Participatory investment

For months now, a debate has been going on about the merits of an instrument called a Participatory Note (PN). Basically, this is a way for foreign investors who are not registered in India under the institutional investor category to buy into Indian stock markets. Such an overseas investor would place a sum of money with the registered institution, which in turn would pool it with all other funds to be invested in the Indian market. In principle, this is pretty much what a mutual fund does, so why should anybody be concerned about the arrangement, particularly since it seems to broaden access to investors who may not have come here otherwise? The main reason for the concern is the anonymity that the PN offers the investor.

The Reserve Bank of India (RBI) has been of the view that PNs should be prohibited. It perceives the situation from the viewpoint of volatility""unstable equity markets translating into significant foreign exchange outflows and, consequently, instability in the exchange rate. In essence, it believes that anonymity is a cover behind which various kinds of undesirable investors can hide. There is the issue of illegal money of course, but, from the perspective of monetary management, such investors are more likely to be the fickle, fly-by-night variety, who will take their money and run at the slightest provocation. It is better, contends the RBI, to constrain access to the Indian market to people who are willing to reveal their identities; the assumption is that such investors are more committed to long-term gains and less flighty in their behaviour. These concerns have been expressed in a note of dissent appended to the report of the Expert Group chaired by the chief economic advisor, Ashok Lahiri, which looked into the broad issue of the vulnerability of the capital market to speculative flows.

However, the majority opinion of the committee, whose report was published a couple of months ago, is against this drastic measure. It believes that the advantages of broadening access to the Indian market through such instruments outweigh the threats. And, under the circumstances, this is an eminently reasonable position. First, there is no evidence to suggest a clear overlap between anonymous and fickle investors. Mere revelation of identities, then, does not guarantee against capital flight in the face of a crisis, perceived or real. Second, since the current users of PNs are in any case completely outside the jurisdiction of Indian regulators, it is unlikely that such a disclosure requirement can be enforced. If investment in India is attractive enough, ways will be found to channel money into the country. The more prominent FIIs may feel compelled to disclose identities to preserve their reputations for compliance, but this will only serve to drive investors seeking anonymity to FIIs less concerned with reputation than with revenues. Managing volatility is a legitimate objective, but the right approach to it is to create non-discriminatory incentives for investors to take a long-term view of the country. This can be partly achieved by specific financial penalties on short-term investments, as Chile did for a while. But, mostly, it requires a good investment climate. Rather than keeping certain types of investors out, the policy objective with respect to foreign investment should be to keep most, if not all, in. That means making it easier for foreign investors to buy stocks in India, to the point where they should not have to come in through the conduit of registered FIIs.