Sunday, October 21, 2007

India seeks to limit foreign investments

Source: Asia Times: India to curb foreign funds deluge

Foreign institutional investors have focused their attention on India since India has emerged as one of the fastest growing economies in the world. For example, over the past ten months, India has received $17 billion in foreign investment. This investment is twice the amount India received in 2006.

The Securities and Exchange Board of India (SEBI) responded to the recent surge of foreign funds flowing into India and driving up the country’s stock markets and currency. The SEBI proposed policy measures that will moderate the capital inflows into India. These measures include restricting offshore derivative instruments, or participatory notes (PN), which foreign investors use to invest in the Indian stock market. Such measures would not allow foreign institutional investors to issue or renew their offshore derivative instruments and the investors must wind up their current position (issued PNs) over 18 months. In addition, sub-accounts of foreign institutional investors would not be able to issue PNs. The stock market reacted to the SEBI’s proposals. The following day, India’s Sensex index fell over 9%.

Participatory notes are “derivative instruments issued against an underlying security.” They are indirect investment instruments. Foreign investors who are not registered to trade on Indian stock markets buy PNs from foreign institutional investors who are registered in India and then use the funds to trade in India on behalf of the PN holders. They are very popular in India because the PN helps foreign investors save on transaction costs and allows the investor to remain anonymous. PNs have contributed $89 billion into the Indian stock market in the past three years.

Most foreign institutional investors do not approve of SEBI’s proposals, believing that restricting PNs will negatively impact the Indian stock market. However, Indian policy makers are not worried about these concerns. An SEBI official clarified that "All SEBI wants is non-expansion for some PN with large positions. There is no proposal to ban PNs and SEBI is looking at simplifying [foreign institutional investor] registration norms so that if foreign investors wish to register in India as [foreign institutional investors], they are most welcome."

For Discussion:
In 1997, Asia suffered a severe financial crisis. At that time there was a strong influx of foreign capital into Asian countries which drove up the prices in the stock market, land, and other parts of the Asian economy. With foreign investment now at an all-time high in India and other Asian countries, will there be a new 2007 or 2008 severe financial crisis in Asia as the stock market and real estate reach new highs? Can India sustain its rapid economic growth?

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