The obsession with ‘how much’ is even more dangerous, because it can not only make unrealistic assumptions about size, but may impose limits that are arbitrary. Consider the numbers in the SEBI consultative document. The notional value of PNs outstanding was at Rs 31,875 crore (20 per cent of assets under custody, AUC) in March 2004. It has grown to Rs 3,53,484 crore (51.6 per cent of AUC) by August 2007. The proposal is to limit the issuance of PNs to 40 per cent of AUC. If 51 per cent is undesirable, and 20 per cent could be tolerated for three years since 2004, what makes 40 per cent optimal? What if there are other ODIs, which the regulator’s limits provide the incentive to create? What is the assumption about growth in AUC? In the last three years, AUC has grown by 23 per cent compounded per annum. Does the 40 per cent limit have an assumption on this number as well? The concern seems to be about the ‘copious’ forex flows that the FIIs have brought in. If AUC grows at a higher clip, given the much discussed attractiveness of India, won’t inflows still be copious, despite the 40 per cent cap? The ‘how much’ in this debate is actually not even about stock markets, derivatives or its ability to deal with these instruments or their volumes. It is about the pressures this brings on the exchange rate and the RBI, given our capital controls regime. What would a quantitative restriction do, when the real problem is about a central bank still unprepared for global flows?

... contd.