Participatory Notes (P-Notes), Offshore bonds vs Onshore Bonds

 

Participatory Notes (P-Notes):

• P-Notes are instruments issued by a SEBI registered Foreign Institutional Investors (FII) to overseas investors, who wish to invest in the Indian stock markets without registering themselves with the market regulator, SEBI. 
• The underlying Indian security instrument may be equity, debt, derivatives or may even be an index.
• They are easy to operate rather than the cumbersome rules that India has for its foreign investors.

 Features of P-Notes:

• The investor in PN does not own the underlying Indian security, which is held by the FII who issues the PN.
• Investors in PNs derive the economic benefits of investing in the security without actually holding it.
• Investors benefit from fluctuations in the price of the underlying security since the value of the PN is linked with the value of the underlying Indian security. 
• The PN holder also does not enjoy any voting rights in relation to security/shares hold through PN.

 Controversary about P-Notes :

• P-notes have been controversial instruments since the very inception as these are freely traded overseas without any control of SEBI.
• P-Notes remain opaque as the identity of the investor is known only to FII and not to the SEBI.
• It is understood that P-notes are being used for money laundering. even by promoters of listed companies.
• Whenever government attempted to regulate them, market start tumbling, which prevents the government to take the harsh step. 

Participatory Notes Crisis of 2007:-- 

On 16th October 2007, SEBI proposed curbs on P-Notes but mere proposal resulted in sharp fall of 1744 points on 17th October 2007 followed by further volatilities.

Offshore bonds: 

                                

• Raising of debt by Indian Companies from global market in Rupee denominated /Dollar denominated is referred to as Offshore bonds. 
• It enables borrower to have access to foreign currency investments.
• These bonds are subjected to different tax rules depending upon tax treaties between countries.
• Offshore markets exposure may induce improvements in domestic bonds markets such as strengthening of domestic market infrastructure, improving investor protection and removing tax distortions that hinder domestic market development etc.

Onshore Bonds: 

                                           

• Onshore bonds are issued by financial entities to raise money from the investors located within the borrower 's home country.
• It is typically in local currency.

Foreign Exchange Reserves, Reserve Tranche Position

 

Foreign Exchange Reserves:

• Assets held as reserve by a central bank in the form of foreign currencies, Gold and  SDR .
• RBI is the custodian of FOREX and  has the primary responsibility of collection, compilation and dissemination of data relating to foreign exchange reserves.
• Most of the foreign exchange reserves are held in US dollars.

 India’s Forex Reserve include:

•       Foreign Dollar assets

•       Gold reserves

•       Special Drawing Rights

•       Reserve tranche with IMF

Forex as on Jan 2025 is 629 .5 Billion US $ with the components as mentioned in the image taken from RBI Report:

Reserve Tranche with IMF :

• Out of total SDR contribution of a country, 25% is kept in the form of gold and foreign currencies while 75 % is kept in the form of local currency and this 25 % is referred to as Reserve Tranche.
• This Reserve tranche provides for unconditional drawing right of the country on the IMF.
• The Reserve Tranche Portion (RTP) of the quota can be accessed by the member nation at any time. 
• This RTP amount remains with IMF and is available as per the demand of the contributing country without any service fee.

Reserve Tranche Position=

        SDR Quota - Own Currency = Foreign Currency/SDRs paid initially for membership.

*As per website of MOSPI,India’s Reserve Position in the International Monetary Fund is not included as part of foreign exchange reserves as they may not be available on immediate demand, although some countries do include these balances as part of their reserves.But RBI considers reserve tranche as part of foreign reserve.

Objectives of Holding Forex Reserves:

• Reserves provide a level of confidence to markets and investors that a country can meet its external obligations in case of any emergency.
• Forex Reserve provides support system and confidence for monetary and exchange rate management.
•  It Limits external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is curtailed. 
• All international transactions are settled in US dollars and are therefore needed to support our imports. 
• It serves as a cushion in the event of a Balance of Payment (BoP) crisis on the economic front. 
• The rising reserves have also helped the rupee to strengthen against the dollar. 

