Author : Kajal Kumari

Co-author : Aashi Roshan

Abstract

Few economies are growing as quickly as India’s, yet its Alternative Investment Fund (AIF) industry remains small when set against national output. We ask three questions here. How wide is the shortfall? Which regulatory and tax features discourage funds from forming onshore? And why do so few domestic institutions commit capital? Our approach is doctrinal and comparative, supported by descriptive benchmarks drawn from the United States, the UK and EU, Singapore, China and GIFT City. The shortfall exists, though its size shifts with the yardstick chosen. Commitments add up to roughly 4.9 per cent of GDP; drawn and invested capital is closer to 2 per cent; and private equity and venture capital put to work each year amounts to somewhere between 1 and 1.5 per cent of GDP. Three conclusions emerge. Rules have grown noticeably more supportive since 2024, but they are rewritten often and policed by several bodies at once, so outcomes are hard to foresee. Headline tax treatment of Category I and II vehicles is now close to neutral, which means uncertainty, together with the design of the Category III and offshore regimes, counts for more than the rates themselves. Finally, pension funds, insurers and similar long-horizon investors are let in only at modest, heavily qualified levels, so wealthy families and individuals dominate the investor pool. We conclude that the institutional investor base is the main bottleneck, with tax and regulatory uncertainty making it worse, and we set out a phased reform agenda.

Keywords: alternative investment funds, private capital, SEBI, emerging markets, fund regulation, institutional investors

JEL codes: G23, G24, G28, K22, O16

1. Introduction

India poses an odd problem for anyone interested in private markets. Official estimates (Ministry of Statistics and Programme Implementation [MoSPI], 2026, as reported by Outlook Business) put real growth for 2025–26 at 7.7 per cent and nominal output at around ₹346 lakh crore. Its listed equity market is large and liquid. Entrepreneurial firms are numerous and are moving into the formal economy at speed. Its securities regulator, the Securities and Exchange Board of India (SEBI), built a purpose-made regime for pooled private vehicles as early as 2012. Even so, the volume of institutional private capital channelled through that regime looks small for an economy of this size, whether one compares it with America, Britain or the more mature financial hubs of Asia.

None of this means the sector has stalled, and we are careful not to suggest otherwise. By June 2026, investors had pledged around ₹17.5 trillion to SEBI-registered AIFs, close to 25 per cent more than twelve months earlier (Business Standard, 2026a), and the count of registered funds is several times what it was five years ago. The interesting part is how the growth is distributed. Yearly PE-VC deployment has gone sideways since peaking in 2021 (McKinsey & Company, 2026). Much of the pledged money has not yet been called. Home-grown general partners account for a far thinner slice of private equity activity than their counterparts in Korea or Japan. And most of the money appears to come from high-net-worth individuals (HNIs) and family offices, not from the pension and insurance pools that underpin private markets in other countries. Our question, then, is why a sector that is big in rupee terms and expanding quickly still looks shallow compared with the economy around it.

Three research questions guide the analysis.

• RQ1: By how much does India’s AIF and private-capital pool fall short of comparable jurisdictions, and is that conclusion sensitive to the way size is measured?
• RQ2: What features of regulation and taxation discourage funds from forming and raising money onshore, and how do these compare with rival domiciles?
• RQ3: What keeps domestic institutions from investing in AIFs in meaningful amounts, and what would change that?

The paper adds to existing work in three ways. Empirically, it compares the Indian industry with its peers on more than one yardstick and shows that conclusions about the gap hinge on whether one counts pledged, called or annually deployed capital, and on which data provider one relies. Doctrinally, it codes the statutes, regulations and circulars applying to AIFs in India alongside the equivalent rules in the US, the UK and EU, Singapore, China and the GIFT City International Financial Services Centre (IFSC), separating provisions that genuinely disadvantage onshore funds from doubt about how provisions will be enforced. On policy, it orders the barriers by importance, traces how they interact, and offers a phased programme that keeps quick administrative fixes apart from deeper structural change.

Put briefly, we argue that the shortage of domestic institutional limited partners (LPs) is what holds the market back, and that tax and regulation aggravate this shortage rather than create it. Since 2024 the rulebook has become considerably more accommodating, and Category I and II funds now face headline tax treatment that is close to neutral. Investors are discouraged less by how heavy the burden is than by how hard it is to predict. Several regulators amend their rules frequently; there is a long record of disputes about whether fund income is capital gain or business profit; and pension funds, insurers and banks may commit only within narrow limits. Patient domestic savings therefore stay in listed markets, and footloose foreign money gravitates to offshore or IFSC vehicles.

The structure is as follows. We describe the institutional setting in Section 2 and review prior research, along with our four hypotheses, in Section 3. Section 4 covers data and method; Section 5 sizes the gap. Regulation, tax and the investor base are examined in Sections 6, 7 and 8. Section 9 brings the strands together and considers rival explanations, Section 10 sets out policy proposals, Section 11 discusses limitations and next steps for research, and Section 12 concludes.

2. Institutional background

2.1 Origin and architecture of the AIF framework

Before 2012, SEBI’s only regime for private pools was the SEBI (Venture Capital Funds) Regulations, 1996, which dealt with venture capital alone. The SEBI (Alternative Investment Funds) Regulations, 2012 (the AIF Regulations) swept that away and created one regime for privately pooled vehicles not already caught by the rules on mutual funds, collective investment schemes or portfolio managers. Funds are sorted into three groups. Category I is for vehicles backing start-ups, early-stage businesses, SMEs, infrastructure and other areas that policymakers regard as socially or economically beneficial; venture capital, SME, social venture and infrastructure funds belong here, and so, after a 2025 change, do angel funds. Category II is a residual group. It takes in most private equity, private credit and fund-of-funds vehicles, that is, anything outside Categories I and III that borrows only to meet routine operating needs. Category III houses hedge funds and listed-equity strategies, which may trade in complex ways and use leverage.

Some features have not changed since the regime began. Every fund needs a corpus of at least ₹20 crore. Each investor must put in no less than ₹1 crore, or ₹25 lakh in an angel fund. No scheme may have more than 1,000 investors. Sponsors or managers must retain an ongoing stake, and exposure to any one portfolio company is capped. Funds in Categories I and II have a fixed life and cannot be open-ended, whereas Category III funds may be. Table 1 brings these rules and the related tax treatment together. Because a number of these parameters were revised between 2024 and 2026, and the table reflects our reading of the consolidated text, readers should confirm each figure against the latest SEBI Master Circular before relying on or citing it.