India's stock market got slammed hard today after it got wind of Finance Minister Palaniappan Chidambaram's plan to slow an influx of foreign capital which has helped strengthen the Indian rupee. The SENSEX index fell nearly ten percent before trading was halted. Although the market later recovered after Chidambaram made some assurances about the government's objectives, the scope of the challenge to India is evident: How can the country remain open to foreign investment while ensuring that stock markets do not overheat and the rupee does not become too strong? It's a delicate balancing act, for sure. From Bloomberg:Indian Finance Minister Palaniappan Chidambaram said rules proposed yesterday by the market regulator are aimed at slowing inflows of overseas capital that have driven up share prices and the currency.``This is part of a series of steps that have been taken to moderate capital inflows into India,'' Chidambaram told reporters in New Delhi today. ``Investors through participatory notes are certainly welcome to invest in India. But for the present, it is important to moderate these capital inflows.''
The rules are aimed at overseas buying that fueled stocks to a record and drove the rupee to a 9 1/2-year high. The controls may stem the record flow of funds that lifted the value of India's stock market 81 percent this year to $1.47 trillion.
The Securities & Exchange Board of India late yesterday proposed tightening rules for buying shares and bonds through offshore derivative instruments such as so-called participatory notes. Chidambaram spoke after India's benchmark Sensitive Index dropped 9.15 percent to 17,307.9, triggering a trading halt for an hour, and the rupee fell the most in two months.
``We are not in favor of banning participatory notes,'' Chidambaram said. ``We are trying to cap the proportion of money coming in through participatory notes vis-a-vis the derivative position.''
Stocks pared losses after the government's assurances. The Sensitive Index recovered to close 1.8 percent lower at 18,715.82. Record share purchases fueled a 12.5 percent gain in the rupee against the dollar this year, eroding export earnings.
The rupee fell as much as 1.6 percent to 39.97 per dollar before closing 0.5 percent lower at 39.565, according to data compiled by Bloomberg. The currency reached 39.27 on Oct. 11, the highest since February 1998.
The regulator proposed that overseas investors buying shares anonymously, using participatory notes, will have 18 months to switch to investing directly in the market. Funds need to respond to the proposals by Oct. 20.
The rules will be introduced on Oct. 25 ``with or without some modification,'' Chidambaram told reporters in New Delhi.
More than half of the record $17.7 billion of net purchases of Indian stocks this year may have been through the use of participatory notes, JPMorgan Chase & Co. estimates. The notes change in value depending on the performance of the underlying securities and provide hedge funds anonymity in their investment.
Inflows ``have become very copious,'' Chidambaram said. ``It is in the interest of everyone that these flows are moderated.''
The regulator proposed to cap the amount of participatory notes that can be issued by each broker at 40 percent of the assets under custody for the issuance of new notes. Brokers exceeding the limit will need to pare their outstanding notes.
An average 8.6 percent annual expansion of India's economy since 2003 has attracted record foreign investments in domestic stocks, pushing up the benchmark index by 36 percent this year.
