You are here: Home » Opinion » Columns
Business Standard

Surjit S Bhalla: Ban FIIs, not P-Notes


Surjit S Bhalla  |  New Delhi 

You want to get rid of P-Notes-get rid of FIIs. Na rahae ga bans, na baje gi bansuri.
The recent controversy around the banning of P-Notes is best understood by looking at the origins. It all began in the early nineties, when the policymakers received a wake-up call regarding the state of their economy, and their socialist policies. Financial sector reforms were not considered that important (at that time); so a hesitant move was made to open up the Indian financial market""not the currency, not government securities, just the stock market.
When the policy was formulated (and here I am guessing) there must have been some bureaucrat who must have poked his finger and said: "But Sir, how shall we control this inflow of money?" To which one should have replied, "One does not 'control' a magnitude about 20 times the amount that originates within India", so why should we control a few dollars flowing in from outside? But Sir, this could be money sent in by Indians abroad, and they should not be allowed to "profit" from the country that they have left. Sir, they are earning a hundred times what we earn, and if they want to profit from our market, they should come back to India and sweat like ordinary humans. This is how the extremely stupid and sui generic Indian policy of making it impossible for Indians abroad (NRIs) to invest directly in the Indian stock market (most likely) originated.
But what about (and now I will be politically incorrect but the message becomes clearer) the white folks wanting to invest in India? After all, we have to open up our markets a little bit, and the foreign investors might also help our balance of payments position. Good point, but let us not get any "bad money" in. But what is bad money? You don't know, how can you be so naïve? Bad money is what it means""money owned by bad people who are up to bad things, and bad thoughts. Drug money, gambling money, money not owned by widows and orphans. Remember BCCI? If you think the failed bank in England (of course Indian banks never fail, especially banks owned by the bureaucrats) or you think the Board of Control for Cricket in India, you are right on both counts, says the tough-minded, upright and right-thinking bureaucrat. But Sir, how do we separate bad money from good? I'll tell you how (and this is how the foreign institutional investor (FII) policy in India originated.
Here is how. We will set up a control room in the office of our securities regulator. All money coming into India not only will be regulated, but also licensed. Why licensed? So that we can control it better, and thereby serve the poor domestic investor more. And who can obtain the licence? Well, whoever we decide and on whatever basis, and moreover, what goes of your father? After all, we are keeping the system clean, aren't we? [By the way, only in India do people believe that they can separate "bad" money from "good" money, whatever either means.]
But what about the fact that by instituting the institution of FII, you will forego any employment gains, and corporate profits, that emanate from a firm based in India? [Recall that an FII, by definition, cannot be based in India, even though its only raison d'etre is to buy and sell Indian stocks!] Sorry, says our top bureaucrat, I did not think of that, but the lost tax revenues will help the poor in Africa. Think of it as Indian foreign aid.
This is how our monster FII policy was born. And like all ill-thought-out policies, it has had the most predicted consequence: it has created a powerful lobby which wants to perpetuate it even though the world, capital flows, the environment, and India have all changed drastically. This lobby consists of the major (mostly white) investment banks in the world. The fact that bad money, however defined, is just as likely (if not more likely) to come via these banks is irrelevant for the three Shakespearean witches residing in Sebi, the MoF, and the RBI. The investment banks gain a large amount of "rent" from their operations. In order to invest in India, you have to pay a hefty fee to these banks for the privilege of investing in India. This operation is so profitable that Indian banks/securities firms have also set up shop overseas to derive this rent.
Let me explain the absurdity of the situation. A Mumbai-based Indian bank invests in the Indian stock market; then wakes up one morning to set up an investment bank overseas to invest in the Indian market domestically. It then applies to Sebi for the privilege to invest in the Indian stock market. [Absurd enough for you?] If this same money originated in India (like yours and mine) we do not need any permission; nor should we. So once this Indian foreign firm has obtained the licence, and makes the promised abnormal profits, it walks over to the other side in lobbying for a continuation of the FII policy. And it pays corporate taxes to the needier US government rather than to the rich Indian government.
What if you don't want to pay the hefty fee to the poor poor white investment bank? You have three options""you can go fly a kite, invest anywhere else in the world, or buy P-Notes. But who issues P-Notes? Why, your favourite investment banks, of course. The Kafkaan three witches circle is complete.
Some investors prefer (for tax and other legitimate reasons) to open a sub-account with an FII investment bank; others prefer P-Notes. Some of the players are pension funds, others are hedge funds. In today's world, there is literally no difference between the attitudes, or good money/bad money, or professionalism, or anything between these major players. So why should P-Note players, or foreign-based individuals, or foreign-based firms, or foreign-based pension funds, or your foreign-based sister be banned from investing directly in the Indian market?
Investors should be regulated, not licensed. There are enough mechanisms available to regulate financial markets and protect investors. It bears emphasis that the institution of P-Notes arises because of the licence-permit-raj FII policy. You want to get rid of P-Notes""get rid of FIIs. Na rahae ga bans, na baje gi bansuri.

Dear Reader,

Business Standard has always strived hard to provide up-to-date information and commentary on developments that are of interest to you and have wider political and economic implications for the country and the world. Your encouragement and constant feedback on how to improve our offering have only made our resolve and commitment to these ideals stronger. Even during these difficult times arising out of Covid-19, we continue to remain committed to keeping you informed and updated with credible news, authoritative views and incisive commentary on topical issues of relevance.
We, however, have a request.

As we battle the economic impact of the pandemic, we need your support even more, so that we can continue to offer you more quality content. Our subscription model has seen an encouraging response from many of you, who have subscribed to our online content. More subscription to our online content can only help us achieve the goals of offering you even better and more relevant content. We believe in free, fair and credible journalism. Your support through more subscriptions can help us practise the journalism to which we are committed.

Support quality journalism and subscribe to Business Standard.

Digital Editor

First Published: Sat, September 09 2006. 00:00 IST