Kolkata: US treasury secretary Henry Paulson said India needs to be “transparent and flexible" using overseas investment rules to curb record inflows, after the capital markets regulator restricted some funds.

Opposing views: Sebi chief M. Damodaran (left) with US treasury secretary Henry Paulson during his visit to the Sebi office in Mumbai.

“The key is going to be how this regime is implemented," Paulson said in Mumbai on Monday. “We heard some positive things about that."

Sensex had its biggest gain in six-and-a-half years last week after the Securities and Exchange Board of India (Sebi) allowed more foreign funds to invest in Indian stocks. Paulson had urged India to avoid placing controls on investments after proposals by the regulator to curb buying triggered a drop in the Sensex.

India needs to attract overseas investment to fund a doubling of infrastructure spending in the next five years to sustain the world’s second fastest pace of economic growth. Finance minister P. Chidambaram said financial sector reforms will be undertaken in a “calibrated manner."

“We are concerned about inflows from unregistered entities and unregulated jurisdictions," Chidambaram said in Mumbai. “As long as funds come after registering in India, we are fine."

Sebi had on 25 October said overseas funds will have to register before investing in securities linked to Indian equities, or sell their holdings within 18 months. It had also said pension funds, charitable institutions, foundations and university funds will be able to register in India and buy stocks.

Overseas investors have bought $18.8 billion (Rs74,072 crore) of stocks and bonds in India this year, exceeding the previous record of $9.46 billion in 2005. That fuelled a 44% advance in the Sensex this year. It touched 20,000 for the first time on Monday.

Paulson, former head of Goldman Sachs Group Inc., said on his first official visit to India that it’s better to let markets resolve economic threats.

“Administrative restrictions of capital flows are blunt instruments and can have unintended consequences," he said. “They tend to inhibit inefficiency and lose their effectiveness over time."

Paulson is making his first trip to the world’s most populous democracy after four visits each to China and Latin America.

He said the Indian government has allowed the rupee to trade with greater flexibility in recent months, and the currency’s rise was helping to cool inflation. The currency has risen more than 12% against the dollar this year, making it the best performer in Asia.

Paulson said India should lift restrictions on international investment, ease demands on banks to hold government debt and reduce requirements that force banks to loan to state-selected industries.

Indian commodities exchanges are closed to overseas funds, although it’s the world’s largest consumer of gold and the second biggest producer of wheat, sugar and rice.

The Forward Markets Commission, which regulates India’s commodity futures market, has recommended to the government that overseas funds be allowed to trade metals, bullion and oil. India needs $40 billion in annual investment for mining, utilities, roads and ports to compete with regional economies, the Organization for Economic Cooperation and Development had said on 9 October. Such funding could boost economic output by almost 1% a year, the report said.

To attract foreign investment, India must develop more transparent regulatory systems governed by independent regulators, Paulson said. India will also have to make “real efforts" to strengthen its legal system so investors can be confident their contracts will be enforced, he said.

Paulson, meeting a group of local reporters, again urged India to ratify the civil nuclear agreement with the US, repeating comments he made in Kolkata. “I think this is important for both of our countries," he said.

Prime Minister Manmohan Singh, who Paulson is due to meet later, faces opposition to the 2005 nuclear agreement from Communist allies whose support is key to the government’s survival.

The Communists contend the accord will weaken India’s ability to follow an independent foreign policy and compromise its own scientific capability. They say the agreement should be delayed until it is debated in Parliament.

Paulson also pushed the Indian government to help bring about a successful conclusion to the Doha round of trade negotiations. “The key will come down to whether bigger emerging markets will provide market access."

John Brinsley in Washington contributed to this story.