Not another quota raj

India has limits on FII (or foreign institutional investor) ownership of a company, implemented in a sensible way. The total ownership by all FIIs of a company is tracked. When the limit is reached, all FII purchase ceases. Sales naturally continue to take place, thus bringing the level back below the ceiling. This is a sensible and non-intrusive way of implementing a limit. The superiority of India's FII framework is particularly obvious when compared with China's "QFII" framework, where each FII negotiates a dollar limit with the Chinese authorities. There is a strong international consensus that India has built a superior equity market, and a superior framework for capital inflows into the equity market, when compared with China.

However, such good sense is conspicuously absent in the Securities and Exchange Board of India's (Sebi's) thinking about debt flows. There is now an overall limit of $2 billion for government bonds and $1.5 billion for corporate bonds. The economic logic of these limits is dubious, though the worry must be about levels of international exposure. Going beyond that, Sebi wants to define a "100 per cent debt FII" as opposed to a "70-30 FII", who only invests up to 30 per cent of its assets in debt. There is no reason for the government or regulator to classify fund managers in this fashion. The sensible thing for public policy is to treat every fund manager as someone who wants to maximise returns and minimise risk, and not get involved in the portfolio choices of fund managers.

Then, Sebi has come up with a bureaucratic allocation of the $2 billion limit for central government bonds: the "100 per cent debt FIIs" get $1.75 billion and the "70:30 debt FIIs" get $0.25 billion. Similarly, in the case of corporate debt, Sebi's bureaucratic allocation is $1.35 billion (out of the total of $1.5 billion) for the "100 per cent debt FIIs". Such quota mongering is a throwback to the age when the government lorded over the allocation of scarce steel. But it gets worse. Sebi has "equitably" allocated limits to individual firms! FIIs apply to Sebi for a quota, and Sebi hands out quotas on an "equitable" basis. Then Sebi will keep a watch on whether the FII is using this limit.

This adds up to manifest over-extension of the state, unrelated to Sebi's core task""which is regulation and supervision of the securities markets. But India's bureaucracies can't seem to break out of the licence-quota mindset. This only serves to underline why rupee convertibility is important. Such thinking at Sebi, which is supposedly a modern agency that interacts with modern securities markets, shows that the flame of the licence-permit raj burns bright even after 20 years of economic reforms.

The concept of a "100 per cent debt FII" as opposed to a "70-30 FII" must be abolished. All FIIs must be treated as financial investors, who will make choices between debt and equity securities based on their requirements and views. As in the case with the limit on FII ownership of a company, Sebi must monitor the aggregate ownership of all FIIs in (say) corporate bonds. When the level reaches $1.5 billion, all FIIs must be forced to stop buying until the level drops to $1 billion. This will ensure that no FII has to walk up to the Sebi office and ask for a quota.