P-Note Investments at All-Time Low in April Share of PNs in total FII investments slumps to 7.9% despite the govt’s assurance on taxation

ANOTHER KNOCKOUT PUNCH TO ECONOMY

 Foreign investors taking exposure to Indian stocks through participatory notes (PNs) have pared their positions. The government's clarification that it would not tax PN holders did little to boost the prospects of these offshore derivatives in April. 

The share of p-notes in total investments by foreign institutional investors (FIIs) in April was at 7.9% — the lowest monthly reading in seven years — according to the Securities and Exchange Board of India (Sebi) figures. This data was not publicly available before September 2003. 

PNs are notes issued by foreign funds and brokers to offshore investors who do not access the Indian market directly. The investment is made on their behalf by FIIs registered with Sebi. 

The value of participatory notes as a percentage of FIIs' stock and debt investments was 10.4% in March and 11.5% in February. It was as high as 50% in August and September, 2007, the peak of the bull run that year. 

"It was widely perceived that if FIIs have to pay tax as per GAAR (General Anti-Avoidance Rule), then they will pass it on to PN holders. So, the general assurance that PN holders will not be taxed did not turn out to be very convincing," said Shefali Goradia, partner at BMR & Associates, a law firm that advises on tax and regulatory matters. 

While most foreign brokers have stopped issuing PNs to clients, hazy prospects are forcing many FIIs to stay away from Indian equities. "Most hedge funds, which are among the biggest users of participatory business, have of late, significantly reduced investing in India because of the uncertainty around market conditions," said Vikas Khemani, president, Edelweiss Securities. 

Jolted Government Swings into Action 

As economists and analysts took the knife to their growth forecasts amid criticism of the UPA for its stewardship of the economy, key government functionaries from the prime minister downwards sought to project an impression they were mindful of these concerns and would act, reports Our Bureau from New Delhi.

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•7 Many FIIs Stop Betting Through PNs 

FIIs pulled out . 4,896.60 crore in Indian equities and debt in Aprilx , after pouring in over . 53,500 in the first three months of 2012. 

Many FIIs are holding on to their existing PN positions under a year to avail tax benefits. "Some of the existing p-note positions might be short-term loss-making holdings and the issuers need not be in a hurry to sell these positions because even under GAAR provisions, no tax would be payable on losses. Moreover, such losses can be used to offset potential short-term gains," said UR Bhat, managing director, Dalton Capital India. 

Lawyers said many FIIs, which had burnt their fingers in the stock market crash in 2008, have stopped betting on Indian stocks through PNs since then because of 'systemic risks'. 

"Many FIIs are wary of the 'counterparty risk' as they are still not certain about the health of many financial institutions if another crisis breaks out. It makes sense for them to come to India directly," said a securities lawyer that advises FIIs. If the PN-issuing broker is unable to conform to the terms of the instrument, it is known as counterparty risk.