The Hindu Business Line : Citigroup sees P-note measures deterrent to new hedge fund flows

Mumbai, Oct. 18 The Securities Exchange Board of India’s (SEBI) measures on participatory notes could have a negative impact on incremental foreign flows into Indian equities in the next three to six months, said Citigroup Global Markets in a report released on Thursday.

The report says there has been a significant rise in the share of participatory notes (p-notes) in overall FII flows into Indian equities and that users of p-notes are largely hedge funds. It said that the lack of any new issuance of Offshore Derivative Instruments (ODIs) with underlying derivatives will take away hedging options for exposures in the cash market. This could be a deterrent for new hedge fund flows.

“While we do not have an estimate on the percentage of p-notes that are through sub-accounts, it could be a meaningful number and result in selling pressure over this period, to the extent of those investors not being able to get the FII registration,” said Mr Ratnesh Kumar, Analyst, Citigroup Global Markets, in the report.

Liberal process

Citigroup expects the tighter controls on p-notes to be accompanied by a more liberal FII registration process for hedge funds.

The long-term impact of SEBI’s measures will, therefore, depend on what percentage of p-note investors (and hedge funds in general) is able to get FII registration.

SEBI’s proposed measures to curtail this surge in foreign flows will, however, aid the RBI in its management of the domestic liquidity and the rupee.

Citigroup expects the pace of currency appreciation and excess domestic liquidity accumulation to slow down in coming months.

The long-term trend of rupee appreciation is unlikely to be reversed and Citigroup expects the rupee to touch 38 against the dollar in 2008.