GLOBAL DEPOSITORY RECEIPT (GDR),American depositary receipt (ADR)

 

GLOBAL DEPOSITORY RECEIPT (GDR) :

• Global Depository Receipt (GDR), is a certificate issued by a Depository Bank (Depository Bank of  London) which purchases shares of foreign companies (TCS) and deposits them in their account. 
• GDRs represent ownership of number of  shares belonging to a  foreign company (TCS).
• GDR's are commonly used by investors in developed markets to invest in companies from emerging markets .

To Understand:

Let there is an investor "X" in Britain  & wishes to invest in any INC "TCS"

        Depository Bank of  London will purchase TCS share 

                           ⇓

        "X" will purchase TCS share from Depository Bank of  London

                           ⇓

                  Depository Bank of London will issue GDR to X.

Advantages of GDR to issuing company:

• Increase the accessibility to foreign capital markets,
• Increase in the visibility of the issuing company globally
• Rise in the capital because of foreign investors

Advantages of GDR to investor: 

• Diversification of investment, hence reducing risk
• Providing an opportunity for the investor to invest in foreign companies

American depositary receipt (ADR):

• GDR in case of USA is known as ADR.
• It is a Negotiable certificate issued by a U.S. bank against  shares in a foreign stock (eg stock of any Indian  company being traded at US stock exchange ) that is traded on a U.S. exchange. 
• ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. 
• ADRs help to reduce administration and duty costs that would otherwise be levied on each transaction.

Advantages of GDR for US investor:

• ADRs are an easy and cost-effective way for US investors  to buy shares in a foreign company. 
• They save money by reducing administration costs and avoiding foreign taxes on each transaction. 

Advantages of GDR to issuing company:

Foreign entities get more U.S. exposure, allowing them to tap into the wealthy North American equities markets.

Components of FDI, Horizontal & Vertical FDI, Indirect Foreign Investment

Components of FDI:

• Equity Capital, 
• Reinvested Earnings and
• Intra-Company Loans. 

Equity capital: It is investment in equity.

Reinvested Earnings: These are retained profits on the FDI which are reinvested in the market.

Intra-Company Loans: Borrowing and Lending of funds between parent enterprises and affiliate enterprises.

TYPES OF FDI:

Horizontal FDI:- 

When a company invests in the same industry in totality  in which it operates back in its own country .

Vertical FDI:-

• When a company expands only a part of the production process to another country is referred to as Vertical FDI.
• This fragmentation of business benefits enterprises, since the production costs in other countries can be way lower than the country of origin.

Indirect Foreign Investment /Downstream Investment: 

• Investment by an Indian company (owned / controlled by foreigners) into another Indian entity is considered as Indirect Foreign Investment (IFI). 
• Indian entity which has received indirect foreign investment shall comply with the entry route, sectoral caps, pricing guidelines and other attendant conditions as applicable for foreign investment.

FPI,FDI,Foreign Venture Capital Investors (FVCI), Overseas Direct Investment

 

Entry Routes for Foreign Investment in India:

There are broadly three entry routes are there for foreign investment in India: 

(a) Foreign Portfolio Investor (“FPI”) ; 

(b) Foreign Direct Investment (“FDI”); and

 (c) Foreign Venture Capital Investor (“FVCI”).

Foreign Portfolio Investment (FPI):

FPIs are short term investments in the form of:

• Debt and Equity in listed Company  ; or 
• Non Convertible Debentures (NCD) in Un-Listed company at stock exchange. 

Such investment is subject to the total holding by each FPI, investment in listed company should be less than 10% of the total paid-up equity.

FOREIGN DIRECT INVESTMENT (FDI): 

• FDI is a long-term investment made from abroad alongwith technology, entrepreneurship, capital and managerial know-how. 
• FDI is about being shareholder in the company so FDI is equity holder exclusively and debt is never categorized as FDI. 

