If there is a good time to liberalise our capital inflows, it is now. The major economies of the world?the US, EU and Japan?are in a slowdown mode. Major central banks have, however, pumped liquidity into the system in an attempt to prevent a complete stall. The money is looking for an avenue with high returns?something a still speedily growing economy like India can provide. India should, therefore, shore up its stock markets which have not been immune to the bad news from the US. Continued restrictions on participatory notes (PNs) are, therefore, even less defensible than before. The government, RBI and Sebi must take immediate steps to remove restrictions on PNs. They might even consider going one step further by allowing non-FII players to become directly involved in stock markets.
The main objection to the extensive use of PNs is that they promote opacity and lead to unknown investors placing big bets in Indian markets. It is assumed that these investors, because they are not registered with Sebi, can act in a volatile manner, causing disruption to the smooth functioning of markets. The solution to this problem is, of course, to allow anybody who registers with Sebi to invest in the stock market?it makes little sense to allow only FIIs and not hedge funds. Obviously, not everyone wants to register as an FII as it means substantial costs in setting up a physical base in India. That is why they opt to invest through PNs. The optimum policy move is, therefore, to end this caste system among players in the stock market. However, if the government is unwilling to go this far, it must at least reallow full trading in PNs. The transparency problem can be solved by following the international practice on depository receipts. In places like the US, foreign investors can hold US stocks through brokerages or banks?these brokerages or banks are compulsorily required to know the identity of the final holder of the stocks under the know your client (KYC) norms. The regulator does not get directly involved. In India, too, PNs should be restarted with the onus on the issuers of PNs to know the identity of the final holder?the regulator can request for this information as a right. That will solve the transparency issue and give the stock market a much needed cash injection.
