Of tax havens and P-notes

It is certainly difficult to spin a racy tome out of such dry subjects as participatory notes, foreign exchange management and the convoluted workings of international tax treaties. That's probably why Chartered Accountant M.R Venkatesh, when penning this book christened it “Sense, Sensex and Sentiments”, tagging on the provocative subtitle - “The Failure of India's Financial Sentinels”.

Despite its title, this is not a book about the behavioural quirks of the Indian stock market. Nor does it reveal secrets that indict Indian regulators. Instead, much of this book is devoted to chronicling how offshore tax havens provide a convenient parking ground for the large pool of black money from India and how FII investments into Indian stocks through the Participatory Note (PN) route, may allow such illicit funds to round-trip back into the country. Such flows, the author argues, create multiple evils. First, flight of capital deprives the country of funds that could be deployed in developmental work. The money leaving the shores may be diverted to drug-dealing, criminal or even terrorist activities. And finally, if it returns masquerading as volatile “FII'' flows, the same money could destabilise financial markets, trigger wild swings in the Sensex and create huge forex management problems for the RBI.

Battle with PNs

The key takeaways for readers from this book lie in its candid account of controversial subjects — global laws on money laundering, the working of tax treaties, the hawala route and how the wealthy subvert international Know-Your-Client laws. Largely free of legalese, the book juicy anecdotes to keep the reader going.

The highlight is the painstaking account of unequal battle that Indian regulators have waged over the years with FIIs such as Goldman Sachs and UBS in their efforts to identify the anonymous investors who invest using PNs to funnel money into Indian stocks. It is clear that regulators have not managed to enforce even a reasonable degree of accountability on FIIs that issue PNs despite this. That PN-routed FII flows have survived, despite the dangers flagged by a Joint Parliamentary Committee (as far back as 2001) and later the Reserve Bank of India and the Securities and Exchange Board of India, are disturbing too. So is the discomfiting trend of SEBI's punitive actions being frequently overturned on appeal or being settled through consent orders.

The regulators did act

However, none of the above instances provides the justification to dub India's financial regulators as ‘failures', as the book repeatedly does. After all, it is globally acknowledged that it was RBI's extreme conservatism on capital flows and interest rates that kept India's financial markets relatively insulated from the US credit crisis. And SEBI did take the very unpopular step of imposing a salutary ban on PNs in October 2007; only to be forced to revoke it in October 2008 as the liquidity crisis threatened to choke off capital flows to industry.

The tendency of the author to launch scathing attacks on various ‘adversaries', without giving credit where it is due could give readers the impression that the book is not balanced.. Sample this from Chapter 6: “SEBI has been vested with enormous regulatory powers….Yet when it comes to direct action, SEBI invariably acts like a frightened fawn caught in front of dazzling headlights on a highway.” This, in a chapter where many pages are devoted to SEBI's persistent attempts at nailing large FIIs, even as its wings were clipped at every turn by the Courts or the Securities Appellate Tribunal.

Flimsy evidence

The book also supports some of its claims with statements drawn from political rhetoric, public speeches or even plain rumours. Take the part which asserts that “Indian markets resemble a rigged casino”. The sum and substance of this chapter is that market commentators in the electronic media have a ‘sinister' motive in ‘talking' the markets up and down. The evidence? “It is rumoured that these market experts have positions in the market running into several hundred crores of rupees at any given point in time”. In a similar vein, is the conclusion that “rise and fall in commodity prices in recent years has nothing to do with demand and supply”. Instead, the blame is laid at the doors of media ‘hype' about monsoon failure and ‘hoarding' by the government in the form of its foodgrains buffer stock.

While the book does a thorough job of highlighting the perils of globalisation and volatile capital flows, one feels that it could have added more value to readers had it also offered solutions.In the final page devoted to ‘What needs to be done', the author has only this to say: “Obviously it is a terrible mess out there. The government must act and act forthwith… One way is that the Supreme Court intervenes in this matter and ensures a comprehensive probe into these issues by constituting a committee of experts with proven track record”. Further, “SEBI and RBI must be asked to get to the root of the PN conundrum. We need to ensure that all PN holders are appropriately identified and only genuine PN investors are allowed to take money out of India”. Incidentally, this is exactly what the regulators have been trying to do.

In any case, PNs as a means of routing money into the Indian markets seem to be losing favour. PNs accounted for as much as 55 per cent of the FII assets by value, in mid-2007. However, this proportion has since steadily declined to 15 per cent now. This suggests that Indian regulators surely, have been doing something right, in their battle against volatile capital flows.