The finance ministry is not quite convinced about the need for a contrarian fund as mooted by the Securities and Exchange Board of India.

In a meeting of the secondary market advisory committee in Mumbai last week, a North Block representative said that the argument for a contrarian fund to counter the rising influence of foreign institutional investors, put forth by the regulator, was loosely structured.

Capital market experts in the finance ministry claim that FIIs do not pose any systemic risk to the markets as perceived by Sebi. Their argument is based on the following premise: if it's the case that retail investors are absent or are not buying into equity, then it is the FIIs who are trading shares between themselves and driving up the markets.

This, the experts point out, reflects the FIIs' belief that companies are doing well and that Indian companies' price-earnings ratios are at a significant discount to comparable global markets.

And if it is assumed that retail investors are only selling, then, too, it bodes well for Indian holders of equity. They can only book profits with the Sensex rising to levels as high as 5,500. And, as is evident from the stock prices list, the rally is indeed broad-based and not restricted to the ICE (information technology, communication and entertainment) sector, as was the case in the 2000 market rally.

Taking the argument forward, the experts point out that even if the market falls following the FIIs' decision to shift their focus away from India to other attractive destinations, then too, it would be the Indian investors who stand to benefit. They can always buy back stocks cheap when the FIIs sell.

A rising index does no harm even if it does so largely because of FII activity is what the experts in the government would like you to believe. Then why does the regulator perceive the need for a counter balance to FIIs? Why are capital market experts and stock brokers outside the government worried?

Ask independent market experts who are vividly watching the Sensex movements and closely monitoring FII inflows, and you can understand their nervousness.

In the current financial year, FIIs have pumped in $7 billion [almost Rs 32,000 crore (Rs 320 billion)] in the Indian markets, of which $6.05 billion [Rs 28,280 crore (Rs 282.80 billion)] has been in the equity markets. This is higher than the total FII inflow in the previous five years and over 50 per cent of their cumulative investment of about Rs 60,000 crore (Rs 600 billion) in the last 11 years, between 1992-93 and 2002-03.

Prithvi Haldea, managing director, Prime Database, the leading primary market monitor, says that FIIs operate in any markets purely for profits. And rightly so. "If for any reason -- not necessarily related to fundamentals -- they change their preferences and pull out, can the Indian markets sustain it?" he asks.

So, the need for an effective counter balance is not entirely out of place. Several other governments, like Taiwan and Singapore, too, have it in one form or the other. "What is important, however, is the way such a fund operates," says Haldea. For instance, creating triggers for intervention and the extent of support are crucial parameters for the operation of the fund.

Adds Vijay Bhushan, a second-generation broker and president of the Delhi Stock Exchange, "The current rally, unlike in the past, has no face to it. It was Ketan Parekh in the 2000 rally and Harshad Mehta the time before. The rising Sensex this time around is purely driven by FIIs." He also feels that the Indian markets cannot withstand the pressure if and when FIIs pull out.

But, why should the FIIs pull out at all, if the economy and the corporates are in a roll? There could be a thousand reasons, varying from a skirmish with Pakistan along the borders to the possible effect of the El Nino and rumours of another Pokhran. That's why the regulator's suggestion should not be taken so lightly.