bourses.
Regulators seem open to the idea. LM Singhvi, senior executive director at the Securities Exchange Board of India, says: “We are putting down new rules for foreign venture funds to register themselves in India just as the portfolio investors are. This should make the process of investment hassle-free. We are also looking at relaxing listing rules for companies that have venture fund investors.” Indian investors may yet see an internet boom on local bourses.
