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P-Notes will remain in vogue

By Vinod K Sharma
October 20, 2007 16:30 IST
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It was only last week that we had discussed the issue of Participatory Notes (PNs) under the heading "The brutal power of liquidity".

And as if we had a premonition of things to come, this is what we wrote - "The near-vertical rise in the stock prices and the FII inflows taken together indicate that days of the unencumbered use of PNs may be numbered. That is the only thing that may explain this anxiety to bring home the booty before the shutters are pulled down."

The issue of PNs has always bothered me. Around eight months ago, writing before the budget in the February 17 column, PNs were termed as the "bomb in our attic". Last week, SEBI dusted those bombs off and delivered them into our drawing rooms.

Though these are essentially only guidelines, they will get altered in the light of the suggestions received from the players concerned.

And going by the tenor of the speech made by the finance minister at a jamboree organised by a leading investment bank in New York on Thursday, substantial leeway could be granted in the final document.

These have been adequately discussed in the media, so we are not repeating the same. But I have a few points to add, which do not appear to have been discussed.

My first suggestion is that having already belled the cat, there is no need to feel apologetic about it. RBI has been long concerned on this front and SEBI has done an excellent job in terms of reducing the instances of PN use, though holes remain. And these holes may have been deliberately left open so as not to snub this segment of investors.

We will go digging for those holes later, but first why North Block should not backtrack: at any point of time, whenever such harsh measures have to be introduced, the markets tumble and investors suffer in a knee-jerk reaction. That has already happened. The price has been paid, not by the PN investors but by the sane Indian retail investors, who think that the government means what it says and will implement it. There is no need now to pussyfoot on the issue or sugarcoat it further.

The second observation is that despite these guidelines, the use of PNs may not substantially decline. To answer how, we will have to go back to the holes we talked about.

According to the SEBI discussion paper, there were 14 FIIs/sub accounts that had issued PNs till March 2004. This number is now 34. So there are not more than 34 FIIs or sub accounts that have issued PNs.

Essentially, the curbs would effect the business of these known entities. But there are 1,078 other registered FIIs that don't know the spelling of PN. Those hell-bent on bringing money through this route could well teach them how to do it. These FIIs who do not have exposure to the PNs yet can issue PNs at an incremental rate of 5 per cent of their non-derivative assets under custody (AUC).

There is a small hitch, however. The guideline says, "The FIIs who are currently issuing ODIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of less than 40 per cent shall be allowed to issue further ODIs only at the incremental rate of 5 per cent of their AUC."

What does the term incremental 5 per cent mean? What is the period after which a fresh 5 per cent can be bought? Logically, it should be a year, but the final guidelines will eventually clarify.

The third suggestion that I would want to make is that the regulators should share their data with the investing fraternity as to what is the ratio of PN money in the total FII inflow. RBI tells us from time to time, on an annual basis.

But it always tells us that percentage of PNs till date. Why can't it tell us that what is the percentage of the PN money in the inflows that have come during a period? That will leave no room for any inferences to be drawn individually.

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Vinod K Sharma
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