The decision to allow foreigners to invest directly in the equity market will encourage long-term investment in the country and reduce dependence on FII "hot money", a senior Finance Ministry official said on Monday.
"This is a very significant step. We were looking at how to increase inflows in the market... the good thing is that unlike FII money, which is deemed to be hot money, people will put money in this for a longer period of time," Department of Economic Affairs Secretary R Gopalan said.
He described the latest step as a way of creating an "enabling environment for Qualified Foreign Investors (QFIs) to come into the market and take part in equity."
Gopalan's comments come a day after the government announced its decision to allow QFIs to directly invest in the Indian equity market.
The move comes in the backdrop of significant foreign capital outflows from the domestic equity market in recent times, which has resulted in rupee volatility.
Amid severe volatility in the capital market last year, Foreign Institutional Investor (FIIs) outflows amounted to more than Rs 2,700 crore.
The situation had an impact on the rupee, which fell to an all-time low of to Rs 54.30 on December 15. Fluctuation in the domestic currency has put pressure on policymakers and the country's import bill.
A QFI is an individual, group or association resident in a foreign country that is compliant with Financial Action Task Force (FATF) standards. QFIs do not include FIIs/sub accounts.
In August last year, the government allowed foreign investors to directly invest up to $13 billion in the equity and debt schemes of mutual funds.
Gopalan further said the government is looking at ways to dispense with the need for PAN cards for investors investing money in the equity market, as required under the existing Know-Your-Customer (KYC) and regulatory norms.
"We are looking at the situation where they can dispense with PAN cards, but as of, now they will have to use PAN cards," Gopalan said.
In October last year, the Income Tax Department had released a new PAN application form for individuals who are not Indian citizens. The proposal to do away with the PAN requirement is intended to help foreigners gain access to the markets earlier.
QFIs would be allowed to invest through SEBI-registered Qualified Depository Participants (DP). A QFI shall open only one demat account and a trading account with any of the qualified DPs and will carry out purchases and sales of equities through that DP only.
The DP should ensure that QFIs are compliant with all KYC and regulatory norms. It would also be responsible for deduction of applicable tax at source out of the redemption proceeds before making redemption payments to QFIs.