The government's proposal in the Budget to increase minimum public shareholding, raising FPI investment limit and divestment of stakes in PSU firms could bring foreign inflows worth $25 billion into Indian equity markets, according to Morgan Stanley.
The investment bank further said that India's weightage in the MSCI Emerging market index could rise if the government is able to implement three
key budget proposals to address the country’s free float problem.
“Our estimates imply inflows of $25 billion, a 146-basis-point increase in India’s weight in the MSCI Emerging Market index, and a 7-percentage-point rise in India’s foreign free float if all three proposals are implemented,” Morgan Stanley said in a report.
India's free-float market cap rank has been lower compared to its market cap and GDP rank because of high promoter holdings and low foreign investment limits, which has constrained active and passive allocation to India from abroad, Morgan Stanley said in a report. It added that these announcements if converted into policy, will have a far-reaching impact on India's free float, its weight in the MSCI indices, foreign flows, and supply of equity.
"The foreign free float problem got deeper in 2013 when many large-cap stocks were removed from major indices owing to lack of foreign headroom or low investability. Some of those got added back in the global indices as their foreign limits were raised but the collateral damage was loss of time, price volatility, and increased tracking error for the MSCI India index versus the Nifty," the brokerage explained.
Proposal 1: Minimum statutory limit for FPI investment in a company is proposed to be increased from 24 percent to sectoral foreign investment limit
The government has proposed to raise the foreign shareholding limits to the maximum permissible sector limits for all public sector companies which are part of MSCI's Emerging Markets Index. The option is given to companies to limit it to a lower threshold. Currently, the automatic FPI limit is 24 percent, which can be raised at the discretion of the company. The government has also merged the NRI and the FPI investment route.
When these changes are notified, using current constituents in the MSCI, the brokerage estimates India's weight in the Emerging Markets index will rise by 81 bps, implying active and passive inflows of $11.4 billion and $2.8 billion, respectively, totalling $14.2 billion.
At the sector level, Industrials and Materials could likely get the most weight increase, it noted. In addition to increasing weights of current constituents, these changes could also make way for new index constituents.
List of stocks which are likely to get the most weight increase given the subsuming of foreign investment limits Proposal 2: For non-financial public sector companies, the government has proposed to include the stakes of government-controlled institutions in computing its 51 percent stake. The government will increase public shareholding of all remaining public sectors to 25 percent.
Government sell downs imply an increase in equity supply of $31 billion. This is, however, not new supply, since the government has been divesting stakes in its companies for several years now. The difference is that divestments may now allow the government's stakes to fall below 51 percent, increasing the free float in public sector companies, with positive implications for India's weight in the EM index, Morgan Stanley explained.
For the current MSCI India constituents, a government sell-down would increase India's index weight by 37 bps, with an active and passive flow implication of $6.4 billion, it added.
Proposal 3: The Finance Minister has asked SEBI to examine the case to increase minimum public holding from 25 percent to 35 percent.
"Controlling stakeholders of the BSE200 constituents would need to supply about $30 billion of stock for all the companies in the index to hit a 65 percent threshold. For the current MSCI India constituents, the index weight rises by 41 bps with a flow impact of $4.9 billion," Morgan Stanley further said.
They believe this matter will be debated since it has implications in several areas:
- For new listings – new companies may not want to dilute a third of their capital on listing
- Listed subsidiaries of multinational companies – some may choose to delist rather than relinquish the power to pass special resolutions without the help of minority shareholders
- Competition for companies attempting to raise growth capital from existing companies trying to meet the new norms.Risks include delay or dilution in adopting the first two proposals, companies choosing to lower foreign limits, a delay in government sell-downs, and a negative change in foreign investor view on India's growth story, which trims active flows despite an index weight increase, the brokerage clarified.