India has allowed foreign individual investors, pension funds and trusts to directly invest in equities, in an attempt to shore up investor confidence and attract money from overseas to bridge widening current account deficit.

Measures that boost capital inflows are high on the government’s agenda as the global downturn led by the Euro zone crisis has led to investors pulling money out of Indian equities. For India, the problem has been compounded by a slump in investor confidence because of policy inaction leading to a sharp fall in new projects.

“The steps that the government is taking should hopefully help restore some confidence in the market,” Finance Minister Pranab Mukherjee told ET.

The finance ministry said in a statement on Sunday that the measures were intended to widen the investor class, attract more foreign funds, reduce market volatility and deepen the Indian capital market. The statement described the new category of investors as qualified foreign investors, or QFIs.

“It will integrate India with the global economya¦ Such flows would be more stable than foreign institutional investors,” said Thomas Mathew, joint secretary in charge of capital markets in the finance ministry.

The BSE Sensex shed close to 25% in 2011, making it the worst-performing major equity market in 2011. Record inflows – $29 billion in 2010 – turned into outflows as foreign investors sold shares.

Luring Wealthy Investors
FIIs pulled out money on account of growth falling below 7% and widely-publicised difficulties in obtaining regulatory clearances. Net outflows exceeded $450 million last year, according to data compiled by market regulator Sebi.

The government is keen to reverse these trends as current account deficit – a key macroeconomic measure – is close to 3%, above the 1-1.5% levels the government has been comfortable with. Last month, a report authored by Morgan Stanley’s Chetan Ahya described India as the “most exposed to global funding risks” among big Asian economies.

Making it easier for wealthy investors to buy Indian equities could be one way of bridging the gap, market participants said. Such inflows are under the capital account. India has a capital account surplus of around 3% of GDP. “I think this move will help investors from Gulf and Southeast Asian countries as they are quite knowledgeable about Indian companies,” said CJ George, managing director of Geojit BNP Paribas.

The finance ministry official said there were a significant number of investors in Europe keen to invest directly. “We expect significant inflows as Indian companies offer much higher yields.” Despite the current hiccups, India is seen as a long-term promising investment destination given its strong economic growth at a time the developed world is struggling. While growth has slipped below 7% in the last quarter, most of the world’s major economies are growing below 2%.

Further, the battering that Indian stocks have received, many believe, has made them ripe for the picking. Foreign institutional investors are divided on their predictions on the direction of the Sensex for this year, though some believe it could go as low 12,000 compared with Friday’s close of 15,454.