Communists want foreign investor notes banned

Posted 10 20 2007 12:37AM

NEW DELHI (Reuters) - India's main communist party, which props up the ruling coalition, urged the government on Friday to curb foreign fund flows into shares by banning a particular type of investment tool to avoid a market bubble.

India's stock market watchdog, the Securities and Exchange Board of India (SEBI), on Tuesday proposed urgent curbs on the flow of funds into shares through participatory notes, which unregistered investors use to gain exposure to Indian assets.

The finance minister says the aim is to moderate high capital inflows, which have pumped up the stock market and pushed up the rupee, but not ban the notes completely.

The plan raised fears foreigners would pull out their cash. The benchmark stock index, which had surged more than 20 percent in a four-week record-setting run, has shed nearly 8 percent since the announcement.

The communists, who recently pushed the government to the brink of collapse over a historic nuclear deal with the United States, said recent volatility in the stock market was a cause for serious concern.

"The Communist Party of India (Marxist) is of the firm opinion that participatory notes should be prohibited, as has been recommended by the Reserve Bank of India," it said.

"DONE DEAL"

SEBI meets on Oct. 25 to discuss the issue and a board member said on Friday it had been receiving feedback on its plan. The proposals call for notes issued to foreigners as surrogates for equity derivatives to be phased out over 18 months and for limits on the amount of notes written on underlying cash positions.

P-notes have provoked controversy in the past without action being taken, but Finance Minister Palaniappan Chidambaram said this week the restrictions would go ahead.

"There might be a thing or two that changes, but it's more or less a done deal," said one chief dealer at a foreign bank who declined to be named.

Chidambaram told a U.S. audience on Thursday the 18-month timeframe could be extended if need be. A chief trader at another bank said the communists' call would make any concessions more tricky, but an outright ban was unlikely.

"It's not that P-notes will be banned totally, though it may become more and more difficult for the government to dilute what has been suggested in the proposed paper," the trader said.

At their peak on Tuesday, portfolio inflows had neared $18 billion for the year to date, well above a record $10.7 billion in the whole of 2005.

Data showed foreign funds were net sellers of $440 million worth of shares on Wednesday, but bought $31 million on Thursday.

Some analysts reckon as much as $10 billion of this year's inflow may have come through the notes and part of the motivation for the move was to curb short-term money from investors such as hedge funds and increase transparency on where funds are from.

The flows have also pushed the rupee to its highest in 9-1/2 years against the dollar, complicating monetary policy.

Rupa Rege Nitsure, chief economist at Bank of Baroda, said even if P-notes were scrapped it may not help policy makers much.

"If they ban P-notes, the effect will be minimal because India is attracting a lot of money through the foreign direct investment route," she said.