Budget 2023: What does the announcement related to P-notes indicate?

Clearly, the govt is worried about inflows in 2022 because of the global economic uncertainty and has decided to encourage inflows via any means possible, PNs included

Amidst the shock of the Adani downfall and the schadenfreude of the deflation of the Adani businesses, an important bit of the Budget for 2023-24 has received inadequate attention, especially from the political parties. This is the announcement regarding participatory notes, more commonly known as P-notes or PNs.

P-notes are a unique Indian financial instrument that allow investors to invest money in the Indian stock market anonymously. Foreign institutional investors issue these notes to persons wishing to invest in India but not wishing to become known to the authorities. They are a boon to Indian tax evaders, over invoices and other dishonest persons.

The Budget announcement says, "In order to remove the double taxation, it is proposed to amend clause (4E) of Section 10 of the Act, to also provide exemption to any income distributed on the offshore derivative instruments, entered into with an offshore banking unit of an IFSC."

So now GIFT-City (Ahmedabad) based foreign banks will also be allowed to issue P-notes, and the government will also allow FPIs to bring down tax outgo to nearly zero.

To put things in perspective, PN investments in Indian markets — equity, debt, and hybrid securities — stood at Rs 96,292 crore at the end of December. Rs 86,351 crore was invested in equities, and Rs 9,855 crore in debt. These amounts could now double or triple, depending on the medium-term fallout of le affaire Adani. It is worth recalling that PN-linked investments were once around Rs 4 trillion. But SEBI banned them completely in the derivatives segment and restricted their use.

The Budget announcement will drop taxes on FPIs to almost zero because, ha! GIFT City has no long- or short-term capital gains tax! In short, it’s that old Johnny Walker song “Sir jo tera chakaraaye, ya dil dooba jaaye, aaja pyare paas hamaare, kaahe ghabaraay.”

Defenders of the new announcement say there will be more checks and balances. This remains to be seen because Indian regulatory practice consists of the old colonial rule: show me the man, and I will show you the rule.

Indignation aside, practical people cite an older aphorism: if you can't beat them, use them. So don't cloak policies in a moral garb. It's the money you want, not a halo of piety. This is what those two great hypocrites of global finance, the US and the UK do.

The problem in India is we don't know how much of the money that comes in via PNs is round-tripping Indian money and how much is something else. Indeed we can't even begin to hazard a guess.

A bigger problem is that it must first go out for money to come back. So how does it go out? In the old days, before electronic money, it went out physically. But now the preferred way is the over-invoicing of imports and under-invoicing of exports.

This is an important reason for the huge growth in trade with China, whose business practices are very opaque. That's why we get along with them so splendidly commercially.

In the final analysis, however, it's a tradeoff that all governments have to make between taxes forgone and benefits gained by turning a blind eye to dodgy business practices that enhance the inflow of foreign money. Clearly, the government is worried about inflows in 2022 because of the global economic uncertainty and has decided to encourage inflows via any means possible, PNs included.

Or, as the great sage of China said, as long as it catches the mice, the colour of the cat doesn't matter.