Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

More on Capital Account Convertibility 2.0

Sandeep Parekh tells me that my posting
yesterday is not quite clear. So let me restate my views differently.

  • I think we should move towards capital account convertibility much
    faster and much more boldly than the CAC 2.0 report suggests. A freely
    convertible currency by 2010 should be the goal.
  • I believe that it is impossible to ban Participatory Notes (PNs)
    when portfolio investment is opened up to non institutional
    investors. This is because:

    • The PN is traded between foreigners outside India
    • If neither party to the PN is an FII, then the PN does not involve
      any party who is regulated by or registered with an Indian
      regulator. Compliance with a KYC norm is not the same as acceptance of
      regulatory jurisdiction.
    • The PN is a cash settled OTC derivative that does not require any
      money or securities to change hands in India.
    • Even if for a moment one can think up a legal theory that creates
      jurisdiction, it is infeasible to exercise such jurisdiction. It is
      one thing to threaten to prosecute 500 FIIs. It is another thing to do
      that with 50,000 non institutional investors who do not even have a
      home country regulator.
  • In an FII oriented regime where only a select few can invest
    in India, the regulation of PNs serves to prevent others from getting
    a back door entry. In the proposed regime where any body can come in
    through the
    front door, I do not understand why the government should go to great
    lengths to
    prevent anybody trying the back door. The whole debate about PNs makes
    sense only if the FII regime continues. The moment that is diluted,
    the case against PNs vanishes.
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