On August 1, 2013, the Reserve Bank of India (RBI) instructed foreign institutional investors (FIIs) which were seeking to hedge forex exposure relating to participatory notes (P-notes) to take prior permission from note holders before doing so.
Not-so-surprisingly, the rupee rebounded sharply.
The RBI notification compelled banks and investors to cut their dollar positions. Curiously, nobody in the policy circles probed further. It was as if everyone knew that some FIIs had been short-selling the rupee in non-deliverable trades without prior formal sanction from P-note holders. It was as if someone powerful in the government had given them the go-ahead, confident that nobody would intervene. That is, till the RBI decided to pull the plug. P-notes were prevented from eroding the rupee.
But what are P-notes?
The story goes back to 1992, when the Securities & Exchange Board of India (Sebi) — to shore up India’s rapidly vanishing forex reserves — permitted FIIs to register and participate in the Indian stock market. Somewhere, sometime, the government decided on a derivative instrument called P-note, which was available to Indians only; but for those with foreign exchange that they could deposit with any FII overseas. In lieu of the money, the Indian would get a P-Note, which the FII could use to invest in Indian markets.
Since all these investments came through the Mauritius route, all speculati
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