Use of participatory notes or problematic notes as a source of foreign funds (A study in the Context of Indian Equity Market)

This paper focuses on the use of participatory notes (PNs) by foreign investors, as a conduit for portfolio flows into Indian equity markets for more than a decade. The broadening of India’s foreign investor base, in recent years, has a bias towards hedge funds/unregistered foreign investors who invest primarily via PNs. While tax arbitrage via capital gains tax has almost disappeared since July 2004, it is intriguing to note that since then the demand for PNs has actually increased. Today foreign investors find Indian market as very attractive destination for their investment, but don’t want to disclose their identity due to many justified or unjustified reasons. These so-called unjustified reasons for using the p-notes are becoming a big reason for the tussle between the different market regulators prominently amongst the Security Exchange Board of India (SEBI) and the Apex Bank of the country i.e. Reserve Bank of India (RBI). The paper suggests some reasons for the continuation of a buoyant market in PNs, and explains the possible impact from the recent regulatory changes.