Finance minister Pranab Mukherjee on Wednesday said India has mechanisms in place to handle foreign capital flows if they cause distortions in the financial system, indicating the government?s wariness about the destabilising nature of an unabated dollar influx and its readiness to counteract any threat.
As reported earlier by FE, foreign institutional investor (FII) inflows have risen substantially this year. FIIs have pumped over $15 billion into Indian stocks so far, compared with a net outflow of around $12 billion in the same period last year, according to Sebi data.
?(The FII inflow) is not a matter of concern as we have a monitoring system. And whenever we find that there are some distortions, we will have arrangements to counteract it,? Mukherjee said. ?Therefore, it would not be disturbing,? he added.
While government officials recently maintained that inflows were not a matter of concern, the finance minister for the first time articulated the government?s preparedness to deal with capital flows should they become disruptive.
Although there is global debate on taxing capital flows (Brazil last month slapped a 2% tax on financial inflows), India?s policymakers would treat that as a last option as the country is hungry for investment. If inflows start looking pernicious, a strengthening of the monitoring system for short-term capital flows could be a first measure that India would resort to. Physical restrictions?like quantitative limits on FII inflows and tightening of ECB restrictions?could follow.
FII investment into India?s equity market this year has almost touched the peak level of $17.65 billion in 2007. In the debt market, FIIs have invested $1.43 billion so far this year, compared with $2.19 billion last year. Sustained inflows have the potential to inflate asset prices, besides result in the rupee?s appreciation?a nightmare for exporters, already hit by the demand slump in the US and EU. RBI has already raised the risk weight on bank loans to commercial real estate?most prone to an asset bubble.
The rupee has appreciated 5% so far this fiscal, after touching a record low of Rs 52.2 a dollar in March. It closed at Rs 46.20 on Wednesday, from Rs 46.30 on Tuesday, as the dollar?s weakness overseas triggered selling of the US currency by exporters. India?s exports fell 11.4% to $12.5 billion in October, dipping for 13 straight months. Global demand collapse is leading to negative export growth, while a stronger currency is exacerbating the problem by paring the competitiveness of Indian exports.
While FII flows have sharply gained momentum, other forms of foreign capital are also landing on Indian shores. Between April and September, India has attracted around $27 billion through foreign direct investment, ECBs, NRI deposits and depository receipt issuances. The Prime Minister?s Economic Advisory Council recently forecast an overall positive balance on the capital account of $57 billion for the fiscal, compared with $9 billion in 2008-09.