Why Investors Fled India

When you land in China, they send two teams of medical crew wearing spotless white attire from head to toe, looking a bit like astronauts heading towards the rocket for a lift-off.

The silent crew parades the aisles, examine your eyes and flash a beam on your forehead to check your temperature. They are looking for symptoms of swine flu.

Only after every passenger has been checked and approved, they allow the pilot to move the plane to the parking gate and offload the passengers.

You land in India and are back to Indian-ness: passengers coming down two escalators and one flight of stairs quickly fill a makeshift queuing system. Within minutes, the continuous stream of people coming down the escalators can no longer get off – the space ahead of them is a stationary wall of people. A lady on crutches falls – the escalator blades disappear from under her feet and she has nowhere to stand.

There is chaos. The airport staff looked on – and did nothing.

I alert them. “We will tell the management,” they respond.

Once you get to the people behind the desk with your medical form, they stamp it – without even looking up. You then proceed to immigration and you are cleared to officially enter India.

If you had swine flu, the Chinese would catch you. In India, the swine flu would catch you.

China, said a friend, has learned from its mistakes.

He was referring to the SARS epidemic that reached frenzy in March 2003. When the medical team from the World Health Organization landed in China to inspect the patients, the hospital administrators bundled all the affected SARS patients in ambulances and made them circle the city.

The WHO inspectors found nothing in the hospitals.

China got a clean chit.

But the Chinese ended up living through the horror of SARS.

Do you think, my friend continued, it is a coincidence that WHO is the only international body that is now run by a Chinese person? China really wanted its nominee as head of WHO – Dr. Margaret Chan. And, within China, there are only two ministries that are run by people who are not from the Communist Party: the Ministry of Health and the Ministry of Science & Technology.

Having made a mistake, the Chinese gulp a bit – and then go on to ensure it does not happen. So going forward China will have fewer cases of swine flu, I guess.

India will have more cases of people’s clothes, shoes, and limbs stuck in escalators as they queue up to go through the motions of a useless medical “examination”.

But no, this is not about swine flu – but about investors that flew out of the Indian stock markets in the year 2008.

The Participatory Note, or “P-Note” investors – the sub-set of foreign institutional investors (FIIs) who have caused havoc in the Indian stock markets on the way up in the year 2006 and 2007 – and on the way down in the year 2008.


These flows (Table 1 above) represent the total net foreign money entering the stock market. On average, the foreign money flows are 4 times those of the money flows from the domestic mutual funds.

However, we don’t know what percentage of this foreign money flow belongs to P-Notes. The P-Notes are a strange animal in the Indian capital markets.

As an Indian, if you want to buy shares, the government wants to know everything about you. As an Indian, if you wish to buy a mutual fund, the government wants to know everything about you.

If you are a U.S., European, or Japanese pension fund, university endowment, or charitable foundation, then the government also wants to know a lot about you.

But if you are a P-Note holder, heck no one cares at all about who you are!

Foreign investors who have a long term interest in investing in India – and by “long term,” I mean a minimum 5 year time horizon (if not twenty and thirty year time horizon) have not yet come into the Indian stock markets in a big way.

I know this because some of them are my clients.

And I meet many of these long-term investors many times in a year. The “genuine foreign institutional investors” (long term pools of capital) painstakingly fill in the foreign institutional investors application forms and sit on the plane as the Indian authorities thoroughly check them out, to ensure they are sound people.

On the other hand, the P-Note pool of money – hot, short-term money – that gets India exposure via Participatory Notes does not even have to fill in that health examination form. Their broker fills it out and confirms they are good people!

Imagine an airline crew in Shanghai airport vouching that the passengers are not affected by swine flu – and signing the form on their behalf. The Chinese would take the crew out of the plane and shoot them or send them off to the hinterland.

In India, we worship these unknown pools of capital – and shoot ourselves in the foot.

Finance Ministers of this country have, time and again, made trips to Tokyo, Hong Kong, Singapore, London, and New York to pay homage to these great hedge fund and P-Note owners.

Rather than being suspicious of short-term money, India welcomes it. We don’t seem to understand that we need pension fund money to build India’s economy over the long term.

Our Indian ministers have probably never visited many of the pension funds. They generally don’t sit in exciting cities. And the brokers don’t really want those pension fund folks investing in India. Because they buy shares and hold them for 5 years or more, the brokerage commissions will collapse and the brokers will be out of jobs.

Unlike China, India is not willing to learn from its mistakes.

When questions are asked about P-Notes, the treatment is similar to that of the ambulance incident with the SARS affected patients.

We will ooh, and aah, and steer the discussion towards thoughts on building a world-class and open capital market.

Our intellectuals mislead us and get caught in their own web.

After the election of the Congress-led coalition, many commentators and representatives of the intellectual community came on TV and said, “We hope this new government will allow higher foreign equity ownership in insurance companies”.

Why? Pray tell, why?

Because, they said solemnly, India needs long-term capital to sustain its development.

I was laughing – and crying.

It is true that India needs long-term capital.

But then – this same set of people – go about saying that banning P-Notes is a bad idea.

On the one hand, they say India must have long-term capital and yet – with a very straight face – they want the Indian stock markets to be reliant on short-term capital via unknown pools of P-Notes.

Having seen the Indian election results, the P-Note owners are now ready to head back to India to ride the gravy train – and add their own flavor to it by sloshing around playfully with their gambling money.

“P-Notes need to be banned.” The Reserve Bank of India wrote in December, 2003.

And, they were finally, thankfully, in a limited ban and phase out by October 2007.

But by October 2008, P-Notes were back in action.

We are back to the future, and looking at an ugly past

India should only accept long-term foreign capital via “genuine” foreign institutional investors. This is not about making the markets a more “perfect” place and advocating “price discovery”.

Speculation and price discovery is not an end in itself. Markets are not gods to be worshipped. They are created to help an economy reach its goal.

But, in India, we will continue debating and discussing and throwing intellectually stimulating arguments to explain why what we did in the years 2006 and 2007 was not wrong – and therefore there is no need to learn from the past.

Because the past mistake was not a “mistake”, it was just an event in time that occurred and had to do what it had to do.

I stand by what I said in October 2008 – and reiterated again after May 15th – one can make a case for the Bombay Stock Exchange’s BSE-30 Index to head back to a new peak of 21,000 by June 2010.

A better economy, better company results – and higher foreign institutional investors flows are all positives for the market. It could happen.

But if P-Notes are a part of that rise – god help us. Because some event in the United States will frighten the owners of short-term capital and then we will see how pigs can flap their wings.

Swine flu or swine flew – I don’t know which one is more frightening. But India is vulnerable – and could be attacked on two fronts.


Ajit Dayal
for The Daily Reckoning

The Daily Reckoning