Ban on fresh funds through PNs may trigger large sell-offs: Experts

The recommendation to phase out inflow of funds into domestic stock markets through the participatory note (PNs) route and to ban fresh inflows through this channel with immediate effect is aimed to check unaccounted money flowing into the country's financial system, say experts.

But, the exit option for investors in PNs in one year's time, as suggested by the apex bank, may result in massive sell-off in the stock market, they say.

The Tarapore panel report on fuller convertibility released today suggested that FIIs should be prohibited from investing fresh money raised through PNs, while existing PN-holders may be provided an exit route and phased out completely within a year.

Currently, it is not possible to prevent trading in PNs as the entities subscribing to the PNs cannot be restrained from issuing securities on the strength of PNs held by them, the report says.

Typically, PNs are instruments used by foreign funds or investors who are not registered with the Securities and Exchange Board of India, but are interested in taking exposure in the domestic equities markets.

These are issued overseas by associates of India-registered FIIs, who are not required to identify their clients to the Indian regulators under existing rules.

"In the case of PNs, the nature of the beneficial ownership or the identity is not known unlike in the case of FIIs. These PNs are freely transferable and trading of these instruments makes it all the more difficult to know the identity of the owner," the RBI report said.

An analyst with a local broking firm felt that the move, if implemented, might also result in a massive sell-off of shares, as a bulk of the recent FII inflows had come through the PN channel.

Kirit Somaiya, president of Investor Grievances Forum, who has been campaigning for a ban of PNs, welcomed the RBI recommendations.

According to the data compiled by the Forum, investments through PNs into Indian stocks up to March 2005, were about 15 per cent of the total FII investments "" ie Rs 57,800 crore out of the total Rs 1,44,596 crore.

However, out of the Rs 48,800 crore new money that came into Indian stocks last fiscal, 87 per cent or Rs 42,600 crore came through PNs.