Capital flows decline in volatile markets

With the financial world in the grip of turmoil, the net foreign capital flows to India were lower until early October 2008 compared to the same period last year. The foreign exchange reserves had also depleted substantially as the US dollar turned strong against international currencies and the Reserve Bank of India used part of its kitty to moderate the sharp decline in the rupee’s value.

The capital flows have remained volatile in this financial year so far, and are lower than those in the corresponding period of 2007-08.

This was mainly because of foreign institutional investors (FII) outflows of $7.3 billion till October 10 in FY09 in contrast to net inflows of $18.9 billion in the year-ago period, according to the central bank’s report on macro-economic and monetary developments.

Foreign exchange reserves during the period declined by $35.7 billion by the end of March 2008, while in 2007-08, they had seen an increase of $57.5 billion till October 12, 2007 over the end of March 2007.

The central bank said India’s balance of payments position during the first quarter of 2008-09 (April-June) reflected a widening of the current account deficit and moderation in capital flows. The merchandise trade deficit recorded a sharp increase in April-August 2008 on account of sustained increase in demand for oil imports.

Net surplus under invisibles remained buoyant, led by increase in software exports and private transfers. The large increase in merchandise trade deficit led to a significant increase in the current account deficit in April-June 2007.

On the state of financial markets in India, RBI said the markets, which largely remained orderly from April to mid-September 2008, saw a surge in volatility between mid-September and mid-October.

The interest rates in money market moved according to the evolving liquidity conditions. The daily average call rate, which had remained mostly within the informal corridor set by the reverse repo and repo rates of liquidity adjustment facility (LAF) in the first quarter of 2008-09, hovered close to the repo rate in the second quarter, but witnessed some spikes in late September due to tightened liquidity.

In the forex market, the rupee depreciated against major currencies. Indian equity markets declined in tandem with trends in major international equity markets as well as rising domestic inflation.

RBI took necessary steps to inject liquidity and reassured the market that the Indian banking system remained sound, well capitalised and well regulated.