An inter-ministerial committee of the government has recommended that foreign institutional investor holdings in important sectors like telecommunications, banking and civil aviation should be kept out of the foreign direct investment limit specified for these sectors.

There will, however, be a stringent inter-locking mechanism to ensure that the holdings do not shift baskets.

The committee, headed by Chief Economic Adviser Ashok Lahiri, had submitted its report to Finance Minister P Chidambaram on July 6, just two days ahead of the Budget.

Since the minister hardly had the time to study the committee's recommendations and their implications, he did not include them in the Budget. He, however, said the recommendations would be examined and implemented in consultation with the ministries concerned.

If the recommendations had been accepted by Chidambaram, the total foreign investment in private banks and telecommunications companies could go up to 100 per cent. In banking, FDI is allowed up to 74 per cent with a 49 per cent cap on FII holdings within the overall FDI ceiling.

In telecommunications, the minister proposed to raise the FDI ceiling to 74 per cent from the existing 49 per cent, and in civil aviation to 49 per cent from the present 40 per cent.

According to officials, FIIs have shown a marked preference for India over other emerging markets. Hence, there is a strong case to further encourage FII investment in Indian companies.

FIIs, or sub-accounts of FIIs, can now collectively hold up to 24 per cent equity in a company. They can increase their stake up to the sectoral FDI cap, provided the company's board passes a resolution followed by a special resolution by the company's general body. In other words, FIIs can hold up to 49 per cent stake in both telecom companies and private banks.

The sources said the committee had taken a leaf out of former finance minister and now Prime Minister Manmohan Singh's FII liberalisation measures announced in the 1992 Budget and notified later in September 1992.

Singh had allowed 24 per cent FII and non-resident Indian holdings in Indian companies. This, however, was over and above the 51 per cent FDI permitted in all priority areas and also excluded FII investment through offshore single/regional funds, Global Depository Receipts (GDRs) and Euro convertibles.

In his Budget speech, Chidambaram said many genuine FIIs were professional bodies of asset managers and financial analysts who could enhance the flow of equity capital and lend depth to the markets.

The proposal to liberalise the FII regime was taken up by the previous National Democratic Alliance government too. Former Finance Minister Jaswant Singh had set up a committee headed by Lahiri last year to study the issue of precluding investments by FIIs from FDI in determining the overall foreign investment ceiling.

Foreign funds FIIs have shown marked preference for India over other emerging markets. FIIs can increase their stake in a company up to the sectoral cap if the firm's general body passes a special resolution. Inter-locking mechanism being suggested to prevent shift of holding from the FDI basket to the FII basket. FIIs can enhance flow of equity capital and lend depth to capital markets.