The issue of managing capital flows is likely to come up for discussion in the next meeting of the high level coordination committee (HLCC) comprising representatives of regulatory agencies and finance ministry officials.
This assumes significance because of the conflicting signals by the Reserve Bank of India and the finance ministry on capital controls. While the central bank has said rising foreign portfolio investment in the country was a potential threat and measures were needed to manage such flows, Finance Minister Pranab Mukherjee said in a recent media interview that while the ministry was keeping a close watch on foreign inflows, there was no need for imposing any restriction on capital flows.
India has a high level of current account deficit and overseas capital flows have been useful to fill it. In 2010 so far, foreign portfolio investment has been $21.243 billion (Rs 94,000 crore) in equities and $10.4 billion (Rs 46,200 crore) in debt. The flows are expected to continue in the coming months. Even C B Bhave, chairman of the Securities and Exchange Board of India, has said that he has no reason to believe that there will be a sudden reversal in foreign investments.
Managing inflows
Huge inflows have been posing a challenge for managing currency, as an appreciating currency leads to loss of export competitiveness. Efforts by the Reserve Bank of India to halt the appreciation of the rupee by buying dollars also increases liquidity in the system. Inflation is already on the rise due to an asset bubble being formed and increasing interest rates to tame it attracts higher foreign investments, as global rates are much lower than that in India.
On the other hand, an appreciating currency thanks to higher capital flows keeps the cost of imported inflation lower Problems due to higher capital flows are not India-specific. In its outlook for the second half, the International Monetary Fund (IMF) said the recent resurgence in capital inflows to emerging Asia has raised potential policy challenges. On the one hand, capital flows have helped support domestic demand. On the other hand, the size of global inflows relative to the comparatively small financial markets has raised or intensified existing concerns, including the risk of inflation, asset price bubbles, financial sector instability (if inflows are not properly intermediated), excessive appreciation, and risks associated with a sudden stop of capital flows.
IMF, however, noted that various countries have already started managing capital flows and added that “economies that are beginning to face inflation pressure should further tighten monetary policy and take measures to discourage speculative inflows”.
IMF has not favoured wholesale restraint on capital inflows and noted that India has already taken some measures to deal with the situation. Measures include raising required reserves for banks, setting limits on external borrowing operations and further liberalising selected outflows.
The fund has favoured development of the financial sector and deepening of the capital market in countries like India.
