The Reserve Bank of India [Get Quote] has suggested that the Securities and Exchange Board of India should put on hold its proposal to permit institutional investors, especially foreign institutional investors, to short sell equities in the secondary market.

In its reaction to a discussion paper circulated by the capital market watchdog on short selling, the banking regulator said the stock market was overheated and it might not be the right time to allow FIIs to short sell securities.

According to the RBI, monitoring foreign investment limits would not be easy, as 100 per cent foreign direct investment is not allowed in all sectors.

Short selling is the sale of a security that the seller does not own and is usually permitted to provide liquidity. Besides, it helps in price discovery.

The RBI regulates the inflow and outflow of foreign exchange and also monitors the individual cap on foreign investment in companies.

It is of the opinion that if Sebi intends to allow institutional investors to short sell, the permission should be restricted to shares in sectors where foreign investment is allowed up to 100 per cent through the foreign direct investment and foreign institutional investment routes.

This is because, if it is allowed in sectors where 100 per cent foreign holding is not allowed, FIIs might exceed the limit. There is no mechanism to monitor this limit on a daily basis in secondary market trades.

Sebi, in its discussion paper on short selling and securities lending and borrowing in December 2005 had recommended that institutional investors should be permitted to short sell in order to provide a level playing field to all classes of institutional investors.

Mutual funds, banks and insurance companies have also been classified as institutional investors in the report submitted by the secondary market advisory committee of Sebi.

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