India’s $7 billion cap on foreign equity investments by mutual funds needs a rethink in the budget

Indian retail investors are being short-changed. While high-net-worth individuals (HNIs) can invest up to $250,000 a year in foreign equity markets through what is called the Liberalised Remittance Scheme (LRS), smaller retail investors are effectively denied that opportunity due to a prohibitive cap of US$7 billion on overseas investments by India’s mutual fund industry. An inflexible cap This cap, imposed in 2009, has not been meaningfully raised since—has effectively closed the door on global diversification for retail investors. The cap was fully utilised as early as 2022, forcing fund houses to stop accepting fresh inflows into international schemes. The result is a striking asymmetry. Wealthier investors can access global markets; smaller investors cannot. This is not just inequitable—it is economically inefficient. GIFT City route is not practical for retail investors In theory, the LRS route—including investments routed through GIFT City—is open to all investors. In practice, it remains cumbersome, documentation-heavy and expensive, particularly for small-ticket investments. Hefty currency conversion charges and minimum balance requirements further add to upfront expenses and penalise small investments in foreign equity markets. Unsurprisingly, these frictions discourage retail participation through the LRS route. The mutual fund route, which could have been a cost-efficient and scalable solution to overseas investing, is now virtually closed due to the cap. In sum, the $7 billion foreign equity cap reduces the ability of smaller retail investors to diversify their portfolios and hedge against the risks of over-exposure to a single market. It forces them to remain over-concentrated in Indian equities, increasing portfolio risk while limiting potential returns. Diversification is a basic principle of sound investing; denying it to small investors results is a worse risk-return trade-off than necessary. The logic behind the $7 billion cap Supporters of the cap typically advance two broad arguments to justify the cap: The first is that the government seeks to protect small investors using the mutual fund route from wild swings in foreign equity markets, compounded by exchange-rate fluctuations. In simple terms: Foreign Equity Exposure = Equity Volatility + Currency Volatility While the intent may be good, the logic is flawed. One cannot selectively “protect” investors from volatility in foreign markets while exposing them to volatility at home. Volatility is inherent everywhere—in Indian equity markets as much as in global ones. More importantly, diversification reduces risk; it does not increase it. Preventing retail investors from accessing multiple equity markets does not shield them from investment risk—it concentrates their exposure in a single market. The $7 billion cap, therefore, prevents diversification rather than helps mutual funds investors manage risk better, and in doing so, undermines the very objective it claims to serve. If investor protection is indeed the concern, the solution lies in better disclosures, clearer risk labelling, and the availability of FX-hedged options—not in blunt quantitative caps that block access to foreign equity markets altogether. In practice, the cap has excluded new investors and fresh investments from global diversification at precisely those times when such diversification would have made sense. For instance, as shown in the table above, it was sensible to take some exposure to Korean, European and the US equity market to make up for relatively modest return from Indian equity investments in 2025, yet mutual funds investors couldn’t do that as the foreign equity cap had already been exhausted. The second argument for maintaining the cap is that allowing mutual funds to invest in foreign equity markets will add further pressure on the rupee. This argument doesn’t hold. Allowing HNIs, corporates, and other high-ticket investors to invest freely while blocking small investors through the mutual fund route does little to support the Indian currency, especially since the main factors behind rupee decline are increased FPI outflows, slowing FDI inflows, and struggling goods exports, made worse by Trump’s tariffs. Besides, the $7 billion cap is too small a number for a $4 trillion Indian economy, with over $687 billion in foreign exchange reserves, growing at 7–8% per annum. An unequal and inefficient outcome The current regime is also regressive in effect and inefficient in capital allocation. While wealthy individuals can access global markets through LRS or offshore structures, smaller retail investors are forced to remain over-concentrated in domestic assets. Such forced concentration has broader implications. When domestic equity markets underperform, retail investors experience a negative wealth effect, which in turn will dampen discretionary spending and weakens consumption—a key pillar of India’s growth at a time when external demand faces multiple headwinds starting from Trump’s tariffs and growing trade protectionism in most of the developed world. Access to overseas equities also provides a natural hedge against adverse currency movements—particularly a weakening rupee that raises the cost of overseas education, a common goal for middle-class households. Denying retail investors the option to diversify by investing in multiple equity markets further skews risk exposure rather than mitigating it. The way forward The upcoming Union Budget presents an opportune moment to at least double the overseas investment cap for mutual funds to US$14 billion. Beyond a one-time increase, the cap should be indexed to the growth of India’s GDP and the assets under management (AUM) of the mutual fund industry, ensuring it keeps pace with economic reality. Raising the cap would expand investment choices for Indian households and improve risk-adjusted returns on investments, and strengthen India’s financial intermediation. It will also provide a new source of revenue stream for the country’s mutual funds industry. In an economy of India’s size and ambition, a US$7 billion ceiling on global diversification is no longer prudent. Lifting it would not only be fairer—it would be better economics. (Ritesh Kumar Singh is a business economist and CEO, Indonomics Consulting Private Limited. His X account @RiteshEconomist.)