India -- Some Graphs

Chronicle of a Capital Control Foretold?

In India today, there seems to be a cloak-and-dagger game at hand between the export lobby (“real” economy) and the financial markets (“monetary” economy) – in so far as capital controls are concerned. The appreciation of the rupee against the USD has threatened to bite seriously into the profits of the Indian exporters. This is particularly true of the small manufacturers, as it is, compete tooth and nail with the Chinese, Malays etc., in the manufacturing sector. Predictably, this interest group wants the government to “do” something to stem the dollar slide. Predictably, a throwback to the eras gone by, one hamhanded response has been to force FIIs to register with the SEBI – this is an old Indian (bureaucratic?) trick. If in doubt, drown them in paperwork. Given the obvious daftness of this effort to control global capital surges and retreats, the next best thing seems to be issue “capital controls”. i.e., devise mechanisms by which FIIs can participate in the Indian equity markets only through very limited, thus rationed (thus corrupt) schemes.

The financial markets are very much against this – and they claim that capital controls is completely the wrong way to go. The rupee appreciation is a reflection of the increased exporting strength of India – and the appreciation is a self-correcting way to correct for emerging imbalances. No doubt, the appreciation affects the Indian exporter – but profit and loss in an industry is hardly the place for governments to intervene. Further, the Indian exporter is hardly the constituency that needs to be salvaged by government programs like NREGA. On the contrary, the government must create programs/schemes to incentivise productivity improving mechanisms. Exchange rate appreciation is perhaps a blessing in form a curse – at least in parts. The government should use this "faith" imposed by global financial markets -- to make radical changes.

All this said, the Indian government is on a back-foot (note, cricketing term!) and after the nuclear debacle and the Communist party’s rhetoric about alternative “development paths” – one shouldn’t be surprised against imposition of moderate to weak capital controls over the next two months. In essence, prepare for a convulsive fortnight in the equity markets, take your profits and hit the mattresses.

An excellent interview with Dr. Ajay Shah here.
(There might be an advertisement early on.)

Participatory Notes... an Introduction.

Yesterday, the Indian equity markets had a over 7% decline. The ostenible reason has that the SEBI (Securities and Exchange Board of India) issued a recommendation (position paper) to the Finance Ministry that Foreign Institutional/semi-Institutional Investors, or their sub-accounts, shouldn't be allowed to issue participatory notes where (a) derivatives are the underlying (b) the notional value of the participatory note is greater than 40% of assets under custody. It is useful to recap what participatory notes are in this context. (From the Hindu Business Line)

Participatory notes are like contract notes. These are issued by FIIs to
entities that want to invest in the Indian stock market but do not want to
register themselves with the SEBI. FIIs registered with the SEBI and their
sub-accounts can issue, deal, or hold P-Notes. The underlying security against
these notes would be listed or proposed-to-be-listed securities on any Indian
stock exchange. FIIs issue these notes to investors abroad with details of
scrips that can be bought and expected returns over specific periods of time. If
the client agrees, they deposit the funds with the overseas branch of the FII.
Then, the Indian arm of the FII proceeds with the transaction, buying the
scrips in the Indian market and settling it on its own account. The details of
the ultimate investor are not revealed at all in the Indian market or to the
SEBI. The SEBI rule, however, says that P-Notes can be issued only to
regulated entities (in any country). Further transfer of these can also be made
only to other regulated entities. FIIs are not allowed to issue P-Notes to
Indian nationals, persons of Indian origin or overseas corporate bodies (which
are majority owned or controlled by NRIs). This is done to ensure that the P-Note route is not used for money laundering purposes. FIIs are required to
report to the SEBI on a monthly basis if they issue, renew, cancel, or redeem
P-Notes. The SEBI also seeks some quarterly reports about investing in
P-Notes.

It is unclear whether re-routing of laundered money is that big a concern to warrant this move? According to Arun Kejriwal, it is! and as per Tushar Poddar of Goldman Sachs (India Views, October 17 2007. Available at https://portal.gs.com/), it is not.