India’s capital and financial markets are in a state of confusion and turmoil. In many ways, this turmoil has a lot to do with the global financial meltdown. But there are differences and several events appear to be marching to different tunes.

The best perspective is thrown up by glancing through media reports.

First came the observation that foreign funds had begun pulling their money out of India. This was to be expected, especially after the September collapse of the real estate, oil and other commodity markets. There was also the fear that the entire financial superstructure would crumble after the demise of Lehman Brothers Holdings Inc.

Also See Ill-gotten Funds? (Graphics)

Then came reports in the middle of January that the lowered interest rates in the US and the higher rates (1:4 at the minimum) in India had persuaded foreign institutional investors (FIIs) to look at India’s bond rather than equity markets. One contrarian view emerged from Mumbai-based brokerage India Infoline Ltd, which said that it expected domestic equities market to generate a return of around 30% in 2009. It believed that FIIs would return to the markets but suggested that it would be in the third or fourth quarter of 2009.

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Then came media reports towards the middle of March that FIIs were unlikely to return to India till the end of 2009.

Yet, all of a sudden, by mid-April, news began trickling in that FII interest in India had revived. This was notwithstanding a worsening political climate, a yawning fiscal deficit which threatened to get worse in the coming months and a downgrading of India’s rating to negative by Moody’s. By the end of April, news reports claimed that FII inflows had turned positive, wiping out the outflows after September.

What caused this sudden reversal?

Could there have been a correlation between foreign exchange inflows and the announcement by the US Senate panel on 3 March? ‘The Washington Post’ reported on 4 March that the Senate’s investigative committee would push Swiss bank UBS AG to release its closely held list of US clients suspected by the Internal Revenue Service of skirting taxes worth $100 billion (around Rs5 trillion), in an attempt to strengthen US tax laws as they apply to foreign accounts.

Within the next two weeks this demand became a clamour as more countries began rooting for abolition of secrecy laws that exist in most tax havens. They, too, began insisting that the list of account holders be released and the ownership pattern of companies listed in tax havens be available for public inspection. Foreign exchange flows into India picked up smartly after that. By 8 May, net investments by FIIs into India’s market stood at $55.8 billion and $5.8 billion in debt, according to data released by the market regulator Securities and Exchange Board of India. Were the inflows the result of an increasingly nervous community of Indians who had stashed their ill-gotten funds overseas and now feared disclosure? One doesn’t know for sure but the coincidence is startling. This possibility could gain credibility if it turns out that much of the inflow has been through the infamous participatory note route that allows FIIs to bring money into India without disclosing the source and the eventual beneficiary of such investments.

If this surmise is true, expect FII inflows to strengthen as the clamour for disclosure of Swiss accounts and account holders in tax havens becomes louder and persistent. It would appear that the global meltdown is finally bringing a tremendous focus on financial morality and scrutiny. Moralists should rejoice.

Participatory notes

The Bharatiya Janata Party may have lost some of its focus against black money. It overlooks the fact that if the generation of black money has to be controlled, it should focus on the three laundering machines that convert much of the black (read slush) funds generated into white (read accountable and legitimate)

Slow PIGS: The Milan Stock Exchange, Italy. Portugal, Italy, Greece and Spain are known for high debt, high trade deficits and unemployment. Giuseppe Aresu / Bloomberg

The answer is not to close the PN route but to treat it as an amnesty scheme window through which ill-gotten gains could be allowed into the country with conditions. These could include that neither the principal nor gains be taken out of the country for a minimum of five years (preferably 10 years), and they be subject to Indian tax laws. If investors desire to benefit from the tax-free window, there must be full disclosure of the end-beneficiaries and sources of the funds. The pressure on disclosure by tax havens will ensure that the money flow into India does not diminish. The condition blocking their volatile entry and exit and being subject to Indian tax laws will allow for more stability in the markets. It is a pity few of India’s finance mandarins have cared to curb this convenient window for slush fund generation, one which causes the biggest headaches for India’s capital markets.

PIGS eye

There is a new nomenclature that is gaining popularity in international finance quite rapidly, and with good reason. No, it isn’t the swine flu, though the acronym PIGS might suggest it to be so. It stands for Portugal, Italy, Greece and Spain—all slow-moving economies with high debt, high trade deficits and high unemployment.

And if India does not get the very same factors under control, it may soon move out of Bric (Brazil, Russia, India and China) and become an added I in PIGS.

R.N. Bhaskar runs a company with significant interests in distance learning and examination certification and writes on corporate and business policy issues. Comments on this column are welcome at

Graphics by Ahmed Raza Khan / Mint