Calm down, curbing P-Notes now may not see 2007-repeat in Sensex. Here's why

Stock-market experts do not expect a prolonged rout in the Indian equity markets even if the government take stern actions to curb Participatory-Notes (P-Notes) transactions. Last week, the Supreme Court had tasked the Special Investigation Team (SIT) to take measures to curb the flow of black money into the local markets using P-Notes. P-Notes are derivative instruments issued by SEBI-registered foreign institutional investors (FIIs) to overseas investors, typically hedge funds, who generally have a short-term view of the market. FIIs, on behalf of these investors, infuse funds in local equities. It isn’t easy for the regulators to identity the end-beneficiary of P-Note transactions. [caption id=“attachment_2364612” align=“alignleft” width=“380”]  Reuters[/caption] The P-Note holders, who are not registered with SEBI, tend to pull out funds at the slightest hint of trouble in local markets. Hence, the government had asked capital market regulator SEBI to take more proactive steps to track the transactions and restrict their transfer. However, the government’s plan to impose further curbs on funds routed through the P-Note channel contributed to the steep fall in local bourses on Monday, even as investors are waiting for Government’s final decision on the P-Notes issue. On Monday, the Sensex opened about 300 points lower and closed down 551 points or 1.96 percent due to investor concerns that the government may take steps to close the flow of money through P-Notes and also because of the sell-off in Chinese stock market. That was the biggest single-day fall percentage-wise since June 2. No cause for panic Most experts Firstpost spoke to said though there could be some knee-jerk reaction in the near term, the issue is unlikely to result in any prolonged fall or panic-situation. “We won’t see any sharp correction in the markets, although some initial knee-jerk reaction cannot be ruled out. Firstly, the developments are in the proposal stage and investors this time would rather wait for the decision before taking any call,” said G Chokkalingam, founder & managing director, Equinomics Research & Advisory pvt Ltd. “Also, the government will not take any such measures that would hurt the investment climate which is already fragile. Taking into account India’s dependence on foreign fund inflows, the government will not take any such steps that would trigger fund outflows,” Chokkalingam said. But, if the chunk of funds being pulled out by FIIs is huge in the event of further action on P-Note holders, this will have a huge impact on the currency markets and lead to further depreciation in the rupee against the dollar, Chokkalingam said. This isn’t the first time the P-Note issue contributing to market fall. In October 2007, when the government had put out a discussion paper that proposed to curb P-note issuances. The move had resulted in a market crash. India’s benchmark equity index, Sensex, had tanked nearly 9 percent in a single session on 17 October 2007. “Any measure to check black money is a step in the right direction, hence the markets may not react sharply to this (in the long term)," said Deven Choksey, Managing Director at K R Choksey Securities. “The government is looking to address unaccounted trades that have resulted in rise in black money flows over a period of time. Already, we have seen flows via P-Note coming down in the past 5-6 years as the previous government too, had made it amply clear that the end beneficiary of P-Notes should be identified,” Choksey said. The value of P-Notes, as percentage of total assets held by foreign portfolio investors, has declined in the past few years, partly due to the government’s rising vigilance over the end-beneficiary of the P-Note holder. The value of P-Note holding over the foreign investors’ total assets was the highest in June 2007, accounting for 55.7 percent of total investor assets (Rs 659,570 crore), going by SEBI data. The proportion fell to its lowest levels in April 2014, at 10.3 percent of total foreign investor assets. In June, 2015, the total value of P-Notes with underlying Indian securities stood at Rs 275,436 crore, constituting 11.5 percent of the total assets (at Rs 23,86,457 crore) held by foreign portfolio investors. (Data support from Kishor Kadam)