P-Note Curbs To Help Economy In Long Term

NEW DELHI: If the surge in dollar inflows continues and there is pressure to keep rupee appreciation in check, it is expected that the government/RBI could further monitor inflows, including those into real estate, lower domestic rates to encourage inflows and propose more measures to encourage outflows, according to Citigroup.

Curbs on capital inflows have remained top policy priority. The various measures to rein in flows this year include tightening the norms for external commercial borrowings, encouraging dollar outflows and the P-note proposals.

SEBI’s approval of the draft circular on P-notes comes on the back of strong trends in capital inflows and is an attempt to temper the pace of rupee appreciation.

Following the 50 basis points cut in the Fed funds rate, forex reserves have risen by $57.5 billion during the fiscal year while portfolio flows have surged by over $15 billion. As a result, the RBI has been taking a number of measures such as encouraging outflows, as well as raising the limit of issuance of market stabilisation bonds.

The proposed P-note measures would temper the pace of portfolio investments coming into India. But, even if one excludes all the portfolio flows, it is estimated that capital flows to be more than sufficient to finance India’s current account deficit and there will still be some accretion to reserves.

Overall, though the new measures will have a short-term negative impact on the markets and currency, but it is unlikely to change the macro story. With the limited headroom available for FIIs to issue new participatory notes due to the 40% limit, return to “regulated” entities rule, as well as the time it might take for entities to get the FII registration, the new measures announced by SEBI may significantly reduce near term flows, says Citigroup.

The market currently though has been consistently rising after the Sebi announcement of these new measures. However, if these measures are followed by rapid large scale FII registration of entities currently using p-notes, it would improve disclosure and transparency in the market, which would be welcome, says Citigroup.

The September 30 date for assets under custody calculation for FIIs and return to “regulated” entities may come as a negative surprise for the market versus the proposals. Relaxation in definition of broad based funds and track record requirement for FII registration would be a positive surprise.