Analysis: Paying the price of running the economy on hot money

If FIIs withdraw more investments, the rupee will join the 60-plus club that prevails in the government and even in some companies

The rupee is likely to join the senior citizens' club that's prevailing in the Parliament and even as the leadership at some companies. At 60.02 against the dollar in early morning trades, it gave the markets a scare that they could have done without.
 
More than the rupee, the market's more worried about  the freeze in the bond markets. TV reporters are saying that it is the first time in the history of the bond market that markets have frozen.
 
The repercussion of this event could be lethal, to say the least. The reason the bond markets have frozen is that FIIs have come out to sell Indian paper and take back their dollar investments. A rise in the bond yield to over 2.33 per cent in the US after Ben Bernanke speech and reducing interest rates in India have made investment in Indian markets unattractive.

 

But with this freeze, there is fear in the minds of the investors that exiting investments may be difficult. There would be an impression in the minds of the investor that ‘your investments are welcome, your withdrawal is not’. FII would now be reluctant to bring in fresh capital as the exits are not as simple as they appear. For a government that has been relying heavily on FII flow to control its deficit, this is more than a warning signal.
 
The government has tried every trick in the book to improve the deficit situation, but is not been able to control it. It has put restrictions on gold imports, which helped only for a short duration of time. Investors still find gold a much safer asset class than other financial instruments. With bond yields falling and only few stocks in the equity markets holding it up, there are few avenues left for investment.

 
If FIIs start withdrawing money from the bond market, controlling the current account deficit will not be easy. The rupee will soon cross the 60-mark and tracking the markets will be as much fun as watching a Zimbabwe-Bangladesh cricket match. This is the price the markets have to pay if the economy is run on other people’s money. BNP Paribas says that almost 60 per cent of India’s current account deficit was financed by ‘hot money’ inflows. We had to pay the price if they came asking for their money, which was to happen sooner than later.