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Worried about the rising flow of foreign funds into the real estate sector, the Reserve Bank of India (RBI) has asked the government to allow FDI into the sector only after clearance from the Foreign Investment Promotion Board (FIPB).

At present, up to 100% FDI is allowed in realty projects through the automatic route, with certain conditions like three-year lock-in on investments and minimum capitalisation of $5 million. But RBI wants real estate to be removed from the list of sectors where FDI can come in through the automatic route.

The central bank wants inflow routes like participatory notes and private equity contained. The market regulator has already initiated moves to restrict investments through PNs.

Sources said the government, which has completely backed regulatory action on checking PN flows, may not relent on other proposals, especially restricting FDI. Also, removing one sector from the automatic route will be seen as a retrograde measure by foreign investors.

RBI’s concerns stem from the fact that the sector witnessed a huge quantum of inflows in the first four months of the current fiscal, surpassing the total inflow for the last two years. FDI inflows in April-July 2007 stood at $627 million, compared to $38 million in 2005-06 and $467 million in 2006-07.

Real estate has witnessed substantial investor interest ever since FDI was allowed into the sector in 2005. There are also fears that some of it could be ECBs masquerading as FDI. Since real estate companies are not allowed to raise external debt, there are reports of them using instruments like compulsory convertible debentures and offshore special purpose vehicles for borrowing abroad and then funnelling the funds to the parent in India as FDI.

This is not the first time that RBI has written to the government on rising inflows into the sector. It had communicated its concern to the government last year as well. But at that time, it had not suggested any measures for a clampdown.

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