Mumbai: A number of foreign institutional investors (FII) say the recent move by stock market regulator Securities and Exchange Board of India (Sebi) to curb participatory notes (PNs), a popular instrument used for allocating money in India by unregistered investors, is only the first step towards foreign capital control.
The next step, they say, could be “some kind of a tax” on FII investments or on the gains over investments, either of which could curtail their returns from the Indian market.
PNs are securities linked to equities used by investors who cannot trade directly in the Indian market.
“The Indian stock market regulator has successfully restricted new capital flows through PNs,” says Fraser J.T. Howie, head of structured products at CLSA, the equity research house ranked best in Asia by 2007 Asiamoney Brokers Poll. “The next step could be a tax on foreign investments in Indian equities. Most of our clients are cautious of this risk,” Howie adds.
Timothy E. Keefe, chief equity officer at Boston-based MFC Global (US), a part of MFC Global Investment Management Llc., which manages more than $220 billion (Rs8.65 trillion) worth of assets worldwide, agrees with Howie. “Indian equity market regulator is seriously concerned about the effect of capital inflows into the country... There could be more steps to control inflow.”
However, this does not dent India’s image as a long-term bull market, adds Keefe, whose firm has more than $1.5 billion invested in Indian securities.
FIIs have invested more than $17.2 billion in Indian equities since the beginning of this year—the highest in any year since India opened its capital market to FIIs. As on 12 November, 1,147 FIIs have registered with the regulator. Since the capital market regulator announced the curb on investment through the PN route, there have been 34 new registrations.
Sebi has restricted investment through the PN route but eased the registration process for FIIs.
“Today, we (all major PN issuers, including CLSA) have ‘a dollar-in, a dollar-out’ model, which means we have to sell almost the same amount to make a new purchase for clients who want to invest in India through PNs,” says Howie.
According to him, many global fund managers are likely to stay invested in India and participate in its growth, even if Sebi adopts new control measures. “Another likely step by the Indian regulator could be norms on minimum investment period, such as what now prevails in China, to ensure controlled long-term inflow.”
However, the steps taken by China cannot be replicated in India, says the director of a major global hedge fund, which has put in its application early this month to get registered as an FII with Sebi.
“China has a proxy market and investors who want to avoid regulations there can buy Chinese stocks in Hong Kong,” says the hedge fund manager who did not wish to be named.
The “risk of capital control in India” is as serious an issue among investors as much the long-term bull market in the country is, he says. “The inflows into emerging markets, including India, is a market-driven mechanism,” he adds. “The restrictions on PNs, as we are told, is a way to moderate it. Sebi should leave it at that.”
Christopher Wood, chief equity strategist of CLSA, says the strongest domestic risk in India is potential foreign capital control by the regulatory authorities. “The risk is highly there.”