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FII inflow, RBI policy review outcome to dictate trend

Sunday, October 28, 2007

Trend in inflow from foreign funds will dictate the near term trend on the bourses. The market on Friday, 26 October 2007, shrugged off Securities & Exchange Board of India (Sebi) directive on restriction of participatory notes (PNs) that came into effect from 26 October 2007. Sebi has banned fresh issuance of PNs with derivatives as underlying and it has also ordered winding up such PNs in 18 months, besides putting curbs on such issue of PNs in the spot market.

According to Citigroup, given the limited headroom available due to the 40% limit on issue of PNs, return to 'regulated' entities rule, and the time it might take for the entities to get FII registration, the new Sebi norms may significantly reduce near term foreign flows. Sebi has proposed an incremental rate of 5% for issue of PNs for FIIs with less than 40%t of assets under custody (AUC) in PNs. Those with over 40% of assets in PNs can issue PNs only against redemptions or cancellations.

Kotak Institutional Equities, in a note, states that it does not expect any major impact of the new policy on the market and it is of the opinion that the market has largely absorbed the changes in PN norms. ‘We rule out any major selling in the market and expect a smooth transition to the new regime’, it has said in a note to clients adding that while Sebi has banned sub-accounts of FIIs from issuing further PNs, PN issuing sub-accounts FIIs have already started the process of conversion to FIIs. There is no ban on issue of PNs by FIIs though restrictions have been put in place for them. There is a ban of fresh issue of PNs with derivatives as underlying.

Providing a major relief over the issue, Sebi on Monday, 23 October 2007, said sub-accounts which intend to covert into foreign institutional investor status have to sent their letter of intent to the regulator within 24-hours. Sebi later said that all the 20 PN issuing FII sub-accounts have expressed intent to convert into foreign institutional investor (FII) status. There are 34 PN issuing entities in the country, of which some are already FIIs. This number was 14 in March 2004.

FIIs can now issue PNs only to foreign entities which are ‘regulated’ in their respective jurisdiction and not to those that are merely ‘registered’ in the jurisdiction as was the norm earlier. This will mean that some hedge funds that are not regulated in their home country will find it difficult to invest in the Indian market. Users of PNs are largely hedge funds, a fast-growing asset class globally in recent years. Nevertheless, such hedge funds can apply for direct registration with Sebi.

Sebi says PNs allow foreigners to make a backdoor entry into the market, and it wants them to register to create greater transparency on inflows. PNs are financial instruments used by foreign investors that are not registered with Sebi, to invest in Indian shares. FIIs and their sub-accounts buy Indian securities and then issue PNs to foreign investors with these securities as the underlying.

Besides some key Q2 September 2007 results, the major events next week are Mid-Term Review of Annual Policy by the Reserve Bank of India on Tuesday, 30 October 2007, and policy meeting of the US Federal Reserve on 31 October 2007. Bank of Japan also holds its policy meeting on 31 October 2007.

Market men see no change in interest rates by RBI in Mid-Term Review of Annual Policy on Tuesday. It remains to be seen whether RBI raises cash reserve ratio so as to suck out excess liquidity in the banking system.

There are hopes that the US Federal Reserve will cut interest rates again at its policy meet on 31 October 2007, given the recent weak US economic data. A further cut in interest rate by Fed, if any, will only add to global liquidity which already remains high. This in turn will ensure that FII inflow in India will continue even as their buying vigour may not be as strong as was recently due to Sebi restrictions on PNs.

Key Q2 September 2007 results next week Maruti Suzuki, Bharat Heavy Electricals, HDFC and Mahindra & Mahindra on Monday, 29 October 2007, ONGC, Steel Authority of India, Tata Power, DLF on Tuesday, 30 October 2007, and Tata Motors on Wednesday, 31 October 2007. On Saturday, 27 October 2007, NTPC, Grasim, State Bank of India will unveil Q2 results.

Posted by FR at 6:06 PM  

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Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.