India’s stock market – a hotbed for hot money?

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The BBC had an excellent article on India's currently highly volatile stock market last week. It's worth reading in full, but some things stood out. Take this:

Over the past two months, India's stock exchanges have been witnessing an unprecedented bull run. Much of this boom has been fuelled by foreign investors who have pumped in more than $4.5bn in Indian blue-chip stocks over the last fortnight alone. This year, net inflows by foreign portfolio investors have exceeded $17.5bn.

This is despite:

Indians [being] parsimonious - roughly a third of the country's GDP is saved and invested. The overwhelming majority of Indians prefer to keep their savings in bank deposits and in post offices, even if such deposits attract relatively low rates of interest. Barely five per cent of Indians have any part of their savings in shares, including mutual funds.

Yet, for many middle-class people, the share markets are perceived as gambling dens where prices are manipulated by speculators.

This inevitably gives rise to question as to the source of much of the money flowing in:

In recent years, over half of the foreign funds that have come to India have been through "participatory notes" or PNs.

The "advantage" derived by users of PNs is that they can be individuals or firms who are not legally entitled to buy or sell shares in Indian stock markets but who operate through one of more than 1,000 Foreign Institutional Investors registered with the market regulator, the Securities and Exchange Board of India (Sebi).

The fact that Sebi can lift the "corporate veil" only up to a point to identify the true beneficiaries of transactions using PNs, has made a number of Indian officials and analysts argue that the government should place restrictions on the use of such financial instruments.

Senior government functionaries, including India's National Security Adviser, have suggested on more than one occasion that stock market transactions should become increasingly transparent to ensure that flows of "hot" money - or funds obtained through illegal means - do not find their way into the country through stock exchanges and end up financing terrorist organisations.

It has also been argued that part of the money that is coming into the country actually belongs to persons of Indian origin who had kept their money abroad at a time when the government used to have stringent restrictions on the use of hard currency. Such "round-tripping" funds are now returning to Indian through tax havens like Mauritius, it is contended.

Almost certainly this analysis is right. "Round tripping" of funds to tax havens is a massive problem throughout the world, but especially in developing countries where it is a key component of capital flight.

Which makes the cal for transparency on the ownership of the funds puring into India particularly pertinent.