A combination of factors like a controversial anti-tax avoidance proposal and the quality of foreign inflows coming under the scanner has led to the share of participatory notes hitting an all-time low.
According to latest data available with the Securities and Exchange Board of India (Sebi), the share of P-notes as a percentage of total FII assets in the country has fallen to 6.1% in August. This is the lowest in the last 10 years ever since Sebi has been maintaining data on such flows. The total value of P-notes is pegged at R1,41,710 crore.
Market experts say the biggest single factor for the fall in P-note issues is the ongoing confusion related to the implementation of General Anti-Avoidance Rules (GAAR), which was proposed earlier this year as part of the Union Budget.
?The finality on GAAR has not come yet and this is leading to a fall in P-note issuance,? says UR Bhat, managing director, Dalton Capital Advisors (India). ?Foreign entities are still waiting for more clarity on the way it (GAAR) will be implemented and so are currently waiting on the sidelines,? he added.
Incidentally, the Shome panel on GAAR has proposed deferring the controversial rules to 2016-17 (assessment year 2017-18). The government wanted to implement it from April this year. The Shome panel recommendations, however, are yet to be approved by the government.
Interestingly, a section of market experts are surprised as the fall in P-note issues comes at a time when FIIs have been aggressively buying Indian shares. The last three months have seen FIIs putting in nearly $5.5 billion while the total overseas investments in 2012 is pegged at over $14 billion.
They say that the quality of flows has been openly questioned in the recent past and that might also lead to unwinding by some ?non-genuine? P-note holders. Meanwhile, data also suggests that P-note holders have increased their activity in the derivatives segment as their share has increased to 12.7%, which is the highest since March 2012.
?It could be due to a multitude of factors with GAAR being the most important,? says Avinash Gupta, leader, financial advisory, Deloitte India. ?Secondly, some of the brokerages have also come out with reports recently questioning the real origin of foreign flows. So it might be that such entities are now taking a cautious stand. But we need to wait and watch for some more time to arrive at a conclusion,? he explained.
P-notes are derivative instruments that are typically issued by foreign brokerages to those overseas entities that want to trade in Indian shares but do not want to get registered as an FII in India. The underlying of these instruments are the shares of any Indian listed company.