Technically,

FDI is the investment by a person resident outside India 

(a) in an unlisted Indian company; or 

(b) in 10 percent or more in a listed Indian company. 

Investments under the FDI route are subject to entry routes, sectoral caps, pricing guidelines, and attendant conditionalities.

FDI vs FPI:

• When total holding of the FPI in a listed Company increases to 10% or more of the paid-up share capital, the total investments of the FPI are re-classified as FDI.
• FPI is considered ‘hot money’ as it is more speculative and volatile and hence have limited potential in economic development of the country while FDI is comparatively more stable and contributes in the economic development of the country.
• FDIs own controlling stake in a company by investing in its physical assets while FPIs invest only in financial assets.
• Significant tax benefit for FPIs as securities held as FPIs are subjected to capital gains while FDI income is subjected to corporate income (which is subject to higher rate of tax).
• FII inflows have a very high service burden among all the foreign resources ie FDI, foreign borrowings, NRI deposits.
• Actually FII comes to earn good returns from the market and exchange rate speculations. 
• FDI is regulated primarily by India's Department of Promotion of Industry and International Trade (DPIIT), under its Foreign Exchange Management Act regime (FEMA Regime) while SEBI REGULATES FPI.
• The FPI route is considered attractive for debt investments given debt investments by FPIs are not classified as external commercial borrowings, which is far more regulated.

Foreign Venture Capital Investors (FVCI):

• Foreign investor, who is registered under the Regulations and proposes to make investment in accordance with the Regulations.
• RBI has restricted investment by FVCIs to investment in: 

(a) Indian companies engaged in 10 permitted sectors (including infrastructure, biotechnology and IT related to hardware and software); 

(b) start- ups irrespective of the sectors; and 

(c) units of a venture capital fund and AIF. 

Investments by FVCIs in capital instruments are subject to sectoral caps on foreign investment in India and attendant conditions.

Why choose the FVCI route?

The key benefits that the FVCI route provides are exemptions from: 

(a) the pricing guidelines stipulated under the FEMA Regulations, and 

(b) pre-issue capital lock-in requirements prescribed under the regulations governing issue of securities. 

• Therefore, foreign investors seeking to make investments in the ten permitted sectors, start-ups  made investments  under the FVCI route.
• Investments under the FVCI route are subjected to at least two-third of its investible funds in equity  and the remaining one-third of investible funds in debt in which the FVCI already has equity investment.

Overseas Direct Investment (ODI): 

• Overseas Direct Investment (ODI) is what Indian residents are investing abroad in the form of assets (opposite of FDI) abroad, shares abroad (opposite of FPI) like Western firms like JAGUAR, Novelis have been acquired by Indians abroad.
• It also includes Reserve Assets held by RBI in the form of  Foreign currencies that RBI is holding. 

FOREIGN TRADE POLICY SINCE INDEPENDENCE, Features of FTP 2023

FOREIGN TRADE POLICY SINCE INDEPENDENCE:

1969 -1984:

1st Foreign Trade Policy (FTP) came in 1969 in the form of Export-Import policy and it was revised after every one year which continued till 1984.

1985 to 1991:

During this period, Foreign Trade Policy (FTP) was revised after every 3 years.

1992 to 2004:

Foreign Trade Policy (FTP) during this period was revised after every 5 years but with sunset clause.

2004-23: Foreign Trade Policy (FTP) during this period was revised after every 5 years. FTP of 2023 was unique in the sense that it doesnot have any sunset clause .

Features of FTP 2023:

The Key Approach to the policy is based on these 4 pillars: 

(i) Incentive to Remission,  

(ii) Export promotion through collaboration - Exporters, States, Districts, Indian Missions, 

(iii) Ease of doing business, reduction in transaction cost and e-initiatives and 

(iv) Emerging Areas – E-Commerce Developing Districts as Export Hubs and streamlining SCOMET policy.

