The Securities and Exchange Board of India (Sebi) announced how it wanted to control capital inflows via restricting/banning the use of Participatory Notes (P-notes) by foreign institutional investors (FIIs).

This regulator-induced correction made the stock market go down 10 per cent in less than 10 minutes; it then recovered most of the decline and ended down only 2.5 per cent. You could say that the markets are confused; the same can be said about most of the commentators and most of those speaking on behalf of the new policy.

Herewith some suggestions for a new policy and how it meets all our goals, including not having an excess of foreign inflows and therefore pressure on the rupee. This policy also opens up markets and indeed allows the market to clear the air rather than a bureaucrat, a regulator, or the government.

This wonder proposal - written several times over the last decade, discussed in several government committees, but always met with the bureaucratic response of what do you know about markets - is simple and as follows. First, anybody who wants to invest in India can freely invest, and do so by freely and without Kafkaesque procedures registering with Sebi.

No licensing from Sebi. Please, we are not living in 1975 (not that we should have had control freak control raj even then). Second, no legal status is given to off-shore derivatives. If anybody wants to invest in derivatives, he can freely do so onshore. End of story, and with it the market will spell the end for P-notes. Na rahega baanz, na baje gi bansauri.

After registration - the foreign individual, or corporate, or pension fund, or Mr Bush - opens a bank account with a domestic bank, say Citibank, or Bank of Scotland. The foreign bank opens an account with a bank in India, say Kotak. Both sets of banks - foreign and domestic - will enforce KYC (Know Your Client) norms to ensure that the monies are clean etc.

If the monies are not as advertised, the banks get into trouble and so have no incentive to launder money. This takes care of the nonsense perpetrated by some controllers that licensing is required to ensure that only clean money enters our so squeaky clean shores. Sebi will, by registration, also know the identity of the client; so much for the other nonsensical concern that P-notes should be banned because we do not know the identity of the investor.

Wouldn't this openness make severe the problem of capital inflows, a problem that the finance minister described as the real target of the new P-notes policy? No; indeed, the problem will be a lot less than the self-created FII licensing wound that the government and the regulator have inflicted on the system and all investors, big and small. Most countries, including India, have limits on stock ownership (delivery stock and derivatives) across different sectors - X per cent for technology, Y per cent for banks, etc. Foreigners as a combined entity cannot invest more than this fraction, and for several important stocks (and their derivatives) the limit has been reached.

So what will the foreign investor do? She can either invest in ADRs, which is fine, and that does not affect capital inflow. Indeed, this helps decrease net capital inflow into India. Or she can invest in a second-rung or third-rung company in India, e.g. Oxus Investments! A lot riskier for this foreign investor, and will restrain her impulse to make some quick bucks, i.e. the so-called "hot money" will seek warmer climes elsewhere.

This policy will reduce excessive capital inflows and make monetary management easier, i.e. prevent the rupee from excessively appreciating, as it has done this year. Such appreciation hurts the economy and only helps the foreign investors and their advisers. (However, I still fail to understand why India, alone among 150 nations, finds handling relatively small foreign capital inflows so difficult).

As with any control policy, there are several myths surrounding its use (myths, not facts, because the latter expose the hollowness of the myths). For example: we need FII licensing to control laundered money, or market manipulation. Or we need FII licensing (and therefore P-notes) to prevent Indians abroad from investing in India via tax havens like Mauritius. We should understand that while a tax haven like Mauritius was important when the domestic capital gains tax was 33 per cent and 20 per cent (short term and long term, respectively) , it is today insignificant as a factor determining investment decisions (the short-term tax rate is 10 per cent and long-term is zero).

In conclusion, this simple policy has all the attributes to recommend it: it makes India a more open economy, it removes the last vestiges of control raj, and it decreases "excessively hot" capital inflows that are so problematical for our monetary authorities. It will also open the floodgates for the Indian financial industry. Total foreign portfolio investment in India is now more than $350 billion (net investments, $70 billion, and capital gains, $280 billion, since the market was opened up to foreign investors in 1993).

None of this money is being managed by the domestic fund managers. Why? Because Sebi prohibits, yes bans, foreign investors from employing domestic fund managers. Indian fund managers have to go settle in Singapore, or Pakistan, or the moon to manage money in Indian stock markets. Why? Search me. You can ask why to all the regressive policies prevailing in our financial markets and you still won't proceed beyond zero base. But the policy makers should realise how many jobs are being lost, and government tax revenue lost, by its stupidly stupid policy of favouring foreign fund managers over domestic fund managers.