A huge amount of $12 billion has already come to India as foreign institutional investment — normally considered as hot money. But unlike 2007 when the country witnessed huge FII inflows, this time the government and the regulators won’t be worried as the share of participatory notes has fallen steeply.

In January 2008, as much as 38.6 per cent of the money pumped in by foreign institutional investors (FIIs) came as PNs, as per Securities and Exchange Board India figures. This means Rs 330,704 crore out of Rs 856,689 crore assets under the management of FIIs was unregulated hot money.

However, by August 2009, the situation has changed even after the Sebi lifted the curbs on PN investments. Only 15.5 per cent of the total FII investment — Rs 110,293 crore out of Rs 710,792 crore managed by FIIs — came as PNs, thanks to the Sebi decision to encourage foreign investors to register directly with the regulator, bring more transparency on the FII investment front and unwinding of PN exposure.

PNs — classified under offshore derivative instruments — are issued by Sebi-registered FIIs to their overseas investors, who wish to invest in the Indian stock markets without registering themselves with Sebi. Under this system, FIIs route their purchases of shares through brokers and then issue PNs to their overseas clients which indicate the underlying stocks. Foreign clients get dividends or capital gains collected from the underlying securities.

The biggest problem with PNs is their opacity in an era of transparency. Indian regulators don’t have any idea about the source of funds and the identity of foreign investors putting money in PNs. On the other hand, Indian investors have to disclose the full details about their funds and identity while putting funds in the market. So there’s no level playing field. There’s also a fear that PNs bring in hot money which comes into the country suddenly and exits at the same speed.

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