• The policy targets exports of $ 2 trillion by 2030.
• Greater faith is being reposed on exporters through automated IT systems with risk management .
• The policy emphasizes upon moving away from an incentive regime to a facilitating regime .
• Merchandise Exports from India Scheme (MEIS) and Service Exports from India Scheme (SEIS) have  been phased out in 2021 in the wake of the reservation of USA at WTO.
• MEIS has been replaced by Remission of Duties and Taxes on Exported Products (RODTEP).
• The FTP 2023 encourages recognition of new towns through “Towns of Export Excellence Scheme” and exporters through “Status Holder Scheme”.
• The FTP aims at building partnerships with State governments and taking forward the Districts as Export Hubs (DEH) initiative to promote exports at the district level and accelerate the development of grassroots trade ecosystem.

E-commerce in new FTP 2023:

• E-Commerce exports are a promising category that requires distinct policy interventions from traditional offline trade. 
• Various estimates suggest E-Commerce export potential in the range of $200 to $300 billion by 2030. 
• FTP 2023 outlines the intent and roadmap for establishing e-commerce hubs and related elements such as payment reconciliation, book-keeping, returns policy, and export entitlements. 

ANALYSIS of FTP 2023:

• There is need for a robust market information and intelligence system for export expansion and diversification.
• There is need of an interactive market information and intelligence system backed up with the required policy support such as incentives, tax exemptions, export assistance, and facilitation is the crux of the export promotion efforts of a country.
• World trade is a demand function, so correspondingly, the supply-side capabilities have to be created or achieved. 

Generalized System of Preferences (GSP)

 

Generalized System of Preferences (GSP):

• Generalized System of Preferences (GSP) is a preferential tariff arrangement granted by the developed countries to developing countries and Least Developing Countries (LDC) to promote economic growth in those countries.
• GSP is an umbrella that comprises the bulk of preferential schemes to promote exports from developing countries to the developed countries..
• It involves reduced Most Favored Nations (MFN) Tariffs or duty-free entry of eligible products exported by beneficiary countries to the markets of donor countries.

Benefits of Generalized System of Preference:

• Developing countries increase and diversify their trade with the developed nations, hence facilitating the Economic growth and development of developing countries.
• Company Competitiveness is boosted by GSP as it reduces costs of imported inputs used by companies to manufacture goods
• GSP promotes Global values by supporting beneficiary countries in affording worker rights to their people, enforcing intellectual property rights, and supporting the rule of law.

India and GSP:

• India has been the beneficiary of the GSP regime and accounted for over a quarter of the goods that got duty-free access into the US in 2017.
• USA removed India from the list of countries receiving GSP treatment in June 2019.
• Even after US withdrawal of GSP, India continues to enjoy tariff preference from many countries including Australia, Russia and Japan, as well as the European Union (EU), among others.

Capital/Financial Vs Current Account, Official Reserve Sale, BOP & Capital account

 

           

Understanding Capital/Financial  and Current Account : 

Capital account deals with the change in ownership of a country’s assets,

                                                              while

  Current Account reflects the change in a country’s net income.

Ex. In case of a factory acquisition by an MNC in India, payment of dollars by MNC will result in Inflows of dollars alongwith lose of ownership by Indian on  the factory.

Income by that MNC will be a part of Current account while acquisition of factory is part of Capital Account.

 Capital and financial  Account:

• Those transactions, which cause a change in the ownership of assets or liabilities of a country.
• Capital and financial account has two categories of the capital and financial account. 
• Many a times ,this account is commonly referred to as Capital Account but its a misnomer as the so-called capital account portion is in fact small or even negligible for many countries. 

Capital account:

• It includes acquisition or disposal of “intangible nonfinancial assets and proprietary rights” such as trademarks, patents, copyrights, leasing agreements, and mineral rights. 
• Debt forgiveness is included in this subaccount, as part of capital transfers

 Because the capital account is typically small, the name for this part of the BOP is often abbreviated as “financial account.” 

