In the past, any decision to tackle participatory notes (P-Notes), by either banning them or by trying to ascertain their beneficial ownership was met by howls of protest. And for good reason. While it may have been important to know whether the money being brought into the country was actually just Indian black money that had earlier been sent out of the country through the hawala route, when a very large proportion of money invested in the markets by FIIs was funded through P-Notes, asking too many questions was certain to affect the flows—that would not only crash the stock market, it would slow down forex flows at a time when India most needed them to fund the current account deficit (CAD).
Over the years, however, things have changed considerably. For one, India is attracting a lot of FDI which, by definition, isn’t prone to flowing out as quickly as FII money, and the CAD is well under control. More important, with a global crackdown on not just tax havens but also on unaccounted flows, India has found it easier to increase the know-your-customer norms for FIIs—so while investors are still allowed to come in through P-Notes issued by well-known fund managers, the details of the beneficial ownership has to be made available to Sebi on a regular basis. Over a period of time, this has resulted in Sebi knowing the ownership details of all P-Note holders in the country and, two, a sharp reduction in the money coming in through the P-Note rule—estimates are less than a tenth of all FII investments in the country take place through P-Notes today. To that extent, taking action against P-Note holders is likely to impact the markets much less today.
The problem with the data residing with just Sebi is that there is no way of knowing whether this is, in fact, Indian black money being round-tripped. Which is why the Special Investigation Team (SIT), set up to track black money has done well to ask Sebi to give it all details on the beneficial ownership of P-Notes. Presumably, SIT will correlate this data with the income/wealth-tax returns of P-Note-holders and see if there are undeclared incomes. Indeed, once Sebi had all the details of the ownership of P-Notes, this is something the income tax department should have done long ago.