P-note unwinding pummels markets

Sensex plunges to its lowest level in 5 months.

The ghost of participatory notes (P-notes) has returned to haunt Indian stock markets. Spooked by a possible government crackdown in the wake of a recent controversy over black money, some investors are offloading their equity holdings, say leading stockbrokers.


According to data from the Securities & Exchange Board of India (Sebi), foreign institutional investors (FIIs) have already sold equity worth Rs 4,837 crore from the beginning of this year up to January 27. Brokerage firms dealing with large institutions say most of this is off-loading P-note positions.

As a result of the sell-off, the Bombay Stock Exchange Sensex fell to its lowest level in nearly five months on Friday. The 30-stock index, which opened at 18,708.62, closed at 18,395.97, down 1.54 per cent, or 288.46 points. It fell to as low as 18,235.45 during the day, but recouped some losses on short covering. The BSE Sensex has shed more than 10 per cent this month so far.

At the National Stock Exchange, the broader 50-stock S&P CNX Nifty ended below the 5,600-level on Friday. It lost 92.15 points, or 1.64 per cent, to close at 5,512.15. The index closed below its 200-day moving average of 5,621 — considered an important technical level — for the second straight day.

Moreover, index counters, including Reliance Industries, DLF, Jaiprakash Associates, Reliance Capital and Reliance Infrastructure, where P-note positions are considered to be high are all trading near their annual lows.

“P-note holders and ETFs (exchange-traded funds) are on a selling spree. In fact, the fall was sharp in the past couple of days as stop-losses of this class of investors seem to have been triggered,” said Deven Choksey, managing director of Mumbai-based K R Choksey Shares & Securities.

In a clear attempt to reassure markets, a senior finance ministry official told Business Standard on Friday that the market fall over the last few days was due more to nervousness than anything else. He pointed out that the nervousness was on account of inflation and a “few other concerns”.

This “nervousness is not warranted”, stressed the official. On the likely inflation scenario in coming months, however, another senior official from the ministry said that it was expected to go down a bit next month, but might pick up again.

P-notes are off-shore derivative contracts whose holders do not want to bring money directly into the country to avoid scrutiny. Institutions issuing these ‘hot money’ instruments are mainly registered in tax havens. Large players in this trade include Morgan Stanley, Merrill Lynch, Citigroup, Goldman Sachs and CLSA. Somewhat similar are ETFs, in which large funds mainly put their money, making it difficult to track the ultimate beneficiary.

Just over a week ago, Sebi had issued a circular asking FIIs to furnish more details and report P-note holdings with a six-month lag. The regulator had also declared 188 FIIs as non-compliant for operating as multi-class vehicles and protected cell companies, which makes it easy to camouflage the identity of the ultimate investors and encourages inflows of unaccounted for money.

This comes at a time when the government is looking into ways to bring back black money stashed abroad. However, when asked by reporters earlier this week if the government is planning to ban P-notes, Finance Minister Pranab Mukharjee refused to comment, saying any statement on the matter could impact the markets. The Supreme Court has also asked the government to disclose the names of those holding black money overseas.

The value of FII investments in the country is estimated to be around Rs 11 lakh crore. Market players say after the recent pullout of funds in January, the net equity positions of FIIs through P-notes would be at historic lows, which will be confirmed only when Sebi publishes its data next month. FIIs have to provide the regulator with P-note details every month.

P-note unwinding was also witnessed in December, when Sebi was thinking of imposing stricter reporting norms for P-note issuers. Last month, when the FII investment in country was at its peak, P-note holdings had dropped. They fell from around 13.6 per cent to 12.2 per cent of FII holdings.

P-note positions had reached 60 per cent of FII investments in 2007, after which Sebi imposed a ban on their issuance. This was revoked by incumbent Sebi Chairman C B Bhave in 2009.