FROM BUSINESS WORLD OF 12 DECEMBER 2005
Unwinding consequences
On 17 May 2004, as it became clear that the Congress would
come to power, the stock market melted down. Manmohan Singh, once finance
minister and imminent Prime Minister, threatened retribution, and it came in
the form of a Sebi enquiry. That enquiry never found a culprit; but at the end
of a year, it invented one: It found UBS Securities to have sold 3 per cent – 3
per cent! – of the securities sold on 17 May 2004. Ignoring the rest who had
sold 97 per cent, Sebi homed in on UBS Securities,and accused it of having
withheld information on the investors behind the participatory notes (PNs) it
had issued, and of having given misleading information. It banned UBS for a
year.
This PN theme had a history even
then. Reserve Bank had complained that discreditable Indian citizens had
smuggled their money abroad and were reinvesting it in the Indian stock market
through PNs. Why on earth might they do such a thing? It could not be to evade
taxes. Dividends are not taxable in the hands of shareholders anyway, and
capital gains tax can be avoided as long as securities are held for a year.
No; money was not siphoned off
abroad for such a simple, economic reason; it was all about. It was promoters
that were resorting to the PN trick, so that they might hold shares in the
companies they controlled without having to disclose their identity. In other
words, PNs were benami investments in a new guise. And then it uttered under
its breath that these nameless individuals may be thieves, smugglers, racketeers
and traitors too.
These frightening allegations
spurred Sebi into action in February 2004. It would have been PNs; but if it
had, all the money invested through PNs would have had to be disinvested; that
would have caused the mother of a meltdown in the stock market. So it banned
PNs with effect from 3 February 2009.
UBS appealed against Sebi’s ban
order to Securities Appellate Tribunal (SAT), which overturned it. Sebi
appealed to Supreme Court, which upheld SAT’s order. Sebi has nowhere further
to go; and its reverses must make it think twice. Sebi believes a foreign
investor it allows into the Indian market – otherwise known as Foreign
Institutional Investor (FII) – must “know his client”. But the FII may have
received an order from another institution, which may be passing on an order
from another institution, and so on; how many layers of investors must an FII
have information on before it can invest the money in India? And how is it to
ensure that the information its clients have given is correct and reliable –
not “misleading” as Sebi would term it? The rest of the world does not go in
for this kind of rigmarole; other regulators only require the investing
institution to know its proximate client, and not go beyond him to his clients.
India is not only unrealistic, but is uniquely unrealistic.
Now a committee chaired by the
Chief Economic Advisor, Ashok Lahiri (the second one he chaired on this subject
– the first one reported in June 2004) is deliberating the issues. Reserve Bank
has told it that it wants to see an immediate ban, not just on PNs, but also on
sub-accounts. In other words, it wants foreign investment to come only from
FIIs registered with Sebi, and not from their clients. If introduced
immediately, such a regime would cause havoc in the market. Not only is the
Lahiri Committee likely to reject it, but Reserve Bank has made the
recommendation to take a stand, not to see it implemented. It has simply
prepared the ground for saying “I told you so” later when, as it expects, there
is a debacle.
The FII category was created 13
years ago because we wanted foreign portfolio investment but were not prepared
to see Arabs, Chinese and Italians in our market; we thought we would only let
respectable, pre-approved institutions come in. Now we find that there is no
way of checking who is investing through the institutions. So the government’s
instinctive response would be to tell the institutions that they may not bring
in investment from specified undesirable categories.
But this is unwise because it
will create policing requirements that no one on earth can fulfil; this is the
way to make sure that Sebi tries to do an impossible job, and to discredit it
in the process.
The government should get clear
about its objectives. If it wants to know the investor, it should throw
portfolio investment open to all, and abolish the concept of an FII. But if it wants
to stop benami investment by promoters, it should remove the reasons why they want to invest so. It should tell Sebi to abolish its pointless rationing
of share issues between promoters, qualified institution investors, personal
investors and so on. The solution either way lies in less, not in more
regulation.