Financial account :

• Direct investment, which is further divided into equity capital and reinvested earnings;
• Portfolio investment, which includes long-term debt and equity securities, money market instruments, and tradable financial derivatives, including dollarnd interest rate swaps;
• Other investment, such as trade credits and general borrowing, and IMF credit; and
• Change in Foreign Exchange Reserves 

Change in Foreign Exchange Reserves:

When BOP is not Zero despite exhaustion of all tools, then country could use its forex reserves to neutralise it.

Official Reserve Sale: 

When all tools of Capital and financial Accounts are exhausted and Current Account Deficit still remains, then RBI sells Foreign Reserves to ensure the Zero BOP.

Correlation between Balance of Payment and Capital Account:

• Balance of Payments of a country should be balanced .
• If a country has current account Deficit, it must be financed either  by selling assets or by borrowing abroad. 
• Thus, any current account deficit must be financed by a capital account surplus, that is, a net capital inflow or selling of the assets :

Current account + Capital account =0

Balance of Trade (BoT),Current Account Deficit (CAD),

 

                     

Balance on Current Account has two components:

1. Balance of Trade or Trade Balance
2. Balance on Invisibles

Balance of Trade (BoT) =

• Value of Goods Exported out - Value of Goods Imported into the country.

Balance of Trade is in Deficit or Trade Deficit:

• Imports of Goods in Country >>>> Exports of Goods out of Country 

Trade deficit is unfavorable for a country.

Balance of Trade is in Surplus:

Exports of Goods out of Country >>>> Imports of Goods in Country

•  Surplus BoT is said to be favorable.
•  BOT is typically the biggest bulk of a country's Balance of Payments (BoP). 

Balance of Trade is balanced:

• Imports of Goods in Country = Exports of Goods out of Country

RBI uses the term Balance of Trade in Merchandise and Balance of Trade in services separately.

Factors that affect the Balance of Trade include:

• Cost of factors of production in the exporting economy vis-à-vis those in the importing economy.
•  Exchange rate movements; 
• Multilateral, Bilateral and Unilateral Taxes or restrictions on Trade; 
• Non-tariff barriers such as environmental, health or safety standards; 
• The availability of adequate foreign exchange with which to pay for imports.

IS World Balance of Trade (BoT) always Balanced:

• It is not easy to measure the ‘Balance of Trade’ accurately because of problems in recording and collection of data.  
• When official data for all the world's countries are added up, exports exceed imports by almost 1% giving an impression of positive Balance of Trade (BoT) .
• This is despite of the fact that all transactions involve an equal credit or debit in the account of each nation. 
• The discrepancy can only be explained by transactions intended to launder money or evade taxes, smuggling and other visibility problems. 

Net Invisibles: 

• Invisibles include services, transfers and flows of income that take place between different countries. 
• Services trade includes both Factor and Non-Factor income.
• Net Invisibles is the difference between the value of exports and value of imports of invisibles of a country in a given period of time. 

Current Account can be either:

1. Current Account Surplus if  Current Account Receipts > Payments
2. Balanced Current Account if Current Account Receipts = Payments
3. Current Account Deficit if Current Account Receipts < Payments

Current Account Deficit (CAD):

Current Account Deficit (CAD) comprises deficit in:

• Trade Account, 
• Services Account ,
• Net Income and Transfer from abroad. 

Out of these three components, Trade Account/Balance of Trade is the largest.

Implications of Current Account Deficit (CAD) :

• Current Account Deficit (CAD) means that India is importing more goods and services than it is exporting. 
• India typically runs a current account deficit as it is a developing economy which relies on imports of several commodities like crude oil. 
• India saw a rare current account surplus in FY2020-21.
• Current Account Deficit (CAD) is not necessarily a bad thing. 
• For India, a current account deficit of around 2.5-to-3 percent of the gross domestic product is said to be sustainable. 
• Deficits beyond this threshold are a cause for concern. 
• Sustained period of CAD  led to currency depreciation, high rates of inflation which further effects the incoming foreign investment. 
• Current Account Surplus implies the country is a net lender to the rest of the world, while Current Account Deficit (CAD) indicates it is a net borrower.