The Reserve Bank of India [Get Quote] and the Securities and Exchange Board of India are once again on a collision course.

This time it is over the extent of participation by foreign institutional investors in the stock markets.

The RBI is of the view that participatory notes, hedge funds and other derivative instruments and sub-account route should be done away with entirely, said familiar sources.

This is learnt to have been its recommendation to the committee set up by the government to fine-tune the norms for the FIIs in India.

The thinking within the central bank is that all foreign investors should be registered with Sebi and only they should invest, they added.

The issuance of participatory notes leads to monitoring problems, according to the RBI.

At present, though hedge funds cannot register in India they can invest in India through the route of participatory notes or other such offshore instruments. A few of them operate in India registered as FIIs.

Incidentally, RBI is said to have the tacit backing of the finance ministry, and a much awaited regulation on hedge funds -- who were allowed to register with Sebi -- has been put on the back-burner at the insistence of the ministry.

Sebi, on its part, is firm that all restrictions on FIIs should be done away with. It is in total agreement with the Ashok Lahiri committee recommendations on foreign investments submitted last year, though RBI officials had labelled the recommendations as too liberal.

In fact another committee, again headed by Lahiri, on reducing the vulnerability of the Indian markets to FII inflows, is expected to be released any time now.

Recently, some officials from the ministry of finance are believed to have made some noises regarding hedge funds investing in India.

Sebi chairman G N Bajpai made a public statement to reporters that there were no intentions of putting any clamps on hedge fund inflows.

Sebi officials said, "we are monitoring hedge funds inflows into India, whichever route they come in and so far they have not destabilised the markets."

The thinking within RBI was brought to the fore by the statements made earlier this month by the governor, Y V Reddy, who said that there was a case for restricting too much FII inflows into India.

Though the finance minister immediately rushed to qualify his utterances and allay any fears in this direction, sources said that some of the bureaucrats in the ministry were of the same opinion as the governor.