The ruling United Progressive Alliance government has made it clear that it would encourage investment in the domestic stock markets by foreign institutional investors, but prevent misuse of the double taxation avoidance agreements.

The stand was made clear in the Common Minimum Programme adopted by the ruling combine, but with a rider that it would take steps to reduce the vulnerability of the financial system to the flow of speculative capital. It has also promised tax breaks to facilitate the orderly development of capital markets.

The endorsement of the role of FIIs in the stock markets comes after the Left parties supporting the UPA had earlier said that the key phrase on FIIs should be dropped from the text of the CMP.

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Government sources said the warning of the CMP to prevent the misuse of double taxation agreements, could mean there would be a fresh look at controversial DTAAs, like those concluded with Mauritius.

The DTAA has been a favoured route of the FIIs to tap the Indian markets, even though the Centre has recently put in riders to ensure that FIIs are not able to misuse the route.

In the wake of one of the worst meltdowns in the domestic stock markets on May 17, the document adds "strictest action will be taken against market manipulators and those who try to deliberately engineer market panic".

Finance Minister P Chidambaram had already said that he was in touch with the Securities and Exchange Board of India to find out if there had been any concerted hammering of stock prices on that day.

The government has made it clear that it will protect the interests of small investors, who will be provided new avenues for safe investments of their savings.

The finance ministry has recently floated a proposal for capital indexed bonds that would provide a hedge against inflation to retail investors.

Besides, the Dada Dadi Bonds are expected to be launched shortly to provide a long term investment shelter for the retired and elderly population.

Demonstrating the government's awareness of the important role which capital markets play in the economy, the document says, "the government is deeply committed through tax and other policies to the orderly development and functioning of capital markets, that reflect the true fundamentals of the economy."