FPI has made our bourses dangerous with no tangible benefits to show

In my article ‘Is FPI holding our markets hostage?’published in this space on July 6, 2022, I had stopped short of making a case for phasing out Foreign Portfolio Investment from the Indian bourses. But L’affaire Hindenburg and Adani have made all of us rethink our worldviews on foreign capital’s role in the Indian markets.

Despite the market regulator SEBI pulling up its socks on the opaque Participatory Notes (PN) mechanism under which anyone could ride piggyback on a SEBI registered FPI and thus hide its identity, round-tripping has been going on unabated because the SEBI registered FPIs can accommodate Indian industrialists, PN or no PN. Round tripping consists of black money generated in India finding its way abroad, either through the subterranean hawala route or through more sophisticated means such as over-invoicing of imports with the excess price being kindly credited to secretive Swiss bank accounts (alleged Bofors style). Payment in foreign exchange for make-believe consultancy services is another useful tool in the kitty of crooks. A substantial part of it is once again credited to the secretive foreign bank accounts by the foreign impostor (the self-styled technology expert). The Indian who has thus stashed away black money abroad soon itches for action. What better action than bring back the money in the guise of FPI? This then is what round-tripping is all about.

To be sure, it is not the American short-seller Hindenburg who has enlightened Indians about the thriving round-tripping business. In fact it has been known all along ever since the floodgates of foreign capital into our bourses were opened by the Narasimha Rao-Manmohan Singh duo in the early nineties of the last century in their unrestrained zeal to unshackle the economy in the names of liberalisation and globalisation. It is amazing that the duo, knowledgeable as they were, didn’t anticipate widespread abuse of the FPI regime by Indians. A cynical if charitable explanation for their, indeed successive governments’ as well, ostrich-like approach could be foreign capital, hot or cold, was quenching our thirst. If FDI was passing India by, let us at least accept FPI!

Apart from giving a leg-up to the pernicious practice of round-tripping, FPI seems to have failed to achieve its broader objectives. It was believed that FPI would result in providing depth and breadth to our bourses but sadly all that it has provided is liquidity or wrenched it away mercilessly at a time when most needed. The bottom line is that the booms and busts in Indian bourses have come to be characterised as liquidity-driven rather than fundamental-driven. When FPI money came in two things happened invariably and predictably — Sensex rose and so did the value of the INR vis-à-vis the greenback. The reverse happened on both the fronts when FPI pulled the plug ie, sold and took back their money.

FPI chasing the Sensex and Nifty shares has also resulted in exaggerated valuations for them. Its echoes have also been heard and felt in the primary market as the very same FPIs have had a vice-like grip on book-building the so-called price discovery process in the run-up to an IPO. The mind-boggling valuations given even to loss-making companies daring to make IPOs has been the bane of the Indian primary market where small investors have been left holding the can.

Far from augmenting our forex reserves, FPI has proved to be a fair-weather friend using Indian bourses as revolving gates. In June 2022, FPIs pulled out Rs 46,000 crore from the Indian bourses, totting up an aggregate net outflow of Rs 2.13 lakh crore in the first six months of 2022. Things haven’t improved since. Foreign portfolio investors (FPIs) pulled out from the Indian markets in a big way in 2022 with the highest-ever yearly net outflow of Rs 1.34 lakh crore. Blame it on global inflation, US Fed rate hikes or Ukraine war, the bottom line is for India the lesson has been chastening — FPI is too hot to bolster our forex kitty. Sadly, we have been guilty of chasing a mirage.

So, it is time for policy wonks to gather and mull over the issue afresh. Has the FPI regime achieved its objectives? The answer is a resounding no. Has it had the opposite effect ie lending itself to abuse? The answer is a resounding yes. Laundering of ill-gotten wealth and its return to the country of origin is old hat for which law-enforcing agencies simply do not have an answer. The Indian government’s writ doesn’t run abroad so much so that we are invariably at our wit’s end in bringing round-trippers to justice. It is also widely known that the funds brought back through round-tripping are used to prop up the shares of the group companies of the round-trippers. Artificially high values are the results at the end of the day.

It is said the baby should not be thrown with the bathwater, but with the FPI regime the problem is how to tell one from the other. So, sadly, both have to be thrown willy-nilly. It is not as if we would be missing a great deal. It is empirically proven thata FPI is hot money, pure and simple. Far from resulting in better price discovery for our shares, our markets have been held hostage by FPI liquidity. The tall claim that FPI’s looming presence would make our companies and promoters behave is yet to be proved. Satyam, DHFL and IL&FS scams have all happened under their noses and gazes. Let us face it, FPI has done more harm than good to India.

S Murlidharan is a freelance columnist for various publications and writes on economics, business, legal, and taxation issues

Published on: Friday, February 17, 2023, 06:00 AM IST