Unfazed by scrutiny, 27% foreign investors still favour P-notes

One out of every four foreign institutional investors still prefers participatory notes (P-notes) for exposure to Indian markets despite increased scrutiny of the instrument, reveals a survey conducted by PricewaterhouseCoopers (PwC), a consultancy firm. P-notes are offshore derivative instruments with Indian shares as underlying assets.

Around 27 per cent of the 203 foreign institutional investors (FIIs) surveyed said they won't go for direct access to Indian markets over P-notes. In comparison, less than 10 per cent of foreign investments happen through P-notes, down from a peak of over 50 per cent during 2007.

Tightening of P-note regulations has seen these instruments shrink drastically over the years. Experts say Indian markets are losing out on investments from foreign investors who don't wish to enter India directly but at the same time find the current P-note framework restrictive. "There are a few investors who don't wish to go through the entire registration process required for direct access. The tightening of the P-note framework might have impacted investments from these investors," said Gautam Mehra, India tax leader, PwC.

In a bid to curb misuse of P-notes, Sebi in May tightened the P-note framework, making it on a par with that for onshore investors.

Despite P-note tightening, FII flows into Indian markets have remained strong this year. Two-thirds of the respondents in the PwC survey said they favour India as an investment destination over other emerging markets (EMs). This has reflected in FII inflows this year. FIIs have net bought shares worth $5.6 billion so far in 2016.

Among other key findings of the survey, nearly half of the respondents said the cost of trading in India compared to other EMs is high. PwC said the transaction cost, particularly on derivatives trading, needs to be brought down for domestic markets. Also, 77 per cent of FIIs said they were satisfied with the ultimate outcome of the minimum alternate tax (MAT) controversy. Last year, the tax department had asked a number of FIIs to re-file their returns with financial statements, in a bid to levy MAT on them. PwC said the issue has now been been resolved and there are no outstanding MAT notices against any FIIs. Majority of FIIs, that participated in the survey, appreciated the quick turnaround time shown by the regulator for their queries and the current trade and settlement process.