The
Nifty tanked 1.88% on the first trading day of the last week of July 2015. The
sharp plunge in the benchmark indices was on account of two reasons – one in
the global context and the other in the domestic context. China’s equity market
tanked 8.48% on 27th July 2015, which led to global equity markets
also feeling the pinch as the World’s second largest economy is set to grow at
a slower pace than expected. The P-Notes issue has once again come into
limelight similar to the situation that was seen in 2007.
Participatory
Notes commonly known as P-Notes are instruments through which foreign
individuals, hedge funds and others invest in India’s stock markets without
being registered with market regulator Securities and Exchange Board of India
(SEBI). P-Notes are popular with foreign investors because they are able to
save time and the costs associated with direct registration with Indian
authorities. In 2007, a crackdown on P-Notes had led to a 10% fall in the
Sensex within minutes of the market opening. Trading had to be halted and then
finance minister P Chidambaram had to make statements to calm the markets.
Investments
through participatory notes in India’s capital market were about USD 43 billion
at the end of June 2015. This amounts to 21% of the total foreign institutional
investment (FII) in Indian markets. Investment through P-Notes has been
steadily decreasing over the years. Till a few years ago, P-Notes used to
account for more than 50% of total FII investments, but their share has fallen
as SEBI has tightened disclosure norms and other related regulations.
The Supreme Court appointed special investigation
(SIT’s) recommendation of stricter norms for P-notes would be viewed negatively
by the market. SIT suggested that SEBI put in place regulations to help identify
individuals holding P-notes or off shore derivative instruments (ODI) and take appropriate
steps to curb black money and tax evasion using the stock exchange.
Based on data from SEBI, SIT report said a major
chunk of the offshore derivate instruments that invested in India were coming from
Cayman Islands around 31%, which translates into INR 85,000 crores. In 2010
Cayam island has a population of 59,000 going by the 2013 census which suggest
that with this kind of population and size most funds flowing from Cayam islands
are not originated from there but the jurisdiction is just used as a conduit to
channelize the funds into the stock market. By which it definitely cannot be
concluded that all the funds that are coming from offshore jurisdictions would
result in tax evasion. Most of the funds that are channelized via an offshore
jurisdiction like Cayam are structured in a way to take most use of the tax treaties
between nations resulting in efficient tax planning and better net return on
capital.
Investors
need not panic as the P-Notes issue is a temporary obstacle and the long term
growth story remains intact for the Indian economy. Any correction in the
benchmark indices would present an opportunity to buy from a long term
perspective. The Finance Minister has given a clarification that the Government
would not take any drastic steps to demotivate FIIs and spoil the investment
climate in the economy.
With
growth slowing around the world along with China, the long term story of India
looks intact with favorable demographics, stable government and growing
consumption the long term story of India looks intact and the events like
P-note saga could impact the markets in the short term but on a long term horizon
the markets would continue to grow outperform most markets around the world.
_
Farzan Ghadially
