There is a sudden surge in foreign institutional investor (FII) inflows through the participatory notes (P-notes) in the last two months. P-notes are offshore derivative instruments issued by Sebi-registered FIIs to their overseas investors who wish to invest in the Indian stock markets without registering themselves with Sebi. In reply to a Parliament question,the finance ministry today revealed that the outstanding P-notes position in October 2009 is Rs 1,24,575 crore. According to Sebi,outstanding investment by August-end stood at Rs 110,355 crore. This means Rs 14,220 crore of FII inflows,or roughly a third of the total FII inflows of Rs 44,652 crore during September and October,came through the P-notes route. When contacted,a finance ministry official said,it was not a matter of concern. What we look at is total FII inflows. Investor decision to take the P-notes route is largely driven by transactional costs, he said. Under this system,FIIs route their purchases of shares through brokers and then issue P-notes to their overseas clients. The P-notes represent the underlying stocks. In P-notes,the source of funds and the identity of foreign investors putting money remain unknown. But the capital market regulator or the Securities and Exchange Board of India (Sebi) can call for such information from the registered FIIs. If Sebi figures are any indication,in September and October,Rs 44,652 crore was added to the total FII outstanding money in the Indian capital market which rose from Rs 710,792 crore at August end to Rs 755,444 crore in October. Simultaneously,the outstanding investment through P-notes shot up from Rs 110,355 crore to Rs 124,575 crore in the two-month period. The spike in P-notes has seen its share which was going down in the last one year in total FII investment rise from 15.5 per cent to 16.5 per cent. This has perplexed some market observers. In January 2008,as much as 38.6 per cent of the money pumped in by FIIs came as P-notes,but subsequently as the Sebi initiated a series of steps to bring FII investments through the front door,its share declined to 15.5 per cent by August 2009. After an outflow of $12 billion in 2008,net FII investment has crossed the $15 billion mark to $15.311 billion in 2009. Market sources say foreign investors who get only 0-1 per cent returns on their money abroad especially from countries in Europe,the US and the Far East where interest rates are at all-time low levels are diverting their funds to emerging markets for higher returns. Brazil,Taiwan and South Korea have already announced measures to curb excessive volatility in their markets with Brazil even slapping taxes on capital inflows. Finance minister Pranab Mukherjee recently said the government and the regulator were keeping a close watch on inflows and would take action if there were any distortions. So far,his ministry has ruled out any measures,stating that the present quantum of inflows did not warrant any action.
