Just why PNs attract such strong views

The S.S. Tarapore Committee has drawn a 5-year roadmap for capital account convertibility with wide ranging suggestions and recommendations. However, the issue of Participatory Notes (PNs) seems to have once again attracted strong views and two of the six members have recorded dissent notes.

The main report says that global integration of capital markets require tax policies to be harmonised and discriminatory tax treaties eliminated. One of the recommendations in this direction is to prohibit Foreign Institutional Investors (FIIs) from raising fresh money through Participatory notes (PNs) and to phase out existing PNs within a year by providing them with an exit route. This is consistent with the Reserve Bank of India's (RBI) long-held view on PNs.

Dissenting Member A.V. Rajwade has said that the PN issue has already been extensively debated by the Lahiri Committee. But it must be remembered that the RBI had also recorded a dissent to Lahiri committee's recommendations. Moreover, the Lahiri committee, which was mandated to check the "Vulnerability of Capital Markets to Speculative Flows", had also recommended setting up another "Special group to study measures to contain large volatility in FII flows" and on-going research on the subject.

What exactly are PNs, and why do they attract such strong reactions from people? The Lahiri committee described PNs as akin to 'contract notes issued against an underlying security, usually to investors that are not otherwise eligible to invest in India'. The problem, as this definition suggests, is that they are not a direct and transparent investment and can sidestep the stringent Know Your Customer (KYC) rules that are required to be followed by Indian investors in the domestic markets.

We know nothing about the beneficial owners of PNs, the quality of their money, their motivations and investment horizon; and this raises fears and concerns about their potential to influence specific stock prices or destabilise the market. Most of all, investment through PNs creates an unequal playing field between Indian and overseas investors in terms of disclosure, identification and transparency.

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