P-Notes in GIFT City
Context:
The issuance of Offshore Derivative Instruments (ODIs), commonly known as Participatory Notes (P-notes), from Gujarat’s GIFT City is set to rise following key regulatory relaxations announced in the Union Budget.
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- These measures are expected to make the International Financial Services Centre (IFSC) a more attractive destination for ODI issuance compared to offshore jurisdictions such as Mauritius and Singapore.
Participatory Notes (P-Notes) are financial instruments that allow foreign investors to invest in Indian securities without the need for direct registration with the Securities and Exchange Board of India (SEBI).
Key Budget Announcements Driving the Shift
- Tax Exemption: Finance Minister Nirmala Sitharaman, in her Budget speech, introduced a tax exemption on income accruing, arising, or received by a non-resident from the transfer of non-deliverable forward (NDF) contracts entered into with Foreign Portfolio Investors (FPIs) in the IFSC.
- Encouraging Relocation: This move is expected to encourage offshore entities to relocate their ODI business from other financial hubs to GIFT City.
- Issuing ODIs: Additionally, it allows non-bank FPIs, including broker-dealers and alternative investment funds, to issue ODIs within the IFSC.
- Competitive Advantage: Industry experts believe that these new provisions provide a competitive advantage to GIFT City over traditional ODI hubs.
- FPIs operating in Singapore, for example, face stringent conditions to avail a reduced 15% tax rate on dividends under the India-Singapore tax treaty.
- In contrast, the same rate in GIFT-IFSC is only 10%, with fewer compliance requirements.
GIFT City
Gujarat International Finance Tec-City (GIFT City) is India’s first operational smart city and International Financial Services Centre (IFSC), strategically located in Gandhinagar, Gujarat. It aims to position India as a global financial hub by providing state-of-the-art infrastructure and a liberal regulatory environment conducive to international business operations.
Key Features of GIFT City:
- Integrated Development: GIFT City spans 886 acres and is designed as a vertical city to optimise land use. It includes commercial, residential, and social facilities, with a total built-up area of approximately 62 million square feet.
- Financial Services Hub: The city hosts multiple International Financial Service Centres (IFSCs) that cater to various sectors including banking, asset management, insurance, and capital markets. It allows both Indian and foreign banks to operate within its jurisdiction, offering international banking services.
- Tax Incentives: Units can enjoy a 100% income tax exemption for up to 10 years out of 15 years, and there are exemptions on Goods and Services Tax (GST) for certain services.
- Regulatory Oversight: The International Financial Services Centers Authority (IFSCA) regulates the operations within GIFT City, ensuring compliance with international standards and fostering a secure investment environment.
Economic Impact:
- Attracting Foreign Investment: The city aims to draw multinational corporations and financial institutions, enhancing India’s competitiveness in global financial markets.
- Job Creation: With over 16,000 jobs generated so far, GIFT City is contributing significantly to local employment opportunities.
- Facilitating International Trade: By offering a platform for overseas bonds issuance and trading activities in INR-USD derivatives, GIFT City enhances India’s connectivity with global financial markets.
Growing Presence of FPIs in GIFT-IFSC
- The trend of shifting ODI business to GIFT City has been gaining momentum.
- In 2023, the Securities and Exchange Board of India (SEBI) allowed FPIs domiciled in GIFT-IFSC to issue ODIs.
- The recent budget announcements further strengthen this framework by extending tax exemptions on these instruments.
- As of November 2024, the total outstanding value of ODIs stood at approximately ₹1.4 trillion, accounting for just 1.77% of the total Foreign Portfolio Investments (FPI) assets under custody (AUC).
- This is a sharp decline from 2007, when P-notes constituted over 40% of FPI AUC.
- The reduced reliance on ODIs is attributed to tighter regulatory oversight and increased disclosure requirements over the years.
- However, with the latest relaxations, GIFT City could see a revival in ODI activity.
- Derivative transactions booked by banks in IFSC in December 2024 reached a significant $40 billion, reflecting growing market confidence in the region.
- Leading financial institutions such as Morgan Stanley, Lighthouse Canton, and Lightrock have already registered in GIFT City.
- According to data from the National Securities Depository Limited (NSDL), 91 FPIs are currently registered within the GIFT-IFSC framework.
The recent policy changes position GIFT City as a strong contender against global financial hubs for ODI issuance. By offering a lower tax burden, reduced regulatory constraints, and enhanced certainty on tax benefits, India’s first IFSC is poised to attract more foreign investors and bolster its standing in global financial markets.
